With climate-related financial disclosures in place, banks now pay more than lip service to sustainability but do they really have a coherent money-making strategy?

Eric Lim, head of group finance at United Overseas Bank (UOB), has a way of explaining esoteric concepts such as expected credit loss, macroeconomic variable models, regulatory loss allowance reserves and management overlay in simple, easy to understand language. On May 11, Lim, who was recently appointed chief sustainability officer (CSO), had the opportunity to put that expertise to good use by articulating UOB’s sustainability strategy and goals as clearly as possible.

Climate change is important because we need to bequeath Earth to our children. But how do companies transition to lower emissions without a huge impact on lives and livelihoods? What are the global standards that measure whether projects are sustainable? And for investors, how will banks profit from climate change?

In the developed world, the average carbon emission per person is eight tonnes or 8,000kg per year. If we do not curb emissions and continue on our current path, the global economy could lose 25% in GDP per capita by 2100, according to various organisations such as Carbon Brief, WWF, Royal Society, IPCC and Pew Charitable Trusts.

As Lim sees it, government and societal pressures have caused sustainability and sustainability financing to go mainstream. “Customers want sustainable finance for manufacturing, big tech and agriculture. Investors are looking for products in sustainable financing. We need to demonstrate that in our conventional banking, we’ve got sustainable finance and solutions,” he says.

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Indeed, banks are eager to boost their sustainable credentials and the relationship between sustainability and banks has been discussed for some years. However, this relationship is like a jigsaw puzzle with pieces missing, leaving market players and investors to slot in green bonds and sustainability-linked loans while leaving out pieces like financing oil majors and offshore support vessel (OSV) players which were once such a meaningful part of the local market.

Do banks get more fees from loans and bonds for fossil fuels or green and sustainable projects? What about coal miners like Geo Energy Resources and Golden Energy and Resources? Where do they fit in? And how do countries across Asean power their economies without fossil fuel?

To be sure, it must be difficult for banks to pass up the chance to finance projects by ExxonMobil, Chevron or Royal Dutch Shell, whether related to fossil fuels or renewables. An example is Hin Leong, The large local oil trading company which went bust had DBS Bank as one of its major financiers. And five years after the 2016 Paris Agreement, the world’s top 30 banks still get a lot more fees on loans and bonds from fossil-fuel financing than green financing (See table 1).

Coal is still an important driver for many Southeast Asian nations. While Singapore’s electricity supply has switched largely to natural gas, which is less polluting than oil and coal, many of its neighbours — which are emerging markets — still rely on coal to power their economies. Switching to sustainable and environmentally-friendly business models will inevitably impact lives and livelihoods.

SMEs and smaller companies are likely to face the most challenges as they attempt to transition to lower carbon emissions. Furthermore, the oil and gas (O&G) sector — although much diminished in clout and stature — is still relatively important. So where do the local banks stand on this and what does it mean for their investors?

A bank’s role and TCFD

Like its other business units, UOB focuses on the ecosystem, says Lim. The sustainability ecosystem comprises government planning, asset managers and investors, and customers and supply chains. As governments roll out sustainable development plans such as the Singapore Green Plan 2030, this changes the way the bank’s customers work, live and invest.

Meanwhile, asset managers are focusing on sustainability in terms of their asset allocation, investment selection and share price. Customers are also asking for more sustainable products such as green and sustainability-linked loans and ESG investments.

“The way we think about sustainability is as intermediaries that manage capital flows, liquidity flows and credit origination. Our role is to look at where the future of these economies are going, based on national development plans, based on where [companies] are transforming their business models and where asset managers are going to be putting their investment dollars,” says Lim.

“It makes perfect commercial sense to build a loan portfolio, fee-based income and revenue model that supports a sustainable outcome and be able to wean ourselves off old economy-type revenue models simply for good business sense,” he adds.

One way to identify financing risk is from a framework established by the G20’s Financial Stability Board’s (FSB) appointment of the Task Force on Climate-related Financial Disclosures (TCFD), Lim points out.

In December 2015, the FSB appointed the TCFD to recommend a reporting framework for use by companies to provide investors and other stakeholders with information relevant to evaluating climate-related risks and opportunities.

In June 2017, the TCFD’s final recommendations (See “TCFD helps in climate change prep”) for voluntary climate-related financial disclosures included industry-specific guidance for the financial services industry. The TCFD recommendations separate climate risks and opportunities into two general categories — transition and physical — and recommend that companies undertake climate scenario analysis to better understand and account for potential risks and opportunities under each category. In the recommendations, stress-testing by banks is likely to include new data, tools, additional expertise, better integration with transition scenario outputs and extensive analysis to better understand the potential linkages between transition risks and credit quality within different sectors and sub-sectors.

