Reflecting on change

As mentioned previously, developments in the investment industry overtook my personal learning objective. To remedy the dearth of sell-side equity research incorporating sustainability in my country, I had wanted to create annual awards for the best ESG-related research. As my posts highlighted, after much engagement, it was clear that awards were unlikely to increase the focus on ESG.

Nonetheless, fund managers’ interest in environmental issues has increased sharply in the past year, from an unexpected quarter. Last year two NGOs and a shareholder activist used our Companies Act to force our two largest banks to include resolutions at their AGMs to disclose their exposure to climate-related risks and to publish their policies on financing coal mining and coal-fired power. As our country’s first climate-related resolutions, these created substantial awareness of the broader E in ESG among local investors. Consequently, they increasingly want companies to report on the risks and opportunities they see from climate change and to adopt TCFD over time. And more investors use ESG data from CDP, Sustainalytics, MSCI etc.

Rather than launching awards, I encouraged the sell-side to get experts on climate change to present at investor conferences. Their rather scary forecasts garnered a lot of attention from the market. Although ESG is still not embedded in most locals’ investment processes (even PRI signatories), there has been some progress. And certainly, awareness is considerably higher.  

Another development was becoming responsible for sustainability in our group, in addition to investor relations. This positions me ideally to embed sustainability into our group strategy, culture and operations, and to emphasize ESG in our investor interactions to cement its importance.

Reflecting on my PLO, there were four learnings. Firstly, that even ‘innocuous looking’ levers can have a large impact, if cleverly chosen. Small stakeholders were able to dramatically raise awareness of climate change in our market by forcing two banks to include it in their AGM resolutions. Even though the resolutions were defeated. Second, it’s amazing how quickly change can occur. Although there’s still a long way to go. Third, while we have made some progress in elevating ‘E’, there’s an opportunity to get experts to present to investors on ‘S’, probably using the SDGs in some form. And lastly, as Oliver noted, when your levers of change aren’t working, it’s important to be flexible and look for better ones!

Taking the ESG case direct to investors

Events of the past three months have overtaken my personal learning objective of increasing awareness of ESG in our local equity market. I planned to do this by encouraging the sell-side to incorporate ESG into their research by starting annual awards for the leading reports. However, pressure on sell-side revenue has intensified, which saw another international house exit cash equities here and a bulge bracket house retrench some of its top rated local analysts. Meanwhile, rumours abound that another may exit equity research globally. Research heads note that incorporating ESG is very costly because it requires hiring scarce skills and often paying for specialized data, in an industry already struggling with declining commission/revenue and profitability. So encouraging the sell-side to publish thematic ESG research is an increasingly hard sell.  

However, the rising interest in climate change among fund managers that I flagged in my last post has accelerated. An NGO and shareholder activist forced a second large bank to include resolutions on climate change and transition risk in the coal-fired power sector at their AGM later this month. And, in first for my country, six large investors co-filed a climate risk resolution to compel our largest petro-chemical group to report on whether their (unambitious) emissions targets align with the Paris Climate Agreement. Unfortunately, the company refused to, but it was a rare instance of big local investors working together and challenging a corporate publicly, rather than behind closed doors.

Our investors still focus far more on ‘governance’, after yet another corporate accounting scandal this year, followed by ‘social’ (largely inequality), with ‘environment’ far behind. Interestingly, last week Moody’s reduced the baseline credit assessment for our state-owned agricultural lender due, at least in part, to ‘a high level of environmental risk’, which is the first time I’ve seen this. The rating agency cited physical risks (drought and hail) and increased frequency of disease reducing clients’ ability to repay their agri loans. I think rising temperatures and fires are more of a threat than the last two risks that Moody’s mentioned.  

Reassessing how best to raise awareness of ESG in our local equity market, increasing my group’s ESG disclosure (in our integrated report and results announcements) may be the most efficient way. Flagging the importance of ESG directly to investors via our investor relations narrative, rather than by getting the sell-side to write about it, appears more likely to produce dividends. Improving our ESG disclosure also addresses investors’ complaints about the lack of ‘usable’ ESG information in our market more generally (rather than us specifically).

How can you encourage the sell-side to produce equity research that incorporates sustainability?

In my country there is considerably less research that incorporates ESG than in more mature markets such as the EU. Where it has, this has mostly focused on G, largely disclosure issues and executive remuneration. My personal project was to consider how to encourage more ESG research, particularly with an environmental and social angle, and this post provides an update on the progress to date.

I have discussed the challenge with the buy and sell-side. Speaking to sell-siders – a mix of research heads, equity analysts and salesmen – the message was that investors are increasingly asking them to incorporate ESG in their research and recommendations. Since the sell-side is under pressure, with significantly reduced commissions and regulatory changes like MiFID II etc, some view ESG as a distraction, others as an opportunity to distinguish themselves, especially with thematic research. Most indicated that the principal obstacles are their lack of ESG knowledge and the cost of obtaining ESG data, when investors were unwilling to pay for this. Some also complained about limited company disclosures. As a result, only a handful of thematic research notes with an environmental flavor were produced in the past year, despite my country having a host of problems ranging from water shortages, floods, fires etc, and large companies (mines, petrochemical, cement and energy) with considerable negative environmental impact that should be factored into investment cases. I asked the sell-side bank analysts to rank 7 key issues impacting my company over the next 5 years. Climate change came last with a score of 2/100, with the majority giving it zero.

