Understanding environmental, social and governance (ESG) risks and dynamics is an important part of a robust investment process. Global financials offer a clear example of the value of putting ESG analysis in action.

Many investors feel the banking industry’s reputation has been tarnished in recent years following the many high-profile breakdowns in governance and breaches of public trust. At PIMCO, however, we do not believe that these past transgressions should be overwhelming factors in the forward-looking ESG assessment of individual banks, particularly for banks that performed well through the financial crisis or banks that have wholly revamped their management teams and governance processes. We view the much stronger regulatory framework and elevated stature of risk management as significant credit positives, both in terms of the higher capital and liquidity balances now held by most banks and in terms of lower earnings volatility. Although many of the changes have been mandated by regulators, leading banks have fully internalized the new rules and have invested heavily in redefining their culture and the conduct of their employees.

How PIMCO analyzes ESG factors in financials

As PIMCO considers investments in individual banks today, we seek to identify banks that have made significant progress in improving their own culture and conduct in addition to the more tangible improvements in risk management and financial product safety. Our assessments of leadership and governance are paramount, though we also carefully assess each bank’s integration of ESG factors in its underwriting as well as the company’s track record of regulatory compliance and litigation. PIMCO’s stress tests complement regulatory stress test results to provide a view of banks’ internal risk management. We also assess the propensity of company management to reward shareholders versus maintaining a conservative capital cushion in case of a downturn.

We assess each bank against global peers across 11 major ESG factors, detailed below. Our assessment combines both the level and forward-looking trend for each factor into an overall ESG score, which in the case of financials places greater weight on governance and social factors because historically these are the most material risks to the banking industry. By contrast, our ESG scores for energy companies are weighted toward environmental factors.

ESG comparison across global banks

PIMCO assesses ESG factors for major global banks across geographies. Figure 1 shows a summary that provides portfolio managers with high-level insights into the key ESG strengths and weaknesses of major banking systems (recognizing that individual banks’ scores vary). Take the U.S., for example: The Federal Reserve System has created a strong, stable regulatory framework, and its Comprehensive Capital Analysis and Review (CCAR) stress testing process enforces risk management and capital discipline. This supports our stronger view of U.S. banks’ risk management and accounting factors. However, U.S. banks generally have yet to demonstrate lasting improvements in culture and business conduct, and many continue to lag European peers at integrating ESG factors in underwriting and product safety.

ESG heat map for major banks by region