SVB’s collapse is a lesson for insurers in failed ESG

Based on ESG ratings in isolation, Silicon Valley Bank appeared a sound choice for a more sustainable investment. Punil Chaubal highlights why its collapse shows companies must take greater ownership of ESG data.

During Covid-19, Silicon Valley Bank (SVB) saw a huge increase in customer deposits, which nearly tripled from pre-pandemic levels. Some of these deposits were used to provide loans to other customers, but the bank also invested them in US Treasury bonds and other bonds deemed high quality by rating agencies.

When the Federal Reserve began raising interest rates, the US yield curve shifted upwards, putting downward pressure on the price of these bonds. Ordinarily, this in itself would not be an issue, as the bank doesn’t have to sell these assets at their new lower valuation, unless it requires liquidity to meet demand for withdrawals. Yet, that is exactly what happened with SVB: customer withdrawals rose more than expected, and to meet the need for liquidity, the bank had to sell these bonds at a significant loss.

SVB, in turn, announced that it would need to raise capital. Investors sold off the stock and customers made a run on the bank for their deposits, trying to withdraw $42bn on 9 March 2023. The following day, the Federal Deposit Insurance Corporation took over SVB’s assets. Similar concerns were raised with other banks, including Signature Bank in New York.

Green appearances can be deceptive

One less-reported aspect of its failure (including the sale of its UK subsidiary to HSBC) is that SVB was well-rated from an ESG perspective. A leading data provider gave SVB a good overall ESG rating and an upper-end score for governance.

What happened with SVB demonstrates the potential limitations of relying too much on single sources of outsourced, off-the-shelf ESG data. As important a source as third-party ESG ratings and scores are, SVB’s collapse shows that insurers must take greater ownership of the data on which they rely for setting a more sustainable investment strategy.

Beware ‘black boxes’

Currently, a lot of insurers that we speak to are still treating their third-party ESG data as ‘black boxes’ where they use the data provided without analysing the methodology used to create the data. SVB was rated well because of its focus on creating initiatives to advance inclusion and opportunity in the innovation economy and its investments in clean energy solutions. SVB was seemingly a sound ESG diversification bet.

Increasingly, using ESG data blindly can be avoided. Insurers can supplement or cross-check rating scores with the expanding range of data available to validate and set ESG strategies. For insurers, there are clear parallels to the rationale for why and what the Prudential Regulation Authority and the Lloyd’s market already expect with regards to validating the output of external models (e.g. economic scenario generators and cat models). Stronger ESG investment controls will likely have capital management benefits in the future.

Ways forward could include using more than one data vendor to get different perspectives. This could also go hand in hand with developing an approach for a company sourcing their own data that more accurately aligns to their specific ESG beliefs, ambitions and targets, such as achieving net zero by a certain date, for example.

The fundamental goal should be to establish a sense check and validate primary data. Other avenues to explore could include periodic deep dives into specific sectors of investment interest to understand what’s driving overall portfolio scores.

Five key takeaways

So, coming back to this article’s headline, the main points for insurers to consider are: