President Joe Biden used his veto power on Monday to block a bipartisan action from Congress that would have prevented pension fund managers from investing retirees’ money according to environmental and social-justice criteria.
“There is extensive evidence showing that environmental, social, and governance factors can have a material impact on markets, industries, and businesses,” Biden stated.
However, despite attempts by its advocates to brand environmental, social, and governance (ESG) criteria as an effective risk-management tool, recent bank failures such as Silicon Valley Bank (SVB) suggest the opposite.
In defense of ESG, Senate Majority Leader Chuck Schumer (D-N.Y.) wrote in a Wall Street Journal op-ed that “America’s most successful asset managers and financial institutions have used ESG factors to minimize risk and maximize their clients’ returns. In fact, according to McKinsey, more than 90 percent of S&P 500 companies publish ESG reports today.”
This echoed a statement by Bank of America CEO Brian Moynihan in 2020 that “our research shows that companies that do well on ESG end up doing better, or fail less.” Also advocating for ESG, The New York Times was quick to “fact check” critics who claimed that ESG was partly to blame for SVB’s demise.
In an op-ed titled, “No, ‘Wokeness’ Did Not Cause Silicon Valley Bank’s Collapse,” the Times argues that SVB “was not an outlier in its diversity goals or its ESG investments,” which is accurate as far as it goes. But the fact that most other financial institutions are doing the same thing is not reassuring to many who are concerned that ESG will now be used as a risk-management criteria for pensioners’ money.
Hiding Management Failures
“If management is focusing on ESG, then important functions like risk-management can easily fall to the wayside,” Aharon Friedman, a former senior counsel to the House Ways and Means Committee and former senior advisor to the Treasury Department, told The Epoch Times. “ESG metrics are inherently subjective and unquantifiable, so using ESG factors to measure a company’s performance can hide bad management practices.”
A cursory glance at SVB’s last two 10-K filings with the Securities and Exchange Commission underscores Friedman’s point. The bank’s balance sheet showed obvious red flags about how precarious its mismatch of assets and liabilities had become, and yet a substantial amount of management’s focus appeared to be on diversity and its exposure to climate change.
From 2020 to 2021, the bank’s holdings of U.S. Treasurys and mortgage-backed securities ballooned from $49 billion to $128 billion. These mostly fixed-rate longer-term assets were funded by short-term deposits, which increased from $102 billion to $189 billion that year, creating an enormous liquidity mismatch for a bank with $16.6 billion in equity and $211 billion in total assets.
These numbers were down slightly by the end of 2022 as depositors began their exodus, but remained in about the same perilous proportion. Given the mismatches on its balance sheet, if interest rates were to increase, which would cause the value of fixed-rate bonds to fall, SVB would be unable to make enough from selling its assets to pay out depositors.
And yet according to the risk factors detailed in its 10-K filings, SVB management didn’t appear to be particularly concerned about that. When detailing the bank’s most important risk factors, SVB’s 10K report dedicated three paragraphs to its exposure to climate change.
The bank’s filing states that because “federal and state regulatory authorities, investors, and other third parties have increasingly viewed financial institutions as important in addressing the risks related to climate change … we have announced commitments related to the management of climate risks and the transition to a less carbon-dependent economy.”
Regulators Push ESG on Banks
SVB was not wrong about regulatory authorities pushing ESG compliance. The Federal reserve Bank of San Francisco, which regulated SVB, states, “The impacts of a changing climate—including the frequency and magnitude of severe weather events—affects each of our three core roles: conducting monetary policy; regulating and supervising the banking system; and ensuring a safe and sound payment system.”
Regarding racial equity, the San Francisco Fed states, “Our Framework for Change is our commitment to taking action that will result in greater racial and ethnic equity in our organization and the communities we serve across the Federal Reserve’s Twelfth District.”
Meanwhile, SVB’s exposure to interest-rate risk—one of the most basic but more mundane aspects of bank risk management—became a material problem in March 2022, when the Federal Reserve announced its determination to fight runaway inflation with the first in an ongoing series of interest-rate hikes. Looking back at the end of that year, the bank noted in its 2023 filing that “increased interest rates can have a material effect on the company’s business … For instance, increases in interest rates have resulted, and may continue to result in, decreases in the fair value of our [available for sale] fixed-income investment portfolio.” But it had little else to say on the subject and nothing that suggested a sense of urgency.
According to one report, BlackRock, the world’s largest asset manager, warned SVB in early 2022 that the bank’s risk controls were “substantially below” what they should have been and offered to assist SVG in managing its portfolio risks. But its offer was rebuffed.
According to another report, SVB’s chief risk officer, Laura Izurieta, stepped down in April 2022, and the bank continued on without a replacement until Kim Olson took the job in January 2023. By that time, interest rates were substantially higher, and there was little the bank could do to right itself.
SVB Earns Top ESG Governance Scores
Prior to its collapse, SVB was a strong advocate of ESG criteria, both from an environmental and social-justice perspective, and it appeared to buy into the notion, echoed by President Biden this week, that ESG was an appropriate risk-management tool. Indeed, according the S&P’s ESG scoring system, SVB was rated an 89 out of 100 in the area of “corporate governance,” just shy of the “industry best” score, which is 91, and well above the “industry mean” score of 51.
Morningstar, one of the top ESG rating agencies, had given SVB a rating of 7.9 out of 10, or “leader,” in the governance category.
“In the case of SVB, the corporate governance management measurement was assessed before the public discovery of the bank’s collapse on March 10, 2023,” a Morningstar representative told The Epoch Times. “The news initiated an urgent review of its rating, resulting in the overall risk rating score increasing significantly with the assignment of a severe controversy (another layer in the methodology) and reflected in our public ratings on March 15. This controversy shows that even companies with leading corporate governance practices on paper are not immune to significant controversial events.”
SVB was able to earn such a high governance rating because of policies like its dedication to racial and gender criteria in hiring and promotion. The bank’s website notes that “45 percent of our board of directors are women, including our new chair as of April 21, 2022.” It further states that “we aim to create equity in hiring, performance management, benefits, supplier diversity, donations and volunteering,” and “we promote inclusion through cultural awareness celebrations, employee advocacy networks, DEI [diversity, equity, inclusion] trainings, employee surveys, and focus groups.”
But while SVB was outperforming according to ESG management principles, some argue that it was doing so at the cost of its most essential responsibilities.
“Insofar as ESG involves trying to show that your board and staff are ‘diverse,’ it means that you are willing to ascribe considerable importance to things like skin color or sex in selecting your people,” Samuel Gregg, author and Senior Research Fellow at the American Institute for Economic Research, told The Epoch Times. “The problem is that people’s degree of financial expertise has nothing to do with such things. If you are willing to trade off financial knowledge and experience for ethnicity and gender, that means you are not giving financial expertise the priority that it should have in banking and finance.”
Credit Suisse, which faced collapse and was rescued by Swiss rival UBS on March 20, had also been promoting its adherence to ESG principles. It created a chief sustainability officer position and announced: “Our organizational structure is designed to ensure that ESG standards are embedded across regions and divisions in our client-based solutions as well as in our own operations as a company.”
Credit Suisse had so many management failures leading up to its collapse that ESG can hardly be blamed. However, it raises another issue about ESG, which is the extent to which corporate managers use it to cover up for underperformance.
An August 2021 study by the University of South Carolina and the University of Northern Iowa found that focusing on non-quantifiable ESG goals over financial results “provides managers with a convenient excuse that reduces accountability for poor firm performance.” In contrast to Biden’s claim that evidence proves the value of ESG investing, this report found that there was a correlation between CEO’s underperformance and how vocal they were in supporting ESG goals.
Disputing the ‘Extensive Evidence’ for ESG
Recently, even firms that had once championed ESG criteria, are now backpedaling.
Testifying before the Texas state senate last December, State Street chief investment officer Lori Heinel said, “I have no evidence that this [ESG] is good for returns in any time frame. In fact, we’ve seen the evidence to be quite contrary. Last year, if you didn’t own energy companies, you did miserably compared to broad benchmarks. The year before, that was quite the opposite … but that was just a happenstance, that’s not because it’s a good investment.”
Last month, Vanguard CEO Tim Buckley said, “Our research indicates that ESG investing does not have any advantage over broad-based investing.”
Meanwhile, a Harvard University report titled, “An Inconvenient Truth About ESG Investing,” found that ESG investing actually hurts returns. “ESG funds certainly perform poorly in financial terms,” the report stated.
SVB may have been no more compliant than its peers regarding its allegiance to ESG dogma, but the problem was that it was too weak to afford losing focus on its core business. Given its smaller size, concentrated depositor base, and undiversified asset portfolio, it could not survive having an unserious risk management structure in place.
SVB depositors were ultimately bailed out by federal regulators, but retirees, who will be affected by Biden’s new rule allowing ESG into Americans’ pensions, have no such guarantees. And when it comes to risk management, pension investors are in a significantly different position than bank depositors. They are the equity holders, who are last in line and who typically get wiped out when companies fail.
“The priority of anyone managing pension funds is to ensure that they create the profit and shareholder value that allows people who have saved to enjoy a comfortable retirement—period,” Gregg said. “If ESG distracts pension fund managers from pursuing that goal, they are doing a grave disservice to present and future retirees.”
From The Epoch Times