16 minute read

activist bank? The

Next Article
heat is on The

heat is on The

Short of turning off funding for fossil fuels tomorrow, Martin Richards from HSBC, Clinton Abbott of SunTec and Alex Garkov at EcoVadis explore how banks can effect positive change in the global economy

100,000 businesses, the more environmentally and socially responsible are usually also the more profitable.

bringing that regulation to them, and it’s something they need to focus on, even at the very smallest end of the market.”

That’s the clarion call of HSBC’s Martin Richards, and underlines the huge ambition – and change – they must embrace.

With their continued investment in fossil fuels and other non-sustainable sectors, banks are regularly attacked for both perceived and real failures in switching to greener, more ethical investments. HSBC itself has been a high-profile target. But regulators, activists and stakeholders are all nudging them in the same direction.

And with mounting evidence that an ethical business is also a more profitable one, there’s a commercial incentive for banks to flex that moral muscle faster.

In its annual report in January, HSBC (then just emerging from a bruising sequence of events that dismayed investors and activists alike) identified ‘greenwashing’ as a corporate risk that might hinder its own and other banks’ access to capital markets. It had already followed Lloyds, another of the Big Four UK high street banks, in deciding to stop direct financing of, and offering advisory services to, new oil, gas and metallurgical coal projects.

Given that HSBC was one of the world’s biggest fossil fuel funders, that move in 2022 was widely seen as a signal that other financiers would find difficult to ignore.

Together, banks are, potentially, the single most influential force in the fight against climate change and for social justice – but not just because of their heft in the markets. Through routine lending decisions and their daily business client relationships, they have the power to alter the economics of corporate value.

The good news is that, according to a report published by EcoVadis and analysts Bain & Co in April on how ESG activities impacted the financial performance of

Not only did it find that ESG activities reduced carbon emissions, but also the companies that embraced them tended to have more diverse leadership and talent, the net result of which was higher profitability and revenue growth, customer satisfaction, and employee satisfaction.

However, it noted a big gap between the achievements of listed and non-listed companies, evidenced in the EcoVadis ratings they received. It’s among the latter that Richards believes there’s a particular opportunity for banks to do more.

“Large, listed companies have sophisticated plans to reduce their carbon footprint over time, whereas some of the small and middle-sized companies are just beginning on that journey,” he says.

Put simply, banks can provide two types of green corporate funding, says Richards. One is loans for businesses of all types and sizes to purchase and execute on their sustainability strategies, such as clean power, transportation and lower waste. The other is financing for climate tech companies, which could be early-stage venture debt financing or infrastructure financing for large projects. But what’s important with any of these endeavours is transparency, so everyone can be confident about a business’s ESG intentions and performance, and everyone can avoid allegations of greenwashing.

This is where an ESG ratings business such as Paris-based EcoVadis comes in.

Alex Garkov is a sustainable finance account executive for the firm. He says: “Most ESG ratings providers in financial services are focussed more on the larger corporates, the listed companies, and they’re usually using publicly-available information to produce their ratings, which they then sell as a dataset.

“But most SMEs will sell to larger companies, and they’re going to be in the supply chain of larger, publiclisted firms. Those listed companies are not only addressing their scope 1 and scope 2 [direct] emissions, they’re also looking at scope 3 [their supply chain], so small businesses have to decrease their carbon footprint not just for themselves but also so they can participate in the supply chain.

“That means, even if regulation hasn’t come to smaller firms yet, buyers will be

"At EcoVadis we’re focussed more on smaller businesses, and we work to produce our ratings by engaging with the companies directly to get access to their internal information and systems. This produces what we hope is an accurate rating, or indicator, of their ESG management and ESG performance over time.

“There’s a huge range of ESG ratings and there’s not a lot of standardisation within the industry,” he admits. “But there's certainly a role to play for different types of ratings, especially when it comes to the risk of greenwashing. Because usually, the ratings providers are assessing a company independently, with no conflicts of interest.

“That’s the role I see ESG ratings playing in financial services; providing third-party verification of a company’s performance.”

At a macro level, focus has rested on specific, standardised KPIs for ESG, such as the EU’s Sustainable Finance Disclosure Regulation for investors that comes into force this year. EcoVadis’s focus on the micro level means it can go further than simply rate a business – it can provide advice to improve their and others’ performance.

“It’s a more holistic, qualitative way to help companies enhance, improve, and change their policies, to have a real impact on the way that they act in the market,” Garkov says.

No bank or business can improve its ESG credentials if it fails to measure its performance – although,

ESG targets go further than a business’s own performance, directors can also assess the performance of partners and potential partners within their ecosystem and fulfilment chain.

Understanding The Task

SunTec is a business solutions company that works with EcoVadis, providing banks like HSBC with pricing and revenue management solutions that include carbon calculators and offsetting programs.

