A fine line’: Canada’s big banks have long stood by the oilpatch, but ESG pressures are changing things

This article was written by Barbara Shecter and originally published in the Financial Post on August 22, 2022.

If you want to understand the sway Canada’s energy sector has historically held over the country’s big banks, you need only look back a few years to a controversy stirred up when Canadian Imperial Bank of Commerce launched a bond to promote the advancement of women in corporations.

The offering, which was the first of its kind for a Canadian bank, explicitly championed gender diversity, but tucked away in the fine print was a covenant that prevented the use of the funds for fossil fuel development.

The reasoning was that investors with an ESG focus that included both gender diversity and environmental goals — such as emissions reduction — could purchase the bond.

However, behind closed doors, there was an outcry from the oil and gas industry. It was taken to heart. In 2018, after the bond had already been sold, the bank took the highly unusual step of removing the fossil fuels restriction.

It was a sign of the oilpatch’s power, but it may also have been a last hurrah of sorts.

In the four years since, earmarking funds for carbon-reducing projects has become commonplace, with Canadian banks issuing “green” and sustainability bonds in the billions of dollars. They have underwritten billions more for other issuers, including governments. Proceeds from those bonds are used to finance projects with environmental benefits including renewable energy, green buildings and cleaner transportation. Meanwhile, the banks have trimmed exposure to direct oil and gas lending as a percentage of their loan books, launched “responsible investing” ETFs and spoken of new and expanding pledges to champion and act upon environmental, social and governance (ESG) goals.

All the while, though, they have maintained an outsized relationship with the oil and gas sector from a global perspective, according to environmental groups.

That symbiotic relationship — forged when energy and resources were the backbone of the Canadian economy — is increasingly coming under pressure from governments, shareholders and environmental groups amid a global movement to cut down on fossil fuel emissions, with many seeing the financial sector as a fulcrum to enact change.

These multi-pronged external pressures, which carry the message that banks ought to be practising what they preach when it comes to ESG, appear to be pushing Canada’s financial giants in what one observer referred to as a “slow walk” in the same direction as their European counterparts, which have for several years been aiming to reduce emissions linked to their lending portfolios. Whether that slow walk is fast enough to appease their critics is another question.

“There’s a fine line and the financial institutions are going to have to figure out how to walk that fine line,” said Gord Nixon, who was chief executive of Royal Bank of Canada for more than a decade before stepping down in 2014.

Move away too quickly, and the business will go to others outside traditional banks and capital markets vehicles, Nixon said. Go too slowly, and governments and shareholders may punish you.

“It’s not easy,” he said.

Tracking by Canadian Imperial Bank of Commerce shows that, since 2015, the country’s biggest lenders have reduced the exposure to oil and gas as a percentage of their loan books — from two per cent to 0.8 per cent by the second quarter of this year.

And the decline wasn’t solely pegged to a shifting mix in loans. The actual total loan size also declined from an average of just shy of $8 billion to a shade over $5 billion.

Not all banks trimmed by the same quantum, but the general trajectory has been the same, a trend that has picked up steam since 2020, according to the CIBC data.

Despite these changes, Canadian financial institutions have largely stood by the oil sector, particularly when compared to some international banks. It’s a relationship that goes beyond loans and includes underwriting activity among other services.

In May, an analysis presented at an online conference held by a shareholder advocacy group called Investors for Paris Compliance — set up last year to hold Canadian companies accountable for their net zero commitments — showed each of the five Canadian banks ranked much higher in fossil fuel financing than in global assets. RBC was ranked fifth and 24th, respectively, for example, while Bank of Nova Scotia was ninth and 41st. BMO clocked in at 49th by assets based on the S&P, and 15th in fossil fuel financing.

Other environmental and social groups behind a report titled Banking on Climate Chaos scolded the Canadian banks for increasing their exposure to oilsands projects in 2022, though much of that was a return to pre-pandemic levels.

The numbers crunched in the Chaos report, backed by groups including the Sierra Club, the Indigenous Environmental Network, and Rainforest Action Network, suggest Royal Bank ranks fifth globally among global fossil fuel financiers, right behind Bank of America, with its overall exposure to the sector pegged at more than US$200 billion over the past five years.

