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Banning dealers is harsh but ESG should apply to them as well as issuers

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When the European Commission excluded 10 of its primary dealers from its debut Next Generation EU syndicated transaction last week on the grounds that they had been found to have violated anti-trust rules, some bankers branded it “unfair”. It may be a harsh penalty, but surely bookrunners should face the same scrutiny as issuers when it comes to environmental, social and governance (ESG) criteria.

It was a bold move by the EC to leave out almost a quarter of its primary dealer network for its debut NGEU syndication — including leading SSA bond houses such as Barclays, Citi and JP Morgan.

An EC spokesperson framed the decision as a strict but consistent application of the institution's ordinary procurement rules, which prohibit it from buying in services from entities that are "in breach of requirements on professional conduct or market integrity”.

While the anti-trust violations happened quite some time ago, the Commission only concluded some of its investigations within the last few months.

It has since reinstated eight of the 10 banned banks as eligible dealers for its NGEU syndications following “a thorough analysis” of the “remedial measures applied by the concerned institutions”, according to a Commission spokesperson.

Investors and issuers face constant scrutiny of their behaviour. Why shouldn't dealers, too? For that matter, why limit that scrutiny to violations of anti-trust rules? Why not take other ESG factors into account, too?

The EU is set to become one of the world's largest bond issuers, so it is fitting to see it becoming a leading voice for the market. But it is arguably being slightly outpaced by another supranational organisation, the International Finance Corp, which last June launched the first systematic attempt by an issuer to formally integrate ESG considerations into the selection of bookrunners.

All of IFC’s underwriters receive an annual questionnaire to complete on subjects such as corporate governance, thematic and impact investing, and ESG reporting. Once IFC receives the responses, it formulates ESG dealer scorecards for each bank. The issuer has not disclosed exactly how it ranks its dealers, but it is worth noting that it uses the scorecard to inform the selection of underwriters for all of its deals, not just green and social bonds.

When IFC launched the survey last year, there were 21 questions. This year’s survey has more than doubled in size, with 46 questions, and has been sent to more than 60 banks, about 20 more than last year. The new questions include queries about dealers’ ambitions and commitments at a parent company level.

The scorecards are not intended to name and shame banks that are not making good progress on ESG, but to shift the discussion of ESG onto underwriters. IFC says it will engage with banks that score poorly to encourage them to improve their ESG standing and practices.

Other issuers are looking to do something similar, and not just SSAs. Corporates are increasingly using ESG criteria in the selection of bookrunners.

As part of its annual review meetings with relationship banks last year, Unilever asked banks to allocate time in their meetings to present their sustainability credentials. But Unilever has not reached the point of saying banks must meet a certain standard to secure work. Rather, it is opening a dialogue.

This is a good start. Issuers do not necessarily need to rush to ban or remove dealers who are lagging behind on ESG standards, and should engage with them to identify gaps and help them improve. Issuers find themselves in a powerful position, which they could use to effect change far beyond their own carbon footprint and diversity initiatives.

But to make full use of this power, they must not to allow banks to turn the process into pure marketing. Allocate a DCM team 10 minutes to discuss their track record in ESG, and they will find a league table in which they are near the top and spend the rest of the time presenting case studies of their latest market-leading deals.

Issuers also need to investigate the darker side — when banks are not acting in accordance with ESG principles, whether it is by financing or arranging financing for fossil fuels, lagging behind in management diversity, or breaking market rules.

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