environmental and social risks from the perspective of

ECOFACT AG, Zurich, Switzerland, www.ecofact.com 1

Olivier Jaeggi

Managing Director

Tel. +41 44 350 60 62

[email protected]

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Environmental and Social Risks from the

Perspective of Reputational RiskCFS Conference "Reputational Risk Management in Financial Institutions"

House of Finance, Goethe UniversityFrankfurt, March 3, 2016


There are at least three reasons to have a chapter on E&S risks in a book about

reputational risk management:

1. It can contribute to a better understanding of E&S risks.

2. E&S risks offer interesting insights into reputational risk (e.g. because they can

translate into reputational risk that can occur independently of other risk types).

3. In most banks, E&S risks are still a neglected source of reputational risk, despite their

importance.

Environmental and Social (E&S) Risks in Banking

E&S Risks from the Perspective of Reputational Risk / March 3, 2016


• Our chapter focuses on the direct relationship between a bank and its corporate

clients (e.g. loans, advisory services, export and trade finance).

• Controversies linked to companies can affect the banks that engage in business

relationships with them.

• Controversies result from

• controversial business practices (e.g. illegal logging),

• controversial sectors (e.g. the mining industry),

• controversial projects (e.g. large dams), and/or

• controversial countries (e.g. autocratic regimes).

• In some cases controversies are based on mere allegations and there is little tangible

information or evidence about the actual situation.

• Controversies primarily occur in emerging markets and developing countries.

However, such E&S situations occurs in any country.

Environmental and Social (E&S) Risks in Banking



The Relationship between Banks and Corporate Clients


Natural Environment

Society

Economy

FinancialInstitution Services

CorporateClient

© 2010 ECOFACT



Natural Environment

Society

Economy

FinancialInstitution

CorporateClient

© 2010 ECOFACT

1. Impacts

Services




Natural Environment

Society

Economy

FinancialInstitution

CorporateClient

© 2010 ECOFACT

2. Perception

1. Impacts

Services




Natural Environment

Society

Economy

FinancialInstitution Services

CorporateClient

© 2010 ECOFACT

3. Risks

2. Perception

1. Impacts



• Almost any project can lead to controversy if it has the potential to impact on a

sensitive location, to threaten an endangered species, or to infringe the rights of local

communities, for example.

• In the words of Michael J. Kowalski, Chairman of the Board and CEO of Tiffany &

Co., who is at the forefront of opposition to the development of the Pebble Mine:

"The mine poses a dire threat to the region's pristine, highly productive ecosystem

that supports the world's most important salmon fishery (…). We have long believed

that there are certain special places where mining simply should never take place, and

we are working to make the retail jewelry industry and jewelry consumers aware that

Bristol Bay is one such place. We are also urging the U.S. Environmental Protection

Agency to use its authority under the Clean Water Act to prohibit mine development

there."

Example: Pebble Mine in Alaska's Bristol Bay Region



• In the 2006 Basel II framework, the Basel Committee wrote that it expects the

banking industry to develop standards for reputational risk management, but did not

provide further guidance.

• In 2007, together with Dresdner Bank (now Commerzbank) we established the

Forum on Reputational Risk Management in Banking to provide a platform for dialog

and knowledge-sharing on common and best practices in reputational risk

management. The Forum now takes place in London. Previous hosts include HSBC,

Deutsche Bank, RBS, and Standard Chartered.

• In 2008, we developed a framework to address shortcomings of earlier definitions of

reputational risk. It also emphasizes the role of tangential stakeholders such as NGOs,

the media, and the public. There have an important influence on how transactional

stakeholders perceive a bank's activities and business decisions.

E&S Risks Translate Into Reputational Risk



E&S Risks Translate Into Reputational Risk



• Two key documents, both endorsed in 2011, are the UN Guiding Principles on

Business and Human Rights (UN Guiding Principles) and the OECD Guidelines for

Multinational Enterprises (OECD Guidelines).

• Although not legally binding, the UN Guiding Principles are considered to be an

authoritative global reference point for business and human rights. Financial

institutions do not have to cause a negative impact to be linked to it. The link is

established through the business relationship.

• The OECD Guidelines explicitly refers to the UN Guiding Principles. Companies are

responsible for respecting human rights and are expected to adapt the scope of their

due diligence processes.

• National Contact Points (NCPs) support the implementation of the OECD Guidelines.

Individuals or NGOs can contact the NCPs if they wish to raise a company behavior

which might be inconsistent with the Guidelines.

International Standards Define Acceptable Business Practices



The Regulatory Environment Is Rapidly Evolving


Initiative: Ban on speculation

in agro-commodities

Interpellation on the risk of the "carbon bubble" for the Swiss financial sector

Alien Tort Statute / Questions concerning

extraterritoriality

Hong Kong Stock Exchange: ESG Reporting Guide

Reporting requirements on environmental and social matters

Initiative: Business and Human Rights

Treaty OECD Guidelines for Multinationals

Conflict Minerals Guideline

UN Guiding Principles

Non-Financial Reporting Directive

Prohibition of financing banned weapons

Dodd-Frank-Act: Payments to

Governments by Resources Extraction

Issuers

Dodd-Frank-Act: Conflict minerals rule

CSR Strategy 2011-2014

Prohibition of direct financing of cluster munitions

Green Credit Policy & Guidelines

• Examples:

Updated Markets in Financial Instruments

Directive

Member States’ National Action Plans on CSR

Development of National Action Plan on Business and Human Rights

Sustainability Working Group at

WFE

Sustainable Stock Exchanges Initiative


Position on relationships with clients associated with controversial activities

(…) We will not knowingly provide financial services to corporate clients (…) where the use

of proceeds, primary business activity of the client or of the acquisition target involves

environmental and social risks, defined as follows (…):



Enhanced due diligence and approval process

An enhanced due diligence and approval process is triggered for areas in which we will only

provide financial services under stringent, pre-established guidelines. Such areas include




2014


How Banks Assess E&S Risks



Banks Must Rethink Their Business Practices


• Five main drivers in the risk landscape of banks increase the need for them to assess

E&S risks systematically. One way to read the connections between them:

• A) The growing materiality of E&S risks changes B) how they are perceived and

influences expectations of banks in addressing them.

• C) Greater transparency makes it easier for NGOs, the media, and other actors to

compare a company's business practices against benchmarks.

• These benchmarks are defined

- by D) new and stricter minimum requirements, and

- by E) advances in business practices defined by sector leaders.

• Deviations from these benchmarks, whether alleged or actual, expose companies –

and their banks – to risks.


Conclusion


� Relationships with controversial clients (e.g. transactions, client relationships,

investments) can lead to reputational risk.

� In some cases, such reputational risk can occur as a stand-alone risk.

� Reputational risk frameworks and definitions should not underestimate the role of

tangential stakeholders.

� Voluntary guidelines are transitioning to soft and hard law; this further increases

reputational risk for banks that fail to comply with the relevant standards.

� E&S issues harbor considerable potential for damage in the here and now.

Banks take a significant risk if they underestimate them.

environmental and social risks from the perspective of

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