ESG Focus: Banks Target Emitters

ESG Focus | Dec 19 2022

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ESG Focus: Banks Targeting Emitters

COP27 has called for a transformation of the financial system, and Australia’s major banks find themselves in the middle of it all.

-Australian regulators set the pace
-Oil and gas, transport and agriculture highlighted
-Litigation risk appears the biggest wildcard
-Global developments
-Banks review lending policies
-The solution is simple 

By Sarah Mills

One of the potentially more impactful developments from the recent COP27 was the Sharm el-Shiekh Implementation Plan’s call to transform the global financial system.

The gist is that multilateral development banks and international financial institutions will soon be called upon to reform their lending practices and align them to climate policy.

Australian banks have already started adjusting their loan policies and are likely to continue to do so if required to keep pace with international developments and regulatory demands.

In October, Germany and the US released a joint proposal, backed by ten countries, including the G7, for a fundamental reform of the World Bank.

These reforms include: climate lending on better terms to developing countries; and targeted budget support for governments seeking to pursue climate-neutral policy reforms.

Australian Regulators Setting The Pace

Already, the Australian Prudential Regulation Authority has asked Australia’s majors to outline how they will change their risk management and loan practices as “climate-related losses” mount as part of a climate vulnerability assessment.

The banks’ proposals included: minimizing exposure to sectors such as mining, manufacturing and transport; and reducing high loan-to-value mortgage lending.

Neither of these proposals was particularly surprising; nor were the results of the banks’ climate vulnerability assessments under two warming scenarios.

APRA’s deputy chair Helen Rowell conclusions was:

“The results suggest that banks’ losses from their lending portfolios could rise in the medium to long-term as climate change and global response to it unfolds. 

“Although those impacts are not expected to cause severe stress to the banking system, climate change could lead to the banking sector being more vulnerable to future economic downturns.”

In other words, steady as she goes. 

As for the vulnerable sectors, one assumes the mere hint of funds deprivation will be sufficient to keep most companies on the straight and narrow decarbonisation path.

APRA’s comments also suggests there might be some abatement in the recent silliness of lending for development in flood-prone areas in Australia.

At the moment, we have banks funding construction on the one hand, and insurers copping the losses on the other.

The government has established a $200m a year Disaster Ready Fund, which should keep some of the smaller engineering firms busy.

The Reserve Bank of Australia’s head of domestic markets warned in August that insurers’ refusal to back fire and flood prone properties could result in lower collateral values for the banks.

This implies future construction will be steered to medium and high-density housing, with positive long-term implications for the development and construction industries.

Agricultural Industry Highlighted

APRA targeted the agricultural industry, saying the grain and cattle sectors, for both beef and dairy (no surprise given the global commitment to phase out meat consumption and improve biodiversity) would be hardest hit.

APRA predicted the industry’s loss rates would double by 2045 in most Australian regions.

Australian Agricultural Company ((AAC)) is Australia’s largest integrated cattle and beef producer – and is largely foreign-owned by the Bahamas-based AATrust, which holds a roughly 50% stake.

Gina Rinehart, Andrew Forrest (a shareholder in AAC) and Peter Hughes are among the biggest Australian cattle producers in the country.

The ASX also boasts a myriad of dairy processing companies that one assumes would be impacted by said losses.

McKinsey advises in a 2022 report that grain yields could fall by more than -15% and expects damage to capital stock from flooding will double by 2030.

“In aggregate, we expect that about a third of the planet’s land area will be affected in some way,” says the analyst.

McKinsey would add real estate to APRA’s list of industries under threat.

Most conservation groups have described APRA’s assessments as conservative.

APRA Targets Litigation Risk

Actual climate risks may not be too much to worry about but the regulator did take time out to emphasis the liability risks for banks stemming from climate litigation.

The banks have proved they are not immune to the power of big capital, when it comes to big fines, and one assumes climate litigation will be no different.

Global Developments

The European Central Bank also recently published its review into climate and environmental risks of 186 banks with assets totaling E25trn.

It stated that the banks’ combined estimation of E70bn in short-term losses (chicken feed in the broader scheme of things) sharply understates actual climate risks.

The UK’s regulatory industries published assessments in October 2021.

In May, the Bank of England warned the finance and insurance industry’s losses could fall by up to -15%.