Clinton Abbott, a senior vice president with the company, based in South Africa, says that data recording by banks is essential to drive change throughout the supply chain. In Africa, development finance institutions (DFI) have demanded improvements in the reporting standards of African banks, which has made them quantify their own ESG performance.

“There has been a very strong driver towards not only the environmental component of ESG, but also the social and governance elements,” he says. “But how do banks take the deliverables, from a board perspective, all the way down to a portfolio perspective? That’s the question.

“If you look at the products that need to be offered, the loan opportunities and credit lines that need to be supplied, how do you make sure that those loans are allocated to the right people?

zero future surprisingly, a recent Mobiquity survey among 300 banks revealed that nearly half were failing to measure ESG performance against their own sustainability targets.

Crucially, Garkov points out, there should be no good or bad rating at the start, adding ‘the idea is simply to provide that transparency, as a baseline, to then benchmark performance in the future’.

Once a reliably transparent system of ESG measurement is in place, directors can determine whether their policies are being delivered at the coal face. And, given that

“Banks have always had a strong focus on credit risk but they haven’t worked to understand a client’s back-end operations before. How does their whole governance structure work? Are they doing the right thing? Do they run their company in the right manner? Ratings agencies, such as EcoVadis, can provide the transparency that helps a bank to better understand their customers. Examining the non-financial aspect means that, rather than simply relying on an industry sector code, as most banks do, they can truly understand what the organisation does. That allows banks to de-risk their portfolio.”

As one of the world’s biggest banks, HSBC has a target of achieving net zero in its own operations and supply chain by 2030, and in its financing portfolio by 2050.

It is two years into a five-year Climate Solutions Partnership with the World Resources Institute and WWF, which will see the bank invest $100million to scale up climate innovation ventures and fund nature-based solutions.

Advice and mentoring are very much part of HSBC’s overall strategy to reach net zero, says Richards, alongside the provision of funding.

He says: “There's our existing portfolio of over 1.3 million companies that we’re working with to transition to a net-zero future. Smaller enterprises typically don’t have huge teams to help them decarbonise so we’re taking best practices from our largest clients to our smaller clients, where it’s appropriate and industry significant.

“And, as those larger global companies try to decarbonise, we’re taking our climate tech companies, that have new technologies addressing hard-to-abate sectors, and introducing their technology to them. That firms that, for example, don’t have enough capital to electrify their transport fleet, but where, over the life of the fleet, it would make economic sense for them to switch.

“With the evolution of technology and the cost curve, you can buy an electric car, or put a heat pump in place, and that would not only be good for the planet but also be good for your business, economically.”

WHAT’S IN IT FOR ME?

As banks seek to encourage ESG spending there has been the emergence of products with incentives that reward the customer. Since banks will be increasingly rated on the sustainability of their portfolios it’s a trend we’ll see grow with ever more imaginative carrots to go green, says Abbott.

“Take the example of a loan facility a bank puts down. Instead of looking at just the pay-off facility, the bank could offer an interest rate discount if the customer meets certain objectives,” he says.

bank are aligned, and everybody walks away with benefits.“

Abbott says banks have an opportunity to drive ESG by understanding their customers’ supply chains and resulting value chains. But they can go further than using their own financial products to incentivise and meet clients’ needs by sharing knowledge, building networks and, ultimately, ESG-focussed ecosystems.

“A customer may benefit from using solar power because there are tax benefits for using it, as well funding benefits, and banks can assist customers to work better with that,“ he explains. “At the same time, because, as a bank, you have the insights into that customer, you can start expanding to build an ecosystem between customers. The bank can give discount pricing, or free transactions, while growing that ecosystem and uplifting their own portfolio.”

Martin Richards, HSBC helps the climate techs scale and the large companies to transition.”

Richards says HSBC is focussed on financing the development of sustainable, scalable infrastructure such as wind farms, green batteries and utility scale solar.

“For the early-stage technologies, such as direct air capture or green hydrogen, there are a lot of lab-proven technologies that need to make commercial scale,” he says. “And we’re seeing a lot of capital being deployed in a blended structure, where you may have a venture capital company coming in, with a bank on top; you may have a government giving a grant, or a guarantee with debt financing on top.

“It’s both a race to deploy existing technologies as fast as possible and innovate new technologies as fast as possible… and then not take as long as we did in getting solar and wind out there.

“For our other companies, the non-climate tech companies, we want to finance

“So, if the customer reduces their carbon component over the next year by putting solar financing into their organisation, they get a two per cent reduction on the interest component. If they meet X, Y, and Z additional criteria, say they make $100,000 of payments through other mechanisms to meet zero-emission goals, they get a discount on that pricing, or they could be given a 50 per cent discount on Swift transfers, for instance.

