By: Michel Riemersma & Jan Willem van Gelder

The Green Bonds market already offers many fixed income options to responsible investors to invest in sustainable companies and projects. But Green Bonds generally have a maturity of 3 to 25 years. A responsible alternative for short-term fixed income investments, such as Commercial Paper, would be a welcome addition.

Many responsible investors therefore will have looked with interest to the announcement by Dutch bank Rabobank of its “ESG Leader” Commercial Paper and Certificate of Deposit Programme. With this money market programme Rabobank aims to raise EUR 1.2 billion from investors, suggesting that the money will be invested in companies that score high on Environmental, Social and Governance criteria and thus are actively dealing with for instance climate change, deforestation and increasing inequality.

In reality, this is far from certain. Apart from the ESG-Leader label, there is no difference at all between this commercial paper and Rabobank’s mainstream commercial paper. The money can be invested in the same selection of companies which Rabobank is already funding, without investors being informed in any way: “Reporting efforts would overburden these instruments. Loans may have already been redeemed or deposits have been returned to the depositor when the reports would become available”, Rabobank states.

This lack of transparency contradicts directly with the spirit of the Green Bond Principles, of which Rabobank was one of the founding members. And it means that responsible investors buying Rabobank’s ESG-Leader Commercial Paper, might expect their money to be used to fund for instance coal mining companies, apparel and electronics producers that do not pay their employees a living wage, Ukrainian mega livestock farming companies, industrial livestock producers, controversial palm oil companies, and granite companies that make use of child labour.

To justify the ESG-Leader label on its new Commercial Paper programme, Rabobank refers to ESG rating agency Sustainalytics. All companies that rank among the top 5% of their industry peers are classified as ESG Leaders by the rating agency. As Rabobank has a top 5% position in the banking industry, according to Sustainalytics’ ESG rankings, it can call itself ESG Leader. And fool responsible investors with this label.

The way in which Rabobank is abusing its ranking by Sustainalytics, underlines the increasing criticism of the role of ESG rating agencies in the investment market. In the past few years, we have seen a strong consolidation trend in which a few market leaders - Sustainalytics, Bloomberg, CDP, RepRisk, MSCI, VigeoEiris - are competing for market share. But the concerns about the quality of their assessments have not decreased.

The American Council for Capital Formation (ACCF) recently published a report identifying three biases that influence ESG ratings: company size, geographical location and industry weighting. The authors conclude that because of their biases, “ESG ratings providers’ methodologies are failing to accurately identify risk. Worse still, when corporate scandals have taken place, many of the affected companies had above average ratings at the same time as their stock price plummeted. By failing to identify risk ahead of severe stock price movements the rating agencies are not effectively assisting investors”.

While this criticism holds true for the ESG ratings of companies in all industries, there are two additional problems with the ESG ratings of banks and other companies in the financial sector:

Firstly, from their clean offices banks and investors do not emit many greenhouse gases and other pollutants, nor do serious human rights’ violations take place inside their skyscrapers. It is not difficult to understand that the main ESG-impacts of banks and investors - on climate change, human rights, deforestation, etc. - occur indirectly, through the companies they are financing. Nevertheless, the Sustainalytics’ ESG-rating of banks is based for 76% on operational issues like GHG-gas reductions and diversity in the bank offices. Only 24% is based on criteria related to responsible investment and these criteria only look at the responsible credit policies of banks, not at their actual investments. That their actual investments are not always in line with their policies is shown time and again by for instance the Fair Finance Guides.

A second problem specific for the financial sector, is that the business model of the ESG rating agencies is based on selling their ratings to banks and investors. This makes it very questionable if they are able to rate banks and investors, which are their (potential) clients, in an objective way. Rabobank may praise the “independent, rigorous and systematic research by Sustainalytics”, but it does not mention that the bank is a big client of Sustainalytics.

Dutch animal welfare NGO Wakker Dier nominated Rabobank’s 2017 advertisement on food security for its Liegebeestverkiezing (Liar’s award). With its new product Rabobank might be in the running for next year’s award as well. Instead of trusting the PR efforts of Rabobank and others, responsible investors considering to invest in shares, bonds or commercial paper issued by banks should better first consult truly independent research on the banking sector, such as Forests & Finance or Coal Banks.

photo: Rabobank head office in Utrecht. Photo: Michielverbeek via Wikimedia Commons (CC BY-SA 4.0)