Banking and the Environment

O, that moral Science were in as fair a way of improvement, that men would cease to be wolves to one another, and that human beings would at length learn what they now improperly call humanity.

Benjamin Franklin

Some call it the Exxon Valdez effect. When the Exxon Valdez oil spill tool place in Prince William Sound, three years ago this month, the televised image of dying oil-covered otters and seabirds was hard for people to erase from their minds. And it has proven to be hard to erase from the courts, with more than 160 lawsuits brought by individuals, businesses and governments.

Eleven years before Valdez, a much larger oil spill took place off the coast of Northern France. The full legal liability is still not settled.

As soon as one of these troubling images fades, another seems to take its place. Each new image generates many new questions. What does it mean, for example, that children playing in the surf must dodge not only the occasional jellyfish but also the occasional hypodermic needle washing in with the waves? Needles, dead dolphins, and oil-soaked birds - are these the signs that we are

now standing on some new beach, facing dangers beyond the edge of what we are capable of imagining?

U.S. Senator Al Gore of Tennessee recently responded to these questions, and to the global destruction taking place on an almost biblical scale, by stating:

With our backs turned to the place in nature from which we came, we sense an unfamiliar tide rising and swirling around our ankles, pulling at the sand beneath our feet. Each time this strange new tide goes out, it leaves behind the flotsam and jetsam of some giant shipwreck far out at sea, startling images washed up on the sands of our time, each a fresh warning of hidden dangers that lie ahead if we continue on our present course.

Although oil spills are among the most highly visible examples of environmental degradation, the problem of environmental liability is not restricted to oil companies. It's a concern for any company that develops, manufactures or transports goods.

And in some jurisdictions, liability provisions catch almost any company remotely involved in an environmental transgression - even, in some cases, the transgressor's bankers.

This afternoon, we will have an opportunity to hear about the issue of environmental liability from the viewpoint of a sector that has a great deal at stake, and an important role to play - the banking industry.

Helen K. Sinclair has been President of The Canadian Bankers' Association for more than two years; in that position, she succeeded Bob MacIntosh. (You will recall that Dr. MacIntosh spoke at this Empire Club lectern a few months ago.) Ms. Sinclair is both the first woman to serve as President of the CBA, and the youngest person ever to hold that position.

Prior to taking over the leadership of the CBA, she held several senior executive positions with The Bank of Nova Scotia, including Vice President and General Manager of planning and legislation.

Ms. Sinclair has been active on a number of public advisory boards, including the Financial Services Sectoral Advisory Group on International Trade, the advisory board of the Financial Services Institute, and the policy analysis committee of the C.D. Howe Institute. In addition, she is a former director of our sister organization The Canadian Club of Toronto.

Finally, congratulations to Ms. Sinclair are in order. Last evening, she was awarded the Women Who Make a Difference Award by The Financial Post, Toronto Life and The Bay.

Ms. Sinclair's message on the environment today is very timely. In less than three month's time, more than 20,000 participants, including global-warming visionaries, worldwide wealth redistributors, and environmental consultants, will assemble in Rio de Janeiro for the UN Conference on Environment and Development, or the Earth Summit.

The meeting, described in a recent Wall Street Journal article as a "phantasmagorical carnival," is the successor to the UN Conference on the Human Environment held in Stockholm in 1972, and it is organized by the same man, Canadian Maurice Strong.

The goal of the Summit: To agree on a set of principles and conditions that will set the world on a new environmental course and, perhaps some day, eradicate the kind of pollution symbolized by the Exxon Valdez disaster.

The stakes are high. This massive exercise in global consciousness-raising on the subject of the world's environment will hopefully live up to its billing of saving the planet for future generations.

In the context of the Earth Summit, Canadians have long regarded themselves as environmental good guys: the inventors of the Blue Box and the people who prodded the recalcitrant Americans into controlling acid rain. But the spotlight must not shift from Canada's burgeoning accumulation of environmental sins.

We must continue to focus on the human profligacy that is destroying or damaging our Canadian ecosystems - from oceans and polar regions to our forests - and the remedial steps to prevent further environmental degradation. Accordingly, today's talk on environmental liability is timely and appropriate.

