Friday, October 2, 2009

Financial Service Sector and Sustainability

Dan Fogel

April 13, 2009

To be published in Lazslo, Chris, et al. (eds) (2009). Encyclopedia of sustainability, Volume 2: The business of sustainability. Great Barrington, MA: Berkshire Publishing Company.

The financial services industry has a vast reach across various industries. Its impacts on the environment are primarily related to its carbon footprint and its reach through loans and its financial standard setting in other industries. Despite this vast impact, the industry has done surprisingly little to decrease its environmental footprint. This lack of action can be explained by a confusing set of standards and measurements, current industry turmoil, and a lack of incentives. Actions are possible and likely in the future. The most important actions are to exercise the precautionary principle including defined environmental sustainability standards, collective action, and environmental requirements for investor decisions.

The financial services industry is a vast combination of various types of companies, spanning insurance, commercial banking, investment firms and asset management. For the purpose of our analysis of the industry’s approach to sustainability, the Global Reporting Initiative (Global Reporting Guidelines and Financial Sector Supplement, 2009) divides the industry into four segments, helpful for our discussion:

Retail Banking: Everyday banking that includes the provision of private and commercial banking services to individuals. This category includes banking for more affluent clients, including wealth management and portfolio management services. Also, retail banking covers other services to individuals such as transaction management, payroll management, small loans, foreign exchange services, derivatives and similar types of instruments.

Commercial and Corporate Banking: All transactions for organizations and businesses of all sizes, including commercial and corporate banking, project and structured finance, transactions with and medium sized enterprise and the provision of financial services to government and government departments. Services include advisory services, mergers and acquisitions, equity/debt capital market services, and leveraged finance.

Asset Management: Management of pools of capital on behalf of third parties invested in a wide range of asset classes, including equities, bonds, cash, property, international equities, and private hedge funds. This category includes investment banking with trading in shares and share derivatives, fixed income trading and trading of credit derivatives.

Insurance: Pension and life insurance services provided directly or through independent financial advisors to the general public and company employees. This category includes insurance products or services for businesses and individuals and re-insurance services.

Some financial services organizations try to be full service, usually referred to as universal banks. Others attempt to specialize, such as investment banks and hedge funds. Regulations enacted in every country control what organizations can and cannot do in terms of providing financial services. Yet, regardless of the restrictions, this vast industry has a major impact on economies. For example, in 2008 U.S. commercial banking revenues, as one sector of financial services, was estimated to be $695 Billion. (IBIS World Industry Reports, 2008)

From a period of September 2008 through the present the world has witnessed massive subsidies given to financial services organizations, including mandated provision of funds to U.S. banks under the Troubled Asset Relief Program.[i] Any commentary on financial services cannot ignore the tremendous power these organizations have on the world economies, as witnessed by their primary role in the various government bailouts during the current economic recession (United States Government Accounting Office, 2009). The current crisis is clearly a collective failure of financial markets as well as of government policies and financial sector regulation and supervision.

One organization’s bailout is particularly noteworthy, that of AIG. The U.S. Department of Treasury rescued AIG in September 2008 with an $85 billion credit line when investment losses and collateral demands from banks threatened to send the firm into bankruptcy court. A bankruptcy filing would have caused losses and problems for financial institutions and policyholders globally that were relying on AIG to insure them against losses. Since September 2008, the government has had to extend more aid to AIG as its woes had deepened; the rescue package had swelled to more than $173 billion by March 2009.

Banks and other financial companies were trading partners of AIG's financial-products unit, which operated more like a Wall Street trading firm than a conservative insurer. This AIG unit sold credit-default swaps, which acted like insurance on complex securities backed by mortgages. When the securities plunged in value in 2008, AIG was forced to post billions of dollars in collateral to counterparties to back up its promises to insure them against losses. The government's rescue of AIG helped prevent its counterparties from incurring immediate losses on mortgage-backed securities and other assets they had insured through AIG.

The concern has been that if AIG defaulted, banks that made use of the insurer's business to reduce their regulatory capital, most of which were headquartered in Europe, would have been forced to bring $300 billion of assets back onto their balance sheets. This amount was larger than the GDPs of Finland, Ireland, or South Africa.

The beneficiaries of the government's bailout of American International Group Inc. included at least two dozen U.S. and foreign financial institutions that have been paid roughly $50 billion since the Federal Reserve first extended aid to the insurance giant.[ii] The AIG bailout has become a political hot potato as many said that it was “too big or interconnected to fail.” Amazingly, the US Treasury holds 77.9% convertible-equity interest in AIG.[iii]

This one story is a poster child for the difficulties this industry has faced. It also illustrates the tremendous power this industry sector has over world economies.

