One of the challenges in constructing an approach to evaluating the ESG profile and potential positive impact of investment opportunities is balancing the varied perspectives on issues that clients bring to the topic. As discussed elsewhere, the SNW Impact Strategy has been built on a pragmatic approach to the evaluation of impact with the intent to identify and invest in those opportunities that have the best potential for positive social or environmental outcomes while still achieving at least a market rate of return. The results of this approach, however, still spark discussion with clients about the suitability of particular credits for inclusion in the strategy.
A recent example of this has been a broad discussion about the suitability of "big banks" as impact investments. This area of discussion is driven, in large part, by concerns about the behavior of financial institutions both pre- and post-recession. In 2011 the U.S. Financial Crisis Inquiry Commission reported that the financial crisis of 2008 was "avoidable and was caused by: widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages; dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; an explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels." Recent scandals involving Wells Fargo have highlighted that problematic practices still exist at the nation's largest financial institutions.
In addition to issues such as these, the financing activities undertaken by banks expose the industry to controversy. Predatory lending practices have long been of concern to investors and have been included in methodologies for evaluating the ESG practices of banks for at least the past two decades. Banks’ support for projects with significant environmental profiles have been under increasing scrutiny. Fossil fuel projects, including infrastructure and development projects, have become of critical concern for engaged investors–particularly since 2008, with the emergence of 350.org as an organizing catalyst. In recent years, banks have faced mounting pressure to address the issue of environmental impact, including climate change related outcomes, in their policies and practices related to project finance. Calls for the boycott of banks financing the Keystone XL and Dakota Access pipelines have received a great deal of attention, with the latter project resulting in notable divestment actions.
Understandably, investors may look at banks today in a much different light than they may have a decade ago.
In response to recent client inquiries, SNW has begun the process of re-evaluating the banking and financial services industry for activities that would be deemed antithetical to the intent of the SNW Impact Strategy’s goal of supporting positive impact for client portfolios. This process is an adjunct to the supplemental review step that is an integral component of our overall rating process.
In the case of banking and financial services firms, this is an extension of the corporate issuer ratings process. Using data provided by external data vendors and supplemented by internal research, corporate issuers of debt are evaluated on four discrete axes: community & politics, human rights, environment, and workforce. All companies in the Russell 1000 index are evaluated through this process, with a company's performance on these elements being comparatively rated to other companies in the same industry. The end result of this process is the generation of a rating for each company.
At its foundation, our approach is a ‘best in class’ evaluation of ESG and impact performance characteristics of the companies being rated. As is true with all ‘best in class’ evaluation methodologies, companies from all industries are included in the original set of eligible companies. The SNW Impact Strategy automatically excludes from eligibility issuers of corporate debt with the following characteristics:
- Tobacco or tobacco product manufacturer
- Involvement in the production of nuclear, biological, or chemical weapons
- Involvement in the production of cluster munitions
- Utility companies whose energy production portfolio includes production sources equal to or greater than 50% of total output that use coal, heavy oil, and/or nuclear energy inputs
- Involvement in the production of GMO seeds or organisms
- Involvement in human rights issues/controversies that indicate a recurring disregard for commonly accepted standards of conduct
- Involvement in environmental issues that indicate a recurring disregard for commonly accepted standards of conduct
- Involvement in industries with significant negative environmental impacts
- Involvement in investment or financing activities that pose serious reputational risk due to environmental or human rights concerns
The last three listed criteria are of particular concern during the re-evaluation process of the banking and financial services industry. Defining each of these elements and determining what behavior rises to the level of exclusion is a challenge. A de minimus involvement screen does not seem to be a reasonable method for triggering an exclusion from portfolio eligibility. Rather, a holistic evaluation of the bank’s activities seems to be in order, and this more appropriate approach is the one being taken.
Bank of America is the second largest bank in the United States, with total assets of over $2.15 trillion, more than the total assets of the banks ranked #5 - #10 combined. Due to this, the activities of the bank are of considerable note and actions and policies undertaken by Bank of America resonate throughout the entire U.S. banking industry. Bank of America is also the parent company of Merrill Lynch, a wealth management firm employing over 15,000 financial advisors and managing over $2.2 trillion in client assets. In addition, U.S. Trust is a subsidiary of the bank, accounting for over $390 billion in assets under management. Bank of America’s Global Wealth and Investment Management division, the umbrella under which both Merrill Lynch and U.S. Trust operate, has been a signatory to the United Nations-supported Principles for Responsible Investment since 2014.
