Deutsche Bank’s Khan: “Risk recalibration fundamental to growing ESG market”
Newly appointed ESG head for Asia Pacific at Deutsche Bank explains to Foo Boon Ping and Chris Georgiou the importance of the region to the global sustainability movement and how the bank intends to embed ESG across all its businesses
- APAC plays critical role as destination of ESG investments and in shaping governance frameworks
- Expanding ESG opportunities in the region and offerings for high net worth individuals
- COVID-19 significantly shifted and recalibrated risk expectations and growth of ESG market
As Asia Pacific sees more capital flows into the environmental, social and governance (ESG) sector, it will play an increasingly important role in the growth of the global impact investment market and in defining evolving sustainability standards, says Kamran Khan, the new head of ESG for the region at Deutsche Bank.
Khan who is responsible for developing and coordinating the bank’s regional business strategy around ESG believes that the rising income of the region and Asian companies reliance on exports and the global supply chain, desire to become more international players as well as rapid adoption of new technologies, expose them to greater risk and pressure to adopt ESG practices. And as this happens there will be increasing need for ESG compliant financing and investment solutions.
He also sees the potential of ESG financing and investment as alternative capital sources for emerging economies in Southeast Asia. This will allow the smaller economies to tap private-public funding platforms that can be embedded into their ongoing development needs while being put into a budget process. It will allow these countries to organise their development finance framework and accountability with key performance indicators and targets, and can be a powerful way for governments to provide information to the market on their progress on the development scale.
Khan attributed the ongoing COVID-19 pandemic as a catalyst for the growth of the ESG market as participants and investors have become more aware and taken steps to recalibrate the related risks and exposures. “The risk related to ESG issues is much more financially significant than thought. It has been interesting times not just because of the capital flow, but also the mental shifts that people have now made,” he observed.
Khan who has extensive experience in financial markets, sustainable development and corporate and public advisory, headed the global investments and operations at the US Millennium Challenge Corporation under the Obama Administration. He had previously established the World Bank Group Hub in Singapore and led the World Bank’s Infrastructure Finance Practice in East Asia. Over the course of his career, Khan has led investments in sustainable development across Asia, Africa, Latin America and Eastern Europe. Most recently, he founded and led an impact fund targeting companies focused on achieving UN Sustainable Development Goals.
He is based in Singapore and reports regionally to Asia Pacific’s CEO Alexander von zur Mühlen and locally to Singapore’s chief country officer, head of corporate bank APAC and head of fixed income and currencies APAC David Lynne. He is also a member of the bank’s Group Sustainability Council chaired by CEO, Christian Sewing.
Deutsche Bank has had a longstanding commitment to sustainability. The bank has been a member of the UN Environment Programme Finance Initiative and signatory of its Declaration of Sustainable Development since 1992, achieved climate neutrality in operations since 2012 and has been a supporter of the Paris Climate Agreement since 2015.
In addition, the bank is a founding signatory of the UN Principles for Responsible Banking in 2019. The bank has also committed that by 2025 its total volume of sustainable financing and investments will exceed $216 billion (EUR 200 billion), and that its operations will be powered entirely by renewable energy sources.
Its asset management subsidiary, DWS, managed the Apple led $300 million China Clean Energy Fund. Launched in 2018 as part of its commitment to address climate change and increase the use of renewable energy within its supply chain, Apple and 10 suppliers invested in the fund over four years to develop clean energy projects totaling more than one gigawatt of renewable energy in China, the equivalent of powering nearly one million homes. In total, DWS manages five clean energy, microfinance and agriculture-related close-ended impact funds, and three asset class-focused mutual funds which are also classified as impact funds. In addition, DWS offers close to 30 ESG-related mutual funds.
The following is the edited transcript of the interview:
Foo Boon Ping (FBP): Talk to us about your role as head of ESG, what does it entail?
Kamran Khan (KK): My role is designed to focus on the commercial end of things, working across the four divisions of Deutsche Bank to see where environment, social or governance (ESG) is coming up in our client dialogue and assess how the needs of our clients can be converted into a banking relationship, whether it is with a conventional product which needs some adjusting, or a completely new solution that we can offer.
Some of our clients have their own corporate strategy that requires them to move or pivot towards ESG and sustainability, while others are dealing with a very specific issue related to ESG matters requiring us to customise a solution that solves that problem on a commercial basis. So, that's my role, working across the four divisions and a variety of different businesses covering all products from investment to transactional banking. How do we convert our business to address a very important shift that is taking place in the market.
