Week 40: Truth or power?

In this issue: ▸ Truth or power? ▸ Corporate polluters fail basic tests ▸ Saudi Arabia's wealth fund goes ‘green’ ▸ The banks and the fossil fuels ▸ The dirty truth ▸ And much more...

Dear all,

“The truth is, truth has never been high on the agenda of Homo sapiens. If you stick to unalloyed reality, few people will follow you,” Yuval Noah Harari wrote in 21 Lessons for the 21st Century (2018). He is right. It is simply too raw for most of us. Unpleasant, itchy, hard, and sometimes very cold. 

Here’s more from Harari, a small extract from his book:

“As a species, humans prefer power to truth. We spend far more time and effort on trying to control the world than on trying to understand it, and even when we try to understand it, we usually do so in the hope that understanding the world will make it easier to control it. If you dream of a society in which truth reigns supreme and myths are ignored, you have little to expect from Homo sapiens. Better to try your luck with chimps.”

“Truth and power can travel together only so far. Sooner or later they go their separate paths. If you want power, at some point you will have to spread fictions. If you want to know the truth about the world, at some point you will have to renounce power. You will have to admit things, for example, about the sources of your own power, that will anger allies, dishearten followers, or undermine social harmony.“

“Scholars throughout history have faced this dilemma: Do they serve power or truth? Should they aim to unite people by making sure everyone believes in the same story, or should they let people know the truth even at the price of disunity? The most powerful scholarly establishments, whether of Christian priests, Confucian mandarins or Communist ideologues always placed unity above truth. Because power comes first.” 

Corporate polluters fail basic tests

Now what has this to do with ESG? Well, just this week auditors were identified as falling down in the disclosure of climate-related risks in a sweeping analysis of companies responsible for 80 per cent of corporate industrial greenhouse gas emissions, as none of the 134 companies assessed passed basic tests.

The annual review by independent non-profit Carbon Tracker group found that carbon-intensive companies were not sufficiently disclosing the effects of climate-related risks and net zero emissions plans in their financial statements, an omission that deprived investors of key information. Out of more than 130 industrial companies that account for the bulk of pollution, 98 per cent did not provide evidence that their 2021 financial statements had taken into account the effects of climate-related matters, according to the report.

In short, auditors do not appear to comprehensively consider the effects of material climate-related matters in their risk assessments and audit testing. That is the truth. 

For example, French multinational Air Liquide and carmaker Mercedes-Benz indicated that climate change would not have a material impact on their financial statements, but did not explain that conclusion, the report said. Mercedes-Benz declined to comment.

When companies don’t take climate-related matters into account, their financial statements may include overstated assets, understated liabilities and overstated profits. Companies know this, investors know this, regulators know this. Is it about the truth or about the power?

Not a single company met all of the seven tests the authors used in their assessment. Only eight companies met some of the tests, which included that financial statements disclose the quantitative climate-related assumptions and estimates used, and that the audit report explain how material climate-related impacts had been assessed.

The companies assessed were from the coal, oil, gas, mining, manufacturing, automotive and technology sectors, and are those being scrutinised by the influential investor group Climate Action 100+. Truth it is. 

Saudi Arabia's wealth fund goes ‘green’

Saudi Arabia's sovereign wealth fund raised $3 billion with its debut bond sale in U.S. dollars that also marked its first foray into ethical finance. The Public Investment Fund sold the debt in three tranches, including a world-first dollar century green bond.

It should come as no surprise that noted ESG titan Crown Prince Mohammed bin Salman’s Public Investment Fund plans to issue green bonds. Why wouldn’t it? Shell boasts of its nature-based solutions and Drax is into forestry. This is simply how the world works today.

Cynicism aside, Saudi Arabia’s bond prospectus is worth a read: the $608bn PIF has never before allowed investors such a detailed look at its books. Anyone interested in the headline numbers can read about them here. 

Bond investors with an environmental bent may be willing to look past all of this, of course. And there’s a chance to snap up some of the most verdant green bonds on offer if they do. Here’s a section from the prospectus:

No assurance is given by the issuer, the guarantor or the dealers that the use of such proceeds [of the notes issued] for the funding of any Eligible Green Projects will satisfy, whether in whole or in part, any present or future investor expectations or requirements as regards any investment criteria . . .  There is no clear definition (legal, regulatory or otherwise) of, nor any market consensus as to what constitutes a “green” or similarly labelled project.

Truth it is. 

The banks and the fossil fuels

Now, the truth is also the following.

Finance Watch estimates that the 60 largest global banks have around $1.35 trillion of credit exposures to fossil fuel assets. At the moment, the climate-related risks associated with these assets are not reflected in bank capital rules to make sure that banks can cover future losses. This is unbelievably bonkers.

Applying a 150% risk weight, the risk weight applicable for higher risk assets under the Basel framework, to banks’ existing fossil fuel assets globally as a Pillar 1 capital measure would be an important first step in cushioning banks against future financial losses on these exposures. Finance Watch estimates that for the 60 banks in the sample, this measure would require additional capital in the range $157.0 billion to $210.2 billion, equivalent on average to around three to five months of banks’ 2021 net income.