Members and guests of The Empire Club, I ask you to welcome a "woman who makes a difference" -Helen Sinclair.

Helen Sinclair:

Thank you very much John and good afternoon ladies and gentlemen. You know John, I used to call your sister organization, when I was on its board, the other place. I'm no longer a director and so I'm now able to make some of the comparisons which I think should be made between the two clubs and to speak out about some of the things I like better about The Empire Club. One of them is that you sing the National Anthem. Another positive feature is that the padre blesses the guest speaker. If The Empire Club could arrange a similar blessing from my member banks - who are represented at

the head table today- I would be prepared to label this Club "nirvana"!

If this were the 1981-1982 recession I would be drawing comparisons between where we were in that economic cycle with previous economic cycles I have experienced in my business career. But this isn't the 1981-82 recession; it's the end, hopefully, of the 1990-91 recession, and I could also draw some of those comparisons.

I could point out some similarities, for instance the fact that unemployment, tracked not dissimilar courses in this and the previous recession. The fact that profits dropped by approximately similar percentage amounts.

I would point out that GNP dropped more in 1981-1982 than it did in this recession but of course the distribution drop has been quite different and the recession has been more severely felt in central Canada this time around.

On the bright side, I would point out that inflation and interest rate performance through the recession has been much more favourable this time around than last. These differences, however, disguise the fact that this has been a recession with a difference.

And the reason for that has been multifold in the fact that we are going through some very major structural changes, that overlie the recessionary impact.

We've had major losses in our manufacturing sector and we've become prone to discussing it as permanent, as opposed to temporary, job loss. We know there's been an awful lot of rationalization at head offices and a certain movement of those offices from Canada to the United States. We talked about the uncertainty of the recovery this time around, I think, more than we did last time.

And that uncertainty ties back to certain fundamentals about our economy, about the mounting debt, about the question of competitiveness in our industry

It's also a recession where we are focusing, as we come out, on major spending priorities perhaps more than we did last time. The debt service - and we have quantified what

that will mean in terms of its command on our resources over future years.

The same with health, which is largely driven by the demographics of our country. And, of course, as you have indicated in your opening remarks, John, there is the issue of the environment.

Some may not view the environment as having the same exigencies on our spending pattern as the national debt or as health. But if you're a politician and you're looking at the minds of the electorate, it certainly does. It was striking, I think that at the very peak of the recession, 76 per cent of all Canadians said that environment remained a priority for them in terms of the allocation of the country's resources.

My theme today will be to say that I think we have to be very smart in dealing with this issue, or we will achieve less than what's achievable and we will risk doing major harm to our ability to return our economy to the health we're all looking for.

Now, many people, when we talk environment, ask what do bankers know about the environment. What the public thinks of when they think environment is incidents such as Love Canal in the early 1980s, 221,000 tons of waste and toxins dumped into the Niagara River. More recently, the public living in Ottawa are thinking of Manotick an outlying community of that city where over 70 groundwater wells are contaminated with drycleaning solvents and benzene.

The water is not suitable for drinking and showering. It has to be brought in and that community knows that it needs an entirely new water system. Now those situations even affect bankers. Bankers, after all, do live in those communities and the health issues which they present affect us as individuals as much as anyone else who lives in those particular locations.

And it also affects us professionally, and this is what I want to deal with today.

It affects us professionally in two very fundamental ways. First of all, and I will continue with my examples, a mortgage

on a residential property in Manotick or Love Canal is simply not the same as another mortgage. The value of property for most communities declines when the contamination becomes known and the servicing of the mortgages by the occupants may become an issue if the economic viability of those communities comes into question.

Secondly behind the residential properties we have the polluters themselves. Loans to those polluters are doubly risky. They're risky because the businesses themselves are in danger and the bank loan is at risk when the business is in danger. And there is a question, of course, of who is going to pay for the cleanup should the polluter be unable to do so. Now, under Ontario law, and the law of other provinces, there are some differences, but law in Canada is evolving along similar lines across provincial boundaries. Those who control a source of contaminate are potentially liable for cleanup.

