Banks: focusing on the E and S as well as the G

Written by Liontrust on 28th Jun 2022

From an environmental, social and governance (ESG) perspective, our analysis of individual banks for the Sustainable Future bond funds has traditionally focused on the third element.

In recent years, however, a growing number of banks are looking to do much more to facilitate the energy transition, through a more aggressive and constructive approach to managing carbon within their corporate loan books.

In doing so, large-cap domestic and global banking names are helping to shape the transition through the reallocation of capital and funding away from carbon-intensive companies and towards those actively seeking to address the climate crisis.

Banking remains among our favoured parts of the credit market, alongside telecoms and insurers, and was the largest sector position across the Liontrust SF Corporate Bond and Monthly Income Bond Funds at the end of September, accounting for 17.4 per cent and 24.6 per cent respectively.

The importance of governance

Governance remains an integral part of ESG analysis for banks given the nature of these businesses and our work tends to stretch across a number of areas. Board independence and a lack of any conflict of interests is essential to all banks, for example, but particularly for dominant domestic names such as Lloyds and large global companies like HSBC.

We also want to see a strong emphasis on risk management, which is key to avoiding excessive exposures that could compromise a bank’s future creditworthiness, and a good track record in digital security. Other important criteria for inclusion in our portfolios are low exposure to controversies that potentially undermine the confidence of current management and, more fundamentally, a business model that focuses on retail and commercial banking rather than higher-risk/lower-return investment banking.

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Not ignoring the E and the S

Such a strong governance skew does not mean ignoring the other aspects of ESG and on the social side – which remains the hardest to pin down – we focus on metrics such as staff satisfaction, looking at key areas like diversity and development and customer satisfaction via net promoter scores.

With environmental performance, we continue to analyse more traditional ‘green’ progress in reducing in-house greenhouse gas (GHG) emissions, waste, energy consumption and paper usage. But while clearly positive that banks are moving to net zero carbon or even net positive, as stated at the outset, these companies can conceivably have an even greater positive impact.

Until recently, best-in-class banks would be those reducing exposure to the most carbon-intensive sectors, such as oil, gas and mining, via a form of negative screening, or introducing or tightening policies to restrict lending to companies that derive a stated percentage of revenues from business lines like coal. It is important not to take such commitments at face value, however, as some banks set such limits at high levels, above 30 per cent or even 50 per  cent, coupled with unambitious targets to reduce these limits over time.

Given the shift within the sector, with many large-cap banks helping to shape the energy transition, we aim to invest in those that are most committed to improving environmental exposure and demonstrating best practice to deliver on this strategy. Broader factors for analysis for this include lending policies related to controversial sectors, lending to green projects and compliance with the Equator Principles for project financing. These are a financial industry benchmark for determining, assessing and managing environmental and social risk in projects.

Case study: ING

Current holding ING is a particularly good example of a bank working hard to move the energy transition forward in a number of ways:

  • Assessing impact against Paris Agreement climate goals of limiting global temperature rises to well below 2C.
  • Using methodology developed alongside the 2˚ Investing Initiative (2DII), an international think tank working to align financial markets and regulations with the Paris goals, to determine the technology shift needed in individual sectors to slow global warming.
  • This is compared against technology used by clients (the shift required by auto manufactures to move to electric cars, for example), and financing decisions are then based upon this analysis.
  • Based on this work, reporting annually on progress relative to targets/timelines for the metrics used for the most GHG-intensive sectors.

ING is also working with other banks to help achieve an industry-wide standard:

  • The ING/2DII approach was released on an open-sourced basis in September 2020.
  • Along with other banks, including BNP Paribas, Societe Generale and Standard Chartered (all held in our portfolios), ING signed the Katowice Agreement in 2018, which aims to deliver the Paris goals.

This agreement helped shape the UN-backed Collective Commitment to Climate Change; signed by 30 banks, it now represents $13 trillion (£10.6 trillion) in loans:

  • It is estimated that $30 trillion (£10.5 trillion) needs to be invested in clean energy and efficient infrastructure by 2035 according to the International Energy Agency. ING’s contribution to this is lending to wind farms, solar energy and geothermal power generation.
  • The company is also promoting energy efficient buildings and production lines and is involved in projects relating to electric vehicles, bio-plastics and circular economy solutions.
  • This funding target also can be partially achieved through green loans and green bonds, sometimes offering lower rates for improved sustainability performance.

Elsewhere, both Natwest and Lloyds (also long-standing holdings in our funds) are looking to reduce carbon within their books by at least 50 per cent by 2030, achieved by cutting lending to carbon-intensive sectors and working with companies to better understand their carbon usage and ultimately helping them reduce emissions.

Societe Generale, meanwhile, is a major lender to energy transition-related companies: to date, it has lent €160 billion (£138 billion) to such businesses since 2017 and is looking to increase this by a further €80 billion (£69 billion) over the next three years.

Based upon such positive developments, we have increased the relevance of how banks are managing the environmental impact of their loan books within our methodology. Moreover, given the obvious benefits that such a shift could produce, we are in the process of engaging with all the banks held within our funds as part of our 1.5 degree transition challenge. This aims to highlight targets to reduce lending to carbon-intensive sectors and increase it to green companies/projects, as well as encouraging greater commitment to a science-based approach to aligning targets with global goals.

As we move forward, we will obviously engage further with any laggards identified to try to effect positive change across the entire banking sector.

By Liontrust fund managers Stuart Steven, Aitken Ross and Kenny Watson

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Risk warning: Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. 

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