Abstract
Banks face a dilemma in choosing between maximising profits and facilitating the sustainable use of resources within a carbon-constrained future. This study provides empirical evidence on this dilemma, investigating whether a bank loan announcement for a firm with high carbon risk conveys information to investors about the firm’s carbon risk exposure collected through a bank’s pre-loan screening and ongoing monitoring. We use a sample of 120 bank loan announcements for ASX-listed firms over the period 2009–2015. We measure high (low) carbon risk exposure based on whether firms meet (do not meet) the reporting threshold of the NGER scheme. We document positive and significant excess loan announcement returns for loan renewals for high carbon risk firms, but not for loan initiations. Further, we document a more significant loan announcement return for renewals with favourable term revisions. Finally, we find no evidence that the market differentiates between domestic and foreign lenders. Taken together, our results suggest that investors perceive that banks incorporate carbon risk considerations into their lending decisions. Our results highlight the value of banks as financial intermediaries given the information asymmetry surrounding firms’ carbon risk exposure, and more generally the need to extend modern banking theory to consider issues such as the impact of banks’ CSR reputation on lending decisions.
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Notes
The mandate of the Conference of Parties (COP) is to review the implementation of the Rio Convention from the Rio Earth Summit in 1992 which sets out a framework to address climate change. The aim of COP21 held in Paris was to keep temperatures to within 2 °C of pre-industrial levels (http://www.cop21paris.org/about/cop21).
Based on total assets, Australia’s big four banks are all ranked in the top 100 banks in the world. In particular, the National Australia Bank is ranked 40, the Commonwealth Bank is ranked 44, the ANZ is ranked 45, and Westpac is ranked 46 (http://www.propertyobserver.com.au/financing/33215-where-australia-s-big-four-rank-of-world-s-top-100-banks.html).
The report ‘Still coughing up for coal: Big banks after the Paris Agreement’ is a collaboration between BankTrack (an anti-coal financing lobby group) Friends of the Earth France, Market Forces, and Rainforest Action (http://eco-financas.org.br/2016/12/still-coughing-up-for-coal-big-banks-after-the-paris-agreement/). As but one example offered to support this interpretation, the report noted that ‘Westpac told shareholders at its 2015 AGM that the bank would operate in a manner consistent with supporting an economy that limits global warning to below 2 °C, and then financed a major unconventional gas project in Papua New Guinea that would add almost 350 million tonnes of CO2 to the atmosphere’.
The aim of the project is to open the world’s largest coalmine, which at various stages over the last 3 years, has had the strong support of both Federal and State Governments.
The Federal Court set aside approval because it found that the Federal Environment Minister had not properly considered advice about two vulnerable animal species effected by the mine—the Yakka Skink and the Ornamental Snake (Anonymous 2016).
Anecdotal evidence suggests that banks see future energy markets as characterised by decreasing demand for fossil fuels and an increasing demand for clean energy (Anonymous 2016; Saunders and Potter 2015). Therefore, customers exposed to carbon risk are identified as more risky because of their increased transition risk to these new business conditions.
Two exceptions are Canada and Japan. Although there is no ETS in place, under the Canadian Environmental Protection Act (1999), all facilities emitting more than a specified threshold of tonnes of greenhouse gases are required to submit an annual report to Environment Canada, starting in 2005 for 2004 emissions. Similarly, Japan does not have an ETS (although the Tokyo Municipal Government launched its own ETS on 1 April 2010). However, annual mandatory reporting of GHG emissions was introduced in 2006 (Kauffmann et al. 2012).
The anticipated emissions trading scheme, the carbon pricing mechanism (CPM), was implemented in July 2012 and required liable entities to pay a price for their carbon emissions. However, the CPM was subsequently repealed in 2014.
The NGER scheme covers Scope 1 emissions (direct emissions from the facility controlled by the firm) and Scope 2 emissions (indirect emissions from the generation of electricity, heating, cooling or steam consumed by the facility). The corporate group reporting thresholds are 125 kilotonnes (kt) of carbon dioxide equivalence (CO2-e) of greenhouse gases (2008–2009 reporting period), 87.5 kt of CO2-e (2009-10 reporting period) and 50 kt of CO2-e from 2010 onward (Commonwealth of Australia 2010).
The US Congress passed legislation in late 2007 to start a national program for reporting greenhouse gas emissions. At this time, the reporting program was seen as the first step for new federal climate change legislation, a component of which was a cap-and-trade program or carbon tax. Ultimately, the introduction of federal climate change legislation was unsuccessful but the greenhouse gas reporting system remains (Richardson 2012).
KPMG recently surveyed the carbon reporting of the world’s 250 largest companies (G250) by total revenue and identified that: there is a lack of consistency in disclosure which renders comparisons between companies problematic; only 62% of carbon reporters reported independently assured data; 47% of companies do not report carbon emission reduction targets (with the heaviest emitters in sectors such as oil and gas the least likely to publish such targets); only 35% of companies with published targets explain the choice of these targets; and less than one in 10 companies report on emissions from the use or disposal of their products (KPMG 2015).
