(a) This evidence outlines the extent to which RBS are continuing to provide finance for significant projects responsible for climate changing emissions, what UKFI is doing about this, what they would need to do to match the best responsible investment practices, to which the Government frequently calls on private institutional investors to apply.
(b) This evidence will focus on the investments UKFI has in the Royal Bank of Scotland, although lessons from it apply to all of the financial institutions in which UKFI has shares. This focus is for two reasons:
- (i) RBS has historically been and remains the UK’s biggest financier of fossil fuel extraction.
- (ii) RBS is the bank in which the UK Government has the largest financial stake.
2) RBS and fossil fuel extraction: The Oil and Gas Bank.
(a) RBS is the UK’s biggest fossil fuel financier. The 2007 report “The Oil and Gas Bank” (Minio-Paluello) found that “The Royal Bank of Scotland is the primary UK bank financing new extraction of the fossil fuels.” The report argues that, in 2006, the emissions resulting from its investments were greater than the domestic emissions for the whole of Scotland.
(b) The 2008 report “Cashing in on Coal” (Smith) examines the role played by RBS, HSBC, and Barclays in providing finance for coal projects. It finds that, of these banks, “the data available shows RBS as having been involved in the greatest number of loans as well as having been responsible for loaning the largest estimated sum of money.”
(c) A more recent report by actuary Nick Silver (2009) argues: “A recent report from PLATFORM found that embedded emissions from project finance attributable to RBS was 44 M tonnes of CO2 in 2006|. However, most of these projects were in collaboration with other lenders and the total annual emissions from these projects was 825 M tonnes of CO2, significantly more than the UK’s total direct emissions and 3% of global emissions. So, through its ownership of RBS, the government potentially has a larger influence on global carbon emissions than it does through all domestic activities.”
(d) The February 2010 report “Cashing in on Tar Sands” finds: “between 2007-09, the Royal Bank of Scotland (RBS) has led underwriting for the largest amount in loans (of UK high street banks) to companies operating in tar sands in Canada, to a total of more than $7.5 billion.” (Evans et al, 2010). The report also outlines the extent to which this project is harming First Nation Canadians, and destroying crucial boreal forest.
(e) RBS sometimes argue that they are also significant financiers of renewable energy. Whilst this is, of course, welcome, the necessary transition to a low carbon economy is not possible unless fossil fuel extraction and burning is rapidly displaced with low carbon technologies. A forward looking investor needs to be finding ways of getting out of the fossil fuel economy and into the growing alternatives.
(f) As well as financing projects responsible for the greatest volume of greenhouse gas emission, RBS have financed numerous projects which have caused substantial controversy. The banks’s energy investment strategy appears not to have been affected by UKFI becoming the majority shareholder. For example, in January 2010, Reuters reported that RBS had acted as a joint global co-ordinator on a share deal for Tullow Oil worth 925 million. RBS was also involved in financing Tullow in March 2009 (Crookes, 2009), when RBS provided around $100 million. Tullow Chief Executive Aidan Heavey told Reuters that the funds raised by RBS would allow Tullow to bring their Ugandan fields to production. The Platform report “Cursed contracts, Uganda’s oil agreements place profit before people” (Lay, 2010) and Guardian article “Uganda oil contracts give little cause for optimism” (Lay, 2010) outline how this deal risks increasing violence and corruption with little benefit for the people of Uganda.
3) What actions can UK Financial Investments take within its current remit?
(a) According to UKFI’s website: “Our overarching objective is to protect and create value for the taxpayer as shareholder with due regard to the maintenance of financial stability and to act in a way that promotes competition.” As this statement makes clear, UKFI do not currently see taxpayer value as extending beyond the role taxpayers have as shareholders (other than with regard to competition in the marketplace). Even within this mandate, UKFI could still go much further to ensure its investments help, rather than hinder, the transition to a low carbon economy.
4) What is UKFI doing now?
(a) UKFI has no Responsible Investment Strategy, no Climate Change Policy and, until recently, it had no Sustainability Policy.
(b) After legal challenges and pressure from green groups, UKFI published a Sustainability Policy in February 2010 (available at https://www.ukfi.gov.uk/about-us/what-we-do/).
5) How could this be improved?
