The issue of cluster munitions has risen to prominence in recent years and received strong public attention in 2011. In order to guarantee that the products and services of Deutsche Bank serve the real economy and society as a whole, we have reviewed the bank’s internal processes once again and as a result we have terminated business relationships with clients that are involved in production of cluster munitions, for example.
What are cluster munitions?
Cluster munitions are containers that open in mid-air to distribute a number of small “bomblets” over a wide area. They are of particular humanitarian concern because they are not targeted weapons and leave a large amount of unexploded material. Bomblets lying on the ground may kill or maim civilians. The debate on cluster munitions gained momentum in the early 2000s after the humanitarian impact during the wars in Kosovo and Iraq. Deployment in the Israel-Lebanon conflict in 2006 sparked international negotiations leading to the 2008 Oslo Convention on Cluster Munitions. The Convention prohibits the use, transfer, and stockpiling of cluster bombs and has been signed by more than 100 states – not including the US, Russia and China. Signatories agree “never under any circumstances” to:
- use cluster munitions;
- develop, produce, or otherwise acquire, stockpile, retain, or transfer to anyone, directly or indirectly, cluster munitions;
- assist, encourage, or induce anyone to engage in any activity prohibited to a government.
Cluster bombs are assembled from several components made by different companies and there is no consensus about what should be defined as key components. Some components are also used in other, non-military equipment. Some countries and NGOs even disagree about what constitutes cluster munitions, despite the definitions in the Convention.
Has Deutsche Bank stopped financing Cluster Munitions?
The Deutsche Bank Group Cluster Munitions Policy has been in effect since autumn 2011 following the earlier decision of the Management Board to exit relationships and not engage in new business with clients involved in this line of business.
The Deutsche Bank Group Cluster Munitions Policy reflects the complexity of the issue and goes beyond our previous approach whereby the Bank did not provide direct funding for cluster munitions (production or trade).
Does the Policy on Cluster Munitions apply to all transactions?
How does Deutsche Bank implement the Policy on Cluster Munitions?
Deutsche Bank has exited banking relationships with most identified conglomerates. Residual relationships relate to pre-existing contracts, which will not be extended.
We consider doing business with clients in this segment only if we obtain confirmation that the client’s cluster munitions-related business has been terminated. If clients have existing contracts, we may accept the time-bound intent to terminate production.
How is Asset Management covered by the Cluster Munitions Policy?
In Europe, Deutsche Asset & Wealth Management Active (DeAWM Active) follows a ESG guideline that also includes statements about producers of cluster munitions. Investment in such companies is generally not allowed.
DeAWM Active is currently working on the implementation of an ESG guideline valid for all divisions of DeAWM. This guideline entered into force in October 2014 and prohibits globally new investments in companies that produce cluster munitions, anti-personnel mines or depleted uranium munitions.
We are also in continuous dialogue with NGOs, index providers, investors and other asset managers on this subject.
Investments in indices managed by a third party that include these companies are allowed.
Indices designed on our own and alternative investments must exclude these companies.
Who monitors compliance with Deutsche Bank’s Policy on Cluster Munitions?
Andrew, as Head of Government and Regulatory Affairs at Deutsche Bank, can you briefly explain Deutsche Bank’s position on cluster munitions?
Andrew Procter (Deutsche Bank)
Our Group Reputational Risk Policy says that anything promoting activities considered contrary to the public good or posing a significant environmental, health, or safety risk has to be escalated within the bank. If necessary a decision goes all the way up to a Group Reputational Risk Committee. In 2008, we decided to do something much more specific on cluster munitions and said we would not engage in any credit transactions that involved them. But we kept being mentioned by NGOs as supporting manufacturers, so it soon became obvious that the whole issue was more complex than we had initially thought. In a recent step, we identified all the companies that major NGO groups had said were involved in the manufacture of cluster munitions. We discovered that very few companies make whole cluster bombs. Lots of companies make components and a few assemble the bombs. So we had a discussion around the concept of key components and around companies in groups. We finished up with guidance which is effectively: “We will not do business with companies which produce the bombs. We will not do business with companies which produce key components. Nor will we do business with groups where the contribution of cluster munitions to the group is anything other than de minimis.”
Tim (Hermes EOS)
Presumably a further issue is that a manufacturer may be trying to get out of involvement in these weapons but is bound by existing contractual obligations which have to run their course?
