IS IT IMPORTANT TO YOU that your investments don’t worsen problems of pollution, the mistreatment of workers, and corruption? If so, you are probably aware of two hot topics in finance: Environmental, Social and Governance investing (ESG), and Sustainable Finance. Both initiatives are bringing business opportunities for investment banks and commercial banks to drive profit growth.
But are these just marketing tools to make money for short-termers? Banks and brokers don’t need factories with heavy carbon emissions to manufacture their products. Can financial firms thus be exempt from ESG responsibility?
ESG IS NOT JUST ENVIRONMENTAL
No. ESG is not just about the environment. The Governance and Social impact aspects are more relevant. To understand what ESG means for corporate issuers, consider this example.
You’d think that Elon Musk, the billionaire, founder, and techno-king of Tesla, maker of electric cars, would be in favor of ESG. In fact, the New York Times reported that he railed against ESG after Tesla stock was excluded from the Standard and Poor’s ESG index in May 2022. Interestingly, the S&P responded in a statement: “While it is clear the company’s product is beneficial to the environment, Tesla is now a big company and it also has an impact on employees and customers, and those issues concern ESG investors.”
New York finance company MSCI provides ESG rating globally. Their analyses indicated that the most frequently used factor was Governance, with 42%, followed by Social, with 32%. Environmental was least frequent, coming up in only 26% of cases.
Looking at an MSCI ESG rating report for a financial firm, the Governance and Social factors together weighed as high as 90% while Environment was just 10%. It seems ESG has been deceptive even for the smartest guys in the room.
We can also consider the Lehman brothers’ bankruptcy in 2008. One analysis said: “Lehman never engaged in ‘real’ Corporate Social Responsibility, rather what they did was philanthropy with ulterior motives in mind. They never issued a CSR report of any kind depicting a lack of transparency and accountability.”
Lehman kept its mortgage customers at arm’s length using a distanced subsidiary as the issuer of its loans. Those cases would have caused low Social and Governance scores if the capital market had taken ESG into risk management considerations.
CHINA HAS AN EDGE
When it comes to Chinese financial institutions which are state-owned enterprises (“SOEs”), the most common governance concerns from the western mindset are two-fold. First, they worry that SOEs lack of independent board member majorities, and second, they worry about CEO equity pay incentive policies.
But in fact, Chinese SOEs have an inherent advantage in corporate governance.
It is believed that these issues above can be prevented or resolved by strict oversight from the government, or from the State-owned Assets Supervision and Administration Commission of the State Council. Since SOE reforms have been carried out, the council has established annual targets and performance measurements.
Some governmental bodies have demonstrated a track record of strong oversight and defined administrative tiers. This can be an important factor in determining their governance performance. And this in turn has raised the Governance scores of finance SOEs.
In Hong Kong, governance is the top concern in ESG, although the others are rising in importance. “Corporate governance is the most impactful ESG factor according to survey respondents, with social and environmental factors becoming much more influential on share prices and bond yields over the next five years,” according to research from the CFA Institute.
This could be an opportunity for Chinese financial institutions competing for global capital.
For Chinese financial firms, sustainability is not just an ethical question, but will soon enough also become an economic question, generating a new type of risk: ESG risk (mainly involving Social and Governance factors). The heightened demand by investors for sustainable products as well as the increasing pressure from regulatory bodies highlights the need for banks to update their risk management frameworks.
However, Chinese banks already have the edge, because they are already very tightly managed. The key is how to prepare their story and communicate it with the global markets. If they can do this well, Chinese financial institutions can create a better image for themselves in the wider world.
Jason Yan is an investor relations professional in a Chinese investment bank.
Image at the top by Christina/Unsplash