Risk and responsibility

A growing number of banks are producing sustainability reports detailing their environmental and socially responsible initiatives. Is this just slick PR or has sustainability become an important risk management consideration? Clive Davidson investigates

Last month, HSBC announced it had gone 'carbon-neutral' – it had cut its carbon dioxide (CO2) emissions to zero by a combination of reducing energy consumption, buying electricity from non-CO2 emitting sources (so-called green energy), and investing in projects such as reforestation that absorb the equivalent of its outstanding emissions.

Elsewhere, after publishing a sustainability report in July that is widely acknowledged to set a benchmark for disclosure, Manchester-based Co-operative Financial Services (CFS) is cladding its headquarters in a mosaic of photovoltaic panel tiles in the largest vertical solar panel project in Europe. At the same time, Bank of America is building what it claims is the world's most environmentally friendly skyscraper in Manhattan, which features an advanced cogeneration plant that will simultaneously produce heat and power for greater energy efficiency and recycled waste and rain water.

These are all eye-catching projects and are undoubtedly good public relations (PR) exercises for the banks at a time of greater environmental awareness and concerns about the quality of corporate governance among investors. And these are by no means the only examples of where banks are making public commitments on sustainability. For example, 33 banks, including ABN Amro, Citigroup and JP Morgan, have adopted the Equator Principles, which commit them to following the environmental and social guidelines of the International Finance Corporation of the World Bank when making project loans of $50 million or more.

But are such steps any more than PR – an attempt by banks to be seen as doing something socially responsible? Or do efforts such as those made by HSBC to go carbon-neutral make sense from a risk management and business perspective? Those banks that have made the biggest commitment to sustainability are clear that it is not about window dressing, but about survival and success. "Every business must be sustainable if it wants to survive," says Liza Vizard, head of corporate responsibility and public affairs at Edinburgh-based HBOS. Meanwhile, Francis Sullivan, adviser on the environment to HSBC, is unequivocal about why banks should care about sustainability. "Sustainability is about good risk management. HSBC's [sustainability] policies are not written by the PR department – they're issued by group credit and risk," he says.

Indeed, sustainability is clearly rising up the agenda of risk management. In setting out the Equator Principles, the originating banks declared: "These principles will foster our ability to document and manage our risk exposures to environmental and social matters associated with the projects we finance."

The principles provide a framework for banks to categorise the risk of projects, require customers to demonstrate their environmental plans and the degree to which they meet certain pollution guidelines and other environmental safeguards, and allow banks to insert into loan documentation for high- and medium-risk projects covenants for borrowers to comply with certain environmental and social management conditions or, if the borrowers fail to do so, to declare the project loan in default.

Like HSBC, many banks are now tying their sustainability activities closely in with their risk management. "Managing risk is both an art and a science," says Lynn Patterson, senior adviser, corporate responsibility, at Canada's RBC Financial Group. "We proactively evaluate and manage all the risks inherent in our businesses, while weighing the economic, social and environmental impact of our practices."

Others see sustainability not as a risk in itself, but as a fundamental element of doing business from which a number of risks arise. "Sustainability isn't a risk per se, but is becoming a business norm like accounting, and a number of risks flow from it," says Ron Dembo, founder and former chief executive of Toronto-based risk management systems supplier Algorithmics. Since selling his company to Fitch Group in January, Dembo has launched a global environmental organisation called 0footprint (pronounced Zerofootprint) to foster green business and other sustainability initiatives. Dembo is one of three former chief executives of leading risk management software companies – the other two being Rod Beckstrom, formerly of C.ats Software, now part of Misys Banking Systems, and Roger Lang, formerly of Infinity Financial Technology, now part of SunGard – that have become environmental activists after selling their companies.

Highly regulated

Sustainability could go the same way as accounting, which over the years has evolved into a highly regulated area of business, says Dembo. And if concern about global warming and climate change increases, companies could be held more accountable and forced to disclose carbon emissions or other environmental impacts through Sarbanes-Oxley type legislation, he adds.

Other risks that flow from sustainability include physical risk – for example, where a bank or its data centre is located in a hurricane or flood area; reputation risk – for example, if a bank is discovered selling its old computers to China where unregulated dismantling causes cancer in the workers; and competitive risk – where the absence of an energy efficiency scheme keeps a bank's costs high compared with greener competitors and inhibits the firm's ability to exploit growth opportunities in green business and investment.

Sustainability-related risks can be brought into current risk management analytical frameworks by including the impact of global warming in scenario analysis for credit risk management. "Given the predictions of what might happen to Florida, with climate change resulting in most of the coast being underwater, if a bank is looking at long-term lending of maybe 30 years to clients in that area and ignores the possibility of flooding, then it is ignoring the effects on defaults levels and equity prices," says Dembo. Of course, there is still a great deal of debate and uncertainty about climate change. "But that is not unlike most other kinds of scenario analysis," says Dembo.

Taking it a step further, a growing number of banks are coming to the conclusion that an active sustainability strategy is not only good risk management, but also makes good business sense. HBOS – one of four banks along with Bank of America, Germany's HVB Group and RBC Royal Bank that made it into the Global 100 Most Sustainable Corporations in the World, drawn up in January by New York-based investment research and advisory firm Innovest Strategic Value Advisors – believes its sustainability policy is of increasing competitive importance. "Our strategy helps us maintain and enhance brand value and differentiation, crucial at any time, but particularly now given issues surrounding public trust in financial services," says Vizard.

When launching CFS's sustainability report, the financial services firm's chief executive, David Anderson, said: "We are convinced that reporting how we are performing and the degree to which we are delivering value to a range of partners in a socially responsible and ecologically sustainable manner is good for the future success of our business."

It can be argued that CFS is a special case in that it has a niche customer base built around its ethical stance. With its origins as the bank of the co-operative movement in the UK, and with strong and long-held policies on issues such as fair trade and ethical investment, as well as its sustainability strategy, CFS (a combination of the Co-operative Bank and Co-operative Insurance Services) has always appealed to those customers that want to get their financial services from an organisation that takes a strong ethical line in its business dealings. But figures in its sustainability report show that, for the Co-operative Bank at least (Co-operative Insurance Services has not done this kind of internal research), the portion of profits the bank can attribute to its ethical stance has increased significantly in recent years. It attributed 34% of profits in 2004 to customers for whom ethics is an important factor in choosing their bank (up from 25% in 2001) and 20% to customers for whom ethics is the most important factor (up from 14% in 2001).

Furthermore, CFS believes this ethical factor is going to become an even greater competitive advantage in the future. In his overview of the company's sustainability report, Anderson said: "I believe the future holds greater opportunity for CFS than any of its competitors. If we get the basics right, our passion to deliver an ethical, co-operative approach to customers will be hard for others to match."

But the current approach to sustainability reporting is of questionable value, and it is the long-term impact of sustainability policies that are important, say some banks. "There are limited PR benefits to sustainability reporting at present," says RBC's Patterson. "There is such a wide range of standards, reporting practices and lack of comparability, that the landscape is confusing to almost everyone but socially responsible investment analysts, investors and sustainability practitioners, making a PR sell of sustainability performance challenging."

HBOS's Vizard agrees that it is not the short-term PR potential that is of value with sustainability strategies. "Although we may achieve recognition in the press for specific achievements and actions, we seek to build long-term brand differentiation and competitive value," she says.

And in some ways, high-profile PR success in sustainability can become a rod for a bank to beat its own back with. Beth Ambrose, senior analyst at Innovest, says: "The more that it becomes expected of a bank to be more socially responsible, the more questions that are asked by stakeholders."

The Equator Principles are a case in point. Drawn up initially in 2003 by a group of 10 banks, including ABN Amro, Barclays and Australia's Westpac Banking Group, as a guideline for managing social and environmental issues related to the financing of projects, the principles have become a benchmark by which investors and banking watchdog groups can monitor how effectively banks are tackling these issues.

BankTrack, a group of 14 environmentally concerned organisations such as Friends of the Earth, the International Rivers Network and the World Wildlife Fund, tracks the operations of the private financial sector and its effect on people and the environment, and produces an annual assessment of how well the banks that have adopted the principles are living up to their commitments. In its 2005 report, BankTrack concludes that while a minority of banks such as JP Morgan, which lowered the threshold of projects it now applies the principles to from $50 million to $10 million, and Citigroup, which hired a senior risk officer with environmental and social expertise to help implement the principles, have gone beyond the letter of what is required and are applying the principles more broadly through their business, "the ultimate impact of the Equator Principles is unclear". BankTrack notes that fewer than half the adopting banks reported the creation of new procedures, standards or tools to implement the principles, and says: "Surely, any bank that implements the Equator Principles in good faith must make changes to the usual ways they do business?"

As with any form of sustainability reporting, paying lip service to the Equator Principles will be found out, and the only PR that will result will be negative. As Innovest's Ambrose says: "Where a few banks are leaders [in sustainability] and have implemented best practices, it is expected that the laggards will have to improve their practices also to avoid being criticised."

HSBC's Sullivan says bank stakeholders – customers, staff, shareholders and partners – are becoming more sophisticated on the issue of sustainability and more penetrating in their enquiries. "The questions [from stakeholders] are becoming harder, and rightly so," he says. One consequence of this is that a bank has to be consistent with its sustainability policy right across its operations. "We need to be consistent about when we are considering lending to, say, a forestry company, that we make the same decision about whether to buy their products as we do on our lending," says Sullivan.

Similarly, CFS has a sustainable procurement and supplier policy, where it imposes its environmental standards on all suppliers with which it conducts £50,000 worth of business a year or more. The standards include the use of renewable energy sources, minimisation of waste and recycling.

One-way street

Sustainability, it seems, is a one-way street – once a bank starts down the route there is no turning back without detrimental consequences. At the same time, a sustainability strategy, properly implemented, is becoming an increasingly important indicator of long-term performance. "It is Innovest's opinion that strong management of intangible value or extra-financial factors [such as sustainability] affects long-term financial performance positively," says Ambrose. There are several reasons for coming to this conclusion, she adds. For example, environmental risk is becoming a part of standard financial risk or credit risk assessment, certainly for high-impact sectors such as oil and gas. "Furthermore, there are increasingly profitable business opportunities available to banks, such as the financing of wind power, carbon trading and environmental loans," says Ambrose.

RBC concurs with this latter statement. It runs a $50 million alternative energy technology venture fund, and in 2004 became the lead investor in Washington-based environmentally focused investment company Global Environment Fund's EF clean technology fund. "We recognise the opportunity in alternative energy resources and finance more than 25 wind farms in Canada, the US, the UK and Italy," says Patterson.

And, last month, HSBC announced that it had created a new team to increase the company's business in the sustainable development sector. At the launch, Stephen Green, HSBC's group chief executive, said: "As our understanding of the sustainability issues in various industry sectors has improved, it has become clear that there is a substantial market in environmental services, particularly in respect of climate change-related technologies and the projects that deliver them, water infrastructure and sustainable forestry."

Serious business

Meanwhile, investment managers are beginning to take sustainability more seriously. The social responsibility investment team at asset management company Henderson Global Investors recently rated HBOS as number one in the banking sector, noting the bank had "developed a strong corporate responsibility strategy that supports product simplification, facilitating better sales practices and greater clarity for customers".

HBOS is now included in the banking choice set approved for investment under Henderson's Global Care Income and Managed funds. And research to be published in a forthcoming issue of the Journal of Portfolio Management shows how using the Standard & Poor's/Toronto Stock Exchange 60 index, a passively managed portfolio can be optimised, with sustainability leaders replacing sustainability laggards to achieve identical performance. This effectively ends the 'fiduciary duty' argument against socially responsible investment strategies, where it is claimed that by including companies on the basis of their social responsibility – which an increasing number of people now consider synonymous with sustainability – undermines the performance of the portfolio, says David Wheeler, Erivan K Haub professor of business and sustainability at the Schulich School of Business at York University in Canada.

The weight of argument for adopting sustainability as a guiding principle for doing business is now overwhelming, many banks believe. "We don't have a choice," says Sullivan at HSBC. "We either do it willingly, realising that it is going to give us benefits, or we don't, and lose money and our brand is eroded," he says. n

Putting energy into sustainability policies

One area where the risk management, business, PR and ethical cases for sustainability converge is in energy use. A combination of a reduction in energy consumption and acquiring energy from alternative sources saves costs, reduces dependency on energy sources with volatile prices and is good for the corporate image. A number of banks are now using their headquarters to showcase their energy and sustainability strategies.

Bank of America's new green skyscraper, currently under construction in midtown Manhattan, will feature an in-house cogeneration heat and energy plant with a thermal storage system that will produce ice in the evenings for daytime cooling, and will have low-energy LED lights with daylight dimming systems.

HSBC has installed chillers in its headquarters in Hong Kong that draw water from the city's harbour instead of using environmentally unfriendly gases for the cooling in its air-conditioning system. The chillers save the bank $140,000 a year and reduce CO2 emissions by 1,000 tonnes.

In addition to its solar panel project on its headquarters (see main story), Co-operative Financial Services (CFS) is erecting 24 micro-wind turbines on top of a second major building in Manchester – the biggest commercial project of its kind in the UK, claims the company. The turbines will generate around 5% of the building's energy needs, and will pay back investment in around three years, says Gary Thomas, head of property and facilities at CFS.