Silicon Valley Bank: Another ESG Failure

All is not gold that glitters

Tue, 04/11/2023 - 00:03

I wrote previously1 that environmental, social, and governance (ESG) metrics are often dysfunctional because they prioritize the wrong things and thus deliver the wrong results.

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The recent failure of Silicon Valley Bank (SVB) despite SVB Financial Group’s “medium” (at the time) ESG risk rating from Sustainalytics2 and its extensive proclamations of ESG goals and achievements3 reinforces this conclusion. SVB’s ESG goals, in fact, achieved final scores of zero across the board because one has to be in business to meet goals. This reinforces the conclusion that if we take care of quality basics, and business basics such as minding the store, ESG will take care of itself. If we put ESG first, or even give it a place at the table, we might not have a store to mind.

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Submitted by jandell on Tue, 04/11/2023 - 10:30

The assumption of cause-and-effect between ESG and a systemic failure of the entire organization - not something I'd coach a new Lean Six Sigma practitioner to do. It appears you may have failed to do the kind of root cause analysis that accounts for ALL possibilities. Your article totally feels like you had a "cause" in mind, and viewed all evidence from that tunnel-vision myopia. If you care to share how you considered and intelligently eliminated alternative causes, I'd welcome the clarification. 

The immediate and obvious causes were not ESG, but rather what was essentially a run on the bank in combination with the unavailability of quick or even short-term assets. If however we start to ask "why," then I believe the problem can be traced to poor governance in the form of diversion of attention to ESG goals rather than minding the store. The reason SVB did not have ready cash is because it invested its surplus cash in 10 year Treasury notes as reported by NPR. https://www.npr.org/2023/03/19/1164531413/bank-fail-how-government-bond…  

"Basically what happened was Silicon Valley Bank wanted a bigger payout," says Alexis Leondis, who writes about bonds for Bloomberg. "So they basically wanted to reach for longer term bonds, because, I think, they felt like what they would get from shorter term bonds was kind of a joke."

The Securities and Exchange Commission states (https://www.sec.gov/files/ib_interestraterisk.pdf) "When the U.S. government guarantees a bond, it guarantees that it will make interest payments on the bond on time and that it will pay the principal in full when the bond matures. There is a misconception that, if a bond is insured or is a U.S. government obligation, the bond will not lose value. In fact, the U.S. government does not guarantee the market price or value of the bond if you sell the bond before it matures. This is because the market price or value of the bond can change over time based on several factors, including market interest rates." 

Most of us learn in college economics courses, if not earlier, that the reason long term bonds pay higher returns is the risk associated with rising interest rates. I am in fact putting together a webinar on time value of money that assumes SVB bought 10 year Treasury notes 2 years ago when the coupon rate was roughly 1.5% (semiannual payments of $7.50 on a $1000 bond) and the rate went up to 3.5% this year (I saw this on Treasury Direct, but it may be even higher now). The exercise is to find the net present value of this bond given 16 remaining semiannual interest payments followed by payment of the principal 8 years hence. The results are not pretty.

SVB nonetheless put money into 10-year Treasury notes to get a little more interest than it would have gotten from (as an example) 26 week Treasury bills. These also come in 4, 8, 13, and 17 week bills, with the longer ones paying a little more interest. If we want to look at this as a root cause analysis, then, where the immediate and obvious causes of the failure were (1) a bank run and (2) money needed to pay depositors was tied up in non-liquid assets, we need to ask why. SVB had little control over the first but it was entirely responsible for the second. I believe it is reasonable to attribute the second factor, money tied up in non-liquid assets, to diversion of attention from minding the store to other agendas not related to performance. Their own ESG web page shows what SVB deemed important, and little of it seemed to relate to business basics.

