Author: David Korslund

Banks have a constant desire to stay within the rules. Unfortunately this goal is too often executed through a focus on the form of the rules rather than the function the rules are intended to deliver. This week The International Consortium of Investigative Journalists released a detailed study regarding money laundering. Working with information provided them by BuzzFeed News, the consortium did a detailed analysis of the flow of funds in those reports. It should be noted that the reports are confidential and it is not clear how BuzzFeed obtained the files but there has not been evidence that the files are not real.

What is clear from the analysis is that many very large banks continue to process very large transactions that have dubious backgrounds. Whilst banks should not be responsible for law enforcement, they do have a responsibility to conduct transactions with integrity. Large transfers of funds intended to whitewash money and defraud governments should not be part of a bank’s activities. Given that the amounts tend to be very large, it is difficult to believe that the bank’s can not take actions to prevent this type of whitewashing.

Of course the banks respond by noting they are not able to comment on client specifics. But that does not lessen their responsibility for knowing their clients and enforcing standards of integrity. And the transactions analysed are just a small portion of the total reports filed (0.02%), what has been reported is surely only the tip of the iceberg.

This week Megan McArdle in The Washington Post had a useful essay on the reaction of the investment banking world to COVID-19 and work habits. She writes about her prior experience working in an investment bank where the importance of being in the office was critical – even if there was no useful work to do.

She noted: “This system is legendarily abusive, and arguably unproductive. But it was durable, at least until covid-19, when a flurry of stories suggested that investment banks were ‘rethinking their pre-coronavirus lifestyle of exhausting global travel, interrupted family time and all-nighters in the office.’”

She then goes on to highlight a particular element of the investment banking culture: “:So I suspect that bankers are going back to the office, not because the organization or the nation requires it, but because bank culture has spent decades filtering for macho displays of pointless sacrifice, and the people at the top are apt to be among those who most enjoy them.”

I think the core to the last comment relates to the issue of “macho displays of pointless sacrifice.” Is this culture one which will allow finance to benefit society? Or one which only allows those to succeed who could care less about the impact of their work on society?

As noted in an earlier post, part of the US regulatory structure is busy looking at rules to prevent pension funds from looking at ESG factors in making investment decision. Interestingly a subcommittee of the Commodity Futures Trading Commission (another US regulatory body) is clearly warning of the risks of climate change for the financial system. This report was reported by the Financial Times in an article that notes this seeming discrepancy between two regulatory agencies. It does raise the question if the right hand knows what the left hand is doing.

At the same time it is heartening to see that even US regulators are beginning to sound the alarm on risks from climate change. The full report of the sub-committee is available for all to read. It correctly notes in its summary that “(c)limate change poses a major risk to the stability of the U.S. financial system and to its ability to sustain the American economy. This reality poses complex risks for the U.S. financial system.” I encourage all bankers to read this report and consider actions they should be taking to mitigate the identified risks.

Two recent articles highlight for me the importance of culture in banks. Over the last several years compliance departments have grown enormously in banks to address shortcomings in practice. But it is increasingly clear that a bank can never hire enough internal police to prevent problems. Rather banks must develop cultures where all employees know what is right and wrong. And this issue is not specific to any geographic area although it does seem to be linked to large banks with complex operations.

Just one week ago the Financial Times reported on the issue of spying at Credit Suisse. This scandal has been going on for some time and led to a change in the CEO. The Swiss regulator appointed an independent investigator to gather the facts and his report appears to be complete. And if that report does not create enough heartburn for Credit Suisse, the FT article provides a number of additional cases where problematic behaviour by bank staff has been cited. Again indicative of a culture lacking a focus on integrity.

Meanwhile on the other side of the pond, JP Morgan Chase has stated that some of its staff and clients may have abused the Paycheck Protection Program set up to support the US economy during the COVID-19 pandemic. As reported by Bloomberg yesterday, the “New York-based bank said it has seen ‘instances of customers misusing Paycheck Protection Program Loans, unemployment benefits and other government programs’ and that some ’employees have fallen short, too,’ according to a memo to staff from the bank’s senior leaders Tuesday.” Whilst it is important that JP Morgan Chase is pro-actively attacking this issue, the underlying cause of some employees lacking a culture of integrity also needs to be addressed.

One of the key promises of the Trump campaign was to drain the swamp. This concept is based on a belief in part that the legal and regulatory system that exists in Washington DC is too often beholden to the rich and powerful at the expense of the average person. Given the complexity of the modern US economy and the needed regulation for that system, this promise to drain the swamp does have solid reasoning behind it. The question is whether or not it is actually happening.

A recent proposed rule from the US Department of Labor as documented in the Financial Times suggests that the promised draining remains only a promise. In effect it will prohibit pension fund fiduciaries from voting on a shareholder proposal “unless the fiduciary prudently determines that the matter has an economic impact on the plan.” This rule appears to be supported and pushed by corporate lobbyists – swampier creatures probably do not exist. Corporations are clearly not interested in having their owners (e.g. the pension funds) vote their shares on issues which may make them more accountable as well as more focused on ESG principles.

Furthermore this proposed US Department of Labor rule is based on an assumption that it is easy to determine if a shareholder proposal has an economic consideration. I can only suspect that that determination will be in the eyes of the beholder – the corporation who will seek to avoid a shareholder view on issues its considers inconvenient. So it appears that draining the swamp has still quite some distance to go.

The investment case for banking in both Europe and North America is not very positive. Low levels of profitability, concerns over risk costs arising from COVID-19 and an interest rate environment that will continue as central banks seek to support an economic recovery all point to unattractive banking returns. This depressing challenge was nicely summarised recently in the Financial Times. Whilst that article paints a slightly more positive picture for banks in North America, the overall conclusion does not provide support for investors returning to the banking sector. The only potential positive is that the very low level of share price relative to book value, especially for European banks, may provide a reason to invest. But the more challenging issue is raised in the article that talks about the “Japanification” of interest rates in Europe – a description that may also fit the US.

But perhaps there is an upside to all this gloom. The financial sector grew substantially relative to the economy in the last several years. This growth and “over-financialization” of the economy is probably not a healthy long term trend. Reducing investments in banks should lead to a reduced size of the banking sector over time. Hopefully that will lead to a focus on the real economy that should also reduce overall financial risk in the system. But it is likely that the transition will come with some pain as the sector re-adjusts to this new reality.

This week Shayne Ebudo in the Financial Times described his experiences in the banking world as a Black person. He relates experiences that are truly shocking not only in their racism but also in the utter lack of common decency and politeness by people in power, all of whom were White and generally male. As banks consider their role in addressing social and economic inequality, they also need to reflect and change internal cultures that allow this behaviour to be tolerated. Similar stories also arise over the treatment of women in banking. Can banks attract talent from all sections of society or must they only take on White men with noxious attitudes to be successful?

Under European Union rules, asset managers will need to provide clarity on the sustainability of their investment portfolios. This reporting is to be in place by March 2021. But of course now that date is coming closer, there is a push to delay it. An excellent article in the Financial Times provides more insight into this issue including a clear discussion of the challenges facing asset managers. However, given the fact that this request has long been known and that there is considerable evidence that attention to ESG factors leads to better financial returns (see the work of George Serafeim for example).

As noted in the article there is a lot of work to be done and not all companies will have the data available. But with any change, starting is the best way to get to the desired end state. And the need to address “greenwashing” is critical if companies and investors are going to move forward to address the challenges of climate change and social and economic inequality. If not today, then when?

As Sergeant Joe Friday in Dragnet would often say: “Just the facts ma’am.” This is also good advice when it comes to approaching the issue of carbon emissions – especially for banks. In today’s Financial Times there was an excellent commentary from Marilyn Waite of the William and Flora Hewlett Foundation. She clearly outlined why banks and other financial institutions should provide consistent data on the carbon footprint of their portfolios. She notes: “(b)anks and other financial institutions are happy to make broad, long-term commitments about reducing climate impact by 2050, but granular metrics are essential to tracking such progress.” She further notes that the impact of climate change is likely to be quite high in the financial system due to the impact of it on portfolio quality.

She goes on to cover various initiatives underway within the financial sector of which the most important is the Partnership for Carbon Accounting Financials. This initiative began in The Netherlands with support from all of the major financial institutions. It is now expanding globally with significant support from the Global Alliance for Banking on Values. This drive to create an open source but consistent way of measuring the carbon footprint of financial portfolios will usefully create the transparency so that investors, clients, co-workers and regulators will have insight to just the facts about a financial institution’s exposure to climate change.

Robert Armstrong in the Financial Times provides his strong perspective on the role of ESG investing. Whilst there is much in his view with which I disagree, he makes several useful points as well. He makes the critical point that is not possible for “shareholders’ economic interests and the social good (to) always harmonise over the long run.” This view is one that is too often ignored by proponents of ESG investing in their goal of having their cake and eating it too. Armstrong correctly notes that “corporate leaders must sometimes make choices that benefit stakeholders at the cost of shareholders.” I believe that view is a healthy dose of realism in this discussion.

He correctly notes that when “companies subordinate everything to maximisation of shareholder value, it backfires.” I would note that the example he uses focuses on IBM’s focus on a specific earnings per share target.  I am not sure that earnings per share are necessarily the best target for creating longterm shareholder value although I fully support his point that exclusively focusing on shareholder value is not always helpful for a company’s long term survival.

Armstrong goes on to say that “(s)hareholder capitalism is an excellent way to manage our corporate economy and we should stick with it.” However throughout his perspective he neither cites studies that specifically prove this point nor the increasing number of studies that show a focus on ESG can deliver greater shareholder value. I find it interesting that proponents of a pure shareholder value perspective require academic proof of the ESG value proposition without requiring a similar standard of support for their own assumptions.

Finally Armstrong addresses a substantive issue related to public policy and politics. He notes that “(m)ost US companies are incorporated in states where the law requires them to put shareholders first” which while true ignores the efforts by B-Lab to make changes in this approach. But perhaps my greatest criticism relates to his final point that “democratic action and the rule of law, . . . allow us to, for example, set minimum wages, tax carbon emissions and change campaign finance laws.” This factually correct statement ignores the significant and successful efforts by corporations and wealthy individuals to subvert the democratic process through the use of their economic wealth to avoid these goals being achieved.