All of Canada’s Big Five banks are in the top 25 on the report’s 2022 list, which is topped by New York-based JP Morgan Chase.

Regulators, too, have begun to express concern about the banks’ potential exposure to climate-related risk, particularly as governments have signed on to global commitments to reduce carbon footprints. These concerns have led to calls around the world for greater disclosure. In May, the Office of the Superintendent of Financial Institutions (OSFI) laid out expectations for enhanced disclosures and management of these risks by the banks.

OSFI said Canadian banks are “in the early stages of incorporating climate-related factors into their risk decision-making and capital management,” and warned that “climate-related risks, including physical and transition risks, could have significant impacts on the safety and soundness of financial institutions, and the broader Canadian financial system.”

Banks are also facing pressure in public forums. Two shareholders represented by Investors for Paris Compliance, for example, took on Royal Bank at its annual shareholder meeting this year with “greenwashing” claims tied to a pipeline deal billed as sustainability financing. The resolution calling on Canada’s largest bank to update its criteria for sustainable finance to “preclude fossil fuel activity and projects facing significant opposition from Indigenous peoples” failed to obtain enough support to pass.

But that doesn’t mean it or others like it won’t be back next year, said Richard Brooks, climate finance director at North American environmental organization Stand.earth. He noted that more than five per cent voted in favour of the RBC resolution, the threshold required in the United States to bring a resolution forward again the following year.

Objections to Canadian banks financing oil and gas projects appear to have taken a far more extreme turn in some cases. Royal Bank has been criticized by environmental groups and the Wet’suwet’en hereditary chiefs for financing the contentious Coastal GasLink natural gas pipeline in British Columbia. In May, police in Montreal said they were investigating whether anti-pipeline anarchists who claimed anonymously online to be acting in solidarity with the Wet’suwet’en were behind a fire that destroyed a Jaguar and Land Rover at the home of Michael Fortier, who is vice chairman of RBC Capital Markets and a former federal Conservative cabinet minister.

At the time, RBC issued a statement condemning the violence and said it was glad no one was hurt.

Unverified online postings have also claimed Coastal GasLink protesters had vandalized the home of Nadine Renaud-Tinker, president of RBC’s Quebec headquarters, using a paint-filled fire extinguisher.

“I guess RBC has a big target on its back because it’s been the biggest bank,” said Yrjö Koskinen, a professor of finance at the University of Calgary’s Haskayne School of Business. “It’s been a good business for them for so many years…. And these are long-term relationships.”

Canadian bank executives are keenly aware of the delicate balancing act they face as the swell of climate change activism and regulatory scrutiny mounts.

Jonathan Hackett, head of sustainable finance at Bank of Montreal and co-head of BMO’s energy transition group, said the executive committee has set a bank-wide strategy to build on longstanding banking and advisory relationships while finding ways to balance client needs with external pressures to reduce emissions.

“If we go to our clients and say, ‘We wish you the best, please let us know how you do on your journey,’ that certainly doesn’t sound like being our clients’ lead partner in the transition to a low-carbon economy,” he said.

Like other Canadian banks, BMO has begun to roll out carbon emissions reduction targets, which Hackett said it will meet by lending to energy-transition and carbon-capture projects, while helping clients tap government programs and off-balance-sheet financing.

That strategy will make way for a different kind of conversation with oil and gas clients that acknowledges the difficulty in continuing to finance the business as it is today, he said, especially in cases where the energy company is trying to maintain historic growth targets and satisfy shareholders.

Executives and academics say part of the difficulty for banks, which may lend to the appearance of a slow walk, is that there is not a lot of readily available, comparable and universally accepted data to rely on to set targets and monitor risks.

This reality is requiring banks to roll out their “decarbonization approach” in stages, a couple of sectors at a time, said Michael Torrance, BMO’s chief sustainability officer, noting that the bank chose to focus on power generation and transportation in the first year.