The purpose here is to outline the environmental sustainability practices that financial services companies are making in light of this economic turmoil. The industry has a tremendous impact on organizations, influencing personal wealth, access to education through loans, community viability, and even the ability of governments to implement policies. This industry must have a major role to improve the environment given its size and its tremendous leverage on world economies. These influences are magnified when loans are not available to fund innovations for decreasing a business’s environmental footprint. The following shows what is being done in the financial services industry related to environmental sustainability and the challenges the industry sector has going forward.
Sustainable Practices and Innovations in Financial Services

Many different discourses occur around sustainability making the definition difficult and the identification of corporate practices equally difficult (Dryzek, 2006; Gray, 2006). Ullman’s observation (1985), one of the first to analyze sustainability in financial services, concludes that social reporting, in general, is a confused state of varied theories, concepts, and inconsistent functional terms. Others have come to similar conclusions (Bouma, Jeucken, Klinkers, 2001; Wagner, 2001; Gray, 2006). More recent data and improved theory show a weak relationship between environmental performance and disclosure (McCammon, 1995; Michalik, 2001; Patten, 2002a; Patten, 2002b; Al-Tuwaijri, Christensen, and Hughes III, 2004). The relationship between market performance and social disclosure is far from conclusive, however (see Gray, 2006 for a review of this literature).

Thus, when we discuss the financial services’ industry performance as related to environmental sustainability we should keep in mind the confused state of definitions, of relationships, and lack of incentives to invest in socially responsible activities. We cannot conclude that the industry is not interested or unwilling. We can conclude that the investment targets are from clear. We can conclude that the more data that point to the industry’s actual or perceived environmental impacts the more corporate action will change. The demonstrable impacts will influence organizational reputation, perceived management competence, and risk management (Orlitsky and Benjamin, 2001). In light of this confusion around theory and measurement, we can point to some directions that the industry is taking.

One way to phrase these discourses is to compare and contrast definitions of sustainability as the politics of constraint versus the politics of the possible (Nordhaus and Shellenberger, 2007; Springett, 2003).

Environmentalism offered something profoundly important to America and the world. It inspired an appreciation for, and an awe of the beauty and majesty of, the nonhuman world. It focused our attention…but environmentalism has also saddled us with the albatross we call the politics of limits, which seeks to constrain human ambition, aspiration, and power rather than unleash and direct them (Nordhaus and Shellenberger, 2007, p. 17).

The politics of constraint expect certain actions to be taken that limit our use of resources and focus our attention on humans as the main cause of environmental degradation. Preservation, conservation and a more radical “limits to growth” approach refer to a massive need to survive (Meadows, Randers and Meadows, 2004). Environmental groups combat the impacts of business organizations on our society, such as those in the financial services, creating an adversarial role among the various societal stakeholders. This type of discourse defines sustainability as preserving at least what we have today without further deterioration in our economy, our environment, and our society, a classic reference to the Brundtland Commission’s commentary on sustainable development (United Nations 1983; United Nations World Commission on Environment and Development, 1987).

This discourse contrasts with the rhetoric of ecological modernization and the green parties across the world. These other approaches emphasize positive actions that balance a triple bottom line approach, i.e., a balance of outcomes in light of inevitable growth our world faces. It approaches the issues of sustainability as cooperative effort that supports human growth with innovation and new approaches to intractable problems. Extreme aspects of this discourse have been advocated by eco-feminists or eco-spiritualists (Dryzek, 2005).

These two discourses or lens on the financial services industry define most approaches that have been taken to address environmental sustainability. Regardless of the approach the industry takes on environmental sustainability, both approaches lead one to conclude that the precautionary principle is the prudent course of action. This principle specifies that regardless of the state of knowledge about environmental sustainability, we should act as if we need dramatic actions to offset the ill effects of environmental degradation (Gollier, Jullien, and Treich, 2000). This principle demands that financial services organizations take deliberate actions to offset carbon emissions and act in a manner that increases beneficial outcomes for our environment.

I focus here on environmental sustainability as defined as actions to meet the needs of the present without compromising the ability of future generations to meet their own needs.

Before proceeding, however, we must note that the discourse around sustainability is matched by a discourse on risk and the financial services industry. Many commentators on the recent financial turmoil point to the psychological impacts of people on financial markets. These impacts stem from citizens’ insecurity about investments, the lack of trust of corporate managers and the desire to have governments punish corporations for losing money, despite the fact that investing comes with risks and rewards. Thus, the focus on sustainability and whether or not the industry follows the politics of constraints or the politics of the possible may be influenced by society’s view of the financial services industry.

What Financial Services Organizations Are Doing

The impact of the financial services sector on society and the environment derives mostly from the capital it employs – from financing infrastructure projects in developing nations to providing loans to businesses – with effects that can change the risk profiles of borrowers and lenders (PriceWaterhouseCoopers, 2009). The industry has a large built environment, as evidenced by branches of banks, large office towers and a tremendous energy infrastructure to support trading and communication related to all sorts of markets and information exchange.

The industry faces, and has faced, a myriad of challenges and opportunities to impact environmental sustainability (United Nations Environmental Program, 1992; United States Government Accounting Office, 2009). If one were to take a broad view of sustainability as including environment and society, some of the major issues that financial services organizations face are brand and reputation management; environmental and social impacts of project financing; accessibility to services for under-served markets;[iv] environmental and social risk management in lending climate change and the impact on borrowers, insurers, financial markets; socially responsible investment, lending and marketing; compliance with regulatory requirements; and, the environmental footprint of facilities.

