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US investors sceptical of ESG, Hindenburg targets Loop, EU rises as green leader 



One thing to start — last week the Global Reporting Initiative announced that its chief executive Tim Mohin was stepping down. All eyes in the environmental, social and governance space will be watching for his replacement, as the company plays a key role in the push to clean up the alphabet soup of disclosure standards.

Today we have:

  • US perception of ESG performance lags behind Europe

  • Short-seller targets recycling company

  • EU sets pace for global sustainability regulation

  • Asset owner giants plot decarbonisation pathway

  • University of Tokyo enters sustainable bond market

A continental divide on ESG performance

It is a truth universally acknowledged among sustainability converts, to paraphrase Jane Austen, that investing in ESG can produce decent returns. Indeed, during the recent months of the Covid-19 shock, there have been a host of studies showing that ESG has performed as well, if not better, than non-ESG investments. That is partly due to the avoidance of fossil fuels but also because any company that tries to meet ESG standards is forced to do a full-blown audit of their supply chains and internal processes, which helps boost resilience.

But are ESG enthusiasts so excited about these findings that they have failed to spot that others outside their bubble see things differently? It is a point worth pondering given the findings of a recent survey from RBC Global Asset Management, to be released this morning. This poll of 800 institutional asset owners, consultants and managers shows that in most parts of the world the Covid-19 crisis has left financiers with an increased faith that ESG improves returns. Apparently, 97.5 per cent of investors think this in Canada, up from 90 per cent last year, while in Europe the figure is at 96 per cent (up from 92 per cent) and in Asia it is 93 per cent (up from 78 per cent).

The outlier, though, is America: just 74 per cent of US investors think ESG improves performance, which is down from 78 per cent the previous year — and 24 per cent think it harms performance. It is not entirely clear why that gap exists. It may reflect Republican politics, which have been sceptical about environmental issues. It may also stem from the mistrust of ESG which seems to be afoot at the Securities and Exchange Commission, or the fact that the Department of Labor seems to have defined fiduciary duty in a way that is not very ESG-supportive either. “When it comes to ESG, Europe is way ahead of the US,” Carmine di Sibio, head of professional services group EY, told a Milken Institute conference yesterday. “The sustainability issue became a very political issue starting 10 years ago in the US — views are different depending on what party is in office.”

Either way, the finding should give ESG activists pause for thought. “This is an area which should be driven by facts and not ideology and emotion,” points out Roger Ferguson, head of TIAA. Quite so. But, in the meantime, investors should ask another question: how might sentiment and market pricing change if Joe Biden wins the election — and policy suddenly changes? (Gillian Tett)

Short-seller report sends shares in plastic recycler plummeting


Hindenburg Research, the short-seller that made headlines alleging that electric truck start-up Nikola was an “intricate fraud”, is coming after another ESG company. This time it has issued a scathing report on Loop Industries, a Canadian plastics recycler, alleging that the company’s technology is “fiction.”

On its website, Loop claims to be able to recycle plastic from sources that would typically be considered garbage, including “plastic bottles and packaging, carpets and polyester textiles of any colour, transparency or condition and even ocean plastics that have been degraded by the sun and salt”.

Hindenburg, which makes money by betting against share prices, said Loop’s claims were “technically and industrially impossible”.

Loop responded that Hindenburg’s claims were “unfounded, incorrect, or based on the first iteration of Loop’s technology”.

However, the company has never reported any revenue. And despite striking numerous high-profile partnerships with companies such as Coca-Cola, it has not yet delivered the recycled plastic it said it would.

If Loop’s technology does not work, as Hindenburg alleges, it will be another blow to the struggling plastic recycling sector. As NPR reported last month, much of the plastic waste separated out to be recycled in the US is just thrown away.

Loop’s share price plummeted after the announcement, which should serve as a warning to ESG investors who do not want to see their portfolios end up in a landfill (like an unrecycled plastic bottle, one might say). But companies making public sustainability pledges should also take note — especially if their plans hinge on technology that has not yet been proven to work. (Billy Nauman)

$5tn investor group shows mettle with decarbonisation goals

© AFP/Getty Images

Thirty of the world’s largest investors have unveiled details of how they intend to strip damaging carbon emissions from their portfolios by 2050, setting ambitious interim targets that, if delivered on, would have ripple effects across the economy.