For instance, banks, including our three local lenders, use stranded assets analysis to calculate the likelihood that upstream O&G assets in their energy portfolio would lose value because of a carbon price or tax and how that would impact clients’ credit quality.

“The TCFD recommendations advocate disclosing clear, comparable and consistent information on climate-related risks and opportunities,” notes Mikkel Larsen, CSO at DBS Group Holdings.

All three banks are following the TCFD guidelines. “We did transition risk this year and physical risk next year,” Lim says.

This involves running models and scenarios including disasters such as which parts of the world are going to be flooded and would that geography encompass UOB’s customers. For instance, in UOB’s different divisions such as wholesale banking and retail banking, the transition and physical risk personnel will have a framework and scorecards.

Stranded asset analysis

Banks following the recommendations of the TCFD have introduced the concept of stranded assets and stranded asset analysis that calculates the likelihood of how upstream O&G assets in banks’ energy portfolio could lose value because of a carbon price or tax and how that would impact clients’ credit quality.

Elsewhere in the O&G complex, larger companies such as the oil majors may not be significantly affected in their ability to repay loans as they transition to lower carbon emissions. But smaller providers of OSVs and their supply chain supporters could be at risk if the price of oil continues to remain low. This has left some smaller producers and owners of OSVs more financially vulnerable, particularly if regulatory risks are not carefully managed.

“Oil and gas infrastructure will run its natural path as the world moves towards renewables and we need to support this transition and there will be business models that support this transition. Coal-financing could result istranded assets. The last thing you want to do is pumping investment dollars into a sunset industry,” Lim points out.

“We will state our position on oil and gas financing in recognition that there will be a period of transition required to get to net-zero emissions,” says DBS’s Larsen.

The main concern is transitioning out of coal, which cannot be done overnight. The reality is that 60% of Indonesia’s power is from coal, and 40% of Malaysia’s. The International Energy Agency (IEA) says Asean aims to derive 23% of its power from renewables by 2025. Moreover, Asean is one of the fastest-growing regions globally and its economies cannot stop using coal abruptly — they need to transition.

“Banks need to think about transition finance. We have clients in these difficult industries. We communicate to them that we are willing to stay if you are willing to make some tough commitments to walk down this path of sustainability. As long as you’re willing to pivot, we will do everything we can to structure transactions, services and products to support this pivot,” says Kamran Khan, Asia-Pacific Head of ESG at Deutsche Bank.

“There are risks associated with projects such as coal-fired power plants. The risk of them becoming obsolete and thus becoming a stranded asset with deteriorating financial returns for banks is a real concern,” says Mike Ng, head of structured financing and sustainability financing at Oversea-Chinese Banking Corp (OCBC).

“Although there might be benefits in the short run for banks that continue financing new coal-fired power plant projects — given that banks would be able to charge a premium with fewer competitors financing such projects — we do not view this as a sustainable strategy in the long run. Thus, in April 2019, we announced that we would no longer finance new coal-fired power plants, becoming the first bank in Southeast Asia to do so,” Ng adds.

Deutsche Bank, which still gets more fees from loans and bonds for fossil fuel projects than green projects, says it is beginning to focus increasingly on sustainable finance. “We are saying ‘no’. We are being clear about what our goals are and what doesn’t fit,” Khan says. “There have been very high-profile cases where we decided not to participate at great cost to us and we maintain this consistency,” he acknowledges.

Financing palm oil, in particular in Indonesia, has become controversial. Deutsche Bank was embroiled in the controversy and was accused by a German publication of financing Wilmar International in 2014. The bank issued a statement saying that it had initiated a dialogue with Wilmar to look for potential solutions together.

In its annual sustainability report, Wilmar says it has implemented a no deforestation, no peat, no exploitation (NDPE) policy, just as other SGX-listed plantation companies are doing.

When asked about its palm oil-financing, Lim says UOB’s palm oil customers are in Malaysia and are part of a high risk ESG portfolio that is less than 5% of its book. “Our policy complies with the NDPE policy for oil palm plantations. We comply with local regulation, with Roundtable for Sustainable Palm Oil (RSPO) and Malaysian Sustainable Palm Oil (MSPO). It’s about sustainability because palm oil will continue to be a major contributor to world food,” Lim says.