Some authors state that financial services organizations have a financial motivation to integrate sustainability into business, mostly those organizations in Europe (Cortazar, Schwartz and Salinas, 1998; Klassen and McLaughlin, 1996; Russo and Fouts, 1997). Weber (2005) shows sustainability that is integrated into the banking business is motivated by personal concern and philosophical backgrounds such as anthroposophy or missions of public bank owners. These strategies lead to new sustainable products, such as venture capital funds (Randjelovic, O’Rourke and Orsato, 2003), micro credit funds or green mortgages, all of which are needed to foster sustainable development (Siddiqul and Newman, 2001; Yunus, 2003; Bornstein, 2007; Elkington and Hartigan, 2008;). Also, Weber (2005) found that financial institutions use five approaches (he calls them models) for successful integration of sustainability into the banking business: event related integration of sustainability, sustainability as a new banking strategy, sustainability as a value driver, sustainability as a public mission and sustainability as a requirement of clients. This would have been one way to organize the material in this chapter.

Yet, I’ll discuss several of these challenges under two headings: climate change initiatives including those related to operations and the built environment, and environmental impact investing, including socially responsible investing and markets. I chose this organizing structure because these two areas have the largest data base for discussion and are two of the most important areas for a discussion in environmental sustainability. I will review these areas through the two lens discussed earlier in this chapter, the perspective of constraints and the perspective of possibilities.

Climate Change Initiatives

The shift to a low-carbon economy is already under way and businesses are finding that they must get ready for it, especially energy, transport and heavy manufacturers. Financial services are not immune from a need to respond despite their relatively low emission as they conduct their work..

Changes in the global climate system during the 21st century are projected to have dramatic impacts on our world, including temperature increases, sea level rises, dramatic precipitation and humidity changes, extreme wind and rain storms and related events (Sussman and Freed, 2008, p. 5).[v]

If current climate science holds true, and we take the average predictions, global greenhouse gas emission should ideally decrease from today’s levels by 90 percent as of 2050 to contain global warming below two degrees centigrade (United Nations, 2007). To reach this goal, the economy’s carbon productivity would have to increase by 5 to 7 percent a year, compared to a historic rate of just 1 percent.[vi] This prescription decouples economic growth from emission growth (Enkvist, Nauclér, and Oppenheim, 2008).

Humanity already possesses the fundamental scientific, technical, and industrial know-how to solve the carbon and climate problem for the next half-century, then we would expect that the financial services industry has at its disposal a portfolio of technologies to meet the climate challenges we face (United Nations, 2007). Pacala and Socolow (2004) propose a means of reaching a flat trajectory of fossil fuel emissions through activities that reduce emissions to the atmosphere. These activities include technologies and lifestyle changes necessary to reach a stabilized emissions outcome through efficiency and conservation, de-carbonization of electricity and fuels, and natural sinks. The financial services industry, unlike many industries, has shown surprisingly little evidence of activity in these areas. Some businesses take voluntary reductions in emissions, signing protocols such as the American College and University President’s Climate Commitment (2009). Buying carbon credits, buying new technologies, and changing product designs are other carbon mitigation strategies. Few of these strategies are evident in the financial services industry (Hoffman, 2001; Hoffman, 2006). [vii]
Swiss Re (2009) was one of the first companies in the financial services industry to announce that it would eliminate or compensate for all of its GHG-emission, with a goal of becoming carbon neutral by 2013. Swiss Re believed that reductions in global greenhouse gas emissions could be achieved through energy efficiency measures and by purchasing high-value emission certificates. It claimed to have reduced its own CO2 emissions by more than 25% from 2003 to 2007 and offset the remaining emissions through certified emission reduction certificates, claiming to be a greenhouse gas neutral company since October 2003.

It is a reinsurance company, having products by which an insurance company can protect itself with other insurance companies against the risk of losses. Individuals and corporations obtain insurance policies to provide protection for various risks (hurricanes, earthquakes, lawsuits, collisions, sickness and death, etc.). Reinsurers, in turn, provide insurance to insurance companies.
Swiss Re is a classic example of using the precautionary principle. Swiss Re CEO Jacques Aigrain stated “in the distribution of possible future outcomes of global warming, there is a significant tail representing very serious consequences. It is the prudent approach – a common practice in insurance and issues of financial stability – which requires us to take action today to mitigate global warming and to adapt to its consequences.” (SwissRe, 2009).

The industry varies whether or not climate change is significant (Knecht, 1997; Gibbs, 2007). In a recent survey, Charles Schwab replied “N/A” to the question about physical risk of climate change, while Lehman Brothers stated “physical risks pose a threat to the operations of all financial services firms and therefore the financial markets overall.” (Sussman and Freed, 2008, p. 10). Travelers, one of the largest providers of personal and commercial property and casualty insurance products in the United States, has taken several notable actions such as extensive risk modeling that includes climate change as a major risk factor, offering risk control services, and engaging in extensive community and government outreach to create greater awareness of this risk category.

newresourcebank in the Bay area in the United States offers extensive green resources (newresource bank, 2009). Some other efforts are Lloyd’s Banking Group’s sponsorship of the Corporate Leaders Group on Climate Change – part of the Prince of Wales’s Business and the Environment Program (2009), which is a collective business initiative to think about, challenge and debate issues of corporate sustainability.