The UN-convened Net-Zero Asset Owner Alliance, which comprises investors overseeing $5tn in assets under management, pledged this week to reduce emissions linked to their portfolios by between 16 per cent and 29 per cent by 2025.

The target is the first interim milestone set by the investors since they came together last year with the aim of using their collective heft to push the companies they own to reduce their overall emissions to zero.

Coalition members, which include German insurer Allianz, the largest US pension fund Calpers and France’s Caisse des Dépôts Group, will set individual five-year objectives early next year. The extent of the cuts will depend on the progress that investors have already made in decarbonising their portfolios.

To achieve these goals, the investors, whose focus is on lobbying for change at polluting companies rather than divesting, have committed to engaging with the top 20 emitters in their portfolios or those responsible for the majority of carbon emissions.

Allianz’s chief investment officer Günther Thallinger, who chairs the coalition’s steering committee, said the group would draw inspiration from Climate Action 100+, the $47tn investor group that has succeeded in pushing groups such as Royal Dutch Shell to set carbon reduction targets, applying its tactics to a broader set of companies.

Mr Thallinger said the fact that the investors were bound to concrete decarbonisation targets would give them added leverage in pressuring companies to change. “We are not just sending a letter and asking for change,” he said. “We need these changes to meet our objectives. That gives us a certain credibility.” (Siobhan Riding)

EU green leadership ripples through finance

The EU is securing its status as the global leader for green investments and regulations — and its efforts have global banks scrambling to identify winning and losing companies.

Today, the European Commission is unveiling the latest piece of the European Green Deal, which was announced in December and remains a key priority for president Ursula von der Leyen amid the Covid-19 pandemic. Wednesday’s report aims to reduce methane emissions (though it remains unclear how rigorous the plan will be in cutting methane).

Other parts of the EU’s multi-faceted Green Deal programme have tantalised investors. The clean hydrogen provisions, for example, benefit UK conglomerate Johnson Matthey, said Morgan Stanley analysts in an October 13 report.

“The announcement of the EU Green Deal shows political willingness to move away from fossil fuels,” Bank of America analysts said in a September report. “This could ultimately end a chicken-and-egg problem whereby prohibitive costs have deterred investments in hydrogen which, in turn, prevented the realisation of economies of scale.” 

On Tuesday, ArcelorMittal announced a host of green steel projects, including large-scale green hydrogen production in Germany to be deployed in a blast furnace.

The US elections next month might help accelerate America’s sustainable investing development (see the Morgan Stanley survey responses below). But for now, Europe is leading the way.

Q: Which of these is going to be most impactful for sustainable investing over the next 12 months?

“I expect that after five years there will be a lot of countries across the world who are following us,” Kadri Simson, the EU’s top energy official, said in a recent FT interview. “This is not just about climate, but about competitiveness.”

(Patrick Temple-West)

Tips from Tamami

Nikkei’s Tamami Shimizuishi keeps an eye on Asia to help you stay up to date on stories you may have missed from the eastern hemisphere.

The growing popularity of social bonds has reached the ivory tower in Asia. The University of Tokyo will become the first national university in Japan to issue social bonds on October 16.

The money raised will be earmarked to fund research for the university’s Future Society Initiative, which aims to contribute to the UN’s Sustainable Development Goals. In particular, the bonds are going to help Japan’s top university to promote global strategies for the post-Covid-19 world.

The University of Tokyo has promised to disclose the usage and impact of the money once a year.

With solid ratings by notable investment agencies, the 40-year debts have been flying off the shelves. Investor demand was six times bigger than the original offer size of ¥20bn ($190m), according to lead underwriter Daiwa Securities. Investors include Nippon Life Insurance, technology company NEC and Japan Women’s University.

“Our brief [stating] that the university can work with capital markets while leading social change is well received by investors,” said Makoto Gonokami, University of Tokyo’s president. He added: “I want other universities to follow.”

While the university has historically enjoyed the top spot in Japan, it is only ranked 36th among global peers in the World University Rankings, behind those in China and Singapore. So becoming competitive academically and financially is very important for the university — and for Japan, too.