In the United States, the Federal Reserve Board announced in September that six of its majors would participate in a similar assessment, with the results due at the end of 2023.

The banks in question were Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Well Fargo.

The Fed also published in December its climate-related regulatory framework.

Banks on the move

Brokers expect the major banks will be impacted most in the near term as they hold the bulk of Australia’s business and institutional banking business and will be required to set the industry standard.

These include Australia’s four major banks: Commonwealth Bank ((CBA)), ANZ Banking Group ((ANZ)), National Australia Bank ((NAB)) and Westpac ((WBC)).

Banks are pulling back from vulnerable industries and regions.

Westpac in July set emissions targets for clients in electricity generation, cement production, and oil and gas sectors.

Outside the usual fossil fuel-producing culprits, this should affect utilities such as AGL ((AGL)) and Origin Energy ((ORG)), and materials companies such as Boral ((BLD)) and Fletcher Building ((FBU)).

ANZ plans to cut financed emissions in the oil and gas sectors by -23% by 2030, while providing loans to companies with credible transition plans.

The bank plans to cut the emissions intensity of its electricity loan portfolio by more than -50% over the same period.

National Australia Bank has banned direct financing of greenfield gas projects. A government declaration of energy security is the only proviso, but this was criticised by conservation groups.

ANZ Bank has earmarked $67bn to accelerate its net zero transition.

It aims to cut oil and gas lending by -26% by 2030 and will facilitate concessional loans for energy-efficient equipment and finance construction of large energy-efficient office buildings.

It plans to have at least 75% of portfolio emissions on a net zero pathway by within two years.

In August, the Commonwealth Bank advised it would reduce its exposure to upstream oil extraction by -27% and gas extraction by -17% by 2030 from a 2020 baseline.

The bank added oil and gas extraction represented less than 1% of its balance sheet. The bank has committed to phasing out its thermal coal exposure by 2030.

At the moment, it's more huff than substance assuming criticism surrounding  gaps in bank datasets. This type of information is essential to determining counterparty risk.

So the above targets are likely to be a bit of a moving feast over the next decade as the banks calibrate their portfolios to international developments. These include the pace of rollout of electric vehicles and decarbonisation of large-scale construction.

The main role of the banks, however, is expected to be in mobilising capital for renewables and downstream markets and we should see a lot on this front over the next five years.

The Solution Is Simple

Greening the electricity grid is regarded as the easiest way to balance out climate risk on the books given there are fewer players, and transparency in bank reporting on grid investment will be considered critical in this respect. There is little doubt the banks will ensure that they are seen to be complying with climate expectations.

This is why litigation risk and governance are likely to be the key areas of concern for investors, as they relate to less manageable aspects of banking.

Greening downstream markets is far more complex and full accounting for these markets is a fair way off.

In the meantime, markets can expect continued strong funding into renewables infrastructure, as well as loans for clean hydrogen and low-hanging fruit in decarbonising downstream markets, and less funding for fossil fuels.

Fossil fuel companies such as Woodside Petroleum ((WDS)) are, at least for the next few years, flush with cash and capable of funding their own projects, although McKinsey expects demand for oil and gas could fall -35% by 2030.

So, as we said: it’s steady as she goes.

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future: 
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/

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AAC AGL ANZ BLD CBA FBU NAB ORG WBC WDS

For more info SHARE ANALYSIS: AAC - AUSTRALIAN AGRICULTURAL COMPANY LIMITED

For more info SHARE ANALYSIS: AGL - AGL ENERGY LIMITED

For more info SHARE ANALYSIS: ANZ - ANZ GROUP HOLDINGS LIMITED

For more info SHARE ANALYSIS: BLD - BORAL LIMITED

For more info SHARE ANALYSIS: CBA - COMMONWEALTH BANK OF AUSTRALIA

For more info SHARE ANALYSIS: FBU - FLETCHER BUILDING LIMITED

For more info SHARE ANALYSIS: NAB - NATIONAL AUSTRALIA BANK LIMITED

For more info SHARE ANALYSIS: ORG - ORIGIN ENERGY LIMITED

For more info SHARE ANALYSIS: WBC - WESTPAC BANKING CORPORATION

For more info SHARE ANALYSIS: WDS - WOODSIDE ENERGY GROUP LIMITED