The financial services sector shows very little evidence of creating a positive impact on our environmental sustainability. This industry sector, unlike several others, does not have any coordinated effort to mitigate climate changes impacts, does not seem to have a systematic focus on climate change, and does not seem to put environmental sustainability at the forefront of its organizational strategies. Yet, some progress has been made with its focus on environmentally focused investing, the subject of the next section.

Environmentally Focused Investing

One place where the politics of possibility takes concrete form is at the intersection of investment and innovation. For example, financial services organizations have modeled some of their investment strategies not on pollution control efforts but rather on past investments in infrastructure such as railroads, highways, and innovative solutions for new businesses.

The financial sector began taking environmental risk into consideration by optimizing its internal environmental performance (Weber, 2005). There were two main reasons for this. First, banks wanted to decrease costs by reducing their use of energy, water and material (McCammon, 1995). Second, they wanted to show their clients that ‘it pays to be green’. As a next step, environmental risk management processes were introduced into credit management. There were some losses in the credit business caused by environmental risks that justified environmental risk management measures in the credit business (Scholz, Weber, Stünzi, Ohlenrith and Reuter,1995; Coulson and Monks, 1999; Sharma and Ruud, 2003).

At the same time, banks regarded the increase in environmental attitudes in society as a business opportunity. They subsequently created specialized credit products and mortgages as well as ‘green’ or socially responsible funds, which invest in environmentally friendly or sustainable firms (Schmidheiny and Zorraquin, 1996; Jeucken, 2001; Schaltegger and Figge, 2000; Schaltegger and Figge, 2001).

However, it has become increasingly difficult to ascertain which kinds of measures or product labeled ‘green’, ‘socially responsible’ or ‘sustainable’ have which kind of effect, both on banks and on sustainable development (Knecht, 1997; Russo and Fouts, 1997; Coulson and Monks, 1999; Repetto and Austin, 1999; Louche, 2001; Stigson, 2001; Melnyk, Sroufe, and Calantone, 2003;). Furthermore, it is difficult to determine which banks and financial institutions are the ‘sustainability leaders’ in their sector.

One way the financial services industry has influenced sustainability efforts has been through the publication of information about companies’ climate change efforts. These publications were mainly aimed at investors. Europeans had been first to conduct this information exchange, such as Europe’s utility sector sponsoring a publication with several new variables that made it possible to measure carbon emission against production and revenues. Goldman Sachs Energy Environmental and Social Index is a US example of such a publication (Pew Center for Global Climate Change, 2004). The Goldman Sachs Energy Environmental and Social (GSEES) Index is based on an analysis of 30 environmental and social metrics in eight categories.

The Carbon Disclosure Project is a more ambitious effort. The Carbon Disclosure Project (CDP) is an independent not-for-profit organization which holds the largest database of corporate climate change information in the world (Carbon Disclosure Project, 2009). It is an organization based in the United Kingdom which works with shareholders and corporations to disclose greenhouse gas emissions of major corporations. The Carbon Disclosure Project includes a group representing institutional investors that manages $10 trillion in assets, sent questionnaires to 500 of the world’s largest companies (mainly companies within the airline, automobile, manufacturers, insurers, power generators, retailers, steelmakers, and technology) asking them to explain their emissions policies and strategies. The project published the results for investors to note in their future investment decisions (Carbon Disclosure Project, 2009).

The data are obtained from responses to CDP’s annual Information Requests, issued on behalf of institutional investors, purchasing organizations and government bodies. Since its formation in 2000, CDP has become a major standard for carbon disclosure methodology and process, providing primary climate change data to the global market place.

Institutional investors (banks, pension funds, insurance companies, etc) who signed CDP’s Information Requests are known as ‘Signatory Investors’. CDP currently has 475 Signatory Investors, including global investment/finance houses such as Banco do Brasil, Barclays, HSBC, Goldman Sachs, Merrill Lynch & Co., Inc, Mitsubishi UFJ, Morgan Stanley, National Australia Bank, Nedbank and Sumitomo Mitsui Financial Group. Of the signatory investors interviewed for a CDP study approximately 60% methodically identified which companies in their portfolio were either not responding to CDP, or were providing poor or trivial answers (Riddell and Chamberlin, 2008). The investors then used this information to further engage with these companies on the issue of climate risk. Twenty-six percent then went on to support shareholder resolutions for better disclosure on climate risk from some companies not complying with CDP disclosure.

Of the signatory investors interviewed, 13% encouraged their investment bankers to use CDP data when making new lending decisions. One pension fund identified their inclusion of climate risk evaluation criteria in their request for proposals (RFP’s) to fund managers, citing that those fund managers who were able to demonstrate their signatory status to CDP were more likely to be awarded the contract. 100% of the investors interviewed agreed that the CDP data is a valuable resource and incorporated it into their decision-making process at some level (CD Project, 2009).

As corporations create internal infrastructure to better understand GHG emissions accounting, the quality of data is expected to improve. Reviewing the CDP responses over the past five years alone is evidence that corporations are listening to their investors and responding to the threat of climate change.

