Global Zero Carbon
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Summary:
The divergent attitudes of financial regulators in the United States and Europe towards ESG have created a significant "transatlantic split". As U.S. finance and banks begin to seize the fossil fuel investment market, European banks are required to make bank provisions for potential ESG risks. Investors' perception of European banks has lagged behind their US counterparts.
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Some people say that in the past two years, it has been difficult for executives of multinational companies in the financial industry to do this, because when it comes to ESG (environmental, social and governance) reporting or information disclosure, it is easy to be divided by different winds and regulatory requirements on both sides of the Atlantic.
Regulators in Europe are pushing hard for everything related to "sustainability", while the "anti-ESG" wave is growing in the United States.
In March, JPMorgan Chase, Citibank, Wells Fargo and Bank of America collectively withdrew from the Equator Principles, an initiative that advocates for financial institutions to fulfill their due diligence obligations on environmental and social issues in the financing of projects above $10 million.
At the same time, State Street Bank and Pacific Investment Management have also withdrawn from the Climate Action 100+ initiative.
Currently, the Net-Zero Banking Alliance, one of the Glasgow Financial Alliance for Net Zero (GFANZ), has 71 European members, but only nine are from the US, while the Net-Zero Insurance Alliance has eight European corporate members, none of which are from the US.
In the European Union, financial institutions are facing stricter disclosure rules, all of which European regulators say are ultimately designed to enable the industry to respond to future risks.
At the same time, in the context of the Republican-led anti-ESG campaign in the United States, many of the planned climate rules and guidelines are being scrapped.
Last month, for example, the U.S. Securities and Exchange Commission (SEC) removed the requirement for listed companies to disclose Scope 3 emissions in its corporate climate risk rules, under pressure from many companies.
Regulators in Europe and the United States are following different trajectories, and this trend is becoming more and more apparent. Fortune magazine has vividly called this "divide" a "transatlantic split."
The "divergence" between US and European regulators on ESG will not only make ESG regulatory standards more and more different around the world, but also actually affect investors' valuations of European banks.
01
The United States and Europe parted ways
The differences between the United States and the European Union on ESG investment are reflected in regulation on the one hand, and market demand on the other.
According to ESG Book, a sustainability data tracker, there are 20 ESG-related mandatory rules and 25 voluntary guidelines for the entire European financial services industry, compared to only 2 mandatory rules and 5 voluntary guidelines in the United States.
ESG investing has a solid regulatory framework in Europe, including the EU taxonomy defining climate-friendly investments, as well as other important EU regulatory rules such as the Sustainable Finance Disclosure Regulation, which compels financial groups to disclose their sustainable investments, and the Corporate Sustainability Reporting Directive (CSRD), which applies to companies in the real economy.
In terms of investor demand, according to a 2023 London Stock Exchange survey, around 73% of European pension plans say climate change is an investment priority in 2023, compared to just 53% in the United States.
Although the demand for ESG from European investors has declined due to the impact of the economic cycle and the general environment, the magnitude is small. According to Morningstar, the number of new ESG funds launched in Europe fell by 10% in 2023, but by 75% in the United States.
In the fourth quarter of last year, outflows from U.S. sustainable investment funds reached $5.1 billion, compared with $3.3 billion in European inflows, making European assets under management seven times larger than those of the United States.
PricewaterhouseCoopers, one of the world's four largest consultancies, estimated in a report that about three-quarters of European investment funds will meet ESG criteria by 2027. According to the report, about 61.5% of European funds are currently ESG compliant.
Based on an analysis of the trends in issuance, flow and investor interest of European ESG funds in 2023, PwC predicts that the level of assets allocated to ESG strategies in Europe will rise to €9.7 trillion over the next four years.
Demand comes from cognition. There is a significant difference in the perception of ESG investing between the EU and the US.
According to a 2022 study by the nonprofit Pew Research Center, Europeans are more likely to see climate change as a "major threat" regardless of their political leanings, while in the United States, the study found a large divergence between the left and right political factions in their views on climate.
02
The scales of imbalance of interests
The very different performance of Europe and the United States in the face of climate regulatory rules is actually a kind of imbalance of interests.
For Europe and the United States, the climate disclosure requirements for financial companies have an important purpose, that is, to restrict the financing of the fossil fuel industry by these institutions through disclosure.
According to Bloomberg, U.S. regional banks are significantly increasing their lending to oil, gas and coal customers.
Regional banks, including United Bank, Citizens Financial Group Inc., and Truist Securities, are all quickly grabbing market share as European competitors pull out.
Whether it is the energy shortage caused by the cold winter of 2021 or the Russia-Ukraine conflict that broke out in 2022, one of the final results is that the EU's energy demand for the United States has risen, the prices of fossil fuels such as crude oil and coal have soared, and corporate stock prices have been strong.
At the same time, clean energy companies are financing equipment through debt, and the Federal Reserve continues to raise interest rates, causing their costs to rise, eroding profits and causing stock prices to languish. The performance of stocks or funds that favor clean energy has also been affected.
In this case, not allowing U.S. financial institutions to invest in fossil fuels would be tantamount to "blocking people's money" and would not be in the interests of states that rely on the fossil fuel industry as the backbone of their economies.
But the EU's surveillance agencies also have their own ideas. The European Banking Authority (EBA) said in January in its draft guidance on ESG risk management that European banks should integrate environmental, social and governance risks into their regular risk management frameworks.
The EBA believes that climate change, environmental issues, social issues, and other ESG factors "pose considerable challenges to the economy impacting the financial sector."
This contradiction erupted at a closed-door meeting of the Basel Committee on Banking Supervision (BCBS) earlier this month.
The Basel Committee on Banking Supervision (BCBS) brings together representatives of regulators and central banks from around the world to set international regulatory standards for banks. Some of these members have been pushing for climate risk and ESG commitments to be at the heart of new rules for banks around the world.
The BCBS had previously proposed that from January 2026, banks should publish detailed information on the impact of climate change on their businesses to help investors and regulators examine how they manage their risks.
The European Central Bank (ECB) is also pushing the committee to further propose that lenders disclose their strategies for meeting climate commitments.
However, US regulators, led by the Federal Reserve, have backlashed against BCBS's climate rules behind closed doors, according to people familiar with the matter.
Caption: Federal Reserve Building
Source: Reuters
Fed Chair Jerome Powell made it clear in his public comments that the Fed should not be mistaken for a "climate policymaker."
03
European banks at risk of valuation
However, when the EU's insistence on ESG meets Wall Street's neglect or even resistance to ESG, it may be European banks that suffer.
In this context, the European Banking Federation (EBF) said earlier this month that European banks will not be able to compete with their US rivals if regulators, led by the European Central Bank, continue to set ESG regulatory rules that have been clearly abandoned by Wall Street.
At that time, the European Central Bank was pressuring lenders to prepare for losses caused by "emerging risks" such as ESG, including "loan loss provisions".
This so-called "loan loss reserve" is actually a kind of bank provision, which refers to the reserve made by a financial enterprise for the financial assets that bear risks and losses, and is also included in the cost of the financial enterprise, and its function is to truly reflect the fair value of the assets.
ESG-related risks include chronic climate events, such as future floods and droughts, as well as rising costs for companies to conduct carbon inventories or use natural resources.
Denisa Avermaete, senior policy adviser on sustainable finance at the EBF, said the ESG provisions required by the ECB were problematic because they were "instruments unique to Europe".
The EBF is concerned that banks are required to set aside financial reserves for risks that are still difficult to quantify before receiving clear regulatory directives, which is likely to lead to a "double counting" of reserves after the climate policy is officially implemented, resulting in undervaluations in European banks.
At present, some banks in Europe have begun to set aside ESG loan loss reserves.
Netherlands-based Rabobank said in March that it had booked €13.6 million in ESG provisions in 2023, becoming a pioneer in the sector.
As a result of this "unique tool", investors' perception of European banks has lagged behind their American counterparts.
According to data compiled by Bloomberg, JPMorgan Chase, the largest bank on Wall Street, has a market capitalization of 1.9 times the value of its book assets. Market pricing shows that investors believe Morgan Stanley's market capitalization is 1.7 times its book value.
Meanwhile, BNP Paribas, the EU's largest bank, is valued at a price-to-book ratio of 0.7, meaning investors believe the bank's real value is lower than the value of its assets. Deutsche Bank has an even lower price-to-book ratio of 0.5.
Philip Richards, a senior banking analyst at Bloomberg in London, said that while European bank shares have risen over the past six months, their valuations are still lower than their US peers.
"If European profitability doesn't pick up consistently, catching up with its U.S. peers seems unlikely," Richards said.
Source: Global Zero Carbon