“Because of digitisation, all of this is managed automatically – and there are tracking mechanisms happening in real-time now – it’s clear if a customer has met their targets. So, it’s possible to make sure the customer and the

Abbott, Richards and Garkov stress that joining the dots with effective ESG measurements, working together in ecosystems and gearing finance to incentivise ESG goals will be a key path to reaching net zero and meeting the world’s commitment to contain global warming to 1.5°C.

Richards says: “Between here and there, every company, every bank, and every country is going to have to do more and it’s a huge opportunity.”

Realising it, however, goes beyond ratings, says Abbott.

“I think the more people talk about it, the more it becomes not just a nice ESG logo but something tangible.

“When you can physically see the difference you’re making as an individual, then you know you’re making a difference as an organisation.

“It’s not necessarily a dollars and pounds measure, rather it’s an acceptance that we all need to make a difference.”

Tropical cyclones are one of the most destructive natural disasters. According to Aon, over the last 10 years, they have caused in excess of $1trillion in economic damages globally, with less than 50 per cent of those damages insured.

This presents a major issue – and opportunity – for the financial services industry and insurance markets, and the clients they serve. The ability to accurately forecast the number, impact, and location of hurricanes, cyclones, and typhoons has always been very challenging, especially as they have grown in intensity due to climate change.

As a result, the financial services sector and re-insurance markets have developed a much greater need to understand climate risks. These businesses are reliant on a clear view of how weather systems are changing in an increasingly volatile climate, so they can prepare for the extent to which their physical assets, infrastructure, business models, and customers are exposed.

Not only does this help to inform insurers’ strategies around climate variability, but it improves capital management and relative volatility of global exposures, and helps to quantify and hedge risk in response to shorterterm extreme weather expectations.

Fortunately, through advances in technology, research, and the use of AI and machine learning, new solutions, such as those from Reask, are emerging to provide decision-makers with the data they need to confidently change their assessment of potential catastrophe risks over multiple time horizons.

The weather does not see borders, which is one reason why the limitations of traditional natural catastrophe (Nat Cat) models, built region by region, are being challenged.

Fresh thinking, improved AI and machine learning, and increased computing power are now enabling experts to understand climate variability better than ever, including the potential impact of the frequency and intensity of natural disasters, worldwide.

Today’s climate models, with a more automated and scalable process, enable experts to get a more interconnected understanding of global climate risk. At Reask we have built robust algorithms to transform this climate model output into risk data that dynamically captures tropical cyclone wind variability down to a neighbourhood scale, over multiple time horizons.

Nevertheless, the ultimate aim is to have a consistent view, born out of one methodology, irrespective of where the exposure happens, from the South Pacific near Australia, to the north Indian Ocean, the Gulf of Mexico, or the Atlantic.

The Learning Curve

Traditionally, historical data and statistical modelling techniques have been used in models over the last 30 years to approximate the likely risk of future tropical cyclones.

Creating these models involves many PhD scientists building one model for one country at a time, then switching to another, or maybe region by region, with each of these models manually taking months or even years to build.

Further, while these models still have some value, they leave many questions unanswered, such as what happens when risks we observe hit new levels? What if they behave in ways that are different from what we have observed in the historical data? And how can we make a model aware that the underlying climate may be different to the historical data?

To successfully and accurately create one global model requires climate pattern extraction with a globally connected framework and machine learning approach. This involves embedding the latest climate knowledge into algorithms that allow the model to know the physics that underpin tropical cyclone risk and build risk distributions accordingly.

By looking into the atmosphere and, to a certain extent, the hydrosphere, we can now understand how the climate impacts the extreme perils that are phenomena of that particular environment.

Furthermore, we need to look at so-called pattern recognition often referred to as ‘unsupervised learning’. These are algorithms that can go through vast volumes of data and figure out what is worth using. Afterwards, human experts need to assess the data to make sure we understand the physics being picked up, but it is close to a fully automated process. insurance coverage. This is a huge area of opportunity, and it is already plugging protection gaps, worldwide.

A lot of what’s been done in the past has been by experts looking at data and picking up global patterns. The typical example would be the ENSO patterns, which cover things like water temperature. They are usually, however, very simplistic. Unsupervised learning allows us to use machine learning algorithms to do that job instead, faster and more accurately.

What we have found at Reask is that we gain much in terms of predictive skills, and we can trust the machine to pick up the right signals to speed up the process considerably.

How often this data is updated depends on what one is trying to do with the data and what part of the model is being looked at. The global climate products available from either the US agencies or the European centres are excellent; their data is available every month and provides the ability to look at hurricane activity in the coming season.

However, for tropical cyclone wind structure and what happens to the winds when they travel overland, new datasets are needed. At Reask, we use a weather forecasting model and run it at very high resolution on hundreds of historical cases. This has been the training data we use for machine learning.

