Experimental feature

Listen to this article

00:00
00:00
Experimental feature
or

The integration of sustainable development in the business of banking has become more significant than ever. Teams of specialist bankers have emerged whose mandate is to find innovative ways of financing projects or creating products with significant environmental and social benefits, while also meeting their banks’ profit targets.

The FT has launched the first global Sustainable Banking Awards, in association with International Finance Corp, to recognise leadership in this field and also stimulate debate on sustainability’s “triple bottom line”.

Rachel Kyte, director of IFC’s Environment and Social Development Department, and Leo Johnson, co-founder of consultants Sustainable Finance Ltd, took part in live Q&A session on sustainable banking on February 22 - answers appear below.


I have been tracking the opportunity for sustainable financing since the early 1990s, I watched the development of the UNEP/Salomon survey of the financial institution industry and the follow up promulgation of the “statement by banks on the environment and sustainable development”. Most of these policies that emanated from this process sat on the shelf to collect dust. Now these policies appear to be turning into principles. As valuable and important as they are, the principles seem to be pretty much still in the ozone layer.

We still do not appear to be hitting the ground level on the practical side - as ONE example (there are certainly others) providing incentives to small business to promote sustainability (and not just in developing countries) seems to be missing. Is it your hope that these awards will spur the move to help the financial institution industry land on the ground, whether it crawls when it gets there or hits it running?

In your opinion, is there value in promoting the use of management system standards, particularly ISO 14001 (NOT limited to third party certification but broadly adopted) as a way to build momentum for the sea change required to broaden the marketplace support for sustainable banking, and a way to provide the banks with greater comfort of better risk management in the lending sphere?
L. E. Johannson

Rachel Kyte: Let me answer the third part of your question first. Management systems certification does play an important role in aligning management’s intentions with capacity to deliver systematically through the business’ operations. We do encourage certification where it makes sense and we do assess the many different management systems that companies use as a critical part of our environment and social due diligence.

I think principles for sustainable finance have travelled a long journey from the early conversations. For us and for Equator these are not merely aspirational principles - they are terms that direct our lending. While Equator for the moment applies to project finance above a certain volume, we apply these standards to all our investment operations. We are also seeing our financial institution clients in emerging markets wanting to know how to use these standards themselves.

For IFC the evidence is there to support the proposition that ES&G risks are material to the performance of a company in our portfolio over the long run and that clients across all sectors and all markets that manage these risks well perform better from a credit perspective. This powerful data is what is driving our sustainability approach.

Thanks for asking about the awards. We are excited about the opportunity they provide us to highlight innovation around sustainability, tell the stories of how this is being done in emerging markets and for the medium, and small companies who drive the majority of the developing countries’ economies, and reward leadership.

Leo Johnson: For sure. The goal of the awards is not to state that this or that bank is a sustainable bank. It is to identify the banks and companies that are innovating, to show the triple bottom line benefits of those innovations and to build a critical mass.


Would you agree with me that banks, not hindered by the political strings that in the end determine IFCs manoeuvring space, are in a much better position to lead on the development of ambitious social, environmental and human rights policies?

We see already many examples of commercial bank policies that are clearly more ambitious than IFCs. - but a lot remains to be done, see our latest report on www.banktrack.org - If so, why would banks bother with IFC performance standards as the benchmark for such policies anyway?
Johan Frijns, Coordinator, BankTrack

Rachel Kyte: We think competition is good and we see a race to the top. This is good for banking and good for development. You and others will play your part in holding us all to account. I hope you will also chase any future freeriders.


On the Global 100 Most Sustainable Corporations 2006 you can find six commercial banks. Which is not so bad. From my understanding it seems that the lack of transparency is one of the big issues that banks are facing in their drive to being more sustainable. How can they move towards developing more transparent policies? What do you think it would take for commercial banks to increase there commitment towards sustainability and develop clear policies towards human rights something that seems to be missing from the mix? Finally what do you think its fair to expect from banks in terms of sustainability?
Arash Nazhad, Vancouver, Canada

Rachel Kyte: I think transparency is becoming a more and more important issue: disclosure to regulators, shareholders and stakeholders of what, when and in what form is something that Banks are having to wrestle with in the sustainability debate. Separating out reporting information so that others can see that the commitment to sustainability is more than greenwash while at the same time not divulging confidential information is complex. Perhaps you have ideas on how to creatively audit the impacts of the sustainability related policies of commercial banks?