In June, the country relaxed rules to allow national universities to tap the bond market to finance research and projects. As government funding declines, other educational institutions in Japan are likely to follow the University of Tokyo’s lead, creating new kinds of investment opportunities for ESG investors.

Chart of the day

Companies communicate honestly about sustainability performance

Citizens’ trust in companies’ sustainability disclosures has increased, but there are significant differences from country to country, according to a report from GRI, a disclosure adviser, and GlobeScan, a consultant. Their survey asked 1,000 people to indicate whether they agree that companies are honest and truthful about their social and environmental performance. Respondents in Asia were most favourable, while those in Europe and the US were a bit more sceptical.

Smart reads

  • JPMorgan Chase, known in its earlier incarnation as the “Rockefeller Bank”, is facing pressure from three fifth-generation members of the Rockefeller family to stop fossil fuel financing. The trio’s comments in the New York Times came days after JPMorgan pledged to shift its portfolio away from fossil fuels.

  • Please check out our special report on impact investing, which includes Gillian Tett’s analysis on the number-crunchers leading the charge to get corporate boards up to speed with ESG. “The direction of travel is clear: finally, more accounting firepower is emerging in the world of impact investing, ESG and sustainability.”

Further reading

  • Boohoo ditches another Leicester supplier ‘in light of’ BBC probe (FT)

  • Companies tread a fine line on executive pay (FT)

  • Black Lives Matter provokes change on Wall Street (FT)

  • Why start-ups are more likely to dodge greenwashing label (FT)

  • The legacy of slavery made my grandmother fear investing (Washington Post)

  • The Short Tenure and Abrupt Ouster of Banking’s Sole Black C.E.O. (NYT)

  • Crunch Time: Global Standard Setters Set The Scene For Comprehensive Corporate Reporting (Forbes)

  • Investor rebellion at Procter & Gamble over environmental concerns (FT)

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ECB threatens banks with capital ‘add-ons’ over leveraged loan risks




The European Central Bank is threatening to impose additional capital requirements on banks that continue to ignore requests to rein in risk in the booming leveraged loan market.

Policymakers are increasingly frustrated by the lack of action to tighten risk controls in the market at some European lenders, which they fear could lead to repayment problems if interest rates rise.

If industry practices do not change, the EU regulator “won’t hesitate to impose capital add-ons” through its annual Supervisory Review and Evaluation Process process, said a person familiar with internal discussions. 

Leveraged loans are junk-rated debt usually used to back or refinance private equity takeovers of companies. Banks keep little of the risk on their own balance sheets and sell almost all of the loans on to other investors.

Fierce competition has led to ultra-low pricing, a softening of underwriting standards and increasing leverage in private equity buyout loans. The use of “covenant-lite” structures — which strip out many of the usual protections for investors — has surged.

In response, the ECB is planning more frequent “on-site” visits — performed virtually during the pandemic — to evaluate banks’ risk management procedures on recent and current deals and adjust their capital requirements accordingly, said the person.

“Where banks incur risks in leveraged lending that are not adequately addressed by appropriate risk management practices, ECB banking supervision is considering supervisory actions and measures, including qualitative or quantitative requirements as well as capital add-ons,” the ECB said in a statement.

Last summer, Deutsche Bank received a request to suspend part of its leveraged finance business because of shortcomings in its risk controls but it refused, the Financial Times has reported.

A senior eurozone central banker said the issue would be raised as a key concern in the ECB’s next financial stability review in May.

Banks have become more aggressive in investment banking as income from traditional retail and commercial lending activities has plunged because of negative interest rates. More recently, they have also had to contend with a surge in coronavirus-related loan-loss reserves.

Supervisors’ concerns have been prompted by changing market dynamics, one of the people said. Indicators suggest that inflation is picking up and once interest rates around the world start to rise, repayments on some of the most aggressive deals could become difficult. Many banks have been pricing loans on the assumption that negative rates will persist for a decade or more, the person said.

In 2017, the ECB introduced guidance that defines “high levels” of leverage as deals where total debt — including undrawn credit lines — exceeds six times earnings before interest, tax, depreciation and amortisation. 

The regulator said that such transactions and covenant-lite structures “should remain exceptional and [ . . . ] should be duly justified” because very high leverage for most industries “raises concerns”. 

Despite these instructions, the ECB found that by 2018 more than half of new leveraged loans by major eurozone banks were already above this threshold.

