Message to bond underwriters: Some big customers are sizing up your ESG credentials.
While vocal opposition to environmental, social and governance principles in the US has dominated headlines of late, behind the scenes, some of the world’s biggest bond issuers are quietly telling global banks that bad ESG scores may dent their appeal as underwriters.
Ulf Erlandsson, founder and chief executive of the Anthropocene Fixed Income Institute, says he’s aware of “a number of issuers” that have been close to putting their bank counterparties “in the box” — industry-speak for halting business with them for a period of time — if a bank is “fundamentally misaligned” with an issuer’s own ESG goals.
“Counterparty de-selection can be a very potent instrument, and one bankers should fear,” Erlandsson said. “Fees are the purest form of profit for bankers, and they really dislike losing them, so even just the threat of being benched is enough to set off alarm bells at senior levels.”
Take KfW, the German development bank whose 2024 funding plans have been set at roughly $100 billion. Ranking among the world’s biggest debt issuers, KfW last year raised questions about a low ESG score at Barclays Plc, according to people familiar with the matter.
The UK bank was told it had the worst rating by some margin among KfW’s top bond dealers, a message that Barclays took as an indication it might lose business, the people said, asking not to be identified discussing private deliberations.
A spokesperson for KfW, short for Kreditanstalt für Wiederaufbau, said the company has regular exchanges with its dealer banks about issues including “potential measures to improve ESG ratings.” When KfW selects banks for its green bonds, ESG ratings are among several criteria that the issuer takes into account, the spokesperson said, adding that KfW didn’t talk to Barclays about ceasing its cooperation with the bank. Last year, Barclays was a lead manager on a €3 billion ($3.2 billion) green bond issued by KfW.
A Barclays spokesperson declined to comment on the extent to which the bank feared losing bond mandates from KfW, but said an absence of regulations around ESG ratings has posed challenges around transparency, quality and reliability.
Barclays encountered similar issues with the Nordic Investment Bank. Last May, Barclays abandoned plans to respond to a request-for-proposal from NIB after concluding it was unlikely to succeed due to a low ESG score, according to one of the people familiar with the matter.
A spokesperson for NIB, which is owned by Nordic and Baltic countries, said it doesn’t comment on the selection of counterparties for its funding transactions. However, NIB applies internal ESG criteria to all banks it does business with, the spokesperson added.
The episodes demonstrate the surprising clout of ESG scores, despite the absence of regulations until very recently. The European Union just approved a plan to rein in ESG score providers through new rules designed to make them more transparent and consistent.
At Barclays, there is a small but growing contingent of clients that ask the bank to disclose its progress on a variety of ESG metrics, one of the people familiar with the matter said. Those issues range from the number of female managing directors that the bank employs to the level of financed emissions produced by borrowers.
Like most publicly traded firms of its size, Barclays is rated by several ESG data providers, including MSCI Inc., Morningstar Inc.’s Sustainalytics and S&P Global.
The ratings that were most problematic for Barclays came from the ESG ratings arm of Institutional Shareholder Services, the people familiar said. Barclays’ governance score at ISS had dropped to 9 in 2022, leaving it just one notch above the lowest possible grade of 10, according to the bank’s financial statements. It has since risen to 4, with 1 being the best grade.
A separate ISS rating gave Barclays a score of 8 — two notches above the lowest grade — as of December, as part of an assessment of corporate involvement in alleged or verified failures “to respect established norms for responsible business conduct” on issues such as human rights, environmental protection and business malpractice.
The low score, which has since improved to 5, was based on reports that Barclays had avoided paying about £2 billion ($2.5 billion) of taxes via an arrangement in Luxembourg, according to ISS. Barclays has previously said its taxable profits were offset by tax losses that had been brought forward, in compliance with Luxembourg law.
A spokesperson for ISS said it doesn’t comment on individual company scores or profiles, while noting that most ISS ESG ratings are freely available on its website.
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