time for financial firms to lift the agency veilNovember 2002
Lenders need to apply social and environmental screens to the projects they finance to minimize reputational risk, says Alan Banks
As SRI investment techniques become part of mainstream stock selection, financial institutions are seeking to be seen as ‘ethical’ and ‘sustainable’ businesses to avoid exclusion from key investment portfolios.
To date they have succeeded in this, partly by stressing the efforts they have been making to improve the social and environmental performance of their operations and the welfare of their staff, and partly by stressing the agency nature of their business – as in, ‘we were only following our clients’ instructions’.
However, it is now evident that financial institutions need to lift the agency veil. They need to start applying broad social, environmental and sustainability criteria to their products and services, in particular for loan and project finance, underwriting and investment portfolios, and also for risk-underwriting and risk-transfer products. If a bank provides long-term project finance to, say, an environmentally destructive project, it can now expect to be held responsible for the damage caused in equal measure with the project owners and managers.
The successful campaign against the banks that financed the logging activities of Asia Pulp & Paper is a sign of how things have changed. Citibank and HSBC in particular came in for heavy criticism. To minimize reputational risk, ABN Amro has since stopped all lending to non-sustainable forestry projects.This sort of challenge applies not only to finance for logging projects, but to many product areas and across all industry sectors.
At last, financial institutions are deciding there is nowhere left to hide. Several recent initiatives, including Forge Two and the World Business Council for Sustainable Development’s position paper on the financial sector, recognize that financing and underwriting decisions must take account of sustainability issues. The WBCSD position paper states that social and environmental issues should be taken into account during the credit or underwriting assessment process, and that this will reduce risks, improve the bottom line and benefit society and the environment.
These excellent initiatives now need to be followed up by an overhaul of lending and underwriting criteria. Banks and insurance companies should walk away from financing activities that cause unacceptable damage to society or the environment. Ultimately, significantly less favourable terms will be offered for such projects – the corollary being that socially or environmentally beneficial projects receive more favourable terms.
Ratings agencies will be looking carefully at how financial institutions implement these new ways of managing social and environmental credit risk.
Alan Banks is group chief executive of CoreRatings
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