Deutsche Bank is among banks the ECB has contacted. Despite receiving a letter from the regulator calling its risk management framework for highly leveraged transactions “incomplete,” Germany’s largest lender refused to suspend parts of the business and said it was “impractical” to follow the request. It was not required to do so because the guidance was non-binding.

Deutsche Bank declined to comment.

As it is for many other big lenders, such as BNP Paribas, leveraged finance is a buoyant and lucrative business for Deutsche’s investment bank. It generated €1.2bn of revenues in the first nine months of 2020, an increase of 43 per cent from 2019.

Recent transactions on the riskier end of the scale include a €4.4bn leveraged loan and high-yield bond package for Swedish alarms company Verisure this month. The deal is more than seven times levered, even when using the company’s own heavily adjusted earnings number, and includes a €1.6bn dividend paid out to its private equity owners.

Deutsche is a joint global co-ordinator of the Verisure debt, with BNP Paribas, CaixaBank, Crédit Agricole and Santander also involved.

Another highly leveraged buyout this year is BC Partners’ takeover of US gynaecology company Women’s Care Enterprises. The deal’s overall leverage is more than nine times its ebitda, according to S&P Global Ratings. Deutsche is again a joint bookrunner.

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Wall Street’s new sheriff is on a mission




Financial markets may soon have a new regulatory sheriff. President-elect Joe Biden, who will be inaugurated on Wednesday, is expected to pick the former head of the US Commodity Futures Trading Commission, Gary Gensler, to run the Securities and Exchange Commission. Given that US capital markets are the broadest and deepest in the world, the chair of the SEC is not only the most important market regulator for America but also, arguably, for the wider world. The good news is that Mr Gensler is exactly the right man for the job. 

As a former Goldman Sachs partner who also served in the Treasury department during the Clinton administration, he is a powerful choice in part because he’s a “born-again” regulator.

After 18 years at the US bank, including time in the risk arbitrage unit, Mr Gensler began his regulatory career working with his former boss Robert Rubin, who had been appointed US Treasury secretary. He then became an under-secretary to Mr Rubin’s successor, Larry Summers, who passed the Commodity Futures Modernisation Act. This was the law that exempted credit default swaps, which exploded the global economy during the financial crisis of 2008, from regulation.

But later, as chair of the CFTC under President Obama, Mr Gensler spent a large portion of his time cleaning up the mess that such lack of oversight created. He passed dozens of new rules to increase transparency and reduce risk in the swaps and futures markets — moving faster and further on financial regulation than any of his peers.

Indeed, Mr Gensler almost seemed to see it as his own personal mission of penance. As he told me in a 2012 interview, “Knowing what we know now, those of us who served in the 1990s should have done more [to protect] the derivatives market.”

Democrats usually decry the revolving door between Goldman Sachs and Washington. But Mr Gensler is both beloved of financial reform types and feared on the Street in large part because of his status as a former insider.

“Gary can’t be intimidated, and he’s usually smarter than you are,” says Dennis Kelleher, president and CEO of Better Markets, a non-profit financial reform organisation. “He’d call baloney on arguments that didn’t withstand scrutiny,” Mr Kelleher adds — recalling Mr Gensler’s tenure at the CFTC, when financial executives would lobby for or against various rules.

Since stepping down from the CFTC, maths-whizz Mr Gensler has been at MIT, studying and teaching on the next big things in finance: blockchain and cryptocurrency. That background will make him even more useful as a regulator at a time when the largest tech platform companies — from Google and Facebook to Amazon and Apple — are moving into the financial industry.

Mr Gensler has so far lauded the convenience and low cost of retail financial services apps while cautioning against the use of decentralised technologies for financial speculation. In a November 2020 MIT paper, he and co-author Lily Bailey discussed the “significant opportunities for efficiency, financial inclusion, and risk mitigation from AI and big data in the financial sector, but also the possibility of ‘regulatory gaps’ that might lead to ‘financial system fragility and economy-wide risks’.” Translation? In a Gensler-led SEC, fintech will be under greater scrutiny.

But he will also have to address past failings. For some years, the SEC has been criticised for not being tough enough on corporate America and not adequately protecting investors. Indeed, scams and fraud have been on the rise during the Trump administration, according to the SEC’s Office of Investor Education and Advocacy.

