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Bank regulator races to enact lending rule that would deal a blow to ESG

SNL Image

A polar bear roams the Arctic National Wildlife Refuge in Alaska, where several large banks have ceased
funding new oil and gas exploration.

Source: P. de Graaf /Moment via Getty Images

An Alaskan wildlife refuge is at the center of an escalating, highly politicized sustainability debate that has pulled in big banks, federal regulators, Congress, climate activists, the oil-and-gas industry and the local Native community.

The Office of the Comptroller of the Currency introduced a polarizing proposal that would require big banks to reverse course on lending policies introduced to combat climate change. With just three weeks to go before the comment deadline closes, the banking industry and sustainability community are locked in battle with the oil-and-gas industry and an outgoing Republican administration that has made moves to dismantle policies seen as friendly to the environmental, social and governance, or ESG, movement.

The OCC's proposal would require banks with more than $100 billion in assets to serve all legal industries, putting an end to bank boycotts of certain sectors. It takes the antidiscrimination language that is normally used to help protected classes of individuals and applies it to protect politically sensitive industries, such as private prisons, gun manufacturers and coal.

John Geiringer, a partner at law firm Barack Ferrazzano Kirschbaum & Nagelberg LLP who focuses on financial institutions, called the proposal "a very forced way to deal with a very complex issue."

Banks are grappling with how to approach ESG and how that intersects with safety and soundness, he said.

"This is the OCC's reaction to banks making decisions not necessarily solely on financial metrics, but also to reputational concerns related to ESG," Geiringer said. "Banks and other companies are embracing ESG because they see that the two concepts are becoming conjoined, that investors are looking for banks and other companies to embrace ESG. And if they don't, that may create its own financial disincentives."

The OCC gave 30 days for comment on its proposal. That is "an incredibly short window," Isaac Boltansky, director of policy research at Compass Point Research & Trading, wrote in a November report.

"This proposal is part of a far broader policy conversation regarding credit access to disfavored industries, which is inherently complicated by the fact that each political party has a different list of disfavored industries," Boltansky wrote.

Many bankers agreed that the comment window was too short. Four prominent industry groups — the Bank Policy Institute, the American Bankers Association, the Consumer Bankers Association and the Financial Services Forum — jointly wrote to the OCC requesting more time to comment on the proposal, which they described as "unprecedented."

Over the past year, all six of the largest U.S. banks committed to stop financing new oil and gas exploration in the Arctic — JPMorgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley Citigroup Inc., Wells Fargo & Co. and now Bank of America Corp. BofA made its announcement 10 days after the OCC released its proposal.

The timing of BofA's announcement is evidence that banks are making their lending decisions based on financial risk considerations and not politics, said Liz Levy, portfolio manager at sustainable investment firm Trillium Asset Management.

"The fact that you see so many global banks coming to the same conclusion — that it's really just not worth it from a financial perspective to fund drilling in the Arctic … shows how much of a business decision this is, in addition to the real reputational risk to the banks," Levy said.

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An S&P Global Market Intelligence analysis of GAAP filings finds that credit exposure to energy-related loans and commitments has been on the decline in recent years for most of the largest U.S. banks. JPMorgan's exposure is up 3.8% from Sept. 30, 2016. But compared to most prior periods, including five years ago, that exposure has declined. Goldman Sachs' exposure to oil-and-gas loans and commitments, rose 23.5% over the past four years to $12.35 billion, but the increase trailed the company's rise in net loans, which were up 128.0% to $111.84 billion during that same period.

The big U.S. lenders join a growing cohort of international peers that have likewise said they will no longer fund Arctic drilling projects. Climate activists applauded these announcements but some members of Congress protested, arguing that the policies discriminate unfairly against the oil and gas industry and harm the Native Alaskan communities that rely on these projects for their economies.

"It is clear that these policies are overtly political and actually meant to appease extreme activists' calls for fossil fuel divestment and to discriminate against certain sectors of the energy industry and projects in specific geographical areas," wrote Republican Sens. Dan Sullivan and Lisa Murkowski and Rep. Don Young in a June 2020 letter to U.S. federal banking regulators.

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Republican Sen. Lisa Murkowski is part of the Alaska delegation
that called on U.S. federal bank regulators to stop banks from enacting policies against investing in new oil and gas operations in the Arctic.
Source: Alex Wong via Getty Images

The OCC responded to the Alaska delegation by pledging to take "a serious look" at banks' oil and gas lending policies. "Given the industry's importance and ubiquity in our daily lives, I am skeptical of claims that the sector poses a "reputational risk" to the banks that serve it," wrote the regulator's acting head, Brian Brooks, in a July letter.

Four months later, the OCC said its investigation found that some banks changed their policies based on criteria unrelated to safe and sound banking practices. "Neither the OCC nor banks are well-equipped to balance risks unrelated to financial exposures and the operations required to deliver financial services," stated the OCC's proposal.

"Organizations involved in politically controversial but lawful businesses — whether family planning organizations, energy companies, or otherwise — are entitled to fair access to financial services under the law," the proposal added.

Other industries would also be impacted. The acting comptroller warned in an op-ed for Game & Fish Magazine that "shooting sports are getting caught up in politics and pressure on banks to cut off funding and services to gun and ammunition manufacturers and dealers."

"If successful, the powerful interests at work will restrict Second Amendment rights and availability of sporting arms by suffocating the industry from capital and financing that make them possible," Brooks wrote.

But Levy said that here, too, banks are making decisions based on financial considerations. "Trillium published a report last year showing how uneconomic investments in gun manufacturers are. If we can do this research, certainly, bankers can do that research, too," she said. "The reason that these things don't get funded is that they're not good investments."

The OCC proposal is not the first policy introduced in the waning days of the Trump administration to push back on the growing ESG movement. In October the U.S. Department of Labor finalized a controversial rule that said fiduciaries cannot pick investment funds based on nontraditional influences such as environmental, social and governance considerations, other than in "rare" circumstances in which the product is deemed indistinguishable from traditional products.

The banking industry has various mechanisms for pushing back on the OCC proposal — through Congress, via the notice and comment period, or even by filing lawsuits under the Administrative Procedures Act. The industry could also wait until Jan. 20 and see what approach the Biden administration will take. As the Jan. 4 deadline for comment on the OCC proposal nears, the Federal Register website reported more than 400 public comments on Dec. 15.

In the meantime, banks and other industries continue working to understand their role in the evolving ESG movement.

"I don't think that direction will be a straight line," Geiringer said. "But it seems to me that the direction things are heading is that many investors are looking for a holistic perspective when it comes to ESG issues. And banks and other companies are going to have to be sensitive to that, or risk falling behind."