Many firms will have invested heavily in Nat Cat models over the years, thus it is important to understand that their existing models still have value and can be integrated with the models and approach we are discussing.

Organisations can have a collaborative view of risk, and augment their existing models with this new, next-gen approach. For example, where firms don't have coverage in certain regions, these models can provide a consistent view across all territories.

One way to think of the operational side is that newer models, like Reask’s, answer questions that other models don't because of the global approach. A client can look at relativities in the long-term view of risk we have, versus a particular season in the Caribbean or US, for instance.

Beyond insurance, the climate-aware nature of our model is being used across operational risk and resilience to assess the impact of climate change on economic and operational resilience of companies and the investments they make.

We have also successfully provided operational forecasts for the ILS industry for four years in a row. Now including where we see more risk, including for hurricanes hitting landfall.

What we are discussing is new, breakthrough science. The market determines, in the end, what is an appropriate approach to take about assessing this risk, and that encompasses all of their internal risk appetite and approach to risk management.

Today, Reask’s model is being utilised across the climate risk and insurance value chain. The resolution and accuracy of the model is being used to underwrite insurance policies exposed to tropical cyclones more efficiently.

The global consistent nature and granularity of the risk data is being used to innovate the parametric insurance space, by allowing risk carriers to offer globally consistent tropical cyclone

Communication is vital and we are in regular exchange with decision-makers across the market to constantly inform others and evolve our methodology. It is a very transparent process. We also write publications that are peer-reviewed and we make that information available to them.

Managing tomorrow’s climate risk today remains a challenge; one that we at Reask are addressing. However, we are very fortunate that all our clients are sophisticated users of risk assessment, catastrophe modelling, and hazard modelling tools.

From ILS firms to reinsurance intermediaries and global insurers, the way they incorporate and utilise our information is varied and unique. The one consistent is how our clients are turning a climate challenge into an opportunity.

Winds of change: The use of algorithms will transform weather modelling

SmartStream CTO Roque

SmartStream and the expanding number of markets it’s opened the door on. AIR (artificially intelligent reconciliations) was just the start.

SO, WHAT DOES IT DO?

When SmartStream unveiled its Cloud-native, AI-driven software-as-a-service SmartStream AIR at Sibos in London in 2019, most of us hadn’t even heard of ChatGPT or had the vaguest idea what generative AI and large language models were all about.

OpenAI’s Generative Pre-Trained Transformer #1 had only been knocking about for a year at that point and wasn’t the head turner that it’s younger sibling #4 would turn out to be. Which is to say that things change mighty fast in the world of artificial intelligence – not just in terms of the technology’s capability, but in what it’s applied to.

SmartStream, a company that for decades had largely been focussed on automating reconciliations in trade processing, is testament to that.

Back in 2019, its management clearly understood that the AI being developed by its in-house team of specially recruited data scientists in its AI lab in Vienna, was the key to unlocking a whole new era – or should that be AIR-er – for the company. In 2020, it rebranded, adopting an infinity symbol as its logo.

Now, it’s becoming apparent just how impactful AI could be – for both

For Roque Martinez, the company’s CTO, AIR’s basic (which is not to say simple) task is to remove friction in a financial institution’s middle and back office processes.

“That, after all, is why AI, machine learning and robotic process automation, which all fall into this realm, have taken off – because organisations are looking to remove that friction,“ he says.

“In reconciliations, you want to take two files, onboard them quickly, have them reconcile and then whatever exceptions come out, you deal with them.

“With SmartStream AIR the point is that you don’t spend hours, days, months trying to build rules to reconcile those data sets. That’s what the product does. It says, ’we know what these things look like,’ reconciles the records and moves them on. There’s a significant reduction in friction because people aren’t doing it, machines are.“

It’s AI’s ability to spot patterns in real-time in data that are simply too large and complex for the human brain to handle, that SmartStream is now looking to leverage for other outputs.

“One of the models that we’ve been talking about especially is around cash and liquidity management,” says Martinez.

It’s a timely thought, given the domino collapse of Silicon Valley Bank, Signature Bank and First Republic in the US. There are accepted ways of measuring if a bank is healthy or not, some introduced after the great financial crisis to avoid a repeat of the failures seen then. The three liquidity indicators used by regulators and analysts are usually liquidity ratio (LiqR), liquidity creation (LiqC) and net stable funding difference (NSFD). If observers keep an eye on those, they should get a heads up on any bank in distress.

But, as recent events proved, that’s not always soon enough – and, for regular counterparties whose job isn’t to watch the numbers and are just sending or receiving funds from a bank that’s in freefall, there are sometimes no signs, other than word of mouth or Twitter jitters – which is why many were caught out when SVB came off the rails.

This article is from: