Investment Dealers Digest
May 24, 1999
Stretching a mile across a spectacular site on China’s Yangtze River, the Three Gorges Dam is the most ambitious hydroelectric project ever attempted. Estimated to cost more than $70 billion when completed, it will provideelectricity to China’s peasants, stop the disastrous flooding of the river and offer billions of dollars in foreign investment.
Ordinarily, that would be good news for the Wall Street firms helping raise the money to build Three Gorges. Not this time. Instead, the environmental degradation associated with Three Gorges has made China’s dam a symbol of the pressure environmentalists are starting to exert on investment banks around the world.
The Three Gorges Dam would force the displacement of 1.3 million people, submerge 15 archaeological sites and numerous villages, and destroy several species of unique wildlife, making it the cause celebre of environmentalists, human rights activists and Chinese dissidents. Given the controversy, the World Bank has shied away from Three Gorges, the U.S. National Security Council has opposed Ex-Im Bank involvement, and one financial institution, Nomura Securities, already has walked away.
But the importance of the People’s Republic of China to Wall Street, and the intense competition for that business, has kept the bulge-bracket firmscommitted. Now, reckoning that some firms’ consumer franchises will make them more vulnerable to public pressure, environmentalists are currently targeting such Wall Street giants as Morgan Stanley Dean Witter, Salomon Smith Barney, and Merrill Lynch, and they may well go after more.
"We have been training people all around the world about the role of financial institutions and where they can find points of leverage," says Julie Tanner, senior financial analyst at the National Wildlife Federation, a Washington, D.C.-based organization. Like many of their constituents, environmental leaders are becoming savvier about finance. The boldest attack so far in the U.S. was a precedent-setting shareholder resolution introduced at Morgan Stanley’s annual meeting last month. The resolution, endorsed by 5% of shareholders, requested the board of directors consider the environmental risks in undewriting and lending, mentioning its joint venture with China International Corporation Ltd., which has ties to the Three Gorges project.
The resolution warned of a "possible boycott" of both Morgan Stanley’s brokerage business and its Discover card. Since then, environmentalists have asked Salomon SB and Merrill Lynch to halt their plans to underwrite a $500 million global bond for the China Development Bank, the state entity funneling the money to the colossal project, which is already under construction. Tanner says the group’s Web site is providing information on that financial backing (and Salomon SB’s connection to Citibank) but doesn’t suggest it’s time to cut up credit cards just yet. "We want consumers to write to them. We’re hoping it will lead to further negotiations to get them to stop financing projects like this." The effort is not new either. Previous letters were sent to the underwriters of a 1997 $330 million Yankee bond for the China Development Bank, underwritten by J.P. Morgan, Lehman Brothers, Morgan Stanley, Credit Suisse First Boston and Banc of America Securities.
As hard as it is for Wall Street firms to resist the Chinese business, it’s also politically unpopular to be viewed as being anti-environmental. And investment banks with new consumer arms may find the public scrutiny a negative side effect they didn’t count on in their quest for gigantism.
"What the Morgan resolution says to investment banks is that certain groups intend to use their consumer businesses as hostage and blackmail over their investment banking business," says Linda Descano, senior vp of environmental affairs at Salomon Smith Barney. The unit she heads is one of the few investment bank departments that vets projects for potential environmental problems, though given the firm’s involvement in Three Gorges, environmental oversight doesn’t necessarily ensure environmental purity.
The targeted opposition to Three Gorges is only one of many efforts to cut off financing for projects deemed destructive to the environment. In Brazil, for example, environmentalists have managed to get a law passed that could potentially face bankers with the prospect of civil and criminal penalties for such projects they finance.
In Australia, demonstrators are picketing Westpac Banking Corp branches to protest its banking relationships with the developer of a controversial uranium mine. And environmental groups in Switzerland are trying to negotiate with banks including UBS and CSFB regarding their financing of Freeport-McMoRan Copper & Gold Inc., the U.S. gold company engaged in an Indonesian mining project that threatens indigenous people.
Morgan Stanley’s dilemma
While environmentalists’ lobbying of bankers has been gathering steam outside the U.S. for close to a decade now, their efforts to get U.S. investment bankers to pay attention to environmental issues in choosing their deals has been largely disregarded.
Indeed, until the shareholder resolution was filed, Morgan Stanley had essentially ignored environmental criticism of its Three Gorges involvement. When Trilium Asset Management, one of the country’s largest socially responsible investing firms, and several environmental groups-National Wildlife Federation, Friends of the Earth, and the International Rivers Network- wrote the firm’s investor relations department a year ago asking for a meeting, Morgan Stanley brushed them off. Then, when the group filed its resolution with the Securities and Exchange Commission, Morgan fired off an appeal, arguing the resolution interfered with its business, which the SEC prohibits in shareholder resolutions. But in its first decision on the issue, the SEC gave the resolution the thumbs up, and its 5% endorsement means it is eligible to be on the ballot again next year.
