Lack of transparent disclosure has been an aggravation since my days as an international equity analyst. In my experience, there is only one solution to this aggravation: research. (Occasionally a sharp stick poked at the company directors worked.) The following was prompted by attendance at the ASrIA conference in Hong Kong in September 2011. The challenge to learn as much about the environmental sector in one week for three reasons: (1) How quickly may a Director and Officer become “reasonably” informed? (2) Do Directors and Officers need to know about it to survive? (3) If so, what should they be disclosing to shareholders and how? This is what I learnt….. The series runs sequentially over various subjects.
Previous titles in this series and on this site are D&O and Peak Everything, D&O and Peak Oil - Carbon - Water - Food. The series runs sequentially over various subjects.
Previous titles in this series and on this site are D&O and Peak Everything, D&O and Peak Oil - Carbon - Water - Food. The series runs sequentially over various subjects.
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Directors and Officer and their Bankers and Insurers
So far in this research series, it has focused on how Directors and Officers would consider their external risks. Potentially pricing their externalities if you will. However, Directors and Officers do not stand as silent sentinels to their own future. Others are looking on; measuring, monitoring, and deciding. Others, that have an impact on the key strategic levers of revenues and costs, such as your bankers and insurers.
However this is all about risk management for Directors and Officers, first and foremost. And of course everybody has heard about the “Black Swan” event, the once in a generation event. The tsunami in Japan (with concomitant nuclear issues), the earthquakes in Christchurch, the floods in Thailand, the snow storm in Manhattan. And that is just 2011 so far. Evan the GFC. They never are Black Swans of course, but that is what people like to call unforeseen events that have been staring them in the face for some time.
I was delighted to read, that there is now a “Platypus” event; a crisis event that goes beyond even the Black Swan. First identified by Luci Ellis, Head of the RBA’s Financial Stability Department, recognizing a Platypus Event early is apparently what helped Australian financial institutions through the GFC. Once seen, never forgotten, it sends shivers down your spine and you immediately see it for what it is: a major tsunami of risk heading your way.[i]
As an aside, I doubt if a single employee of the central bank of Australia has seen a platypus in the wild. I have a family in the creek on the farm, and usually when I see a platypus, it fills my heart with joy, not my spine with shivers. Who knows what shapes another person’s mind, huh?
I would suggest to the reader that these resource issues for Directors and Officers are front and centre all over the world, that you cannot turn around without stubbing your nose, elbows, shins and toes on the FOWC Peaks [let’s call them-for Food Oil Water and Carbon]. The risks from the FOWC Peaks identified in this series, are known risks.
Their impact on Directors and Officers, and the companies they manage on behalf of others, can be measured. And, no genius here, if they can be measured, they can be managed. If they are being measured, they can also be reported to shareholders, stakeholders – the latter includes staff, suppliers and customers, local communities, governments, ministers and other organisations of influence.
The FOWC Peaks are not Black Swans, nor Platypodes (the correct Greek plural of platypus).
Managing Out the Risks by Hedging
If you are unconcerned about what your banker or insurer think about constraints on your business inputs, you may in any event want to hedge your “bets” so to speak.
One answer is to turn to the international markets. There are now many indices to use. One is the Global Climate Change Benchmark quoted in US$, it can be easily found on the internet, accessing it is free, and measuring it and monitoring over time is also free. It’s called the HSBC Global Climate Change Benchmark, and its reference is HSCCB:IND on Bloomberg.[ii]
Actually there is a plethora of indices that can be used expressly for this purpose.
Using hedging by going “long” this index, would effectively mean doing nothing about climate change or the FOWC Peaks at all for your company nor Directors and Officers personal risks. In the worst case scenario of climate change, say, theoretically this index should rise as your revenues crash, as investors switch to this index’s stocks from other industrials. Of course this can never cover your entire loss, so like all hedging and insurances, there will be basis risk – or a real PLATYPUS event, complete mismatch in risk response in the market. There have been a few of those recently.
It is not clear if there are any products offered by investment bankers on this index to date, but it is my experience that any one of them would take your business because they would bet on two flies these days to make a quid.
Pricing is always the issue of course. The closer to the Platypus or Black Swan event, the greater the probability of incidence, the greater the severity in loss, and the larger the risk you require to be covered, the more the party on the other side of the swap / hedge is going to charge on the premium. There may be currency risk if your business is in GBP rather than USD, or some other non USD trade block. And the OTC product you build out may not perfectly correlate the risks and benefits because we are dealing with the unknowable.
As yet another aside:. Reviewing this index relative to the DOW over the last 5 years, there is good opportunities for any hedge fund manager looking for an interesting long short position. Note comments on flies above. The HSCCB has greater volatility, but with a well-structured position, relationship appears quite good to the DOW for example. Even naked long or short looks attractive.
Over the last 5 years (11/08/2006), the HSCCB has fallen 23% and the Dow 5%. However, in the reverse, when the DOW rises, the HSCCB rises exponentially both relatively and in absolute terms.[iii] There are other issues to consider such as liquidity (which may contribute to volatility measure).
Over that same 5 years, the Climate Change index has outperformed Goldman Sachs, UBS, and HSBC itself, long renowned for its climate change initiatives. Interestingly, it has a close correlation with Sainsbury’s Plc OTC (JSAIY:US), a company mentioned herein and with a long record in sustainability as embedded in its management practices. Maybe it is a component of the index?
Finally, one other benefit from this index is that Directors and Officers can now track their own share prices against it.
Managing Out the Risks with D&O Insurance
One of the good things about D&O insurance is that you, the Director and Officer, don’t have to pay the premium. The company does.
However, if the insurance policy doesn’t cover every single contingency, then you do pay; personally. And with legal fees at the level they are today, and increasing litigation and class actions, it could be with your home, your family maybe, and in some tragic cases, your life.
One of the risks not clear to me is whether D&O insurance policies cover criminal negligence; due to the commonly held belief that you cannot insure against your own criminality. A thousand insurers and lawyers will no doubt have the answer. On the other hand, the burden of proof for a criminal conviction is beyond reasonable doubt, very difficult to prove. BP and its partners reputedly continue to face these legal risks[iv].
When you phone an insurer you will have similar outcomes to that of dealing with you banker as covered later; they will be scoring your company on the FOWC Peaks. They too will have portfolio Peaks on their own balance sheet.
It was interesting to read for example Munich Re’s carbon policy[v] (as an example) whereby its “head office is carbon-neutral and the entire international organisation will be carbon neutral by 2012. Carbon emissions will be reduced by 10% per employee by 2012 (compared with 2006).” What a pyrrhic victory for Munich if its own business is completely carbon neutral, but all its customer's risks are not. This suggests that it too would be “scoring” its risks and managing those risks on a portfolio basis. Being at the end of the insurance food chain so to speak, that risk concentration would be high.
Munich is part of the Climate Group, whose members include many of the world’s largest finance and risk product providers. These members are measuring their carbon risks [at least], reporting them, actively reducing them, and winning plaudits. They are all measuring their risks. You can be sure that they are also measuring yours. If not now, soon.
And if you have not been measuring your own FOWC Peak risk, then IF an insurance company agrees to underwrite your D&O insurance risk, they will be tripling and doubling the risk premium. Or diluting payout events and amounts / limits for Black Swan climate events.
Essentially forcing the company to self-insure high risk components of their business. On the face of it, that strikes me as something that must be disclosed to shareholders under mandatory disclosure requirements for listed companies, but I am sure you will find a lawyer to give you an opinion to the converse. Well, you must have a very complacent shareholding group or a very forgiving family if it is your home on the line.
It appears self-evident that the cost of increased insurance premium for not having any knowledge about your FOWC Peak risks may well be a great deal higher than the cost of setting up an internal group (outsource some?) to get out there and monitor your oil, carbon, water and food footprint.
Managing Out the Risks with your Banker and Other Suppliers
Whenever you hear a banker mention “scoring”, you know he (mostly) is talking about something he is going to whip you with. It’s the “not me, I am only doing what I am told” diversionary tactic for making your life difficult. It’s the “your score is xyz, so we have to significantly increase your risk margin this time”. Read, cost. Or it is the, we cannot do this business, you have to go elsewhere”. For the latter read “the whole market is talking about you, your financial needs are toast”.
So credit scoring is not only something that enables a bank to either accept or decline your banking business autonomously, it also sets the preferred cost of any lending or risk over a benchmark; it also enables a bank to cluster similar credit scoring customer relationships so that its balance sheet risk management is enhanced (such as, by way of example, a concentrated exposure to a particular industry, country, product, or currency within its portfolio).
Banks are now scoring your FOWC Peaks; let’s call it the Climate Score. If not now, soon.
This of course enables the bank to refuse any particular company their business on the basis of “our concentration in carbon (water, oil, food) heavy industries is already too high”. This is simplistic portfolio risk management; but who cannot recall being in the property sector, or the mortgage sector, over the last five years as liquidity dried up.
Not just banks, but also major suppliers who rely on your ongoing capacity to pay in large long tail relationships. They also consider counter party risk, and will adjust their credit terms according to their scoring of your company as a risk.
If a climate score is not already applied to your business I can assure you it is on the way. When you see one bank doing it, especially a risk leader, soon they all will. See HSBC Scoring Climate Rate Risk report, by way of example.
Part of what they will be building into the risk model to review your company, and its risk scoring process, they describe as “we expect what are currently ‘off balance sheet’ costs – whether in terms of carbon emissions or biodiversity loss – to be brought more formally into economic decision making. This will reward the corporations and countries that make resource productivity a key element of long-term strategy.”[vi]
That is, even if you are not costing your externalities, they are; and all their competitors are as well.
Not pricing externalities of course means living off future harvest today. The cost doesn’t go away, it is just kicked down the road. Not any more if what HSBC is saying is correct. And intuitively, it seems so.
Bloomberg LP now provides information about a company’s carbon footprint. Standardised in such a way, so that its investing clients can compare companies across industries and regions. Another example is the Asian Sustainabilty Rating that uses ESG benchmarking tools to examine leading and listed companies in ten Asian countries for investors and other stakeholders, with a view to the sustainability of the companies.
Even if you, the Director and Officer, decide on behalf of your company NOT to measure your FOWC Peaks footprint, others will be. And they will make you pay. That means your suppliers of goods and capital, your shareholder, your customer, your staff, and your community.
Even if you, the Director and Officer, decide on behalf of your company NOT to measure your FOWC Peaks footprint, others will be. And they will make you pay. That means your suppliers of goods and capital, your shareholder, your customer, your staff, and your community.
The Platypus moment:
It's that sense of disbelief, of incredulity, that something is too ridiculous to be true, and yet it is true: that feeling is telling you something. When you have that feeling, you are having what I have come to describe as a Platypus Moment. And it is that moment, that feeling, we should be alert to. It is not just a reaction to a statement or claim you find unbelievable. The reaction is to a practice or behaviour you concede is truly occurring, but find bizarre or foolish. The motivations underlying the behaviour are not coherent. The behaviour spurred by the motivations is not internally consistent, at least not from the perspective of the system. [vii]
[i] The Platypus Moment: Rents, Risks and the Right Responses; Speech by Luci Ellis, Head of Financial Stability Department of the Reserve Bank of Australia on 13 October 2011, http://www.rba.gov.au/speeches/2011/sp-so-131011.html. Only in Australia…..
[ii] HSBC Global Climate Change Benchmark Index quoted on Bloomberg at http://www.bloomberg.com/apps/quote?ticker=HSCCB:IND
[iv] Finanical Times, “Deepwater continues to reverberate”, Wednesday October 19 2011
[v] http://www.theclimategroup.org/our-members/munich-re/
[vii] The Platypus Moment: Rents, Risks and the Right Responses; Speech by Luci Ellis, Head of Financial Stability Department of the Reserve Bank of Australia on 13 October 2011, http://www.rba.gov.au/speeches/2011/sp-so-131011.html. Only in Australia…..
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