A drycleaner who may have dumped cleaning solvents into the city water supply is liable as long as that drycleaner is in business. Therefore, a loan to that drycleaner is risky. A mortgage securing the loan can be outright liable because the lender may be on the hook for the cleanup if it comes to control the business, for example, by taking over the business as part of an insolvency proceeding.

Now I don't want to cast this as a drycleaning issue, obviously it isn't. Nor is it really a natural resource issue.

The issue is really that we have believed for the past 100 years that we, as a country, hold a limitless supply of fresh water, fresh air and new frontiers and that it doesn't matter if our relatively small population uses our soil, our lakes, our rivers, and our air as garbage sites.

What we have as a legacy of our past 100 years of history is a large inventory of environmental damage coming from a wide cross section of Canadian industry. From large resource manufacturing and processing firms - pulp and paper, mining, steel, oil and gas sectors - and others from small

business, drycleaning, photography, scrap metal, gas resources.

The issue has really come to a head during the recession because what we have found as bankers is companies weakened by the recession. As we and governments move in to examine the situation, we are finding the properties underlying most businesses polluted, and liability, therefore, becomes a major issue. Kemtec is one such example. What you have there was a petro-chemical subsidiary of Lavalin, about $65 million in loans from five lending institutions, four of which are my members.

When the company became insolvent, the lenders were advised by legal counsel not to take control of the inventory because it might be deemed, under Ontario law, to be taking control of the contaminants. The lenders walked from the inventory and the recovery on the loans was in the range of 15 per cent. Now there are many, many potential Kemtecs in this country and many many potential similar lose-lose situations.

What you have is a company which was insolvent and people who have lost their jobs. You have bank loans which are not repaid. You have a cleanup which doesn't occur and ultimately, in most situations, you have a property which is simply abandoned and which eventually reverts to government when taxes are unpaid. It's not just banks. It's pension funds, who happen to hold in their portfolio large amounts of real estate secured assets. It's worker buyouts, and I point to Algoma. If you looked at the fine print in the newspaper last week on the agreement on Algoma, there was a statement by the company, to the effect the government had agreed to grant certain waivers, indemnity and exemption. I suspect that some of those waivers, indemnities and exemptions are in fact waivers with respect to the environmental liability which the workers who are effectively buying out the company, would otherwise carry.

I think the liability issue may be most particularly severe for our municipalities who have an extremely difficult chal-

lenge. A situation with a development, which has been in the press of late, is a very good example. What you have there is a low-cost housing development initiated in 1988, designed to create 7,300 units of housing. But major contamination was discovered on the site, formerly industrial land. The discovery of contamination led to many stages of environmental assessment, contributed to major delays and, of course, to mounting consulting costs.

The estimated cost to completion is anybody's guess, but from the numbers that I've looked at, I would suggest that they have doubled in the four years since the project was first announced. And of course a very large portion of the over-run is tied to the environmental assessment. The estimated cleanup costs run between $160 and $200 million. And there are additional interest charges incurred because of the delays as the environmental risk assessment has proceeded.

The risk, or the loss, in this situation is that a low-cost housing development becomes, at best, a high-cost housing development. You have very uncertain liability for the city, which faces very fundamental decisions. For instance, how clean is clean if it decides that it wishes to clean up the site? Where can it turn if it decides the site cannot be cleaned up?

It's not just Toronto. I was in Saskatchewan last week and I heard about a very small community which had bought out an old gas bar, two tanks underground. It was discovered that the tanks had been leaking gasoline into the soil and the cleanup cost in that situation had been estimated at $500 thousand, a major bill for a community of that size.

What is very important at this stage, I think, is that we stop stumbling along the way that we have been, that we get a handle on the problem. In my industry, we have to delineate fairly clearly between the problems of the past, the inventory of contamination we have built up in our past 100 years of history, and the potential problems of the future.

There are many issues surrounding the problems of the past. One key one is who pays for the cleanup. There are many candidates; they include government, a super fund, a

solution which has been followed in the United States, a solution involving the levying of taxes on businesses and the creation of a fund to support cleanups, and third parties, which I call "deep pockets," those are the likes of our industry.

Now if deep pockets - deep pockets, by the way, include workers, they include pension funds, they don't just include banks - are to pay, I think we have to think very carefully. Third-party liability, as I hope my examples have illustrated, have caused lose-lose scenarios. In the short term, lenders will walk away from the very big problems where the estimated cost of cleanup exceeds the estimate of realization on the property.

In the longer term, and I don't think we've seen the longer term yet, the supply of capital for a significant number of borrowers will dwindle if third-party liability is to be the order of the day.

Let me move on to talk about managing the future because I think that's a very different exercise and it's one that's aimed at prevention rather than cure. It seems to us in our industry that what we need desperately, if we are to manage the future and avoid the problems of the past, is a large set of standards. We need audit standards for those who do environmental assessments, and for people such as ourselves we need new diligence standards.

What we're talking about is assigning responsibilities between various sectors of society. I think if we're going to arrive at standards which make sense, we're going to have to go through a process of consensus between the private and the public sectors which will involve sorting out the jurisdictional fragmentation that we face in this country.

It's not just a question of a federal department of the environment and 10 provincial departments of the environment. The Crombie Commission on the waterfront reported that it had identified more than 80 agencies having some role to play in the management of our waterfront. Now what is the banks' role in this process of establishing standards? We play

a role in having the limitations on our liability for cleanup tied to the due diligences which we exercise in granting loans and in managing our general lending responsibilities.

We effectively have, over the course of the past year and under the stewardship of Bill Brock, developed in the industry a set of standards for lenders. They involve general evaluation when new loans are made. They will involve, for loans which are deemed to be riskier, extensive audit, searches of property title, samples of soil, water and other substances found on the property.

They involve the taking from clients of a significant undertaking at the time the loan agreements are signed. Those undertakings might include an agreement to give the bank, on a regular basis, the results of environmental audits done on the property. They might include an undertaking not to use the property for purposes other than those stipulated in the loan agreement. And the banks' obligations also, include standards for monitoring the loan to ensure that the client's undertaking has, in fact, been lived up to.

Now we are very conscious in our industry that we're walking a fine line in establishing these standards. We will be , seen by some as offering a private market solution to pollution. But we will be seen by others as restricting credit to an economy in recovery. Inevitably the cost of implementing these standards will be reflected in the cost of borrowing.

That is one of the prices we will pay in the years ahead for

a cleaner environment. Governments will greatly influence or balance the act by the decisions they make. And I think it's fair to say that a world of unlimited third-party liability will not be hospitable for Canadian industry seeking new capital.

On the other hand, a world where liability is defined, as mitigated by the diligence with which we monitor our loans and our customers, will be much more workable. I think it's important that I not close with the message that the management of the environment is no more than a new cost centre for an economy recovering from the recession because there's a much rosier picture.

I always promise Michael MacKenzie when I sit down with him or talk to him on the phone, that there will be a goodnews story in the course of our meeting. Here it comes Michael.

There is a rosier side and the rosier side is a whole new industry lurking in the shadows. An industry which can boost our domestic economy, provide a great source of export and, at the same time, enhance our ability to preserve our environment. I think the challenge is to make this happen. Suppliers of capital need to be reassured that they won't be left with unmanageable liability should there be hiccups along the way.

I want to leave you with a short description of what might be one of these ventures. It comes out of a trip I made to Saskatchewan last week, and it involves a development in Lake Saskatchewan, which holds a very old uranium deposit. I'm told it's 1.3 billion years old, in a very unique geological formation.

The formation of natural vaults, a group of entrepreneurs has decided, may provide very key information on storage for nuclear waste. If the project were to be successful, you would have the rental of uranium rather than the sale of uranium and the rental price, from the information I've been able to see, would be 10 times that of the sale price. Uranium is selling for about $10 a pound today, but the price of rental would be $100 a pound and, of course, the difference represents value of safe dumpage of the waste.

I think it's the first commodity in the world, Michael, where your cost of rental will be substantially greater than your cost to purchase, and that is my good-news story. Thank you very much.

The appreciation of the meeting was expressed by Catherine Charlton, President, the Charlton Group, and a Past President, The Empire Club of Canada.