This evidence suggests that increasing capital requirements for fossil fuel exposures in this way can be achieved without a reduction in lending capacity, which is important in the context of the sustainable transition.

This solution also encourages supervisors to work with banks to establish plans over a suitable time frame. The current practice of not treating banks’ fossil fuel exposures as higher risk assets under the Basel framework not only encourages the continued build-up of prudential risk, but is also effectively a subsidy from banks to the fossil fuel industry, which Finance Watch estimates to be worth around $18 billion a year.

You can find the great report by Finance Watch here.  

The dirty truth

Now when we know this to be a truth, how do we deal with it?

Well, the UK has opened up a new licensing round to allow oil and gas companies to explore for fossil fuels in the North Sea despite threats of a legal battle from climate campaigners. The North Sea Transition Authority has begun a process to award more than 100 licences to companies hoping to extract oil and gas in the area. Almost 900 locations are being offered up for exploration. Well, it has to be about power. 

The truth can be naked, beautiful, cold, nasty and also very dirty.

Many utilities have pledged to clean up their electricity production, but research by Sierra Club shows these promises often  amount to little more than greenwashing. In a 2021 report, released a year and a half ago, they analysed the plans of 77 utilities owned by the 50 parent companies most invested in fossil fuel generation. They found that despite pledges to reduce emissions from many of these companies, most utilities did not have plans that would actually achieve the necessary emissions reductions by 2030.

Now, the updated report investigates what progress, if any, these utilities made over the last year and a half to turn their pledges into real action. So, have utilities stepped up to meet the challenge and make the changes needed to save lives, reduce costs, and address climate change by transforming our power system? Well, take a wild guess..

Survey: ESG is material and thus financially relevant

Now, after so many articles written the ESG backlash the question is also: Is ESG financially relevant to investing? The truth? 

Well, a large majority of asset owners – including pensions, sovereign wealth funds, and insurers – believe that considering ESG information is material and thus financially relevant in the investment process, according to a new survey by Morningstar.

The survey interviewed 500 individuals at asset owners in August about their attitudes toward ESG. The asset owners are fiduciaries who oversee some of the world’s largest pools of investment assets. There were 100 respondents from North America and 200 respondents each from Europe and Asia-Pacific, overseeing about $32.7 trillion in assets.

Some 85% of the respondents said ESG factors are “very material” or “fairly material” to the investment process. “If you’re a fiduciary, ‘materiality’ is the magic word,” said Tom Kuh, head of ESG strategy, Morningstar Indexes, in an interview.

At least 80% also described ESG as material across a range of asset classes, including listed equities, fixed income, alternatives, and real estate. ESG has become more material for asset owners in the past five years, according to 70% of the respondents.

Environmental concerns win out over social and governance issues in terms of materiality, with the most with the most significant issues being energy management and greenhouse gas emissions. 

How Chanel (mis)used green to get cheap financing

And to top-up this week of truth we end with the smokescreens of green fashion.

Fashion giant Chanel, known for its iconic perfume and tweed suits, keeps up to date with changing tastes. These days that means showing consumers – and investors– that it’s doing its part to combat climate change. So when the company needed to borrow money two years ago, it turned to a hot new financial product: sustainability-linked bonds (SLBs).

The investors who purchased Chanel’s €600 million ($589 million) of bonds also got a promise: If the company didn’t meet certain climate goals, it would pay them millions of euros more. In other words, they’d pay a penalty for not being green.

Philippe Blondiaux, Chanel’s chief financial officer, said at the time that the deal “was a great way to align our financing strategy with our company strategy cantered around our sustainability targets.”

But Chanel and other companies that sell such bonds aren’t risking much. They get to set their own objectives, creating an obvious incentive to make them easy to meet. Most investors, instead of insisting companies set more challenging goals, seem to be satisfied as long as what they’re buying is labelled green. Demand for the bonds exceeds the amount on offer by two, three or even five times.

Bloomberg News analysed more than 100 SLBs worth almost €70 billion sold by global companies to investors in Europe – the most mature market for sustainable finance products – and found the majority are tied to climate targets that are weak, irrelevant or even already achieved. The result, researchers say, is that companies are getting something for nothing: cheaper financing and an enhanced green reputation without any real effort to deliver on climate goals and no chance of financial penalty.

A closer look at the Chanel deal showed that, in fact, the company had fulfilled a key objective before it even sold the bond to investors. The bond required Chanel to reduce its so-called indirect, or Scope 3, emissions – basically the emissions produced by its suppliers and customers – 10% by 2030. But the company’s own disclosures show that, by the time the bond was issued, those emissions had already fallen 21% below the baseline set in the bond contract.

So Chanel was getting to pay its lenders a lower rate for meeting a goal that it had already succeeded in achieving…

Have a great truth or power week, or just a good week.

Kind regards,
Sasja