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Year of the Spac, Fink sees a ‘tsunami of change’, US-China climate fight



Breaking: as Moral Money went to press Boris Johnson, UK prime minister, laid out a 10 part plan for waging war on the combustion engine in the UK as part of a new green policy plan. The details are yet to be worked out, but make no mistake: this is (yet another) sign that the policy climate is changing in a way the private sector cannot ignore.

Two things to start: FT Investing for Good USA: Accelerating Global Climate Action will take place in a digital format on 2 December at 12:30 EST. This event will discuss the role capital markets can play in unleashing the financing so urgently needed to recover from the Covid-19 crisis while also avoiding the worst effects of climate change. As a Moral Money subscriber, register here for your free pass.

And Alice Ross, the FT’s deputy news editor, is releasing her latest book Investing to Save the Planet, this week. It is a useful guide if family members or friends ask you for an introduction to green investing; we all need some hope in these dark days.

Today we have:

  • BlackRock’s chief executive on the sustainability tsunami

  • Sustainability Spacs hunt for $3.2bn of business deals

  • UN PRI partners with European leveraged finance market on ESG

  • And later today, please join Moral Money, Alecta and Amundi for an FT Live event about impact investing. Register here for free.

Why Larry Fink is reminiscing on his mortgage days

What impact with news like Johnson’s move have on investors? Judging from Larry Fink it will add to a growing momentum trade.

Mr Fink, BlackRock’s chief executive, told Gillian Tett that “we’re seeing a tsunami of change in asset reallocation right now”. Indeed, the current boom in green finance reminds him of how the mortgage market grew from less than $1bn of mortgage outstanding to becoming a dominant component of the capital markets in five years alone.

What makes him particularly upbeat is that the shift could soon spread to passive investing, as well as the active sector. Passive investments have hitherto been a big impediment to the expansion of green finance — and green critics of BlackRock often cite its vast passive business as a factor that undermines Mr Fink’s climate pledges (since money remains invested in dirty assets, by default).

However, Mr Fink argued that growing customisation of indices is about to revolutionise this space, and make it easier to inject a green lens into passive investing. And as asset prices respond to the momentum trade towards green, this will also get reflected in passive allocations. “[Sustainability] will be the lens from which we view everything in 10 years,” he insists.

The proof of these bold promises remains to be seen. But some change is already evident: Mr Fink published a letter at the start of this year calling on companies to adopt the Sustainability Accounting Standards Board Framework (SASB), and since then SASB has seen a 400 per cent growth in companies reporting.

Separately, Mr Fink argued that sustainability also explains the divergence in companies’ share performance this year: those without proper ESG strategies are becoming laggards. “The best companies are those that are heavily engaged in their corporate purpose . . . and you see that in their profitability,” he told US Chamber of Commerce president Suzanne Clark, at a separate event. “We’re talking 20, 30, 40 per cent divergence of companies in the same industry. I’ve never seen such a broad divergence of price-to-earning ratios.” (Kristen Talman)

The blank cheques inked in green

Welcome to more alphabet soup. While most of us will remember 2020 as the year of the coronavirus pandemic, financiers will also remember 2020 as the year blank cheque companies exploded in equity markets. Special purpose acquisition companies (Spacs), which raise cash on the stock market and hunt for a private company to take public, are poised to be a strong source of funding for sustainability projects going into 2021.

Now Spacs are mingling with ESG: already this year, the fourth-largest category of Spac deals involves renewable energy acquisitions — topping fintech, real estate, software and other sectors, according to Spac Insider. 

Deals by sector

A Moral Money analysis of Spac Insider data identified $3.2bn of Spac funds dedicated to sustainability that are searching for acquisitions. These include blank cheque companies dedicated to sustainable food acquisitions as well as a Spac launched by Citic Capital, the private equity arm of China’s state-owned financial services group, to buy energy efficiency and clean technology businesses.

And this dollar amount probably underestimates the Spac money looking for sustainability deals, said Kristi Marvin, founder of Spac Insider. While some Spacs are dedicated to sustainability acquisitions in their offering documents, others are probably pivoting toward the sector, she said. Typically, there is a six to 12-month lag from when a Spac trades publicly to when it makes an acquisition, setting up a prosperous 2021 for sustainability businesses. “In the New Year, it could be a bumper crop for sustainability companies,” she said.

The US is unlikely to embrace its own version of Europe’s “green deal.” But the US stock market might be able to fill a void in transition financing with the Spacs bonanza. (Patrick Temple-West)

UN PRI partners with European leveraged finance market on ESG

The UN Principles for Responsible Investment (PRI) and the European Leveraged Finance Association (ELFA) are collaborating on ESG disclosures for leveraged finance transactions.

The duo wants to increase disclosure of material ESG factors for “junk” or subinvestment grade corporate borrowers. The PRI and ELFA will publish a briefing of their findings in the coming weeks.