APAC plays critical role as destination of ESG investments and in shaping governance
FBP: Where do you see the opportunities for ESG in Asia Pacific?
KK: We consider Asia Pacific to be core to a truly global ESG movement. We think Asia Pacific is going to play a very critical role in what happens in the global ESG market both as a destination where ESG investments will be deployed, but also as a region that is going to have some input into how ESG frameworks are going to be adjusted over time. And there are a variety of reasons for that.
The first, most important, is that Asia Pacific economies across the board depend upon exports and the global supply chain. So as ESG ideas are strengthened around the world, in the large buying markets of North America and Europe, there is always a risk for exporters in Asia Pacific. They have to establish sustainability practices and clean up their manufacturing processes to allow for people looking for an ESG-compliant supply chain to continue to do business with them.
Second, fast emerging global companies out of Asia Pacific, new MNCs that are headquartered in Asia, and selling finished products into the global market, are looking at ESG as a way to establish their global brands against their global competitors. ESG is a very powerful tool for such Asian companies to compare their ESG track record and credentials with their global competitors. We believe it is going to be a very important strategy for many Asian companies. It is a proactive driver of ESG adoption here in Asia Pacific.
Third, technology investments in Asia have continued for the last two decades. Technologies that are coming in are creating an environment where Asian companies, systems and manufacturing processes will become easier to classify under ESG regimes. New technologies tend to be cleaner, efficient, greener, and very digital. They provide the data, the building blocks of a sustainable society. You intrinsically have companies better able to justify and document themselves as sustainable businesses.
And the last is the fast-rising incomes in Asia. In the most lucrative urban markets, consumers are now demanding better corporate governance from companies, whether they're global companies with offices or operations in Asia Pacific or local companies. All of this is adding buyer pressure and stakeholder pressure. Governments are now very active in trying to incentivise companies to be better corporate citizens, especially in the wake of the COVID economic crisis. The expectation is very real, both from consumer as well as from governments.
In Asia Pacific, we are engaged with a variety of economies trying to create an environment where more ESG investments will happen and companies need to find the models which will allow them to do good and stay profitable at the same time. But this is not about CSR (corporate social responsibility) or philanthropy, this is about adjusting practices to do good business and not cause damage.
FBP: Tell us amid the diversity of definitions and standards when it comes to classifying impact investments, ie. ESG, SDG, sustainable finance, responsible banking, how does Deutsche Bank create clarity internally and with your clients about what exactly you are offering and how it is achieved?
KK: It is understandable to see multiple standards in the industry. This is the start of a very long curve, which will define whether impact investing should be called sustainability, ESG or another acronym going forward. People have different concerns, so they have adopted different frameworks to address these concerns. But this is a good opportunity for the market to o incorporate other fundamental changes before these frameworks become widely accepted.
Invariably, one or two will become well established over time. Meanwhile, at Deutsche Bank, we are building our own standards. We will only be comfortable to classify something as an ESG or a sustainable finance transaction if it goes through a specific process we have put in place. We have to take responsibility for how we do our business and have our own strategy around it.
We are establishing standards that are group-wide and used globally. We have a sustainability council which is chaired by our CEO. I am also on this council where there are representatives from the different businesses. We are building our own taxonomy and framework for how we conduct our business and our standards are very similar to some of the key leading frameworks used in the market. They are rated by a well-established rating firm to make sure that we are in the right zone.
And these standards will be continuously adjusted. For example, thus far the industry has focused on how a deal is classified under which framework and regime in order for the issuer to have the right to say it is an ESG transaction. But eventually, the real value and classification of an ESG deal will be done by the investors. And if you are an ESG investor, you are buying two things. You are buying the economics, the interest rate and the financial elements of the deal, and you are buying impact. How much CO2 will be reduced? How many lives will be touched? What specific structural governance issues will be addressed? These indicators are an integral part of the deal you buy.
It is also important to note that when many of these assets are sold in the secondary market, the valuations are going to depend upon the economics as well as the results on the ground. The Asia Pacific region will play an important role, because it is where a lot of these investments will be deployed. Asian countries have gone through significant economic growth over the last several decades and have a good understanding of what ESG problems look like and what these investments are supposed to help with.
FBP: Give us a breakdown in terms of the proportion of assets between the different regions for ESG as part of the 2025 commitment to increase total volume of sustainable financing and investments to above EUR 200 billion ($216 billion)?
KK: Our approach is to look at it from an organic standpoint – what is the right solution for the client, regardless of the location. A number of deals may be booked in Asia Pacific, for clients located in Europe and vice versa. Our focus is more on building an ESG business that is leveraging our global platform and our existing relationships.
FBP: Which are the markets in the region that would be interesting?
KK: All the key markets active with Deutsche Bank are shifting towards ESG in roughly the same proportions. China has been leading in green finance and this trend is going to continue. Korea is coming up very strongly especially with social bonds. Japan is not far behind. In ASEAN, ESG should also help some of the emerging economies to organise their capital sources for development. For example, for a small economy that used to borrow from multilateral organisations or donors, this source of funds will become a private-public platform embedded into its ongoing development needs while being put into a budget process. It also gives emerging economies the potential to organise their development finance framework and accountability with key performance indicators and targets. It can be a powerful way for governments to provide information to the market on their progress on the development scale. Subsequently, the emergence of the ESG market is going to have impact on the development finance community.
FBP: How are you reaching out to the private investors of impact, the high net worth individuals?
KK: An impact fund has to distinguish itself from a charity by demonstrating a strategy and a way to create leverage and impact, while being able to provide supporting data.
Impact funds will have traction in Asia going forward, and we believe that it is starting. There are a few that are already doing quite well.
Expanding ESG opportunities in the region and offerings for high net worth individuals
FBP: What are the types of ESG assets that you are offering to institutional, high net worth individual clients?
KK: Our private bank is looking into this market, as it is very important to us. We are building capacity to understand sustainability projects and implementation on the ground.
DWS, our asset manager, has a strong track record of doing impact investment, not only with their own funds but also by managing also third-party funds. For example, DWS manages Apple's fund in China for renewable energy.
We have the expertise and are planning to launch new products and services coming in the coming months and years.
FBP: Tell us about the corporate governance that the bank has on ESG, degree of disclosure, reporting and transparency of investments. For example, how are executive KPIs linked to ESG?
KK: For the ESG, or sustainable finance business, we have the sustainability council, with a number of supporting structures. We are working through a process for the internal incentive structures and the business KPIs to make sure that we link them around our strategy.
FBP: This is still something of a work in progress?
KK: It is something that will likely remain in progress because as the industry evolves, and the products evolve, we will have to continue to tweak the incentive structure within the organisation to make sure we provide the right incentives.
COVID-19 significantly shifted and recalibrated risk expectations and growth of ESG market
FBP: Finally, share with us the impact that the COVID-19 pandemic has had on the relative interest of sustainable and ESG-linked investments?
KK: It has been a difficult time for investors and the banking industry. The pandemic has made money managers recalibrate their risk profile on their portfolio at the onset and this has brought at the forefront the importance of environmental and social issues.
We have also seen some structural shifts. Stakeholder issues and the expectations of consumers have proven to be more significant than originally thought.
And the risk related to ESG issues is much more financially significant than thought. It has been interesting times not just because of the capital flow, but also the mental shifts that people have now made.
Finally, the cost of capital is relatively low right now. A company thinking about pivoting towards sustainability practices, but concerned about the costs, this is a great time to do it. Almost every company has to make some adjustments to their business processes because of the COVID-19 pandemic, whether it's manufacturing adjustment or supply chain adjustment. These adjustments often fit well with adoption of sustainable practices.
Chris Georgiou (CG): What is the impact of the pandemic on the relative performance of sustainable and ESG-linked assets?
KK: The ESG indices have beaten the broader market this year. That can be explained by the fact that ESG investment baskets do not include oil and gas and other commodities which have performed very poorly this year. However, it is also important to note that fund managers have undertaken strategic and structural recalibration of portfolio risk because of COVID-19. Many investors have discovered that the environmental and stakeholder risk they were carrying in the investment portfolios was higher than they had realised. This has resulted in reallocation of capital towards ESG-aligned investments. This mental shift regarding recalibration of risk is a very important structural change that will help grow the ESG market.
While we think about ESG as a defined market, the risk management strategy around ESG is now being used by almost all investors whether they call themselves an ESG fund or not.
Keywords: Esg, Sustainable Investment, Sustainable Development, Risk, Technology, Covid-19
Institution: Deutsche Bank, US Millennium Challenge Corporation, World Bank, UN Environment Programme Finance Initiative, Apple, China Clean Energy Fund, DWS
Guest: Kamran Khan, Alexander Von Zur Mühlen, David Lynne, Christian Sewing, Foo Boon Ping, Chris Georgiou