SVB: Nothing gets past Corporate Governance
SVB did not over pivot to CSR, but was taken down by Governance
The run on Silicon Valley Bank (SVB) last week and the takeover into receivership sent shockwaves through the markets, social media, and the startup community. First, this is a tough time for many. I hope most of us offer startups and their employees a hand rather than slapping them down. Second, a lot of information is swirling around with SVB, and while I know there are a lot of Financial Services firms and consultants who subscribe, for those who aren’t in the field, here’s what you need to know before we dive into this week’s topic.
SVB essentially had one type of depositor, startups. Richard Waters described that this has always been the case in his FT write-up:
It was founded 40 years ago to fill the void left by big banks that often balked at lending to start-ups.
Startups typically receive investments from VCs, Private Equity, capital raisings, etc. In the period of extended growth we just exited, startups made a lot of deposits but took very few loans. Lending is a primary way banks make money. So instead, SVB took a chance that interest rates would stay low and invested in bonds. The problem with bonds is that most are at a fixed rate over the long term. So if interest rates suddenly go up, banks lose money. SVB had around 56% of its portfolio wrapped up this way and started taking action to recoup potential losses.
In the meantime, some VCs were watching this unfold and spooked their startups into withdrawing their funds. This warning caused a run on the bank, the stock collapsed, and the rest is history.
Bad takes skim the surface
Since this is an ESG newsletter, let’s pivot! Unfortunately, the anti-ESG machine is in full swing. Apparently, the belief is that having an ESG report or supporting diversity means you are overfocused on non-material matters. The reactions range from the focus SVB had on ESG issues like this (note: the graphic is helpful, and I refer to it below):
To opinions like this:
First, SVB was not one of the most progressive banks regarding ESG, but they did have a CSR report labeled as an ESG report. In reviewing it, Frog Capital is right, kind of. SVB touted many of the same non-material CSR issues that companies across industries focus on, like carbon, DEI, and board diversity. Its $5B climate investment does appear material as they’ve been into climate tech for 15 years. One could also make an argument that the Community Benefits Plan at $11.2B was material as it invested in the communities where SVB operated. DEI is material when looking to hire diverse talent to match customers, but it isn’t clear that was the case here. Still, it is unlikely that SVB invested so much in these efforts that it impacted their ability to cover a run on the bank or that ESG distracted from the bank’s focus.
Whoever needs to hear this: Corporate leaders make a lot of money and can focus on more than one thing.
Still, ESG did play a role in SVB’s downfall, but it wasn’t the E or the S. Let’s take a look.
Stakeholders are the S, but understanding them is the G
While there is disappointingly no materiality matrix in SVB’s ESG report, they do include a little about stakeholder groups. Here’s my take (the Stakeholder Type column is my add).
Every bank should pay attention to these stakeholder groups and focus areas, but this report only scratches the surface. For example, nowhere do they tie this information back to the core of the business. This stakeholder view is particularly troubling because it is built on platitudes, not details. For 35 years, SVB had a primary type of depositor (aka. stakeholder), startups. The focus was a particular stakeholder profile that operates similarly and has similar challenges. This niche was their opportunity to capture as other banks turned startups away, but ultimately, it became a risk.
The word “founders” appears 4 times in SVB’s ESG report, mostly related to philanthropic efforts. The word “startups” bizarrely appears only twice, and once, it states this around their SASB disclosures:
First, our client base includes startups, some of which are considered small businesses under Small Business Administration guidelines. Small business lending is at the core of SVB’s business strategy, but the definition of “small business” varies.
Startups are SMBs, but they have unique needs. At their founding, SVB understood startup stakeholders as a differentiator for them and tried even to mitigate its risk from its small lending book with bonds. However, they failed to realize how those stakeholders would behave if the bank experienced risk due to this approach.
As the economy slowed, startup funding began to dry up (from as early as July 2022). From then on, the pressure on startups grew into the need to withdraw funds to cover expenses. Meanwhile, the exposure to interest rates required SVB to sell bonds at a loss to cover the activity. From here, things came together predictably.
A tightly knit group of startups and VCs spread concern quickly.
Technology afforded withdrawals quickly.
Understanding stakeholders like this is a core Governance issue.
First lesson: You must realize how quickly a niche material opportunity can become a risk. Stakeholders sit at the center of modern business. Understand how they operate, especially if you are not diversified, as disruption is rampant.
ESG scores can reveal core issues
Every rating agency has proprietary IP that analyzes a company’s data to try aggregating it into cohesive information, usually a score. To the second tweet, ESG scores won’t save a company from anything. The focus on material issues may. Still, looking at the ratings can uncover material issues. As of March 2023, here are publicly available ESG ratings and information for SVB Financial Group’s ESG:
MSCI: A rating (highest is AAA). A relevant Laggard issue listed is Access to Finance, which may have indicated their singular startup focus, but this is unclear. What’s interesting is that for Corporate Governance, they were considered a leader.
S&P Global: 28 out of a possible 100 rating. They did not choose to respond to S&P’s Corporate Sustainability Assessment (CSA), which means this score uses only publicly available information (most do). However, S&P called out an interesting risk, Risk and Crisis management, at a 9, with the industry mean of 27 and a high of 100. Business Ethics, at 35, is along the industry mean but nowhere near the high of 99. Yet, similar to MSCI, SVB’s Corporate Governance was high at 89.
Refinitiv: Refinitiv is pretty brutal by comparison. Across the Board, SVB’s ratings don’t go above 70, with only Product Responsibility hitting 76. For as much as they talk about DEI and employee resources groups, their Workforce rating is a paltry 35. For Corporate Governance, their Management rating is 65. Still, they rate just outside the top third of Banking Services Companies at 383/1106, which makes you wonder what issues the other firms might have.
Sustainalytics: A 28.4 risk rating (0 lowest/40+ highest). They rank slightly worse than the top 50% at 564/988 banks. Of note is this statement: “SVB Financial Group's Management of ESG Material Risk is Average.” Sustainalytics does not break out a Corporate Governance score but calls it out as the first material issue.
So, it is false for the anti-ESG crowd to say that SVB was considered an ESG leader.
Second lesson: ESG scores can help uncover material information and broadly shape areas you should focus on. In my experience, rating agencies want to engage and talk with publicly traded companies. Take advantage of this to ensure your company addresses material issues.
Governance will get you every time
If I remember right, in this podcast, Dan Bigman from Corporate Board Director said that the G should have been first in the acronym because it dictates everything else. In many ways, Governance has become the forgotten letter of ESG due to the corporate platitudes across the E and the S and the anti-ESG pushback. Even if your ESG scores in other pillars are stellar, you will fail without quality Governance.
Governance comes from qualified people making informed decisions and building a strong, cohesive culture to execute. Looking at SVB’s Executive Team, you will find leaders in finance and banking, which we should expect. On the surface, I found that their Board appears to have material experience in banking and finance, startup leaders, and those leading funds. Here are the names and titles from SVB’s site:
So, we have what appears to be material expertise at the top level. What’s interesting, however, is that SVB did not have a Chief Risk Officer for almost a year. The Business Pants podcast does an excellent job pointing out that the Risk Committee, which met 18 times last year, lacked expertise in financial risk. SVB placed its bet in the wrong place in a high-risk environment, which is a Governance issue, and then had no one with the experience to call it out. Further, it seems to have complicated issues as early as 2015 when CEO Greg Becker lobbied to have parts of Dodd-Frank rolled back/adjusted. Here’s an excerpt:
The final argument here was a typical refrain about the high regulatory cost. Ultimately, Trump rolled back the protections, moving the target for regulation from banks with over $50B to over $250B, and here we are. According to the Forbes article, the bank had under $40B in assets when Becker wrote this and worried about the regulations SBV would be under as they grew. I doubt he could have predicted that as of last Friday, they had grown to $212B.
Of note, Becker is the CEO and President and sits on the board. Depending on his influence, this can be a Governance risk due to too much singular influence.
Lesson 3: Operating a business is now even more challenging in a world of interconnected risks. Even with qualified individuals, we still need policy and regulatory structures to protect you and your stakeholders. Those regulations can also be a risk, but a material counterargument shows the market you know what you’re doing.
A follow-on recommendation for those who took advantage of Trump-era regulatory rollbacks: You might want to revisit your lobbying efforts and do what was being asked. Remember, Norfolk Southern lobbied against pneumatic breaks similarly, and we know how that turned out. Quality Governance means understanding the cost of your externalities and risk, being part of progress through productive dialogue, and adjusting your business model accordingly.
There is an argument that Governance should be first because it is foundational to everything. However, Governance is last in the acronym because it is the final test of whether any company issue will take you down.
Resources
There has been a lot written up about SVB over the past week. Here are the standouts.
A great opinion piece and explanation as to what happened by Matt Levine:
Startup Bank Had a Startup Bank Run - Bloomberg
As always, we can look to Theodora Lau for her perspective on leading with empathy in this BBC interview.
There was a lot of panic over the weekend that SVB’s issues were more systemic, but there is no indication that a run on the banks was coming as per:
SVB is not a canary in the banking coal mine | Financial Times (ft.com)
If you’re interested in examples of how Institutions Do Not Fail, People Do, check out this read by Melissa Bradley, co-founder of Ureeka.