Week 10 - BlackRock case, ESG & debtholders Flashcards
8 motivations for BlackRock to make the pronouncement about linking profits and purpose
- large size and influence (largest asset manager)
- long-term orientation / value creation
- importance of ESG
- client demand for ESG investments
- fiduciary duty to steward their investee firms
- opportunity for growth
- establish competitive advantage & leadership in industry, against Vanguard & State Street Global Advisors
- Fink as a leader
5+1 concerns for BlackRock to take the stand of linking profits to purpose
- is BR too powerful?
- what if investors’ preferences shift to something not good for society? - potential CONFLICTS OF INTEREST
- BR owns shares in most companies AND their competitors - regulators concerned about COLLUSION among competitors
» since BR owns shares in most publicly listed firms - MARKETING ploy
- propaganda, branding strategy
- no concrete guidance
» risk of greenwashing; measurement issues of exactly linking P&P, easy to say but how exactly to measure - is it their place?
- should BR leave the strategy to corporate board?
> > sacrificing financial returns & might lose certain clients
3 points that BR is doing good enough to enforce its stand on purpose
3 points that BR is NOT doing good enough / what BR needs to do to further enhance its stand
Good enough
1. shareholding voting
2. engagements & dialogues with companies
3. divest (active funds only)
Not good enough
1. BR often votes IN FAVOUR of management, esp. high executive compensation packages (exhibit 5)
2. what can BR do if mgmt doesn’t listen? {what are the next steps if mgmt doesn’t listen?}
- mostly passive investor, cannot divest
» also no concrete measure of impact after voting, hard to quantify and measure
3. no collaboration with other asset managers
» collaboration can help to REDUCE ENGAGEMENT COSTS & better UNDERSTAND investee firms
6 considerations for the Goldilocks dilemma - should BR do more or less stewardship?
*later BR’s website disclosed its voting choices to clients…
- potential REGULATORY and anti-competition concerns
- potential CONFLICTS OF INTEREST
- also in terms of People vs Technology, eg. investing in AI vs engagement - global vs local presence (culture, tradition)
- high ENGAGEMENT COSTS
» since BR holds many portfolio of firms across all industries, around the world - DIFFICULT to UNDERSTAND business & operations of investee firms
» again since BR holds many portfolios - many asset managers rely on input on investment decisions from PROXY ADVISORS, eg. ISS
» criticised for too heavy reliance, PAs themselves might be facing conflicts of interest
As socially responsible investors, are DEBTHOLDERS or SHAREHOLDERS more able to make a positive impact?
Debtholders
1. SIZE of debt»_space; size of equity in the world economy, thus banks play a very important role in changing the world through debt financing
2. FRESH CAPITAL raised (new capital injected into economy to potentially fund new projects)
3. can SPECIFY ex-ante in debt CONTRACTS (and link ESG targets to covenants) the diff. interest rates & WAYS TO USE PROCEEDS
4. CONCENTRATED OWNERSHIP reduces coordination costs
5. involves relationship banking, eg. local biz borrowing from local bank; biz can build Reputation by doing what lenders want
- cannot exit since fixed income and fixed term
- no voting rights, so cannot intervene until default
Shareholders
1. VOICE/VOTING RIGHTS/ENGAGEMENT, but again there are concerns of coordination due to DISPERSED ownership
2. can link EXECUTIVE COMPENSATION to ESG
eg. get xx bonus if reduce carbon emissions, executive compensation is decided by shareholders
3. allowed to divest; can THREATEN to exit if firm is not doing what investors want
- uses EXISTING capital -> cannot facilitate new innovations & harder to control how managers ALLOCATE the capital (lack of contracting)
3 types of bonds in this topic (1&2)
Green bonds vs Transition bonds
Green bonds
- debt securities issued by corporations or govt.s
- the PROCEEDS from the sale of green bonds must be used for environmentally friendly purposes (reducing GHG emissions, mitigating climate change)
- the project being financed achieves significant CO2 emissions reduction AND takes us to an end state of wholly green technology
» very subjective to judge what is WHOLLY green
eg. funding a wind farm
Transition bonds
- the project being financed achieves significant CO2 emissions reduction AND does NOT take us to an end state of wholly green technology
eg. coal to gas switching
Corporate green bonds
1. Why do companies issue green bonds?
2. 1 pro & 2 cons
3. Academic evidence
*majority by oil & gas industries, where the opp.s are for green initiatives {strict eligibility criteria so only limited industries can issue green bonds}
*issued by both developed and developing countries
- due to business model, wish to pursue green initiatives, eg. fossil fuel companies -> renewable energy
- ENHANCE REPUTATION of the company + lenders’
eg. by removing scope 3 emissions from lender’s portfolio - to credible SIGNAL company’s commitment towards the environment (related to academic evidence below)
Pros & cons
+ REDUCED COST OF CAPITAL
- DIFFICULT to MONITOR; once lenders lent the money, not much can be done & it is difficult to ensure that the proceeds are used in the way as intended
- DIFFICULT to DEFINE “green”, there is not much clear-cut regulation on this, only the EU Taxonomy of the 6 Environmental Objectives and 4 Conditions
- Issuing corporate green bonds seems to have a +ve impact…
- improved environmental performance for issuers: Higher environmental ratings & lower CO2 emissions
- issuing used for SIGNALLING
Greenium + academic evidence
= the PREMIUM in the price of GREEN BONDS, relative to the price of existing comparable non-green bonds
Academic evidence
1. greenium is 0 for US govt green bonds
- investors are not willing to forgo wealth (pay extra) to invest in environmentally sustainable projects
2. +ve greenium for German twin bonds issued by German govt
2 controversies around Green bonds + then what’s the point
- GB do NOT cut carbon
- firms that issue the most green bonds tend to be cleaner in the first place - GB do NOT reduce the cost of borrowing
» since no greenium in the US
What’s the point?
1. some green projects don’t reduce carbon but are WORTHY
eg. water mgmt
2. enhancing REPUTATION for lenders & investors
3 types of bonds in this topic (3)
Sustainability-linked bonds/loans
= a loan/bond where the interest rate or other loan/bond terms are linked to the borrower’s sustainability performance
= often no constraints on how the borrower can use the proceeds (as long as meet targets; decision is up to managers)
Sustainability-linked bonds/loans
1. Why do companies issue sustainability-linked debt?
2. pros & cons
3. Academic evidence
Larger growth of SLL due to greater flexibility for managers in the way of using proceeds (as long as can meet targets) & can be used by any industry {while only limited industries can issue green loans}
Larger growth of SLL due to greater flexibility for managers in the way of using proceeds (as long as can meet targets) & can be used by any industry {while only limited industries can issue green loans}
- Purpose is to INCENTIVISE companies to improve their sustainability practices
Pros & cons
+ FLEXIBILITY in using proceeds
+ encourages companies to set and achieve sustainability TARGETS {vs green bonds which don’t have tangible targets}
+ LENDER MONITORING: borrowers’ sust. performance is regularly REPORTED to ensure TRANSPARENCY & ACCOUNTABILITY
+ can put covenants into debt contract, hence encouraging co.s to report their ESG performance
- HARD to MEASURE ESG performance, subjective {also risk of Greenwashing}
- how to set the right targets for ESG metrics? have to be hard but not impossible to achieve.
- HARD to effectively MONITOR achievement of targets, eg. since renewable energy is not audited
In conclusion, evidence suggests that despite the tremendous growth in green bond/loan markets, they make LITTLE IMPACT on the ENVIRONMENT.
Instead, their issuance seems to be driven by financial engineering to make PROFITS.
Why?
Partially due to a LACK OF TRANSPARENCY & DISCLOSURE from lenders
- voluntary for banks, banks don’t need to disclose the ESG risks associated with their lending portfolios
» REGULATIONS need to catch up to make disclosures mandatory…