Calvert, a socially responsible investment company, demonstrated particularly progressive use of CDP data conducting the following best practices:

• A qualitative analysis using CDP data to evaluate companies on a sector by sector basis. The utility sector is the main target, but additional areas of focus lie on the Oil & Gas, Auto, Financial, Insurance and Manufacturing sectors

• Calvert specifically looks for a company’s public policy outlook, mitigation strategies, trajectory information, management opportunities and the level of qualitative information provided in a company’s response

• The information provided via CDP provides a platform for leaders and laggards, which is then incorporated into the decision making process Calvert follows to invest in well managed corporations

• Calvert engages non-responding corporations, which in some cases leads to shareholder resolutions and in others a change in response status to the CDP (Carbon Disclosure Project, 2009).
Other efforts that involved the financial services industries was the formation of the Equator Principles, a financial industry benchmark for determining, assessing and managing social & environmental risk in project financing (Equator Principles, 2009).

Another comprehensive project has been the The United Nations Environment Programme Finance Initiative (United Nations EPFI, 2002), a global network of signatories and partner organizations across the banking, insurance and investment communities that focus on the latest developments and emerging issues on finance and sustainability during these challenging and changing times. UNEP FI works closely with over 170 financial institutions who are signatories to the UNEP FI Statements, and a range of partner organizations to develop and promote linkages between the environment, sustainability and financial performance (See Figure 1).

Figure 1: Signatories by Region and Category to the UNEP Financial Initiative
Source: United Nations Finance Initiative (2009), Signatories to UNEP Finance Initiatives Statements.

Through regional activities, a comprehensive work program, training programs and research, UNEP FI carries out its mission to identify, promote, and realize the adoption of best environmental and sustainability practice at all levels of financial institution operations.
In the United States, the Coalition for Environmentally Responsible Economies (CERES, 2009) (pronounced “series”) is a national network of investors, environmental organizations and other public interest groups working with companies and investors to address sustainability challenges such as global climate change. Its mission is to integrate sustainability into capital markets for the health of the planet and its people. CERES launched and directs the Investor Network on Climate Risk (INCR, 2009), a group of more than 70 leading institutional investors with collective assets of more than $7 trillion. Another effort is the Institutional Investors Group on Climate Change (IIGCC, 2009), a forum for collaboration between pension funds and other institutional investors on issues related to climate change. They seek to promote better understanding of the implications of climate change amongst our members and other institutional investors and encourage companies and markets in which IIGCC members invest to address any material risks and opportunities to their businesses associated with climate change and a shift to a lower carbon economy.
Swiss Re (1994) was ahead of the curve with its publication on climate change in 1994. Swiss Re sought to bring climate change into policy and investment decisions. Swiss Re recognized that it is more at risk from the physical impacts of climate change than many organizations. The insurance industry, in general, could experience dramatically increased costs due to growth of climate-related effects, including growth in natural disasters, disease, and mortality rates over the next ten years (UNEPFI, 2002). In 2004, for example, the industry recorded around $40 billion weather-related natural catastrophe losses, the largest amount in recorded history.

Swiss Re asset management started to build a Sustainability Portfolio comprised of investment that supports sustainable development and efficient resource utilization. In 1996, Swiss Re started building up a sustainability portfolio of investments in companies supporting sustainable development, with particular emphasis on efficient resource utilisation. The target investment universe focuses primarily on alternative energy, water and waste management, and recycling. Investment clusters range from infrastructure/project finance-type investments to ”Cleantech” venture capital. In 2006, the portfolio value grew substantially to CHF 376 million. In April 2007, Swiss Re announced the successful close of the EUR 329 million European Clean Energy Fund, one of the largest funds of this type in Europe (Swiss Re, 2007). The Fund, a UN accredited investment vehicle, provides capital to European clean energy projects, which are environmentally beneficial, generate carbon credits or tradable renewable energy certificates. Swiss Re was the anchor investor in the Fund and acts as carbon advisor for the selected projects (Swiss Re, 2007).[viii]

Other insurance companies have followed Swiss Re’s lead: Most insurance companies have been developing more accurate underwriting tools, such as catastrophe models, to establish appropriate exposure-based rates for insurance.

Some financial services companies linked existing products to environmental sustainability including complementary product offerings and emissions offsets (van Bellegem, 2001). For example, GE’s Money Earth Rewards Platinum MasterCard links purchases with offset products, similar to British Petroleum’s Global Choice Program (Deutsch, 2007). Barclay’s (2009) offers the Barclaycard Breathe, from which .05 percent of what clients spend on the card goes to Pure, the Clean Planet Trust to fund government approved environmental project.

One small but interesting innovation is in Japan (Japan for Sustainability, 2009). Three popular Japanese musicians, Takeshi Kobayashi, Kazutoshi Sakurai and Ryuichi Sakamoto, established a bank in Japan, known as the AP Bank Co., (AP standing for "Artist's Power" and "alternative power.") to provide low-interest financing for activities related to renewable energy, energy conservation and environmental protection. In 2001 Sakamoto launched Artists' Power to mobilize the influence of musicians to promote renewable energy sources. About 30 people got together to learn about environmental issues through a series of study sessions. In the process, they learned about the Mirai Bank (Future Bank), launched and headed by environmental activist and writer Yu Tanaka. The Mirai Bank accepted funds invested by citizens and offers low-interest loans for environmental projects or citizen-based activities that the bank wants to encourage. Inspired by the Mirai Bank, Kobayashi and Sakurai decided to establish a bank of their own.[ix]

Merrill Lynch (2009) is an interesting case in point of an organization that has taken bold moves despite its difficulties. As a provider of capital, they facilitated financing for renewable and clean energy investments. They claim that as a proprietary investor, they promoted investments in renewable and clean technologies; as a global wealth manager, they provide solutions to integrate environmental investing into client portfolios; and through global research, they publish reports which highlight the risks and opportunities associated with the renewable and clean energy industry.

In the financing for Ulu Masen Ecosystem in Aceh, Indonesia, Merrill Lynch, in partnership with Carbon Conservation (working on behalf of the governor of Aceh), came up with a deal that provides carbon financing for the world’s first independently validated avoided deforestation project, which is compliant with the Community, Climate, Biodiversity Alliance (CCBA) standard (The Climate Community and Biodiversity Alliance, 2009).[x] It may not be the first avoided deforestation scheme, but it was one of the first to harness the power of an international investment bank and to link environmental benefits with companies’ product offerings.[xi]

Merrill is using credits to create packaged products for institutional clients who want to offer ethical products to their retail customers. For example, a power company that wishes to offer a carbon-neutral electricity tariff, or an airline offering carbon-neutral flights, or a car manufacturer who wants to carbon-neutralize its cars, would use Merrill’s products.

“Companies compete on technology, on labour costs and on supply chains, and sustainability has become another competitive dimension. From that standpoint, the need to demonstrate a clear strategy and a strong performance in climate change efforts is [sic] critical to corporate stakeholders,” Abyd Karmali, global head of carbon emissions at Merrill, said.[xii]

Wells Fargo & Company (2008) said it had provided more than $3 billion in environmental financing, surpassing its goal to provide $1 billion in environmental finance commitments - two years ahead of schedule. Wells Fargo environmental financing included:

Green buildings - Wells Fargo provided $2 billion in financing for building projects designed to meet U.S. Green Building Council's Leadership in Energy and Environmental Design (LEED) certification requirements, including: energy and water efficiency; on-site renewable energy; resource conservation measures; and improved indoor air quality.
Renewable energy - Wells Fargo invested and committed more than $700 million to support solar and wind projects nationwide. Combined these projects are expected to generate enough clean, renewable energy to power about 475,000 households.
Green businesses - Wells Fargo provided $500 million to support customers who have made environmental sustainability a key part of their missions, including companies focused on renewable energy, energy efficiency, sustainable agriculture and forestry, and resource management.
Community development - Wells Fargo provided $50 million to support nonprofit organizations that improve the environment in low- to moderate-income communities.
Wells Fargo’s $1 billion lending target was part of its 10-point environmental commitment aimed at helping to integrate environmental responsibility into its business practices (CSWIRE, 2006).
Hewlett-Packard, PepsiCo, Procter & Gamble and eight other global companies will measure their supply chain emissions as part of efforts to reduce greenhouse gases and to inform investors of their carbon footprint. The data will be fed to banks and funds, such as Goldman Sachs, Merrill Lynch and HSBC Holdings, to help guide their lending and investment decisions (Morales, 2008).

Morgan Stanley (2009) partnered with Det Norske Veritas (DNV) to launch a Carbon Bank. HSBC developed the Climate Confidence Index that aimed to gauge and make available to the public trends in attitudes about climate change (HSBC, 2007).[xiii] Most of their other efforts are rather meager, including a beach clean-up, sponsoring an e-book on green tips and sponsoring the processing of bottle caps.

These projects provide a more hopeful look at what the industry is doing. Yet, compared to other industries and the needs for environmental impact, the efforts are relatively meager. Unlike other sectors, the financial services sector has not focused on the challenges surrounding environmental sustainability and the need for them to play a major role in addressing these challenges. The next section addresses what the industry could do to address these challenges.

What Could the Industry Do?

If one were to look only in the short run, the outlook is bleak for the financial services industry to support and be part of environmental sustainability initiatives. The preoccupation with survival, the lack of evidence that any impact has occurred due to their efforts, and the lack of focus on environmental sustainability will contribute to a decrease in activity in this important area.

The financial services industry could have a major role to play, however. Among the impacts they could have is to continue their development of investment metrics. A most important topic would be to verify the investment returns in those organizations that support and achieve climate reduction versus those that do not. For example, the efforts by HSBC, UNEPFI, Swiss Re and others could have a major impact on the valuations of companies. If these financial services companies could produce data that investors trust, then substantial investments could be made to decrease the world’s environmental footprint. In all likelihood, however, the financial services organizations will need to partner with other organizations to produce these data, such as with the Global Reporting Initiative or independent rating agencies, such as the Institute of Chartered Accountants in England and Wales or the Financial Accounting Standards Board in the USA (Gray, 2006).