The validity of the empirical evidence on the market reaction to bank loan announcements has also been questioned because of potential self-selection bias in a firm’s decision to announce a bank loan. There is evidence that announcing firms systematically differ from non-announcing firms, with announcing firms having higher information asymmetry, their loans comprising a material amount of their assets, and being more likely to be facing actual or expected cash flows problems (e.g. Fery et al. 2003; Maskara and Mullineaux 2011). However, a more recent study by Ongena and Roscovan (2013) confirms the existence of positive, excess returns around bank loan announcements after controlling for self-selection bias by using a more representative sample of 17,457 published and unpublished bank loans announcements drawn from DealScan over the period 1987–2003. They document a cumulative abnormal return of 0.39% in a 3-day trading window around the loan announcement.
The industries are petroleum, government, chemical, metallurgy, service, pulp and paper, and mining.
Counterbalancing our argument that carbon risk is reflected in credit decisions is the possibility that: (a) a borrower may have significant financial strengths and collateral which offset the impact of carbon risk on credit risk; and (b) there is a mismatch of time horizons between the credit risk of loans as relatively short-term financial products and longer-term carbon risk. In both cases, these possibilities will likely bias against finding that investors value loan amounts for high carbon risk firms more than low carbon risk firms. Thus, it becomes an empirical question that we investigate in this paper.
Due to limited disclosure of loan term details in the loan announcements, we cannot directly examine whether the level of carbon risk is also reflected in the terms of the transaction and not just in the decision to lend. As a result, our focus is restricted to the signal provided to investors by the decision to lend, as well as by whether the renewed loan terms are favourable. The latter is possible because firms will disclose whether a loan renewal contains favourable terms around interest and restrictive covenants. However, typically there is no disclosure about the exact interest rate and/or the levels of covenants.
The reporting thresholds are identified in Footnote 11. To identify firms with greater apparent carbon risk exposure, we match our hand-collected loan announcement data (described in ‘Sample Data’) with NGER-registered corporations from the Clean Energy Regulator’s website. Since there is no common identifier across these two datasets, we initially match firms according to their names using a name recognition program implementing the Levenshtein algorithm and then hand-check each remaining loan announcement against the published list of registered corporations.
Within our sample, none of the loan renewals involved a situation where one of the terms or conditions was made less restrictive while another was made more restrictive. As such, the classifications Favourable and Unfavourable are clean or unambiguous.
Compliance with Listing Rule 3.1 Continuous Disclosure requires that ‘once an entity is or becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately inform the ASX’.
The adjusted R2 of 0.055 for Model II is comparable or slightly higher than those documented in the literature. For example, the models employed by Billett et al. (1995) and Lummer and McConnell (1989) exhibit adjusted R2s ranging from − 0.001 to 0.030. In unreported sensitivity analyses, we alternately proxy for borrowers’ profitability using the lagged value of EPS, diluted EPS and adjusted EPS; alternatively proxy for borrowers’ size using decile ranks; and alternatively proxy for borrowers’ leverage using lagged debt to assets. In all instances, the results are qualitatively identical to those reported in Panel C of Table 5. Results and conclusions are also robust to the inclusion of year fixed effects in the models.
An identical conclusion emerges when we alternatively consider the following model which includes an interaction term designed to distinguish the market reaction to a loan renewal announcement relative to a loan initiation announcement:
$$\begin{aligned} {\text{CAR}}_{t} & = \delta_{0} + \delta_{1} {\text{High-Carbon}}_{t} + \delta_{2} {\text{Renewal}}_{t} + \delta_{3} {\text{High-Carbon}}_{t} *{\text{Renewal}}_{t} \\ & \quad + \, \varSigma_{k} \lambda_{k} {\text{CONTROL}}_{kt} + \varepsilon_{t} \\ \end{aligned}$$where Renewal is an indicator variable set equal to one for a loan renewal and zero for a loan initiation. When this model is run based on the pooled sample of 120 bank loan announcements, the coefficient on the interaction term, High-Carbon * Renewal, is positive and significant (4.386, p = 0.046), indicative that the market views a loan renewal announcement as incrementally informative for high carbon risk firms. In contrast, the coefficient on Renewal is insignificant at conventional levels, indicative that the market does not view a loan initiation announcement as incrementally informative for high carbon risk firms.
Results for the selection model (Eq. 5) are available from the authors upon request.
Fama–French Asia Pacific 3/5 daily factors are downloaded from Ken French’s website (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html#International).
In untabulated results, we also run the market model and three-factor model over the alternate event windows (− 1, 2) and (− 1, 3). The results are qualitatively the same as those reported in Table 9 for the five-factor model.
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Acknowledgements
We are grateful for the financial support provided by CPA Australia via a 2016 Global Perspectives Research Grant (Grant No. 001/2016). We also thank Kevin Thai and Pei-Jia Lum for their excellent research assistance.
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Herbohn, K., Gao, R. & Clarkson, P. Evidence on Whether Banks Consider Carbon Risk in Their Lending Decisions. J Bus Ethics 158, 155–175 (2019). https://doi.org/10.1007/s10551-017-3711-3
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DOI: https://doi.org/10.1007/s10551-017-3711-3