This article in Axios comes to the same conclusion. https://www.axios.com/2023/03/30/svbs-collapse-was-a-failure-of-esg-as-… "But the key risk the bank failed to deal with was a “bread and butter” issue, as Barr explained this week. That is the bank failed to manage its interest rate risk. That failure was its undoing."

 https://www.forbes.com/sites/shivaramrajgopal/2023/03/15/svb-is-one-mor…  "To me, SVB is less of an E&S story, contrary to the storm in the ESG teacup raised in certain quarters. Its certainly a story of dodgy “G.” But even when established monitors, both inside and outside, seemed to have failed so spectacularly at detecting poor risk management, one cannot hope for much from the ESG ratings establishment."

It totally feels like "5 why" was taken to a predetermined destination. I know plenty of organizations (I'm thinking 3M and Motorola in the late 80s and early 90s) that recognize the capitalistic benefit of environmentalism - when applied as preventation rather than containment. Loads of ROI models that verify it.

When you acknowledge that they were pursuing a higher payout - nothing in that practice remotely smacks of properly managed ESG. And a company that (a) can't manage ESG, and (b) operates itself in full alignment with a Deming Deadly Disease or two - well, maybe they are proof that "survival is not compulsary."

But you still fail to convince me that without ESG they'd still be solvent. I think ESG is a long-game management philosophy, far more aligned with Deming's admonitions than the quarterly race they were pursuing.

Henry Ford showed us more than 100 years ago why environmentalism, even if not mandatory (they didn't have the EPA back then) is good business and 3M also is known for good business and also high quality products. Companies need to pay attention to everything they throw away regardless of whether it is an environmental aspect. Then the "environmental" part of ESG takes care of itself because, at least ideally, nothing will be thrown away.

Problems arise when ESG metrics become the masters rather than the servants. One of SVB's ESG goals included "Renewable electricity use 100% by 2025" and another "Carbon-neutral operations 100% by 2025." If the renewable energy is more expensive than fossil fuel energy, the waste must be paid for by customers, investors, suppliers, and/or employees. This is an example of the ESG goal as master rather than servant. If on the other hand the organization says, "Wasted energy, regardless of its source, wastes supply chain resources" and uses ISO 50001:2018 to remove the waste, energy metrics become the servant rather than the master, and improve bottom line performance.

If we look at SVB's ESG goals at https://www.svb.com/globalassets/library/uploadedfiles/svb-environmenta… (page 12), it looks like they were serving quite a few masters whose requirements did not contribute to bottom line performance. Even the first, "Engaging and Empowering Employees," has little to do with actual employee empowerment  because the metric is "SVB employees to participate in diversity, equity and inclusion education, 100% by 2023." I had a 1-hour online course in this which was mandatory as an adjunct instructor, and it was well designed (I rated it 5 out of 5) but it did not relate to engagement or empowerment. Empowerment means that, if an employee sees waste, a potential quality problem, or a potential safety problem, he or she is encouraged to initiate corrective and preventive action to remove the root causes. This means that the one strategic initiative that I would have expected to improve performance did not have metrics related to actual employee engagement.

The issue about pursuit of a higher payment relates however to governance, and the governance was clearly less than adequate.

I concur that metrics can drive disastrous results. But that is the flaw of how organizations manage (or mis-manage) using metrics. I presume you have read Muller's "Tyrrany of Metrics" which is a well written deep dive on how the tail all too often wags the dog.

But badly managed metrics is a ubiquitous problem, of which ESG is merely a small example. I'd wager we could find SVB mismanaging oodles of metrics, andwith many of them contributing to the failure.

I have not read Tyrrany of Metrics, but I see that it relates to dysfunctional metrics of human performance. I have written material about dysfunctional financial metrics that lead to bad purchasing decisions (e.g. buying large quantities for which there is no immediate use to get a volume discount, a practice Benjamin Franklin warned against about 250 years ago). I would expect that measuring people, e.g. "number of service calls answered per hour," could lead to bad results such as cutting corners on resolution of customer complaints to handle more calls per hour. In both cases, the metric becomes the master rather than the servant.

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