The private sector’s responsibility for human rights is now at the top of the human rights agenda and the sustainable development agenda. Professor John Ruggie of Harvard has been appointed a special advisor to the Secretary General of the United Nations on business and human rights. It will be interesting to watch his two year process and how he reports out. For me I think the challenge for financial institutions is to get our arms around the concept of complicity and make sense of direct and indirect responsibility for human rights. This is not clear yet and something that we are putting time and effort into clarifying. Thanks for the question.

Leo Johnson: The key to this has got to be reporting. The Equator Principles marks a key shift, from the generic “we will strive wherever possible to act according to reasonably acceptable practices, unless otherwise” approach to an approach where projects are governed by specific, and measurable standards. Disclosing those results, as some of the leading banks are beginning to do, will be a powerful driver of performance.


Dear Ms Kyte
1) There is no shortage of sensitive issues surrounding the IFC/ExxonMobil sponsored Chad-Cameroon pipeline. World Bank President Wolfowitz pulled the Bank out because of revenue problems with Chad, yet the IFC remains involved presumably because the IFC chose not to deal with those issues in its contractual relationships to the project. How do the new performance standards profess to change this outcome (where the Bank refuses to stay involved in a dodgy project, but the IFC remains) on future projects? If the new performance measures don’t change that issue, what safeguards should the IFC put in place?

2) Given the IFC’s mixed experience with environmentally and socially sensitive extractive projects, can you flag five key issues that might be at the heart of a decision for IFC NOT to support an A) oil or gas pipeline and B) gold mining project under the new IFC framework?

3) An editorial recently suggested that the new IFC performance measures have much to do with keeping the IFC relevant in middle income countries. Do you think this is a sufficient rationale for taking away previous guarantees for mandatory consultation requirements with affected communities?
Jon Sohn, Senior Associate, World Resources Institute

Rachel Kyte: The decision to finance or not depends on a whole series of analyses of risks, country, business, currency, environmental and social etc. The governance capacity of the country, the laws and regulations that allow revenues to flow to development purposes are part of that assessment. More now than before. The question of how the World Bank, with countries as their clients, and IFC, with the private sector as theirs, work together to ensure that the best outcomes for the country, communities and the company are produced is something on all of our minds and something that Paul Wolfowitz, the President, is paying acute attention to. What would you suggest?

Five issues that could be at the heart of a decision to not invest: potential destruction of a critical habitat necessary for the survival of a species; destruction of the traditional lands of indigenous peoples without their agreement; lack of confidence that the project sponsor shared the same vision and goals for their business as us and that we could work well together over time; lack of comfort that the project would lead to development benefits in the country; failure by the project sponsor to engage with communities in a way that allowed the community to raise concerns and participate in a process where those concerns were addressed.

I don’t think we have taken anything away in our approach to consultation: it is a much higher standard - engagement over the life of the project, detailed approaches for high risk scenarios, more disclosure of documents, and reporting back to the community over the life of the project by the project sponsor on how they are doing in mitigating identified impacts.


While of course applauding anything that gets corporate responsibility onto the agenda, I would like to ask about the connection between sustainability as an environmental agenda and sustainability as an ethical agenda. Is it possible to pursue credible and far-sighted policies in one sphere while pursuing short-term profit maximisation in your own back yard?
Aidan Ward

Leo Johnson: The letterbox limbo is a magnificent concept. One question is can sustainability get you away from it. Can a sustainability lens help you provide differentiated solutions to corporate and retail clients that address their real needs, and provide solutions that deliver value for them. Can sustainable finance enable a bank to intermediate not capital, not risk, but reward?

Rachel Kyte: Corporate governance is the third pillar of IFC’s approach to CSR. For us ES and G (environment, social and corporate governance) are vital whether we look at a short term investment or long term. We do not differentiate. However, it is true that the G part of ESandG and its correlation to performance is better understood and measurements are more advanced. Then I think we know a lot about environmental performance and return on investment. The weaker of the three (in terms of measurement and direct correlation) is social. Yet all the evidence anecdotally is that this where brand and business risk can be destroyed very quickly.

On your question of bait and switch - two faces to the same corporation - we think that globalisation of markets and information and of who your stakeholders are, make this increasingly difficult.