“The amount of work that it takes to actually evaluate financial conditions and quantify it for a particular sector and set targets understanding decarbonization pathways, doing the modelling, understanding what initiatives are within an industry, it’s an incredibly difficult undertaking,” he said.

Alexander Dyck, a professor of finance, economic analysis and policy at the University of Toronto’s Rotman School of Management, said the well-documented difficulties reaching a global consensus on what constitutes a true green initiative or sustainable finance project gives the banks an incentive to form industry groups to collect data and set standards to ensure they don’t push out ahead of the pack.

“In this circumstance what you would imagine is that the (banks) would prefer to go through an industry solution, rather than one firm trying to be the best in that space or the worst of that space,” Dyck said. “So there’d be a lot of reliance on ‘Let’s all move there together,’ which is another way of slow-walking this effort.”

Indeed, Canada’s largest banks have joined the international Partnership for Carbon Accounting Financials (PCAF), a group that aims to standardize emissions disclosure internationally, as they work to catalogue, disclosure and manage climate risk.

Dyck, who has a cross-appointment with his university’s faculty of law, said he was surprised by a recent commitment from BMO that singled the Canadian bank out for praise from environmental groups among its domestic banking peers.

A line deep in a 46-page document produced by Canada’s fourth-largest bank in mid-March pledged a 24 per cent reduction in absolute emissions in its upstream oil and gas lending portfolio by 2030. Stand.Earth’s Brooks said he was surprised to see that commitment, which was a first for a major Canadian bank. Most so far target only end-use emissions reductions that are measured by intensity, which can be achieved even if overall emissions increase.

Dyck said BMO appeared to be taking a calculated risk, perhaps betting that any clients who didn’t like the move would be offset by those who did.

“This is really difficult to do, and it could lead to them losing some clients,” he said.

Banks are not alone in trying to find the balance.

In other parts of the financial system, institutions are carving separate paths. Caisse de dépôt et placement du Québec, for example, has committed to divest all its oil production assets by the end of this year. When it was announced in the fall of 2021, the assets were valued at $3.9 billion. This is a different approach to the one taken by the Canada Pension Plan Investment Board, whose chief executive, John Graham, has explicitly and repeatedly said fossil fuel divestment is not on the table for the organization responsible for investing on behalf of Canada’s national pension scheme.

In a response that has no doubt been observed by Canada’s big banks, the Caisse has faced pushback. The Canadian Association of Petroleum Producers, for example, struck back by saying the Caisse’s strategy does “nothing” to impact demand for oil and natural gas. Furthermore, the association argued, Canadian financial institutions turning their backs on the industry drives investment away from a “responsible” country to other nations that will be less so. CAPP has also suggested that Canadians will have fewer job opportunities while enriching other nations “that do not share Canada’s environmental or human rights standards.”

The Ontario Teachers’ Pension Plan has not taken as strong a stance as the Caisse, committing to cut the carbon intensity of its investments by 45 per cent by 2025 from a 2019 baseline, and then by two-thirds by 2030. Alberta Investment Management Corporation (AIMCo), meanwhile, is unlikely to pursue a divestment strategy, executives have said, preferring to continue invest in the western Canadian province’s expertise in energy through a transition to a lower-carbon economy.

Nixon, the former CEO of RBC who now sits on several corporate boards including BCE Inc., where he is chair, said one-size-fits-all solutions would be ill-advised, as would strident requirements to pull away from the oil and gas industry.

He added that the banking sector has long dealt with external forces and regulations that require executives to re-think the way they manage risk and capital, including pivots in strategy. This often creates friction, he said, because it is the job of regulators to push — but never to the point of a breakdown.

“I think it’s a huge mistake to (take the position) that you’re not going to work and support the energy industry as you manage through that transition,” he said. Removing bank lending and capital markets participation from the oil and gas sector will simply shift the activity elsewhere, he said.

“And that doesn’t provide a solution to the challenges of global warming.”

Read the original article here: https://financialpost.com/fp-finance/banking/a-fine-line-canadas-big-banks-have-long-stood-by-the-oilpatch-but-esg-pressures-are-changing-things