Although oil palm plantations help with carbon dioxide mitigation, oil palm plantations growing on peat soils are subject to a debate concerning the magnitude of carbon dioxide and methane emanating from the peat.

UOB looks to US$1 trillion a year

In a results briefing on May 6, Wee Ee Cheong, UOB’s group CEO, said that ESG is embedded in everything the banking group does. “As a responsible financial steward, we embed ESG considerations into our business strategy, supporting customers financing and investment needs,” he said. He added that there could be US$1 trillion ($1.3 trillion) in annual economic opportunities in Southeast Asia as the region transitions to a green economy.

“For financial services, people tend to think in numbers, return on equity, net interest margins, cost-to-income ratio and common equity tier 1. We are shifting beyond financials to impact investing, including greenhouse gas emissions, social goals to assist the low income, alignment to sustainable development goals (SDG) and we are trying to change the numbers to impact on the environment and social impact,” Lim says.

All of UOB’s sustainability loans — and it has written some $12 billion to date and its investment management business — are aligned with the UN’s 17 SDGs.

UOB’s research identifies four main sectors where it sees its US$1 trillion in opportunity within Asean. These are renewable and transitional energy, food and agriculture, efficient industries including digitalisation of logistics, sustainable packaging and green and connected cities that include green and intelligent buildings, and shared and intelligent mobility. Each segment would require investments from anything between US$200 billion and US$250 billion.

Asset managers are giving investment dollars to those who have a path to net-zero emissions. “So all public companies have to respond and this translates to every listed company. Corporate customers want products that are sustainable like green loans and bonds as they too are investing in green assets. Hence, UOB is willing to give them sustainability-linked finance,” Lim says. “We will continue to print loans at market competitive rates although with US$1trillion, you can grow your book.”

Financing the transition

Transitioning to a green economy is a process. First, in terms of power generation, banks all claim they do not want to finance coal anymore. These black and brown projects probably comprise about 10% of banks’ total books. At the other end of the spectrum are renewables. All banks want to finance a solar farm and a wind farm. Even then, the opportunity in renewables probably comprises another 10% of banks’ loan book. Moreover, most companies are not black like coal or green like renewables but somewhere in between.

“They are companies like us which draw energy from the conventional grid. We will use air-conditioning. For this 80%, it is important we help them move towards a sustainability journey to lower emissions and the main tool for this 80% are sustainability-linked loans,” Lim says. “For the 10% of loans that are truly green, we have green finance. For the bottom 10%, there is responsible financing for the black group,” Lim adds.

UOB has a substantial SME book and these are the companies that could find it challenging to transition. “We are working on a sustainability conversation with our SMEs from an advisery perspective,” Lim says. This includes explaining the need for lowering emissions and advising them on how they can achieve this goal.

Opportunity is turning profitable

Based on data from Bloomberg, since the Paris Agreement in 2016, banks still get a lot more fees from underwriting fossil fuel-related loans and bonds than from green projects. However, that could be changing.

According to a study by Bloomberg, from a profit and loss standpoint, industry executives now have proof they can make money participating in the transition away from fossil fuels. Banks are earning fees of about 0.6% for underwriting green bonds and loans, according to Bloomberg. This is six basis points more than similar deals for energy companies.

The amount of capital needed to get to net-zero emissions, or at least a low carbon future, are in the trillions. Analysts at S&P Global estimates some US$3 trillion in annual investments would be needed if the world hopes to limit warming to 2°C by 2050 as set out in the 2016 Paris Agreement. Of course, it is not possible for emissions to drop to zero.

However, companies are making an effort to achieve net-zero — the balance between the amount of greenhouse gas emissions produced and the amount removed from the atmosphere — and that in itself is likely to consume capital. In a briefing by DBS Bank, the Singapore Exchange, Temasek Holdings and Standard Chartered on May 20, it was mentioned that about 1,800 companies are aiming to get to net-zero emissions.

According to a Citi report titled Financing a greener planet issued in February, capital is needed to fund the technologies required to help markets evolve towards decarbonisation. To decarbonise the world, the investment gap between what is being spent currently and what needs to be spent is likely to be higher than US$5 trillion per year.

Furthermore, Citi calculates that decarbonising high emission sectors that are responsible for over 25% of today’s carbon dioxide emissions like shipping, aviation, road freight, steel and cement could cost anything from between US$900 billion and US$1.6 trillion a year.