When evaluated for suitability for inclusion in the SNW Impact Strategy under the ratings process for corporate issuers, Bank of America qualifies with a rating of four stars, placing the company in the top 15% of the evaluated issuers in this category. Bank of America ranks in the middle of the pack on the community & politics as well as the human rights axes, but ranks very high on the environment (#2 in industry) and on workforce (#1 in industry). As a result of this evaluation, credits issued by Bank of America are eligible for inclusion in the SNW Impact Strategy’s General Impact Overlay as well as the Environmental Issues Focus.
In early 2015, Bank of America made a commitment to begin lessening its exposure to the coal industry. This included the adoption of an official Bank of America Coal Policy that “recognizes that climate change poses a significant risk to our business, our clients, and the communities in which we operate.” This policy aligns with the bank’s Environmental and Social Risk Policy Framework, adopted in 2016, which states, “As one of the world’s largest financial institutions, Bank of America has a responsibility to help mitigate climate change by using our expertise and resources, as well as our scale, to help accelerate the transition from a high-carbon to a low-carbon society. As a financial institution, we have a critical role to play in helping to provide capital for renewable energy, energy efficiency and other low-carbon related financing.”
Beyond such policy statements, Bank of America has made public commitments to improve its performance on issues related to the environment. In September, 2016 the bank committed to carbon neutrality and the use of 100% renewable electricity by 2020. Bank of America joined RE100, a part of the We Mean Business Take Action campaign led by a partnership between CDP and The Climate Group. The bank also committed, by 2020, to reducing location-based greenhouse gas (GHG) emissions by 50 percent, energy use by 40 percent, and water use by 45 percent in its operations across the globe.
In addition to internal actions such as these, the bank has made a clear commitment to supporting and financing projects that have positive environmental outcomes. Bank of America has provided over $62 billion since 2007 to finance low-carbon and sustainable business activities. In 2012, the bank committed to providing an additional $125 billion in capital by 2025, along with significant intellectual capital, to support businesses and projects addressing climate change and other environmental issues. In 2015 alone, the company provided $14.5 billion in financing for renewable energy, energy efficiency, low-carbon, municipal sustainability, and other similar green projects.
Another way in which Bank of America is supporting environmentally positive projects is through its underwriting activities. As the top underwriter of municipal bonds in the United States for the past five years, Bank of America Merrill Lynch (BAML) has an outsized ability to support the financing of projects with positive environmental profiles. The bank is a major funder of the Climate Bonds Initiative and a member of the Green Bond Principles. In 2015, the bank was the largest underwriter of green bonds, with over $4.5 billion in bonds originating through its service. The bank accounted for almost 30% of such debt issued in the United States and also supported similar issuances in Europe, Canada, Mexico, and Asia. Through the end of the 3rd quarter of 2016 (the last quarter for which data has been made available) the bank continued to hold its position as the leader in this field.
These activities, as well as other aspects of the bank’s policies and programs, help to explain why the company received a positive impact rating. In its industry the bank is a leader in many areas, particularly areas related to the environment, climate change, and sustainability.
The company, however, is not immune to criticism from investors regarding its history of financing problematic projects and its continued provision of financing support to the fossil-fuel, extractive, and energy industries. The company has been identified by activist organizations as one of the banks financing the Dakota Access Pipeline. Of the roughly $3.8 billion that has been borrowed to construct the pipeline, at least $350 million of financing has been provided by Bank of America. The bank has also been identified as the sales agent for the Bowen Basin coking coal mines owned by Rio Tinto. Other similar projects are still active for the bank.
These projects, however, account for a minimal part of the company’s outstanding book of business. They appear to be the exception, rather than the rule, and recently adopted policies by the bank are indicative of a change in the bank’s willingness to finance such environmentally unsound projects. When placed in the context of the broader positive activities of the bank, it has been determined that they do not warrant barring credits issued by the company from inclusion in the SNW Impact Strategy.
Over the upcoming months we will continue to review issuers of corporate debt in the banking and financial services industry. As these reviews conclude, we will communicate to our clients any exclusions that emerge.
The above determination regarding Bank of America may diverge from the analyses of some committed investors. We understand that this may be the case. Balancing the perspectives of all clients is challenging, which is why we provide options for those clients who may choose to exclude financial services firms such as Bank of America from their portfolio. Please feel free to contact Client Service via email at email@example.com or by phone at 866.769.2773.
Source: Climate Bonds Initiative