Banks should adopt collectively a set of Principles in a Code for Responsible & Sustainable Banking which should be drafted in close consultation with national governments. According to Herman Mulder, Independent Advisor, former Head Group Risk Management ABN AMRO 1998-2006 and initiator of the Equator Principles (Equator Principles, 2009), such a code may include the following public commitments:

(1) Commit to incorporate in mainstream operations the imperative for the banking sector to actively foster social responsibility (CSR) and sustainable development (SD) “in its own sphere of influence”; commit on an annual basis to an explicit percentage of capital to be invested in SD business; commit to an explicit target for generating revenue from SD business; incorporate SD targets in business targets and performance appraisals; raise staff-awareness and create active staff-engagement by special programs;

(2) Mandatory publishing of their own business principles, policies, analytics, risk management procedures, toolkits, performances in operations; define clear no-go interventions and be clear and consistent; offer an independent “grievance” procedure, allowing stakeholders to challenge the performance of an individual institution;

(3) Incorporate SD issues in research, advisory and lending operations with respect to its public and private sector clients; require from major clients the similar, sector-specific disciplines, including thereby the material contributors to the supply- and distribution chains; emphasize the importance of verification and certification of products and services;

(4) CSR & SD to be an explicit responsibility of a member of the European Managing Board or the United State’s Boards of Directors; appoint a member in the European Supervisory Board or Boards of Directors in the United States with strong CSR &SD credentials; create an independent Advisory Council to the Board with focus on CSR &SD. [xiv]

Another move the industry could make is to clean up its own house, by enforcing high environmental standards for its buildings and workforce activities. Wachovia’s major project in Charlotte, North Carolina to build a complex of buildings is exemplary (Charlotte Observer, 2009). It is not only building its office tower according to Gold LEED certification but is sharing space with Wake Forest University in an attempt to create a cultural campus that is sustainable and efficient. Bank of America applied for Platinum certification for its Bryant Park New York office building, yet another US example of notable performance.

Bank of America, HSBC, Citi, and Swiss Re were the sustainability leaders in the financial services sector yet, their recent difficulties, especially at Citi Bank, will curtail much of their efforts. We will likely see smaller, more versatile and less encumbered financial services organizations lead the way for financing sustainability efforts. For example, in the United States, regional banks such as BB&T could be leaders in financing renewable energy projects.

The industry could create something like the President’s Climate Commitment (2009) for higher education. While not likely, executives could participate in at least carbon offset programs and commitments that going forward, they would support reducing carbon footprints.

Banks manage and lend money. Most financial services organizations have capital requirements and incentives for people and businesses to do businesses with them. Yet, few have incorporated processes for monitoring clients’ implementation of and compliance with environmental and social requirements included in agreements or transactions.

Further analyses will be necessary to measure the impact of integrating sustainability into the business strategies of the financial sector; these strategies reach beyond pure financial success measurement and integrate the impact on sustainable development as well (Edwards, Birkin, and Woodward, 2002; van den Brink and van der Woerd, 2004). Initial approaches that can fulfill this necessity already exist. One example of such an approach is the sustainability balanced scorecard (Callens and Tyteca, 1997; Schmid-Schönbein and Braunschweig, 2000; Figge, Schaltegger and Wagner, 2002).

Finally, we must look to the financial services industry to do market making for climate exchange. This role would involve facilitating markets that trade carbon credits, help firms participate in the markets, and to develop instruments that would securitize various instruments. Organizations such as The Chicago Climate Exchange, European Climate Exchange, Insurance Future Exchange, Montréal Climate Exchange and Tianjin Climate Exchange are making markets for carbon (Wikipedia, 2009). The exchanges are financial institutions whose objectives are to apply financial innovation and incentives to advance social, environmental and economic goals through cap and trade system for all six greenhouse gases, with global affiliates and projects worldwide and derivatives exchanges that offer standardized and cleared futures and options contracts on emission allowances and other environmental products. These financial institutions need to be supported and regulated, similar to other financial exchanges.

In sum, the industry will not, in the short run, make significant strides in the area of environmental sustainability. Yet, with some political will, and customer pressure, the industry could eventually increase its presence in support of environmental sustainability.

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[i] The Troubled Asset Relief Program ARP allows the United States Department of the Treasury to purchase or insure up to $700 billion of "troubled" assets. "Troubled assets" are defined as "(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress."
In short, this allows the Treasury to purchase non-liquid, difficult-to-value assets from banks and other financial institutions. The targeted assets can be collateralized debt obligations, which were sold in a booming market until 2007 when they were hit by widespread foreclosures on the underlying loans. TARP is intended to improve the liquidity of these assets by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses. As of March 27, 2009 the banking system received 238.9 billion out of an allocated $552.5 billion.
[ii] Top US European Banks got $50 Billion in AIG Aid. Serena Ng and Carrick Mollenkamp (2009). Wall Street Journal. March 7-8: B1;B6. Some banks that were paid by AIG after it was bailed out by the government included: Banco Santander, Bank of America, Barclays, Calyon, Danske, Deutsche Bank ($6 billion in payments between mid-September and December 2008), Goldman Sachs ($6 billion in payments between mid-September and December 2008), HSBC, Lloyds Banking Group, Merrill Lynch, Morgan Stanley, Rabobank, Royal Bank of Scotland, Société Générale, and Wachovia. Other banks that received large payouts from AIG late last year include Merrill Lynch, now part of Bank of America Corp., and French bank Société Générale SA. More than a dozen firms with smaller exposures to AIG also received payouts, including Morgan Stanley, Royal Bank of Scotland Group PLC and HSBC Holdings PLC, according to the confidential document.
[iii] This type of holding is not unique, however, as the German government has a 25% stake in Commerzbank and the Swiss government holds convertible notes in UBS, the largest Swiss bank.
[iv] This has been a particularly challenging area, and one that has been addressed largely outside the traditional financial services industry. Mohammad Yanus (2003), the famed Nobel Prize winner for his work with Grammean Bank, illustrates the type of solutions that are now labeled micro-financing and have grown substantially, especially in under-served markets such as Asia and Latin America.
[v] More specifically:
Temperature increases: global average warming of approximately 0.20 C per decade for the next two decades; projected longer-term warming associated with doubled CO2 concentrations in likely in the range of 20 C to 4.50 C; the amount of warming generally increases from the tropics to the poles in the Northern Hemisphere; warming will result in fewer cold days and nights and warmer and more frequent hot days and nights; increased frequency, intensity, and duration of heat waves is very likely in central Europe, western USA, East Asia and Korea.

Sea Level increases: sea level will continue to rise in coming decades due to thermal expansion and loss of land ice at greater rates; sea level rise of 18-59 centimeters is project by the close of the 21st Century; projected warming will continue to contribute to sea level rise for many centuries after greenhouse gas concentrations are stabilized.

Precipitation and humidity: high latitudes will generally see increases in wet days and precipitation, and subtropical areas will generally see increases in dry spells; increases in annual precipitation are expected in most of northern Europe, Canada, the northeast United States and the Arctic; winter precipitation is expected to increase in northern Asia and the Tibetan Plateau; the length and frequency of dry spells over the Mediterranean, Australia, and New Zealand is expected to increase, with increased seasonable droughts over many mid-latitude continental interiors.
Extreme wind and rain storms and other events: increased tropical cyclone activity; increased frequency of flas floods and large-area floods in many regions; increased risk of drought in Australia, eastern New Zealand and the Mediterranean, with seasonal droughts in central Europe and Central America; increased wildfires in arid and semi-arid areas such as Australia and the western United States.

Other related effects: decrease in snow season length and snow depth over most of Europe and North America; fewer cold days and nights leading to decreased frosts; accelerated glacier loss likely over the next few decades expected reduction in and warming of permafrost.

[vi] Carbon productivity is measured in GDP per unit of greenhouse gas emissions and shows how emissions performance of an economy develops over time.

[vii] Many companies describe how climate change began as an endeavor within a functional area, such as environmental affairs, but diffused from the periphery to the core, and in the process, became an issue of strategic importance to the company. No such evidence exists in the financial services industry. In fact, by analogy, the finance and accounting functional areas were viewed as the most resistant for climate related strategies.

[viii] The Fund was placed in Europe by Swiss Re’s affiliate, Conning Research and Consulting.

[ix] In 2003, the bank was approved as a non-profit incorporated organization and registered as a money-lending business. On May 1, 2004, it started accepting loan applications mainly via the Internet, and received 75 applications within the month. The bank plans to start extending the loans in July, while also introducing ongoing financing plans and environmental projects on its Web site.Initially, the bank operated only on the founding members' capital, and did not accept investments from the general public. If this new initiative takes off, however, requests for investment from the public will be considered in the future.

[x] This is a partnership between leading companies, NGOs and research institutes seeking to promote integrated solutions to land management around the world. The CCBA has developed voluntary standards to help design and identify land management projects that simultaneously minimize climate change, support sustainable development and conserve biodiversity.

[xi] In April 2008, Merrill Lynch essentially paid villagers in Aceh $9m not to log the rainforest, which, as well as ‘trapping’ carbon dioxide, is home to rare Sumatran tigers, clouded leopards and orangutans. In return, Merrill will get the carbon credits judged to be earned (in return for the carbon that is trapped by the forest which, if it were cut down, would escape into the atmosphere). The process is monitored and verified by CCBA.

[xii] Abyd Karmali, global head of carbon emissions at Merrill, says the deal vindicates governor Irwandi Yusuf ’s ‘Green Initiative’, which laid the foundations for the transaction. “And it’s a good model for other parts of Indonesia, which faces one of the biggest deforestation challenges,” he says. Mr Karmali believes that the credit crunch and slowing global economy may have some impact on projects, but that because sustainability has become one of the variables on which companies compete, such efforts will not be derailed.

[xiii] The launch of the HSBC Climate Confidence Index is part of HSBC's broader strategy to contribute to tackling climate change. Other initiatives include the Global Environmental Efficiency Program, a US$90m commitment to reduce its own direct environmental impacts; the Carbon Finance Strategy, to help clients respond to the challenges and opportunities of creating a low-carbon economy; and the HSBC Climate Partnership, a US$100m program involving four environmental groups and HSBC's employees in helping reduce the impacts of climate change worldwide.
[xiv] Private correspondence labeled “Values’-based, sustainable, responsible banking: More than ever…time to scale.” January 18, 2009.

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