According to the IEA, as of February, around 110 companies that consume large amounts of energy or produce energy-consuming goods have announced net-zero emissions goals or targets. Around 60% to 70% of global production of heating and cooling equipment, road vehicles, electricity and cement are from companies that have announced net-zero emissions targets. Nearly 60% of gross revenue in the technology sector is also generated by companies with net-zero emission targets. In other sectors, net-zero pledges cover 30%–40% of air and shipping operations, 15% of transport logistics and 10% of construction.

Investors, lives and livelihoods

While sustainability and green loans are very much in the news, banks operating in Southeast Asia need to be more circumspect in their financing models. “In Asia, this is where E (the environment) and S (social) issues combine. During some of this transition, when you look at the S side, you’re going to truly punish people with the least resources to manage this change,” notes Khan of Deutsche Bank. “You’ve got to find a balanced approach where you’re pivoting on the E side but you’ve got some landing on the S side so you don’t make lives miserable and you’re not destroying lives.”

While UOB’s remaining tenor for financing coal fire power plants is five years, it is working with big coal anchors on their diversification plans into renewables. “In Asean, reliance on coal ranges from 40% to 70%. The national development plans for these countries cannot hit zero coal. Our strategy is to pick national anchors that have the will and capacity to transform,” Lim says.

“The one thing not to forget is, we are an intermediary and the way we create an impact is by working with customers helping their models change. There is no point standing at the top of the mountain shouting climate change. We must bring customers along,” Lim says, which is where his knack for making complicated subjects simple will come in very handy.

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Sustainability-linked loans continue to rise

Local banks have announced targets for sustainability-linked loans. United Overseas Bank (UOB) has written $12 billion of sustainability-linked loans and has an unambitious target of $15 billion by 2023, of which $4 billion was achieved in 2020. 

Mike Ng, head, structured finance and sustainable finance at Oversea-Chinese Banking Corp (OCBC), says his bank has written $10 billion of sustainable finance by 1Q2020, two years ahead of schedule. “We have since announced a new sustainable finance target of $25 billion by 2025 and have made good progress towards this target. By the end of last year, we had already achieved $20 billion in sustainable finance commitments.”

On May 24, OCBC announced that OCBC Wing Hang had provided a green loan of RMB500 million ($103.4 million) to Shanghai Kai Tong Wen An Development Co, a subsidiary of K Wah International Holdings, to finance the construction of a green office tower in Suzhou Creek, Shanghai.

By far, DBS Group Holdings has the most ambitious target. CSO Mikkel Larsen says the bank recently raised its sustainable financing target to $50 billion by 2024. “Since 2018, DBS has concluded over 100 sustainable financing deals worth about $17 billion.”

As a portion of their traditional loans, sustainability-linked loans are relatively modest. DBS has the largest loan book at $386 billion as at March 31. OCBC’s loans stood at $271 billion while UOB’s was $293 billion as at the end of 1Q2021.

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TCFD helps in climate-change prep

In 2017, the Task force on Climate-related Financial Disclosures (TCFD) unveiled a reporting framework for use by financial institutions and companies to provide investors and other stakeholders with information relevant to evaluating climate-related risks and opportunities.

“Inadequate information about risks can lead to a mispricing of assets and misallocation of capital and can potentially give rise to concerns about financial stability since markets can be vulnerable to abrupt corrections,” states the document by the TCFD.

The number of companies that are committed to reducing carbon emissions are now in the thousands. Yet, the reduction in greenhouse gas emissions implies movement away from fossil fuel energy and related physical assets. This coupled with rapidly declining costs and increased deployment of clean and energy-efficient technologies is likely to have financial implications for organisations (and countries) dependent on extracting, producing, and using coal, oil and natural gas, the TCFD says.

Climate-related risks and the expected transition to a lower-carbon economy is likely to affect most economic sectors and industries. The task force divided climate-related risks into two major categories: (1) risks related to the transition to a lower-carbon economy and (2) risks related to the physical impacts of climate change.

Transition risks and opportunities are those risks and opportunities that relate to technological innovations, policy changes, carbon pricing, and other factors in the transition to a low-carbon future. These are policy and legal risk, technology risk, market risk and reputational risk.

Physical risk analysis addresses the direct impacts of climate change, which include acute extreme weather events or chronic changes to climate that could affect companies’ businesses and physical assets. TCFD‘s discussion of physical opportunities includes the ability to provide a variety of services, including financing and resilience planning, to mitigate exposure to physical climate risks.

A 2015 study cited by the task force estimated the value at risk, as a result of climate change, to the total global stock of manageable assets could be as high as US$43 trillion ($57.1 trillion) between now and the end of the century. Much of the impact on future assets will come through weaker growth and lower asset returns across the board.