Yes, so we allow for that if the company says it will exit this business once contracts are filled. Similarly, in one or two cases we had longer-term financing commitments with groups that would have involved a breach of contract to exit.
In Germany, financing companies that produce cluster munitions isn’t actually illegal, is it?
Germany has signed the Convention, but it doesn’t have domestic law that makes it unlawful to finance them. Most of our business in the armament sector is in the United States, which hasn’t even signed the Convention. So we as a bank have chosen to take a position closer to the German view, which results in lots of push-back in the United States.
What if your investment funds hold shares in such companies?
Our asset management people would say they have to maximize value for their investors. If we have investments in a company that does have cluster munitions capacity, we couldn’t tell the asset management company to sell the shares. But we are going to have to get better at saying up front that there are some things we are not going to invest in.
Jerome (UN Global Compact)
Asset management has a fiduciary duty to maximize shareholder value, but if you really go up the food chain of investment, ultimately you have got ordinary people there, either through pension funds or mutual funds, or just people who deposit money. Thus, to me there is no conflict between the fiduciary duty to shareholders and the attempt to be a good corporate citizen, because with the democratization of share ownership, you are talking about the same people ultimately.
Sabine (Deutsche Bank)
We are signatories of the UN PRI. That has led our Asset Management to take Environment, Social and Governance (ESG) factors into account. In some portfolios, you will not find any holdings of companies involved in cluster munitions.
When talking to the general public and to nongovernmental organizations, how difficult is it to explain a bank’s position on issues such as cluster munitions?
Reinhilde (Ethix SRI Advisors)
The need to take a public position and to present it in a fair way publicly is a huge challenge, as far as we observe as an SRI advisor. Some institutional investors took credit early on for their position on cluster munitions, without at the same time implementing such a position comprehensively and systematically. Such a partial implementation has received surprisingly wide acceptance, including by NGOs.
As you see, we have gone much further than we are required to and then people say we are not as good as, for example, the Norwegian Government Pension Fund. It is a tricky thing for us. We have serious issues around comparison, around key components and around components or weapons that are close to, but not exactly the same as is covered in the Convention.
What we at Hermes EOS have tried to do for our clients is identify the status of the companies and tell the clients: “We think that this company is going to withdraw from the business, or this company makes such or such a component, you can decide whether you want to exclude.” But it has been seriously difficult because of misinformation that is out there which we have to overcome for our clients.
I think there are two issues. There is lack of transparency on the part of the companies. And you have a variety of expert providers who are not all of the same quality. So you can have a superficial evaluation of a company which then gets labeled as a cluster munitions provider – perhaps based on information that is seven years old.
George (F&C Investments)
At my firm, F&C Investments, we will contact companies and sometimes they don’t respond at all. With regard to cluster munitions, for example, we wrote to 84 financial institutions and asked about their policies, about how they address this issue. Of the 84 we wrote to, only 39 bothered to respond. So there is a significant lack of transparency, because increasingly companies are recognizing it is not necessarily in their interest to make these points very clear. Silence might imply guilt.
I assume it is easier for banks to get definitive answers through their due diligence and contractual terms before a credit or investment decision.
That is right in theory. But there is competition and there is a reluctance to annoy the client. Asking the clients questions about their future intentions is annoying. So the ability to ask the question is more in theory than practice sometimes, just because it is a competitive world.
Naturally the senior relationship managers are more reluctant to ask difficult questions of the client. In these cases the sustainability team can facilitate the process.
Maybe one of the fears that banks have when they discuss these issues with NGOs is showing the compromises they have to make. To some extent a policy has to be pragmatic, you cannot have the perfect policy that will resolve all the problems.
We have seen developments within the NGO community. From being very poorly informed they have become much better informed and I have seen a lot of constructive approaches on this issue with investors. But we also have the media. At Ethix SRI Advisors, we have observed some reasonably good and comprehensive and fair reporting by NGOs, but some very, very bad media campaigns. I think communication is about a longer-term engagement on the complexity of the issues. It requires stakeholders to be willing to engage with you and not just you willing to share with them.
NGOs always ask for transparency. But what I hear is that it is not only about transparency regarding the policy, it is also about transparency at the level of implementation. Is this something that the UN Global Compact has dealt with?
“Communication is about a longer-term engagement on the complexity of the issues.”
“Transparency about process is as important as results.”