(a) This policy is some way behind best practice amongst the institutional investment community. We will take the Universities Superannuation Scheme (USS—the pension fund for university employees) as a comparator. They have a number of documents detailing the processes by which they ensure investments are socially responsible. They have also signed up to the principles of the Institutional Investor Group on Climate Change (https://www.iigcc.org/), and the United Nations Principles of Responsible Investment (https://www.unpri.org/principles/). UKFI has not signed up to either of these.
(b) The United Nations Principles of Responsible Investment have 700 signatories from investors responsible for billions of pounds. The Institutional Investor Group on Climate Change have more than 50 members. Many UK public sector investors have signed these principles. UKFI ought to do the same, or, at the very least, incorporate them into their own policies.
(c) The policy fails to recognise that UKFI is a universal investor. The Universities Superannuation Scheme Responsible Investment Strategy 2006, for example, explains: “Universal Investors have holdings that are so diversified that their investment returns are impacted by the returns from the economy as a whole as much as any specific industries or companies. This gives UIs a breadth of concern that aligns with whole market performance. For example, pension funds can be concerned with externalisation of costs such as pollution and training of staff, whereas an owner with a perspective limited to a particular company or industry may consider these to be unacceptable expenses because of competitiveness problems”.
(d) Similarly, as Nick Silver points out, (Silver, 2009) this is an argument the government has made to investors: City Minister Paul Myners said recently: “Any change that will lead to fund managers behaving more like “owners” and less like “investors” will have to come from the end client| Short-termism, as practised by pension funds, is self-defeating for those charged with delivering pensions over many decades into the future, and yet it remains a predominant form of behaviour|
- “A focus on `shareholder value’, as measured by relative share price performance over quite short time periods lies at the heart of a number of behaviours which have delivered less than ideal outcomes, such as| A failure to take account of the longer-term consequences of investment activity, including impact on the broader economy and society.”
(e) The UKFI policy says: “If it were proved to be the case that any of our investee companies’ sustainability policies, including environmental, social and governance issues, were significantly out of line with existing regulatory standards and guidelines such that they would have a negative effect on the value of the company and its shares|”. Other investors recognize that such a provision is not sufficient. UKFI has a stake in four separate financial institutions which, between them, have a large stake in the UK and global economies as a whole. If RBS externalize a cost or a risk onto a company in whom Lloyds have invested, then UKFI stands to lose out, even though RBS don’t.
(f) The USS strategy says it seeks to “Ensure USS Ltd plays its role as a Universal Investor| the Fund has an interest in ensuring that externalities and market failures (for example, in the form of pollution or systemic / weak corporate governance controls) do not affect market wide economic performance.” By limiting its concerns to each bank’s own separate share value, UKFI is failing in its fiduciary duty in that it will only take action when it’s investees have policies which damage themselves, rather than taking into account the fact that they could damage each other. It may be that long term future external costs, such as climate change, do not impact UKFI, who do not aim to exist in the long term. But the policy does fail to recognise those externalities which have more immediate risks—such as risks from funding projects which may de-stabilise central Africa (see Lay, 2010, for example).
(g) PriceWaterhouseCooper argue in their November 2009 report “Back to the future—Government, financial institutions and the global financial crisis” (PWC 2009) that the Government is likely to have shares in the bailed out banks for years to come. John Hitchins, UK banking leader, PricewaterhouseCooper, said: “Governments need to accept, given the limited likelihood of a quick extraction from the sector, that their main focus needs to be on the positive role they can play given they are `inside the tent’. With governments retaining stakes in FIs for some considerable time |they must: be seen to be `good owners’ focusing on wider social and economic objectives as well as narrow financial goals.”
(h) The final paragraph of the UKFI policy says “If it were proved to be the case that|” However it gives no account of how this will happen. It is possible that UKFI have, alongside this policy, put in place appropriate mechanisms to monitor RBS investments but there is, as yet, no evidence to support this.
(i) The report “Towards a Royal Bank of Sustainability” has recommendations for what UKFI would have to do to match investment industry best practice:
- (i) Becoming a signatory to the Carbon Disclosure Project (CDP), enabling UKFI to assess the climate risks of its investments.
- (ii) Being fully transparent by stating clearly guidelines on Environmental, Social and Governance (ESG) considerations and undertaking a periodic independent audit that takes into account ESG considerations.
- (iii) Seeking expert advice on how best to incorporate ESG considerations into its investment analysis and decision making processes.
- (iv) Behaving as an active owner and incorporating ESG issues into its ownership policies and practices; as well as seeking appropriate disclosure on ESG issues by the entities in which it invests.
- (v) It is not clear that UKFI has fully met any of these proposals despite the fact that these are the very principles of best practice the Government has long been encouraging investors to follow. Furthermore,these proposals are all clearly strategic in nature, rather than management decisions for RBS themselves so it is appropriate for UKFI to intervene.
- (vi) UKFI have chosen to interpret their mandate narrowly. Increasingly, investors have active sustainability policies. The principles on which these are based are widely understood and promoted by the Government. Yet UKFI fails to follow them.
6) Why UKFI’s mandate should be extended/clarified.
(a) If UKFI currently has a mandate to prioritise direct shareholder value above the broader interests of the UK government, this is problematic. With the Universal Investor principle, institutional investors know they have a broader stake in the economy as a whole than do the individual companies in which they invest. As a result, there is a conflict between the interests of investors, and those of investees. Investors actively oversee company strategies in order to ensure theirs are the interests which are secured.
(b) UKFI has a direct fiduciary interest in much of the UK economy. But UKFI’s owners’—HM Treasury—have a much larger stake in the longer term future. If it is appropriate for investors to intervene in their investees in order to secure their broader financial interests, then it is similarly appropriate for the Government to intervene in UKFI in order to secure their broader interests.
(c) The Government should, essentially, apply a “universal investor plus” principle. While UKFI and RBS may not have a long term stake in the costs resulting from the burning of fossil fuels, the UK Government does. Lord Stern suggests climate change risks a 20% reduction in GDP. Nick Silver suggests RBS alone are involved in projects and companies responsible for 3% of global emissions. Effectively, the Royal Bank of Scotland is externalising costs onto its owners.
(d) As well as recommending that UKFI match best practice of institutional investors, Nick Silver also highlights the necessary steps for UKFI to provide leadership by:
- (i) Providing incentives for long-term, sustainable behaviour by linking executive pay to the companies’ long-term performance and to the bank’s environmental and social performance.
- (ii) Ensuring bank lending is screened on environmental and social criteria. The bank’s commercial customers should be subject to independent audit on environmental and social criteria.
- (iii) Appointing a board member with specific ESG (Environmental, Social and Governance) responsibilities.
- (iv) Commissioning an independent review to investigate a “sustainable” bank model, with recommendations and lessons learned that could be applied to RBS.
(e) It would be possible for UKFI to introduce such policies with their current mandate. Active ownership is entirely in keeping with policies of many large investors. These are appropriate strategic decisions for owners to take, rather than management decisions which ought to be left to RBS. However, as UKFI have failed to enact these, the Treasury ought to make it clear that they are expected to.
(f) The application of the “Universal Investor Plus” principle requires setting a strategic direction. It is not sufficient to simply “negatively screen” projects—to prevent financing for those which are most destructive. The Government should also push for strategies which align with their interests—just as pension funds do. The Norwegian Government Pension Fund, for example, not only has comprehensive ethical guidelines (Norwegian Finance Ministry, 2004). They have also recently decided to actively use a proportion of their funds ($4 billion) to finance green energy. The Financial Times (Lamont, 2009) were told by a Norwegian Government representative that “the new investment strategy reflected Norway’s recognition of the need for a strong partnership | `in the international arena to find a solution to challenges such as climate change’”.
7) Towards a Green Investment Bank.
(a) In parallel to debates about UKFI’s remit, the Government and opposition parties have been considering proposals to establish a state backed Green Investment Bank. Green Alliance, E3G, Policy Exchange, Climate Change Capital and others have called for the establishment of such a bank to lever in significant private capital for investment in the infrastructure required to deliver a low carbon economy. There are a number of ways that such a bank could be created, but to be successful it will need a capital base. One route would be to use a proportion of the public stake in UKFI to provide some of the initial capital for a Green Investment Bank. The energy funds in RBS could be transformed over time into a low carbon infrastructure fund, and held back from sale when shares of RBS are eventually sold.
(a) The Government’s failure to properly scrutinise RBS and the other bailed-out banks from financing fossil fuel extraction could be their biggest contribution to global climate change. If they accept the arguments they have previously made to pension funds about responsible investment, and if they are to truly help the effort to transition to a low carbon economy, then they must act now.
(b) The report “Towards a Royal Bank of Sustainability” has a number of clear actions the Treasury and UKFI could take, and we recommend that they do.
(c) We further recommend that they look at the possibility of using part of the stake in RBS as a foundation for a green investment bank.
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