Who’s afraid of a counterparty ESG test?

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??This week: Banks could be facing ESG risk on a new front , as Bloomberg reported some debt issuers in Europe are weighing bond underwriters’ ESG credentials when deciding whom to appoint for their deals.

That trend might pose little additional risk to banks in South-east Asia, of course. If a factor materially affects a bank’s ability to act as a counterparty, potential issuers are probably already watching out for it regardless of whether the factor is labelled ESG.

Furthermore, South-east Asia is an emerging and developing market, so setting the bar too high could be counterproductive.

According to Bloomberg, some bond issuers blacklist bond underwriters whose ESG track records are deemed to be misaligned with the issuers’.

Anthropocene Fixed Income Institute chief executive Ulf Erlandsson called the phenomenon “counterparty deselection”.

Citing sources familiar with the matter, Bloomberg said UK bank Barclays had come under scrutiny from German development bank KfW and the Nordic Investment Bank for its ESG performance.

Barclays had received poor ESG ratings by Institutional Shareholder Services, which advises large investors on how to vote on shareholders’ resolutions, Bloomberg said.

There are important commercial reasons for taking ESG factors into consideration when deciding whether to award an underwriting mandate for a coming bond deal.

An underwriter with significant exposure to potential stranded assets could be at risk of a balance sheet hit. An underwriter known to be financing companies that exploit child labour could be subject to legal or policy jeopardy. An underwriter with weak governance would generally not instil confidence.

Where these factors might pose a material short-term risk for the bank, however, most potential issuers are already aware of and looking out for these factors as part of the issuers’ existing due diligence processes.

There will, nevertheless, be additional risk if issuers are also looking for alignment with the issuers’ ESG objectives.

The head of funding and investor relations at Berlin Hyp, a German commercial real estate lender, told Bloomberg that the firm assesses counterparties’ ESG factors out of a concern for “reputational risk”.

This might not be a very high hurdle to cross in South-east Asia. To begin with, local context matters – which means that potential issuers will calibrate their requirements for the realities of the markets they’re in.

For instance, expectations for diversity, equity and inclusion policies and targets cannot be simply transferred wholesale from Europe to South-east Asia. These markets have different starting points, and cultural norms can affect the pace at which progress happens.

With that in mind, issuers are probably more lenient in South-east Asia when it comes to values alignment and assessing reputational risk.

ESG issues that are not severe enough to pose a meaningful risk in the short term may not be enough to derail a deal.

Even if ESG issues do exist, it’s not a given that potential issuers will simply reject an underwriting candidate outright – especially if the issuers have an existing relationship with the bank.

The broad view in the financial markets is that engagement with an underperformer might be a more effective way than exclusion to generate progress.

Growth markets also tend to be sellers’ markets. If you don’t want to buy my services, someone else will. Mere “deselection” may not wield much influence under these circumstances.

In any case, Singapore’s three local banks appear to be in a good spot if deselection becomes a bigger trend in South-east Asia.

Although there are significant variances in ESG rating systems, for the most part DBS, OCBC and UOB are among the best-rated Asian banks. They still lag behind the major European banks but seem to hold their own against US lenders.

Counterparty deselection should be expected as ESG factors become increasingly integrated into financial ecosystems, and this phenomenon reflects positive progress in ESG standards.

Whether it becomes widespread in an emerging market such as South-east Asia is far from certain.

??Top ESG reads:

1. Indonesia and Singapore will deepen cooperation on the green economy , the two countries’ outgoing leaders said at their final meeting in office.
2. Indonesia’s new president must partner with global companies to capture a piece of the enormous green technology pie , says The Business Times columnist Shoeb Kagda.
3. Sembcorp Industries has clinched 18-year power supply deals with data centre trust Equinix to provide renewable and gas-fired power.
4. Singapore’s government must demonstrate strong leadership to ensure proper sourcing of feedstocks for sustainable aviation fuel, says Propelo Aviation founder Jamie Bloomfield.
5. If the coming COP29 UN climate conference in Azerbaijan fails to deliver on securing stronger pledges, doubts will grow about the future of the annual meeting, says LSE Ideas associate Andrew Hammond.

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