At the UN Global Compact we have a philosophy that transparency about process is as important as results. A very public communication can be extremely helpful, showing the process and the complexity of the journey you are on, but also giving stakeholders a clear map of these complexities. I think it is really important to make stakeholders aware that there are consequences to just refusing to invest in any company involved in anything that relates to ammunition. You could severely affect the economic development of certain regions and people. It is also important to highlight the bank’s different responsibilities: to the companies the bank has invested in or given credit to; to the bank’s own shareholders; and as a trustee of investors’ or depositors’ money. And in the case of a universal bank like Deutsche Bank, demands from stakeholders are often conflicting. It is crucial to help people understand that there are a lot of unintended consequences to taking a strong stance on one single issue and not looking at the other aspects.
There is one issue that concerns me regarding communicating: it is excellent if people are saying they have a certain goal, but they are not yet quite there, which by definition means you are not perfect. If that is acceptable and you don’t get hammered for it, so to speak, it would be easier to engage.
I would be sympathetic with that. But for many clients it is binary – you are either in it or you are out. The challenge is to explain that there is black, white, but also a bit of grey. As a consequence, I think you should be as transparent as you can.
You say you are on a journey and there are lots of descriptions about the future, but there also have to be signs and milestones for investors. From my point of view, that is terrifically important: the fact that you tried to do x, y, and z, but life was more complicated. And if we accept that good reporting and transparency is a proxy for being aware of the issues, for trying to manage the issues effectively, then I think the banks that do it well over time will be identified in a more favorable light.
Speaking about issue management and transparency: Why has this become a topic for investors, why is an organization like F&C interested?
We are very much responding to client needs. There are investors who will put ethical issues as an end in themselves and not necessarily prioritize commercial consequences. We run a series of ethical funds at F&C, where retail investors want to disassociate themselves from munitions, even at the risk of potentially losing economic opportunities and achieving a lower return. But there is another dimension, too. Even if you are an investor that doesn’t look at ethics as an end in itself, there is a reputational risk dimension, because there are people who recognize that there can be commercial consequences.
I would add that clearly there is also a legal risk, particularly in certain jurisdictions. There are different layers of risk and we as an investor want clarity as to the extent of involvement of certain companies in the industry. Then we can consider where we sit on the risk curve.
Most investors seem to be more concerned about opportunities and risks rather than about values.
“These issues aren't going to go away. You have to embrace and manage them.”
“At Deutsche Bank, we have an aspiration to be a firm that creates value with values for a sustainable future.”
We have an aspiration to be a firm that creates value with values for a sustainable future. That means value creation is number one, but the idea of embedding sustainability into our core business is very much at the forefront of our thinking. We do a lot on what I call the sustainability opportunity side, where climate change and energy are foremost for us. We are considered leaders in climate change because of the intellectual leadership that we have developed. Immediately when you talk about energy, you talk about opportunities in renewable energy. Then fossil energy instantly brings a lot of the mentioned ESG risks.
Does Deutsche Bank’s investment research take ESG risks into account?
The research people are focusing on these questions more and more: What is acceptable, what role should investment banks be playing, how does the market work, to what extent is speculation necessary for the efficient operation of the market? But I don’t think we are anywhere near the end of the debate.
If the research product isn’t there it is because there isn’t sufficient demand. We are not yet quite in a world where it is generally acknowledged that ESG information is essential for making a longerterm assessment of a company. It is a question of who demands it and who pays for it.
Sometimes I feel like the cogwheels are not coming together. Even if sell-side analysts want to disclose ESG information, we often hear that there is not enough interest from investors. How long do you think will it all take?
I think you need to directly relate it to risk. Anticorruption is a good example. We are seeing enforcement picking up and management getting replaced, fines being imposed, companies being blacklisted. From my point of view, the sell-side people often concentrate primarily on traditional risks, and can often have a short-term focus. They need to be able to connect “extrafinancial” issues as carbon emissions, anti-corruption, health, and safety, more clearly to risk and to the extent to which that risk may affect the long-term value to the creditor or shareholder.
Actually, you are seeing a greater connection between risk and ESG than a few years ago. And we know these issues aren’t going to go away. You have to embrace and manage them. That is the big lesson from other industries. It is not an option. It has got to be integral to your strategy because over time you might miss the odd deal, but to be a trusted, respected bank gives you a commercial advantage. So it is painful, but if it is executed well, there is a benefit.
“It is painful, but if it is executed well, there is a benefit.”