Investment Banking Sustainability: Can the financial sector be the climate change savior?
An interesting new wrinkle emerges in investment banking sustainability
Banks are the driving force behind improving transparency through robust ESG reporting. As ESG investing is becoming increasingly important to investors, banks want to get a handle on the risks associated with ESG reporting, and the benefits of proper reporting.
The “E” of ESG investing, i.e. “environmental,” is where banks are focusing their efforts in gaining clarity into their risk exposure due to climate change. They see investment into clean energies and sustainable operations as an investment in their own future.
Investment banking sustainability: Are banks now taking the environment as seriously as profits?
Banks are directly exposed to ESG and climate risks through their owner operations. They are also exposed indirectly through the services they provide. If not well managed, these risks can negatively impact the organization’s performance.
Banks are taking climate change so seriously that 19 of them have come together to form the RMA Climate Risk Consortium (“The Consortium”). UN Net-Zero Banking Alliance represents 40% of global capital and is committed to a 2050 Net-Zero goal.
In fact, six major banks will be working with the federal government in a pilot climate scenario to test climate-related financial risk and financial institutions resilience against those risks. The goal is to understand how a given set of scenarios would impact portfolios and business strategies. This should be a signal to all companies of what’s to come. The Federal Reserve is acknowledging climate change and large financial institutions as well.
Banks’ investment exposure to climate risks
For banks, revealing information about their exposure to climate risks is both a challenge and an opportunity.
Reporting information about the bank’s exposure to climate risks makes it vulnerable to public criticism and reputation damage. But at the same time, it gives the bank an opportunity to demonstrate their trustworthiness and resilience. Trustworthiness and resilience are now competitive benefits to stakeholders. And stakeholders are scrutinizing banks’ investment and lending practices based on these factors.
Banks are risk-averse and concerned about stranded assets. The transition risks that will accompany the government’s efforts to crack down on emissions, and the risk of regulatory sanctions and litigation by outside parties.
In addition to minimizing exposure to environmental risks, banks are treating the E in ESG, as a business opportunity. Banks are looking to accelerate investment in renewables, or are investing in industries that are part of the low-carbon economy.
A proactive approach to investment banking sustainability
Banks provide the investment capital that drives every industry. Major climate crises lead to damage to assets and lost productivity. Understanding these risks is at the forefront of the banking industry’s drive behind ESG reporting.
The adoption of new investment frameworks
Banks are following financial reporting science and creating structure for investors to be able to compare information across regions. The IASB has built a framework to compare GAAP numbers which brings normalcy to markets and provides a uniform ranking structure to evaluate these things to determine the better investment.
Banks are also looking to various frameworks for guidance, including those recommended by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures. The International Integrated Reporting Council and the Sustainability Accounting Standards Board, which recently merged to form the Value Reporting Standards Board, are also providing guidance.
Banks are playing a leading role in driving the framework behind climate impact reporting. By setting industry-wide standards and best practices, banks are helping to establish a common framework for measuring and disclosing climate impacts, which is essential for driving progress on this important issue.
Investment banking sustainability and the materiality data gap
The data is not yet meeting the standard. Recently the EPA published a 200-page document suggesting changes to emissions calculation methods in an effort to improve the data they have on file.
There is a desperate need for accurate data on emissions and the data is not yet where it should be. This is another reason why banks are pushing for more structured data. Getting clear data to and from the EPA is one more piece of the framework puzzle that must be accounted for.
A major benefit of all of this reporting is increased investor confidence and improved company credibility. Investors feel confident in the level of transparency that ESG reporting provides them. It provides a window into how a companies actions reflect its ESG commitments.
Improved reporting has additional benefits of helping companies discover opportunities for risk management and business innovation. Forcing companies to look inward at improving their own processes so their ESG reports improve.
It also prevents “green-washing,” whereby companies pledge or try to be more sustainable, but are not actually sustainable. It’s often a cheap play for investors in the modern moment. More robust data means more investment banking sustainability, which means more people following along with best practices around ESG reporting. All this hopefully means a better climate and generally-better business practices in terms of impact on future generations.
Investment banking sustainability essentially “starts” with materiality
For those new to the world of ESG investing, materiality refers to those factors that are reasonably likely to impact the financial condition or operating performance of a company and therefore are most important to an investor. Consider:
Over the last 10 years, various meta-studies have empirically validated that ESG performance is correlated with financial performance. For example, one of the largest of these meta-studies combined the findings of more than 2,000 empirical studies, in which 90% showed either positive or neutral correlations between ESG factors and financial performance.
Also, the Center for Sustainable Business at NYU Stern and Rockefeller Asset Management found in their analysis that not only did ESG drive positive financial performance in 58% of cases (with 13% of cases showing neutral financial performance, 21% showing mixed performance, and 8% showing negative performance), but efforts to decarbonize business operations were also strongly correlated with financial performance.
This backs up our stance that understanding a company’s ESG maturity can help inform investors as to the future health of the company when climate considerations are accounted for.
Double materiality is the direct impact companies have on climate change. Banks are using the apples-to-apples frameworks they develop for reporting so a fair analysis can be done in order to make informed investment decisions. Banks want to understand how their investments impact the environment and how those impacts affect their investments. This is the understanding provided by Scope 1 emissions reporting.
Example: If a grocery store chain leaks 1,000 lbs of refrigerant into the environment, that will have a direct impact on the business. How? Leaking refrigerant increases the impacts of climate change, driving higher global temperatures. This will cause the grocery store chain to use more energy for refrigeration and force them to run longer duty cycles. Longer use and higher stress leads to increased maintenance and shorter equipment life.
As more companies report their Scope 1 emissions, it will become clear who the major contributors are, and that will cause investors to take action. Understanding a company’s refrigerant emissions is a good way to understand their environmental risk.
An example of real risk
A company has deferred maintenance and failed to invest in their infrastructure. It’s after January 1, 2025, when the new AIM Act GWP thresholds kick in for HVAC/R assets. The company is now in violation of the AIM Act and regulators come knocking.
Regulators find the company’s operational controls to be poor. The company is hit with a sizable fine and is forced to cease operations until it remedies the situation.
Question: Was this risk apparent to the investment institutions financing the company? Probably not. Suddenly, what the bank thought was a solid investment is now a risk to the entire portfolio.
Investment banking sustainability, or “how the bleeding doesn’t stop”
Continuing with the company in this example: the company’s assets are now tied up during legal action. This will result in a loss of revenue and production will lead to the stopping of overall operations. This would expose the financial institutions to credit risk, as it affects the company’s ability to repay its loans, earn revenue and generate profit.
Now the company represents a liability on their balance sheet. If it’s a big enough investment, investors may want to move away from the financial institution for one they deem to be less risky.
Additionally, financial institutions that lend to or invest in companies or projects with hidden risk in their operations may suffer reputational damage and risk losing new business opportunities. Customers may opt for financial institutions with a better reputation for sustainability, seeing how risky assets are impacting the institution’s overall performance.
Materiality gaps and workforce training concerns
There is another material consideration, the labor cost of implementing change. Changes to equipment mean there is a need to educate and train the workforce. Educating the HVAC/R workforce on these changes will be critical to maintaining compliance. Without understanding from the front-line workers what is being asked of them and why any compliance program is doomed. This is additional exposure for investors and banks.
Refrigerants and ESG Investing
Refrigerants present a unique challenge to disclosure reporting. What makes this pillar of ESG more complicated is that it is, in a word, data. It is extremely difficult to pull accurate information from maintenance records, which have historically been the source of truth for auditors: bad records, incomplete records, unclear assets lists, etc.
But, despite these challenges, some financial institutions are engaged in improving disclosure accuracy. The goal is to improve their ESG reports. Because understanding an investment’s refrigerant use and emissions is a window into their overall environmental impact. Refrigerants will increasingly come under the microscope, especially as we head into 2025.
The government, state, and international regulators aren’t slowing down with their Net-Zero commitments. So understanding the financial, legal, and environmental risks investments have when it comes to refrigerants will be key in companies surviving.
Some essential takeaways on investment banking sustainability and where we’re at now
Companies don’t want to contribute to a problem they have to pay for. By limiting their impact on the environment, the environment’s impact on their operations will be limited.
If a company goes belly up, banks are liable for financing something with a short survival window, and their concern becomes how to deal with not making back their investments.
Avoiding having assets on the books that shareholders would have negative feelings, concerns, or doubts about. Shareholders are well aware of the impact companies are having on the environment, and are choosing to invest in good actors, not bad apples.
In the end, it comes down to mitigating risk, ultimately having detailed data helps the banking industry make the decisions that will help them maintain the integrity of their investments.
Better tracking and more accurate reporting build trust. Trust is critical to strengthening relationships. We see it as finance is the bottom line, and environmental material reporting is the top line.
How Trakref (that’s us) can help you out
Trakref is a future-ready resource for compliance and sustainability. Our rules engine is constantly evolving with federal, state, and European regulations and guidelines around refrigerant tracking and management. Trakref is not only for staying in compliance and keeping records. Trakref allows your company to truly understand its impact on the environment from one comprehensive data source.
Most importantly at our core, we are a tier 1 asset resource. This means that we manage our workforce, data collection, and rules engine systems carefully to account for materiality, and double materiality. We are not a one size fits all solution hoping to solve all problems. Our highly focused mature process for refrigerant tracking means you can obtain the investor-grade data that you need for your F-gas container cooling assets.
Trakref provides investor-grade data about refrigerants. We are an important piece of the ESG reporting puzzle. Sustainable finance is the future. Banks will continue to prioritize risk management and prioritize climate-related risks.
Feel free to reach out for any help today.
Managing and developing ESG and EHS content for Trakref since early 2023.