If a community wants to work with local bankers to create an investment fund specifically limited to financing local business ventures using savings and/or retirement funding supplied by interested local area residents, are there any successful existing models to follow? Also, are there good sources for educational material concerning the possible arrangements, procedures for getting the process rolling and potential roadblocks/pitfalls?
Scott Cratty

Rachel Kyte: There are many examples of cooperative banks or credit unions that try to address local business needs with local depositor funds. Sources of information? I am going to ask other readers to direct Mr Cratty in the right direction as this is not my area of expertise.

Leo Johnson: Scott, the use of local resident savings or retirement funds is a very interesting angle. The tradition has been a) government disbursement, or b) the corporation substituting. Clearly this would be a powerful tool for making sure the stuff that gets financed is stuff the community really wants (not another football field). Would you be looking to secure a financial return for the community from these investments? If so - how would you make that work?


Corporate Social Responsibility in financial services is no more or less interesting than in manufacturing. The interesting bit is what happens when liquid funds, good credit risk, insurance, and electronic transactions meet poor people with ideas above their station. Modern banking and insurance is a letterbox limbo dance between lower margins, tighter regulations, and higher expectations. Institutions survive by automating everything, including credit risk and customer contact. The number of customers is constant, so financial services are a frantic scramble to recycle someone else’s customers for less.

At the other extreme, financiers of development in poor countries rely on walking to new customers and sitting down with them outside their houses to count their pigs. These customers are real, but in the virtual world of electronic services, they don’t exist. In the long run, it is only by spanning these two poles that banks and insurers as we know them will go beyond being responsible citizens actually to finance development in a way that makes money for everyone. This has to be possible: with electronic communications spreading, liquidity a given, customers a plenty, and back office scale rising, the requirement for good underwriting to cover local risk and costs is the same in London or Lumbumbashi. Is anyone really trying to span the gap? If so, I and others like me would like to be a part of it.
Ant Evans, London

Rachel Kyte: Ant - your illustration is better than mine: so your question is how to bridge the missing middle - from micro to medium sized. This is what we try to do every day. We try to take medium down and grow micro up. BRAC started as a microfinance institution and remains so, but BRAC Bank was specifically created to help those with financing needs above microfinance limits. BRAC is now going beyond Bangladesh.


My (limited) understanding of “Sustainable Banking” is that under this type of banking, borrowers would be denied access to credit if their proposed use of funds does not meet certain defined sustainable criteria. If my understanding is correct, will this not place such banks at a competitive disadvantage to other banks which do not impose such lending criteria? Indeed, given the ease with which capital can be accessed from different countries, currencies can be exchanges, exchange rate risks can be hedged, will capital not simply flow to the lenders which do not impose such criteria?

My own opinion is that “Sustainable Banking” is a worthy and much needed initiative, however its success may depend upon international agreements and standards, which could be very hard to achieve given divergent corporate and national priorities. How do you propose making “Sustainable Banking” a widely adopted practice?
Robert J. Piliero, CFA, Graduate of Middlebury College

Rachel Kyte: I think it is remarkable that in the past few years, following reputational shocks that threatened the industry not just individual brands, financial institutions are talking about the standards of the industry and where they should be competing, and where they should be collaborating. Equator is a remarkable transfer of a public good, into a private sphere. What started as brand protection, became risk management and now is being used as a way to target growth and portfolio value for EP institutions. It will be interesting to see how other parts of the financial markets look at these risk and opportunities in environment and social sustainability. The Principles for Responsible Investment provide a place for pension funds to discuss their approach and the Who Cares Wins initiative also provides a place for asset managers to discuss these issues.

Leo Johnson: Interesting observation. One emerging issue is the fact that there is often an alignment of interest between the banks and their clients. They both face risks, whether reputational, legal or credit. The role that a number of banks are taking is to work with the clients to help them identify these operating risks, and provide value added solutions that differentiate the bank.


Dear Mrs. Kyte. The Board of Directors of the IFC yesterday approved the updated environmental and social standards. There has been criticism by NGOs but also by voices from the banking sector that these new standards don’t meet the higher standards set by the Equator-Principles, a framework developed by the private banking sector. Especially two points have been criticised: Not adopting the UN-standards for human rights and child-labour protection (e.g. as set by the ILO) and not including sufficient requirements for external expertise which may lead to the danger of moral hazard. How do you see as a member of the IFC these criticisms?
Ulrike Lohr

Rachel Kyte: Yesterday the Board did approve the new sustainability policy and performance standards of IFC. It is a huge shift in our emphasis to outcomes and will provide stronger and more comprehensive standards.

On Labor issues the new standards are guided by the ILO core labor conventions and for child labor issues by the UN Convention on the Rights of the Child as well. For the first time we have a set of labor standards which are robust.

