Two industries being shunned by banks—one rising, one falling—illustrate the changing landscape of business financing.
Violent hurricanes and devastating tsunamis, scorched-earth wildfires, biblical rainstorms and bone-whitening drought. Weather-related disasters—growing in both frequency and intensity—are wreaking economic havoc. Munich Reinsurance reckons that in 2017 insurance losses topped $147 billion, the worst year on record.
They are also focusing the attention of citizens, governments and business leaders on the problems of global climate change and the impact of fossil fuels. Renewables and possible new regulations threaten future demand. The fossil fuel sector upon which most of the world depends is falling out of favor with practically everyone—consumers, governments and investors. These factors are making it harder for such businesses to get funding.
“Banks are asking themselves, ‘What industries should I not deal with, which are good players, and how do I define that?’” says Alastair Ryan, analyst at Bank of America Merrill Lynch in London. “Banks are wrestling with getting good answers to these questions and talking to the market about it.”
Most prominent among the sectors that banks are beginning to avoid are carbon-heavy, fossil fuel-related enterprises including the coal industry, oil and natural gas exploration, distribution and refining companies, oil pipelines, utilities and transportation. Enterprises that drive demand for fossil fuels, such as shipping, are also in the crosshairs.
The coal industry has been hardest hit by the decarbonization trend. In 2014, natural gas displaced coal as the main source of boiler fuel at US utilities; since then, the pace of coal’s exit from the electrical power grid has quickened. The industry is rife with bankruptcies. Three coal companies have filed for Chapter 11 protection since the spring, including Cloud Peak Energy, the third-largest US coal producer.
Sheer economic reality is conspiring against the hydrocarbon industry, says Alfred Watkins, a former World Bank economist and Washington-based consultant. As the risks of fossil fuels continue to grow, the price of renewable energy is tumbling. “The cost of installing solar panels used to be $2 per watt ten years ago,” he says. “Now, it’s about 20 cents.”
In an environmental, social and governance (ESG) report issued in April, HSBC declared that it no longer makes loans to the coal industry or its customers. “Supporting the transition to a low-carbon economy is a key part of HSBC’s strategy,” the report states. In March, BNP Paribas announced that it would be pulling around $1 billion out of coal stocks. In June, after fruitless discussions with Exxon Mobil executives about dealing proactively with climate change, Legal & General Investment Management, one of the company’s top shareholders, announced it had dumped $300 million in shares—and would use its remaining holdings to vote against the CEO.
Disinvestment is a last resort. Banks, often in tandem with nonprofits, are attempting to nudge corporate entities in the right direction with new metrics. Swami Venkataraman, a credit analyst at Moody’s Investors Services, rates companies on their ESG record. Shareholders seek to pressure businesses over concerns such as the water crisis in South Africa, the opioid crisis in the US and customer-relations problems such as the fake checking-account scandal at Wells, Venkataraman says.
“There’s been a paradigm shift in the thinking within the financial sector,” says James Mitchell, manager of the Reinventing Climate Finance initiative at the Rocky Mountain Institute in Boulder, Colorado. The new model asks banks “to shape the sectors they’re active in through capital-allocation decisions and client engagement.”
The new approach exposes companies to a host of new, non-financial performance yardsticks. Consider palm oil. When produced unsustainably, palm oil can result in deforestation, climate change and threats to endangered species—especially to the orangutan and tigers whose habitats are threatened by plantations in Indonesia, Borneo and Malaysia.
Since 2014, HSBC has had a policy requiring the palm oil producers that it finances to certify that they observe principles promulgated by the Roundtable on Sustainable Palm Oil, an independent organization. By the end of 2018, according to the bank, it was financing 22 customers engaged in palm oil production “that have either met our policy or will do so shortly” while discontinuing new financing for 19 customers that did not measure up. In addition, the bank has adopted a full panoply of internal policies on agricultural lending.
Similarly, in June, the world’s 11 top maritime financiers, including Citi, Société Générale and ABN Amro, officially launched The Poseidon Principles—“a global framework for responsible ship finance”— after nearly two years of development in partnership with shipping companies and other stakeholders. The financial institutions are pressuring their clients to shrink the industry’s greenhouse gas emissions to 50% of 2008 levels by 2050, “with a strong emphasis on [getting to] zero emissions,” according to their June announcement.
“As banks, we recognize that our role in the shipping industry enables us to promote responsible environmental stewardship throughout the global maritime value chain,” says Michael Parker, global head of shipping & logistics at Citi. Entities that can’t or won’t meet the criteria may be shut out of these banks’ combined $100 billion in lending to the industry.
Cannabis Cropped Out
An entirely different set of circumstances has put a rising star of commerce—the cannabis industry—in a similarly difficult spot getting funds. In the US, according to a American Bankers Association (ABA) report, 33 states and the District of Columbia have legalized cannabis for medical, recreational, or other use. Federal law, however, holds that “any business that derives revenue from a cannabis firm—including real estate owners, security firms, utilities, vendors and employees of cannabis businesses, as well as investors—is violating federal law and consequently putting their own access to banking services at risk,” Joanne Sherwood, chair of the Colorado Bankers Association, explained to the Senate Banking Committee in July. That includes banks in Canada that want to do business in the US. “Cannabis firms and their suppliers are typically forced to operate in cash,” the ABA report declares.
So seriously does LivWell Enlightend Health, a Denver-based, full-service cannabis company boasting $100 million in annual sales, take the skein of regulatory and legal constraints that the company has 40 people dedicated to compliance work—almost 10 percent of the staff. Dean Heizer, LivWell’s executive director and chief legal strategist, tells Global Finance that bootstrapping is the industry’s most common form of financing. “We’ve built our entire business organically using revenues generated from the business,” he says. “The only [financing] money available is ‘hard money,’’ he adds, “expensive nonbank money from private lenders at credit-card rates of 15% to 30%.”
That parallels the experience of Prospect Green Capital, exclusively an equipment-financing fund for cannabis, with the equipment as collateral. The company was spun off a year ago by a financing firm that had been offering collateralized debt for over ten years, to provide offerings for cannabis-friendly investors separately, so as not to offend its non-cannabis-friendly clients. “Most investment into cannabis is private money and usually equity-based, which is more expensive in the long run,” explains Gene Komissarov, Prospect Green’s business development specialist.
A few investment banks, Heizer says, will arrange equity financings for cannabis concerns, taking the role of matchmaker between businesses and wealthy individuals and family offices. Similarly, says Komissarov, cannabis-friendly investors are, at present, mostly family offices and private equity, with overall the same risk tolerance as investors generally. And the underwriting and loan structures are the same as in any other industry. “At the end of the day,” he notes, “a balance sheet is a balance sheet.”
A 2018 analysis of the cannabis industry by Ackrell Capital, a San Francisco-based boutique investment bank, declares: “A lack of access to banking and other traditional financial products and services continues to impede the growth of the industry.” Despite such barriers, the industry has grown to $10 billion already.
The $18 trillion US banking industry is thus rallying around a proposed law to eliminate some barriers. In 2020, at least seven additional states are expected to have ballot propositions legalizing marijuana, and conservative projections put the industry at $75 billion by 2030.