“We need to reach a consensus on a minimum list of meaningful information,” said Carmen Nuzzo, head of fixed income at the PRI. Discussions with the people preparing offering materials are “a crucial place to start for ‘singing from the same hymn sheet’ and enabling practical solutions that can move the industry forward”, Ms Nuzzo said. (Patrick Temple-West)

To fight climate change, Hank Paulson recommends US co-operates with China

© Bloomberg

US co-operation with China is essential to combat global warming, and the Biden administration has crucial decisions to make in the months ahead to reset US-China relations to prioritise climate change solutions, former US Treasury Secretary Hank Paulson said this week.

In a speech before the Bloomberg new economy forum, Mr Paulson said voluntary climate targets are insufficient, and that tough policies need to create incentives to curb emissions. The Biden administration, by rejoining the Paris agreement, is taking the first steps in developing a climate architecture, Mr Paulson said. But much more needs to be done.

Next, Mr Biden should join forces with China to invest in technologies to avoid tragic climate outcomes — even if they are not commercially viable, he said.

One of the biggest sticking points for the Biden administration is China’s resistance to WTO negotiations on tariffs for environmental goods and services, Mr Paulson said. Both countries should lift these tariffs as there is an estimated $3tn opportunity in China to help clean up its polluted air, he said.

“Working with China is in our self-interest,” Mr Paulson said. (Patrick Temple-West)

Grit in the oyster

On Monday, the World Benchmarking Alliance, which develops public rankings comparing companies’ performance on the UN’s sustainable development goals, published its corporate human rights benchmark, grading international companies on human rights qualities such as responsibly sourced minerals and women’s rights.

In March, WBA collaborated with 176 international investors to send a letter to companies that failed to score any points on human rights due diligence indicators. WBA’s new findings show that 79 of those companies continue to score zero on human rights due diligence.

Notably, car companies are the worst-performers on human rights, WBA’s data show. The average score for automotive companies is 12 per cent, WBA said — the lowest score ever. Two-thirds of the companies scored zero across all human rights due diligence indicators.

Tips from Tamami

After the wave of Asian financial groups pledging to stop funding new coal projects in recent months, a new kind of commitment just emerged from South Korea.

Shinhan Financial Group, a leading bank in the country, announced earlier this week that it aims to be carbon neutral by 2050. According to the bank, the commitment is the first of its kind among financial institutions in south-east Asia.

Under the “Zero Carbon Drive” initiative, Shinhan will divert loans and investment from companies with high carbon emissions to green ones, aiming to cut emissions from its asset portfolio by 38 per cent by 2030 and 69 per cent by 2040, before achieving net zero by 2050.

Sejong Youn, director at a South Korea-based climate policy group Solutions for Our Climate, applauds Shinhan’s decision as “a meaningful step”. He said: “It is the first financial institution [in the region] to talk about overall carbon exposure and plans to reduce it.”

Mr Youn also thinks it is a step forward from the “no further coal” commitment, explaining: “It really does not take a lot of effort to step away from the coal industry, which is already in deep decline.”

“It is clear the end game we are now headed to [is] zero emissions. Coal is just the first step,” said Tim Buckley, director of energy finance studies (Australia and South Asia), at the Institute for Energy Economics and Financial Analysis.

He observes that the year 2020 is turning out to be a pivotal year for fossil fuel exits, partly thanks to the strong trend in Asia. Mr Buckley added: “Asia started 2020 as a global laggard, with almost no climate risk discussion, and no credible coal exclusion policies from [major] companies, [but] now we are getting Asian policies every week or two.”

Decarbonisation has strong public support in Korea, but Mr Youn is expecting significant push back especially from the carbon intensive industries, and believes that “the difficult part [of decarbonisation] has just begun”.

In order to keep the momentum, Karl Yang, executive director at Korea Sustainability Investing Forum, thinks that the pressure from international investors plays a crucial role. “[Overseas investors’] active engagement would lead more [financial institutions and companies] to join Shinhan”.

Smart reads

  • The UK is preparing to make a big bet on hydrogen power, writes FT energy correspondent Natalie Thomas, as prime minister Boris Johnson this week prepares to lay out his plans for a “green industrial revolution”. UK ministers have promised to respond “early” next year, while a long-awaited energy white paper, expected before Christmas, will also include plans for hydrogen.

  • Deutsche Börse has agreed to buy a majority stake in Institutional Shareholder Services in a deal that values the shareholder advisory group at €1.9bn and marks the latest in a string of deals among the world’s largest exchanges. The US-based proxy adviser is in a court fight with the US Securities and Exchange Commission over onerous rules the agency adopted for proxy advisers earlier this year.

Further reading

  • FTI Consulting faces client backlash over oil industry work (FT)

  • Unilever aims for €1bn sales from plant-based products by 2027 (FT)

  • ESG falls down the investment agenda (FT)

  • Johnson seeks Downing St reset with ‘green industrial revolution’ (FT)

  • Japan looks to Asean nations for carbon capture and storage (Nikkei)

  • Morningstar to integrate ESG into all investment analysis (FT Adviser)

  • One in Three Professionally Managed Dollars ‘Sustainably’ Invested: Study (Fund Fire)

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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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