On the buy-side, a few leaders already include ESG in their investment process, using external data providers. Nonetheless, very few have done as much, especially among smaller investors who simply don’t have the resources to hire ESG specialists. Some large investors, who are members of the PRI, prefer not to change their processes to embed ESG, although they may use it in basic screening. There’s still healthy skepticism as to whether factoring in ESG improves performance/returns or simply increases costs. One event brought corporate governance to the fore, when a retailer (a one stage the 5th largest on our stock exchange by market cap) collapsed after fraud. Moreover, a number of other scandals have arisen in the past three years, where auditors were heavily criticized in a corporate failure. In the WEF’s latest Global Competitiveness Report (2018), my country has plummeted from the perennial #1 in “strength of auditing and reporting standards” to outside the top 50 in the past 5 years. So investors are increasingly concentrating on governance as a consideration.

Positively, there has been a dramatic upsurge in interest in how climate change impacts banks recently, after an NGO forced one large bank to include a resolution on improving their disclosure on climate change risk (effectively implementing TCFD) in their 2019 AGM resolutions. Although it was voted down at the board’s behest (given ridiculously short timeframes for the disclosure, in my opinion), investors are now asking the whole sector about climate change.

Initially, my plan was to create annual awards for the best ESG-related research, as an incentive to encourage equity research that incorporates sustainability. This remains a work in progress, particularly getting suitable judges and some funding. The other aspect, which became very evident in my discussions, was the need to improve corporate disclosure of material ESG data, in order to enable better analysis in the first place.

Banks coalescing on funding?

Southern Africa’s temperature is likely to increase almost twice as fast as the global average this century. Under scenarios of low global mitigation, its temperature could rise over 4°C and exceed 6°C in parts, which could threaten food security and have serious implications for biodiversity, water scarcity and human health. The WWF forecasts South Africa’s water demand to exceed supply by 17% in 2030. So SA should have a strong interest in reducing its comparatively high emissions. For instance, last month Greenpeace said that SA has the “most polluting coal-fired power stations in the world.”

However, its economy is very energy and coal-intensive. This complicates the shift to low-emission pathways, particularly in a country with significant poverty (19% live on less than US$1.9 a day), income inequality (highest globally) and 28% unemployment. And real GDP growth has disappointed, averaging just 1% the past five years, including a recession in the first half of 2018. The transition must also be carefully managed, to ensure it is ‘just’ for SA’s coal workers and truckers, who are concentrated in one province.

In addition, SA’s state-owned power monopoly, Eskom, is struggling to meet demand. It implemented rolling black outs in January. Moreover, Eskom’s financial position is precarious and it required another bailout from Treasury this month.

So local banks have had to think about their role in funding SA’s power sector. On the one hand, they have done a great job financing SA’s renewable power program, the largest in Africa, with 92 projects and a capacity of 6322MW. Although renewable energy prices have dropped to competitive levels (and construction is considerably faster than power stations), they generally can’t be used for baseload power due to their intermittent supply to the grid. Hence coal is likely to remain an important part of SA’s power longer-term and will still contribute 40% of Eskom’s energy supply after decommissioning older stations.

Banks also have to decide whether or not to fund Eskom itself. The five large banks provided it with R15bn of funding this January, which could be seen as essential to ‘keep SA’s lights on’. In addition, they agreed back in 2015 to fund two approved coal-fired power plants that form part of SA’s long-term energy plan. However, three of SA’s five large banks recently withdrew their support, after adopting policies to no longer fund coal-fired plants.

Recent speculation that government might consider forcing banks to fund various sectors through prescribed lending, irrespective of their policies, is concerning for the sector.


Here for good?

Standard Chartered launched a new brand promise of “here for good” in 2010. At the time I thought it a clever tagline that differentiated the bank from global peers. Positioning Stan Chart as a ‘force for good’ set it apart from rivals whose fixation on profits had caused the global financial crisis. It also said Stan Chart would be around for the long-run, again, unlike some banks that collapsed during the crisis or were hobbled by it and retreated.

Stan Chart’s adverts at the time asked “can a bank really stand for something, can it balance its ambition with its conscience?” Although meant to be rhetorical, it is debatable how well Stan Chart actually performed on social responsibility. For instance, two years later it was accused of consistently violating sanctions in Iran. And when Bill Winters took over as CEO in 2015, he found Stan Chart had “some good businesses” that were “covered in fertilizer”, before spending years trying to improve compliance, risk management and culture.

Looking at some rankings, Stan Chart’s CDP climate change score dropped from A in 2015 to a B in 2017. Although still above the global average for banks, this score certainly doesn’t make it a leader. In addition, its C- rating on both coal mining and coal power from Banking on Climate Change in 2018 were slightly behind those of HSBC, the other large international bank focused on Asia. Perhaps Stan Chart’s announcement last September that it will no longer finance ‘new coal-fired power plants’ will improve these ratings. One area where Stan Chart has excelled is its Seeing is Believing ( community investment, which has raised $100m and reached 167m people in poor communities since staff started it in 2003.

It’s clear that Stan Chart’s share price and operational performance have lagged peers noticeably for many years. For instance, its 5% return on equity is low, particularly for an emerging market bank. Meanwhile, its share price has dropped about 40% in the past four years, well below the global bank index’s 20% rise (according to Bloomberg).

Thinking about Stan Chart and “here for good” raises the broader question of whether companies that ‘do good’ perform better, either operationally or their share performance. Most academic work finds a small positive relationship (e.g. the meta-analysis by Margolis et al 2007), but determining causality is difficult.

In any event, Stan Chart refreshed their brand campaign last April to “Good enough will never change the world”. It will be interesting to see whether the bank can live up to this even more ambitious brand promise over the next decade.