As head of the SEC, Mr Gensler would therefore have to balance two jobs. First and foremost would be restoring trust in the agency’s ability to accomplish its core mission of protection, financial stability and penalising violations. In addition, though, as a longtime Democratic politico, he would want to help facilitate the Biden administration’s priorities, such as addressing income inequality, racial injustice and climate change.

On the former, progressives will look to the next SEC chair to acknowledge that it is not banks that break laws, but individual bankers. By appointing a tough director of the enforcement division — perhaps a former prosecutor or a consumer advocate — the chair could send a message: there will be no more sweetheart deals for individual executives while organisations write-off their regulatory fines as a cost of doing business. The chair could also revisit Trump-era deregulation, and toughen rules around whistleblower protections, pay clawbacks for illegal gains, and limits on executive pay for high-risk activities.

On the broader Biden agenda, the SEC could meanwhile play a big role in increasing transparency and disclosure around hidden fees, predatory lending and unseen risks from factors such as climate. Imagine, for example, if companies had to disclose their potential litigation risk around lending to the fossil fuel industry or developing waterfront property. This, combined with opening up the black box of algorithmic finance, could go a long way towards mitigating risk at a delicate time for the global economy. 

With a new administration and a new “born again” SEC director, markets may soon get regulatory religion too.

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ESG accounting needs to cut through the greenwash




The writer is professor of business and public policy at Oxford’s Blavatnik School of Government

For investors seeking more focus on environmental, social, and governance issues, 2020 might have felt like a good year as numerous CEOs embraced ‘ESG-speak’. But much of this, I suspect, was to dress up the disappointment of Covid-19-induced losses. And their posturing only seemed real because accountants and standard setters got in on the act.

Before investors take any ESG claims seriously, though, the accounting has to become a lot more serious. That means incorporating the features of high-quality accounting rules — and here are three that I believe could make a difference.

First, prudence. In accounting parlance, that means having a higher threshold for recognising positive claims than for negative ones. As companies laud themselves for wins on the environment or on meeting social responsibilities, the ESG accounting rules should impute scepticism.

To date, however, I have not encountered a single set of ESG standards that requires prudence. UK-based fashion retailer Boohoo waxed eloquent in its 2019 report about its “zero-tolerance approach to modern slavery”, and scored highly on several ESG indices — only to be exposed for using suppliers that paid workers less than the UK’s minimum wage.

Second, dual reporting. If a firm is reporting on its greenhouse gas emissions in a given period — what accountants call a “flow” — then this figure should be contextualised against the corresponding “stock” in accounting terms: ie, cumulative greenhouse emissions over prior periods and, if relevant, any pollution credits for future emissions. After all, It is an accepted principle that a company’s financial reporting should encompass both the flows and stocks of the item being reported on.

Reporting on flows gives users a picture of current-period performance, while reporting on stocks allows users to examine how sustainable that performance has been over time. But, again, I am not aware of any ESG standards that mandate both flow and stock reporting in the unit being reported.

Third, “matching”. This is how accountants set current investments against future benefits. For example, £1bn building cost of a new factory is not simply recorded as an expense on the income statement but held on the balance sheet and gradually recognised in the income statement as depreciation during the asset’s life. ESG accounting needs benefits matching, too.

This matters because it encourages investments in the future. If managers had to take large current losses on capital expenditures, they might think twice about them — especially if the benefits were very long-term, and only enjoyed after their tenure. Accounting rules that set out the matching of ESG investments and their benefits would moderate this problem.

At the same time, if we want corporate managers to make costly pro-social investments in the environment or in community welfare, we need matching rules to assess their impacts in the future. Recently, Nestlé announced that it was investing €3bn over five years to cut greenhouse emissions as part of its 2050 “net zero” commitment. But how do we know this is enough and will make any meaningful difference to the environment? ESG accounting standards should require Nestlé to state more precisely what ESG value it expects its investment to generate and over what period. The investment could then be “matched” to any realised benefits over that period.

These three principles — prudence, dual reporting and matching — are all fairly basic in financial reporting, but virtually unheard of in ESG accounting standards, As the accounting authorities and the auditing firms push for more environmental and social reporting, this situation has to change.

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