On the use of experts to conduct environmental assessment: it is in the interests of a lender, IFC, Equator or anyone - that the business and the management of the company understand all the risks inherent in their projects or business models. Therefore we do require, except in certain high risk scenarios, that companies conduct their assessment themselves or hire consultants to do this. We will review before forming an opinion on whether to finance or not. Its important that the company own all its risks and its choice of mitigants.


In addition to compliance on social and environmental issues (Equator Principles etc), do you think that local economic development, enterprise development, alternative livelihood, economic diversification and supplier development initiatives (linking local suppliers with MNCs . . . what IFC call “Linkage Programs”) etc will gain weight in determining potential investment decisions?

With respect to investment in the extractive industries (and all the problems this brings to local communities) do you believe that the above could become the “third leg of the stool” to compliment social/investment mandatory requirements..so addressing sustainability with respect to people’s income generating potential? Perhaps only then, can we get “real” traction regarding these issues....
Hamish Dingwall, Edinburgh, Scotland

Rachel Kyte: Good point. The difference is between assessment and then development outcomes. You are describing the assessment and consultants process. Turning these from papers on a shelf into meaningful parts of a management system is at the heart of successful business operations from a sustainability perspective. There are many fine examples of multi-volume consultant reports and assessments that stay just as that. Our focus now is on how the decisions that flow from these assessments, are integrated into the operation of the company on a daily basis and then how they are monitored and reported to us as a lender, or to regulators and communities, where affected.

IFC has a development mandate and so we are concerned to take an enterprise that is managing all of its risks well and see if they can turn this into opportunity as well (revenue streams from carbon credits for example) but also to ensure that the jobs, economic impacts and the development benefits (SMEs developing in the upstream and downstream supply chains) are secured as well.

The other difference between our old system and the new one related to outcomes is the move from rules to principles. Principle based approaches allow parameters to be set for the use of judgement in decision making - our decision to invest or not as the basis of our environmental and social due diligence. Rules based approaches always allow for the loophole to be found and exploited. Better to agree on the outcomes and the principles that will drive us their than set rules and rely on them.

Leo Johnson: Hamish, you are right on the money. Bolivia, Nigeria, Chad, Cameroon. Getting the local operating license is critical to making these projects and strategic sectors viable.

One of the key challenge facing the extractive industries right now is to figure out ways to deliver the economic benefits to achieve that operating license. Linkages programmes, where the company supports local micro-enterprise development in a way that delivers economic growth, but also benefits the companies operations is a critical driver in making that happen.


The application of the Equator Principles (EP) is limited to (1) new projects and (2) project finance. Many other environmentally sensitive investments - expansions in pulping capacity and natural resource extraction come to mind - are funded in the international capital markets where much lower standards apply and disclosures are insufficient to even begin to apply EP standards should one want to.

For Mrs. Kyte:

[1] Is the IFC, through its leadership position in the EP looking to leverage on this by encouraging other EP members to raise standards in the large volume of financing that are not covered directly by the EP?

[2] According to the FT article, the new rules will focus on expected outcomes. I have yet to see a proposed investment that projects negative outcomes. Practice so far has been for the sponsor to commission a consultant study that is not necessarily comprehensive in its analysis of potential impacts. Do you expect that the new rules will deal with this more effectively, and if so, how?

For Mr. Johnson:

[1] What do you see as the principal barrier to implementing higher standards in non- EP projects? In asking this question I am especially thinking about financing raised by companies that are already in existence.

[2] what steps do you think should be taken to raise the quality of environmentally sensitive investments that are financed in the international capital markets and through other means that are not subject to EP safeguards?
Masya Spek - FT reader in Asia

Rachel Kyte: IFC hopes that the existing Equator Principle Institutions do move to use IFC’s new performance standards and that then more institutions will choose to join the Equator in the coming months. We are interested in encouraging institutions to use our standards or the Equator Principles.

Leo Johnson: Excellent question. The principal barrier I would pick out is incentives. For the project finance market, the Equator Principles have created a powerful incentive for implementing high standards. The Finance Director, putting it simply, knows he cannot get access to up to 90 per cent of the project may not be in place. One option is to shift the focus away from risk, and on to identifying sustainability-driven opportunities for that company.

Copyright The Financial Times Limited 2017. All rights reserved.
myFT

Follow the topics mentioned in this article

Comments have not been enabled for this article.