The Taiwan Banker

It’s no secret that the complexity of sustainable finance presents a minefield for Taiwanese banks, as it does for banks globally. Varied stakeholders from regulators, customers and investors each have their own sustainable finance objectives. Not to disregard the importance of regulators and customers but investors and, specifically, shareholders yield the most influence over the strategic direction of a bank through their influence on the board of directors (“Board”), which is usually persuasive. Put simply, if the Board isn’t taking care of the interests of the bank’s shareholders, then the directors might put themselves at risk of removal from office, or worse, a claim for breach of their director’s duties. As agents of the shareholders, the Board also sets the tone for a bank’s strategy on sustainable finance. But, should shareholders drive the sustainable finance agenda in banks? This question carries increasing importance as banks are perceived as playing a vital role in global decarbonisation efforts and are an integral part of the financial system. Banks are by their nature competitive, risk-taking organisations constrained by the rules that regulators put in place to keep such institutions safe from or at least less prone to collapses that do and will undoubtedly continue to happen. History has a tendency to repeat itself. Understandably, given the important role of banks in society, sustainable finance regulations have also evolved and banks are under pressure to continue to adapt. Central banks and regulators, globally, have also steadily increased requirements of banks in monitoring and disclosing their Environmental, Social, and governance (ESG) risks. One notable example is the European Central Bank (“ECB”) which has an advanced, comprehensive set of sustainable finance regulations in place. The ECB is also ready to fine banks if they fail to properly manage their climate risks. Aside from other considerations, climate change is understood to translate into increased credit risks of bank loan portfolios. Climate risks are even thought to represent systemic risk to the global banking industry. Additionally, research suggests that organisations that have good ESG ratings are generally more profitable and resilient than those that are not. The major credit ratings agencies might also agree – ESG metrics have been an input into credit ratings for some years now. A bank’s cost of funds also impacts profitability and banks, as debt issuers, are keenly aware of the pricing impact that credit ratings have on the bonds that they issue. Much of the focus of bank management teams has been on meeting, at least, the minimum regulatory requirements demanded of them as well as the requirements of shareholders. Shareholders can influence banks through: 1. Portfolio screening in which investors divest their capital from banks that don’t meet their sustainability requirements to the banks that do. 2. Shareholder engagement (also called “voice”) whereby investors directly urge companies to adopt more sustainable practices through means like meetings, shareholder proposals, or voting. Generally, a fewer number of larger shareholders are in some respects relatively easier to understand as their views can be made more clearly to the Board than a larger shareholder base with smaller shareholdings. Presentations and meetings with key shareholder groups can help the Board understand what the shareholders’ sustainable finance objectives are and respond accordingly. The following initiatives may be considered by a Board in order to progress a bank’s sustainable finance objectives: 1. Properly integrate ESG into the Board’s strategy: The Board’s ESG oversight responsibilities for board members should be specifically defined as well as that of specific committees. This should be detailed and require alignment of sustainability into the bank’s strategy, it’s opportunities and risks. This may include developing an ESG committee (and sub-committees, as necessary) with an agreed scope so that the Board can be advised appropriately by the committee. Furthermore, the Board should set priorities for the relevant members of the management team i.e. updating it of the bank’s ESG agenda, deliverables, regulatory compliance and readiness. The Board’s strategy should be regularly reviewed to ensure it is appropriate to the business context. 2. Ensure management team accountability: In addition to Board-level responsibilities, the management team needs to be appropriately tasked with responsibility and empowered to lead on ESG. A senior-level manager, such as the CEO, should take the lead to ensure that there is the right-level of messaging from the top and so that employees understand the importance of a bank’s sustainable finance agenda. 3. Monitor ESG integration in line with shareholder objectives: A bank’s progress towards the shareholders’ sustainable finance objectives should be monitored and transparently reported to the Board so that it is properly appraised by the management team or, ideally, the ESG committee, which will have reviewed the ESG reporting. 4. Align internal audit with the bank’s sustainable finance agenda: A Bank’s Audit Committee should coordinate with the Board to understand how ESG risks are defined and measured, who the risk owners are, which committees are tasked with overseeing ESG risks and the disclosure process for any material risks that have been identified. 5. Review the bank’s ESG maturity: Taiwanese banks are subjected to changing local requirements (e.g. the various iterations of the Financial Supervisory Commissions - Green Finance Action Plans) and international standards (e.g. the SASB standards which support the identification and disclosure of sustainability risks via the International Financial Reporting Standards framework) to support transformation, disclosure and measurement of a bank’s ESG performance. The Board’s role is critical in agreeing to the standards that will measure the bank’s sustainability objectives as well as meeting the needs of shareholders, investors and regulators. 6. Ensure proper disclosure and communication strategy: Shareholders, along with other stakeholders, have an increased focus on transparency and credibility of ESG disclosures, how much a bank is aligned with it’s ESG strategy and the progress it is making towards implementation. The better a Board understands a bank’s ESG position, the better it can communicate with shareholders. Banks can also obtain assurances from independent third parties which can provide further confidence to shareholders. In the case of green bond issuances, for example, a bank can obtain a second party opinion (also called an SPO) to provide assurance to a bank and its stakeholders. A bank’s ESG progress should be a positive selling point for banks not just a regulatory exercise. The Board should also consider fresh opportunities for product design, improved public relations, marketing and branding strategy. The above list is not exhaustive and each bank will have their own specific ESG-objectives based on regulatory and shareholder requirements. In recent times, despite the importance of sustainable finance, there has been debate by some companies and investors internationally, particularly in the United States, over the appropriate use of ESG ratings. However, this debate should be seen as an evolution of sustainable finance which remains a critically important topic for stakeholders. Boards should therefore prioritise the ESG issues that provide the highest value to a bank and be prepared to be scrutinised on a bank’s sustainable finance agenda by investors, regulators and other stakeholders. Fergus Clark is an international banker with over 20 years of specialist and senior-level expertise across Australia, Asia and Europe. He is an independent non-executive director of Southeast Asia Commercial Joint Stock Bank (SeABank) Vietnam and has led the risk transformation of a commercial bank in Asia and developed ESG strategy and roadmaps globally.