Simon Billenness, a senior analyst at Trilium, and other environmentalists, say there’s another reason they went after Morgan: its Discover card and Dean Witter retail brokerage businesses make the firm vulnerable to the negative publicity that environmental and human-rights groups have already used to great effect on companies in the oil and apparel industries.
Morgan was quick to catch on. Just before the annual meeting, general counsel Christine Edwards, who had not been involved in the initial brush-off, made a conciliatory phone call to Billenness. "She said the firm was reviewing its policy around environmental issues in underwriting, which it hadn’t previously done in any thorough fashion," he says. "And she said they were interested in dialogue."
At the annual meeting Chairman and Chief Executive Phil Purcell and Morgan Stanley President John Mack made a point of speaking to the resolution’s sponsors, says the National Wildlife’s Tanner. "They all said they were interested in talking with us and trying to work together," she says, "which bodes a lot of good will on both sides."
Mack told shareholders that Morgan Stanley’s relationship with China International Capital Corp., of which it is a founder and 35% owner, is more venture capital than a joint venture. He said the firm plans to sell its stake once the company is firmly on its feet.
Like any investment bank, Morgan Stanley is reluctant to antagonize a client, and the Chinese government considers Three Gorges Dam a source of national pride. "We have spent a lot of time in China and given it a lot of attention," Edwards explains. "And we are competing with firms from every other country that want to do business in China. It is a highly competitive environment." Nonetheless, the firm has begun meeting with the resolution sponsors. Both sides agreed the initial meeting went well. Says Edwards: "We are trying to forge new ground."
If it’s any consolation to Morgan Stanley, its environmental headache is bound to be shared by an increasing number of U.S. banks, say environmental activists and investment bankers. For one thing, multilateral institutions like the World Bank have backed away from such megaprojects, in part due to environmental lobbying. "The bottom line," says Billenness, "is that funding for these projects has become more and more privatized, so the key decision-makers are now in the corporate and investment community."
In addition, as Glass-Steagall divisions between commercial and investment banking give way in the U.S., and universal banking becomes the norm, U.S. banks face the same pressures of long-targeted European banks.
"We have connections with more than 10 million personal customers," says Christopher Bray, who heads environmental risk management at London-based Barclays Bank, "and if a large number of people begin to believe an activity we’re associated with is not environmentally beneficial, a significant number of them will be Barclays’ customers. When you offer a vast range of services in the retail, wholesale and institutional marketplaces, activities in one sector can pretty quickly damage opportunities in another." "Whether you agree with these groups or not," says Salomon SB’s Descano, "the die is being cast. The integrity of your brand name is going to depend in part on how you can balance all these competing interests."
Politics adds to pressure
Political and legal developments are adding to the pressure. Brazil has long been the focus of environmental groups because of the potential destruction of its rain forest. Last year, the country passed a law making all institutions involved in a project liable for any environmental damage it causes. What’s more, the penalties are not just civil but criminal, says Isaura Frondizi, head of the environmental advisory group at the National Development Bank of Brazil. "Bankers could see the sun rising square, as we say here," she adds. Rules for the new law have yet to be drawn up, and it’s unclear how wide a net they will cast. But there is at least a possibility that bondholders, as well as banks, could be covered.
In Great Britain, meanwhile, plans are being drafted to force pension funds to disclose their consideration of environmental and social issues when making their investments. Such a move will almost inevitably boost funds’ interest in so-called socially responsible investing, predicts John Ganzi, an independent consultant who works with environmental groups and financial institutions. And in Switzerland, there is talk of requiring pension funds to add some form of sustainable development criteria to their investment policies.
In the early 1990s, the United Nations Environment Programme, or UNEP, put forth a financial institutions’ initiative regarding the environment. Although the initiative’s standards are nonbinding, the banks that sign on agree, among other things, to finance only projects that support sustainable development and comply with environmental regulations. However, the initiative is limited: It would not, for instance, cover the many projects being built in countries with lax, or no, environmental standards. Nor does it cover indirect lending, a problem environmentalists have had with both Salomon SB and Banc of America, the only two major financial institutions to sign up with UNEP.
According to Tanner, Banc of America has said it won’t underwrite or lend directly to Three Gorges. That is little consolation to environmentalists, since it’s the China Development Bank that raises the money. Nor is the fact that Goldman Sachs’ chairman and chief executive officer Henry Paulson serves on the Nature Conservancy’s Asia Pacific Council, which promotes the protection of the Yangtze. Despite protests from the environmental community, Goldman underwrote a $1 billion global bond for the People’s Republic of China that reportedly funneled $200 million to Three Gorges Dam.
The UNEP standards are not the only ones out there. Credit Suisse, at least in its Swiss operations, has signed on to a stricter set of international rules, which involve the integration of environmental standards into banking and insurance products and services. UBS is also in the process of signing on.
Mike Kelly, the coordinator of the financial institutions’ initiative at Geneva, Switzerland-based UNEP, says banks that wouldn’t sign the UNEP document "were afraid that if one of their customers caused a problem, they would be held guilty; that the courts would say they clearly hadn’t implemented all the principles they had signed up to, or they would have spotted the problem." U.S. bankers point to the U.S. superfund legislation, enacted in 1980 to force cleanups of toxic sites, which holds all companies involved responsible for the cost, as an example of the long reach of the law. "We literally make decisions differently in this country than outside it because of the litigious nature of U.S. society," says Morgan Stanley’s Edwards.
There’s some justification for those fears. One reason environmentalists are targeting UBS and Salomon is simply that they have strong environmental records. "If a bank signs onto something like the UNEP statement, there is an assumption on the part of the public that the bank itself has a commitment," says National Wildlife’s Tanner, referring to Salomon’s involvement in the China Development Bank deal. But that may give false hopes to the environmentalists. As Descano says " I never said to any environmental group that I’m in a position to veto, nor should I be."
As investment banks begin to pay more attention to these issues, both Kelly and Salomon SB’s Descano are getting increasing numbers of calls from bankers who want to figure out how to head the environmentalists off at the pass. "Most of the requests are in confidence," Kelly says, "but a lot of banks are looking for very clear guidance on the reputational risks of being associated with a client who has an environmental failure."
Wide gulfs remain between environmental groups and financial institutions. Bankers complain that environmental groups have only the sketchiest knowledge of what it is they actually do, let alone the pressures they face. "Many public interest groups don’t understand how transactions work, or the role of the underwriter," says Descano. "Some believe our role is to question if clients should be in a particular business," she says. But, she argues, investment bankers’ responsibilities are simply to make sure the client has the appropriate licenses, check on what regulations apply and their cost, and try to ascertain financial implications of changes in the law.
Environmentalists are trying to educate themselves and others about the role of financiers, but there’s a long way to go. "I’ve been asked by European public interest groups to go through the financial statements of financial institutions with environmental glasses on," says UNEP’s Kelly. "They don’t understand that they’re not going to see a figure in there for environmental issues."
On the other hand, Kelly says, bankers have unreasonable expectations about how much public interest groups should know about their business. He notes that bankers were unimpressed by one recent educational effort, a handbook for public interest organizations from the World Resources Institute called Leverage for the Environment. "But if you’ve never driven a car," he argues, "and someone gives you an old Mini, you don’t say Where’s my Ferrari?"
Those bankers who make their living negotiating among competing pressures are also frustrated by the one-issue focus of environmental groups, which can derail their most well-meaning attempts to manage environmental issues responsibly. "We may have a completely harmonious relationship with Greenpeace or Friends of the Earth on a whole range of issues," says Barclays’ Bray, "but that won’t stop them from opposing us on the one issue where they take exception. It’s quite difficult to manage."
Bankers also tend to think that environmentalists go overboard. Bray cites a mining operation in Turkey, which was being financed by a German bank. "The mine had the most high-tech, cutting-edge technology in terms of safe extraction and refining the ore onsite," he says. That was an environmental plus. However, a local politician found that the process used a dangerous chemical. The potential for hazardous spills as it was shipped across Turkey mobilized Turkish workers in Germany, who picketed the bank, which then walked away from the project.
Some even suggest the environmentalists are exaggerating the negative side of Three Gorges. "To people in the West," Bray says, "the forced relocation of over a million people is a horrendous thing. But on the scale of China, it’s just a drop in the ocean. When the Yangtze flooded last autumn, 50 times that many people were displaced by the floods."
A blunt instrument
Environmental groups’ strategy of following the money may be effective, bankers say, but these groups exaggerate the power of an investment bank either to change its client’s behavior or to buck competitive pressures. "A bank is a fairly blunt instrument," says UNEP’s Kelly, a former banker. "It has the interest rate it charges a client, which it can change and the ability to say no. Once you get beyond that, there are not too many instruments it can use apart from persuasion."
Bray says that Barclays has turned down deals on environmental grounds. But that decision only changes a client’s behavior when the client doesn’t have other financing options. "Project sponsors can usually find lodgings with a queue of banks that have slightly less rigorous criteria," he says. True, it’s often more expensive financing, which may provide a long-term disincentive. But in the short run, the bank’s power is more limited than many environmentalists believe.
Descano, whose unit is in many ways a model for the kind of relationship environmentalists would like to have with investment banks, says she’s uncomfortable with being asked to police government policies, as in the case of Three Gorges. "Banks should disclose what’s appropriate under securities law and factors that could affect the bottom line. But it’s up to investors to weigh risks and benefits."
Indeed, what’s lacking from the current Three Gorges Dam debate is any evidence that the dam project, the largest of its kind, will turn out to be an engineering disaster and white elephant for bondholders, as many environmentalists argue. Environmentally aware bankers say that the best chance for getting Wall Street to walk away would be offering an analysis showing the probability of such an occurrence. Descano says she’s asked environmentalists for a persuasive summary of those arguments, but, so far, none has been forthcoming.
The current Morgan Stanley negotiations are likely to provide a case study of all these complexities. Despite Morgan’s conciliatory approach, environmental groups aren’t likely to find the firm an easy mark. Edwards also argues that targeting Morgan Stanley’s retail business, and in particular the Discover card, is shortsighted as well as unfair. "The Discover card is a socially responsible card," she says. "It has a program where you can take the cash-back payment and contribute it to any of several different charities." The firm has also made a significant corporate commitment to educating children at risk in the nation’s schools, she says, contributing its own funds. Morgan Stanley also encourages employees to contribute both time and money.
Though the firm doesn’t have a formal environmental affairs unit, it prides itself on the recycling efforts and energy-efficiency of its offices. In addition, says Edwards, "We’ve received awards for taking over facilities and cleaning them up."
One result of the negotiations may well be that Morgan Stanley will set up an environmental policy unit. But as Salomon SB’s Descano can testify, the mere existence of such a group does not promise that environmental issues will become foremost in the minds of investment bankers.
After all, Descano notes, at the end of the day, it’s not the inhouse environmentalist who has to pay the price for a firm’s decisions. "The bottom line," she says, "is that it’s the banker, not me, whose bonus is at risk." Wall Street looks for environmental profits When bankers think of the environment, they don’t like to say no. In predictable Wall Street fashion, they want to figure out how to turn that green consciousness into greenbacks. "These issues pose both challenges and opportunities, and I’m interested in trying to get people to focus on the opportunities," says Morgan Stanley Dean Witter general counsel Christine Edwards, the point person dealing with environmentalists opposing the firm’s connection to the Three Gorges Dam.
That view is gathering steam. Salomon Smith Barney’s paper and forest products industry analyst Norman Waite says that information he got from the firm’s environmental affairs office put him on the cutting edge of new developments. "Linda Descano (who heads it) helped me realize that because of new state and federal requirements, some companies were earning a lot of money off recycling," he says. "All of a sudden I realized there was a whole new revenue stream out there." On the investment banking side, Serge Maton, a London-based Salomon SB vp, says that the sharper environmental due diligence approach of Descano’s office helped boost the investor appeal of an Eastern European electric utility, whose nuclear and emissions issues were worrisome to investors. "She advised us to hire a third party to look into the company’s nuclear record, and he translated it into something investors could understand," Maton says. The deal, which came to market just as Russia blew up, was ultimately sold in a private placement once investors were assured the problems were being dealt with.
Descano says she has found that clients frequently push bankers and analysts on these issues. She sometimes gets calls from frustrated clients wanting to know how to get analysts to focus on the benefits of their environmental performance. "More chief executives of corporations are beginning to talk about the environment as a strategic factor," she says. "As it becomes a standard business issue, it sends signals to bankers."
European banks are increasingly trying to reward environmentally sound businesses. In a recent survey, 15 parti- cipants in UNEP’s Financial Institutions Initiative said they offer discounted interest rates for environmentally responsible companies, shaving as much as 50 basis points from the rate and halving the fees. But even offering financial incentives doesn’t always work. When one London-based European bank launched a credit product offering interest rates 100 bps lower for environmentally sound companies, they couldn’t find enough companies to use up the GBP500 million set aside for the program, according to John Ganzi, an independent environmental consultant to financial institutions.
Such realities are disconcerting to bankers. "If we can’t connect this to a bottom line benefit, this is going to be in the realm of marginal issues," says Evan Henry, senior vp and manager of the environmental services department at Banc of America. "That’s the biggest issue."
Categories: Three Gorges Probe