Banks face pressure to stop financing fossil-fuel companies.

In the world of global finance, bank loans, new bond issuances and project finance are arguably more important than traditional equity for providing companies with working capital. But this financing, when directed to the most carbon-intensive forms of energy, is an inefficient use of financial capital and a key contributor to climate change.

Stopping funding for fossil-fuel industries immediately is not an option because there is no fully fledged global alternative energy system that eliminates the need to burn fossil fuels. Creating a global alternative energy system is a huge financial, industrial and technological challenge. Demand for fossil fuels, even in Paris-aligned scenarios, is expected to continue for at least the next 30 years, although the likely pace of phasing out use of different commodities is a source of significant debate.  

But climate change poses a clear and present danger to banks. The financial risk from climate change can occur through the following mechanisms:

  1. Corporate loan defaults: the bankruptcy of the world’s largest coal miner, Peabody, was a powerful example that climate change can affect the ability of a fossil-fuel business to continue operating. Demand for fossil-fuel commodities is expected to increase over the next 10-20 years, mainly owing to emerging-market growth. But over the next 30 years the industry is expected to enter structural decline, potentially causing bankruptcies and defaults.
  2. Industry exposure in loan books: typically, banks have diversified loan books so any negative impact through defaults or delayed interest/loan repayment is relatively small in comparison with the overall performance of the bank. Industry breakdowns of loan books is often poorly or inconsistently disclosed so shareholders are rightly demanding more information.
  3. Underwriting new equity or debt issuances: in an underwritten capital-markets offering for shares and bonds (IPO or follow-on or syndication), banks guarantee a minimum price. There is a risk that banks overestimate market demand for fossil-fuel equity or debt issuances and end up taking the risk on their own balance sheets or risk taking losses.
  4. Damage to collateral that underpins loans from extreme weather events: flooding, wildfires and hurricanes can damage the value of property which acts as collateral against mortgages or loans.
  5. Reputation: a poor reputation can lead to depressed share prices, even if the business looks like it has strong future cash flows. We believe reputational risk is the most likely near-term climate-related concern for the banks. Furthermore, we struggle to see why the small fees generated from financing Arctic or ultra-deep-water exploration are worth the reputational risk and the potential negative consequences from this.

Of course, on the flip side, banks can positively respond by understanding and mitigating the downside risks highlighted above as well as taking advantage of the burgeoning renewable, clean tech and green product financing opportunities that are available.

Banks perceived as laggards can expect to attract attention from shareholders. At its upcoming AGM in May 2020, Barclays is expecting to face a shareholder resolution asking the bank to disclose its targets for phasing out lending to those energy and utility companies that are not aligned with the Paris Agreement. Barclays is being targeted as the largest European financier of fossil fuels and the sixth largest globally, with total financing amounting to US$85.2 billion between 2015 and 2018.1 The shareholder resolution highlights an important issue and we expect to support it. We also suspect other banks will soon face similar resolutions from their shareholders.

[1] Banking on Climate Change Report from Rainforest Action Network (2019).

Authors

Newton responsible investment team

Newton responsible investment team

Responsible investment team

Comments

Your email address will not be published.

Newton does not capture and store any personal information about an individual who accesses this blog, except where he or she volunteers such information, whether via email, an electronic form or other means. Where personal information is supplied, it will be used only in relation to this blog, and will not be collected or stored for any other purpose. Comments submitted via the blog are moderated, and, as a result, there may be a delay before they are posted.

Newton manages a variety of investment strategies. Whether and how ESG considerations are assessed or integrated into Newton’s strategies depends on the asset classes and/or the particular strategy involved, as well as the research and investment approach of each Newton firm. ESG may not be considered for each individual investment and, where ESG is considered, other attributes of an investment may outweigh ESG considerations when making investment decisions.

Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice. The securities shown are accurate as of December 31, 2019 and were selected based on being top-ten holdings in one or more of our strategies. The specific securities identified are not representative of all of the securities purchased, sold or recommended for advisory clients, and actual holdings may vary by client. It should not be assumed that an investment in the securities identified was or will be profitable.

Important information

This is a financial promotion. Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Newton Investment Management Limited is authorized and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation. 'Newton' and/or 'Newton Investment Management' brand refers to Newton Investment Management Limited. Newton is registered in England No. 01371973. VAT registration number GB: 577 7181 95. Newton is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton's investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only.

Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including Newton and (iv) representatives of Newton Americas, a Division of BNY Mellon Securities Corporation, U.S. Distributor of Newton Investment Management Limited.

Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2020 The Bank of New York Company, Inc. All rights reserved.

Explore topics