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People and MarketsCommentLeader

Banks’ ESG policies hide more than they reveal

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It is time to scrap 'direct financing' exclusions

Banks love to talk about the transparency brought by the green bond market, letting investors know more clearly what their money is being used for.

A lot can be said about how true that claim is, but for now, let it stand. How about banks showing some transparency themselves?

Despite the immense resources, financial and intellectual, that banks command, their environmental, social and governance policies are often astonishingly vague and uninformative.

It would be unfair to single out any one firm here, but if you work for a bank, how about looking up your own employer’s policy. Let us know if you disagree.

More and more banks say they will curb a lengthening list of activities perceived as shameful, which may include tobacco, adult entertainment, controversial weapons, coal mining, coal power generation, deforestation, drilling for oil in the Arctic and excavating bitumen from the sands of Alberta.

But what is actually excluded? Often the rule is couched as “we will no longer provide direct financing” for a given activity.

But that only bars the bank from providing specific project finance to, say, an Arctic drilling project. There is nothing to stop it leading a bond issue for an oil company participating in the venture, to raise finance for general corporate purposes.

The bank is still financing the Arctic drilling, just through a different instrument.

Some slightly more robust policies pair this with a limit on corporate financing, usually defined by a percentage of revenue.

For example, “we will not finance any company that makes more than 25% of its revenue from coal mining”. But much of the world’s coal mining and trading is done by big, diversified groups such as Glencore and BHP, whose exposure to that mineral is lower. Such a policy would not touch them.

Anyone trying to understand, by reading a policy like this, what the bank was actually going to refuse to do, and how that differed from what it was doing before, would be completely stumped. Only with the aid of a spreadsheet listing the bank’s relevant clients and their percentage involvement in various activities could any sense be pieced together.

Exclusions like this may actually involve withdrawing from some business. But who is to know? From the point of view of stakeholders, such claims are therefore, in the literal sense, meaningless.

It is time banks gave up framing ESG policies using this confusing matrix of conditions.

A far clearer approach would be to declare how much financing the bank provided in the previous year to clients engaged in a specific harmful business, and how large those clients' engagement in it was. Then commit to reducing the bank's exposure to the activity, at a declared pace.

Either the clients must reduce their investments or earnings from that activity, or if they fail, the bank must lower its financing.

Such transparency would be easy to monitor and laudably honest.