Selecting which minority-owned institutions to include on deals requires asking the right questions.
Netflix, Apple, PayPal, Microsoft and other companies launched prominent initiatives to support Black-owned banks and brokerage firms this year in the wake of the social justice movement sparked by the death of George Floyd in May.
- Scores of other corporates are making or doubling down on commitments to support financial institutions serving minority communities. They’re doing it through bank deposits, investments in community development financial institutions (CDFIs) and by engaging Black-owned firms to participate in capital markets transactions, among other approaches.
Seeking metrics and best practices. At several NeuGroup meetings this fall, including one devoted to capital markets sponsored by Deutsche Bank, members discussed the challenges of managing risk as they commit capital amid broader corporate mandates on diversity and inclusion (D&I) efforts.
- Treasury teams are also seeking input on best practices for choosing and evaluating minority-owned firms and establishing metrics to measure the corporate’s efforts at effecting change.
- “We have yet to find a good way to measure the effectiveness of including the firms—or which firms to include or exclude” from capital markets transactions, the assistant treasurer of a company that has used minority-owned banks for liability management and bond transactions said.
- “We don’t have good way to assess them,” he added. “We need a more comprehensive strategy on how, why and when to do business with these groups.”
Capital and capabilities. In response, other members suggested questions to ask and criteria to consider when selecting minority-owned firms, including:
- A financial institution’s capital levels and who has invested in it.
- The longevity of the relationship the company has with the minority-owned bank. “Firms tend to pop up and disappear,” one AT said.
- The firm’s breadth of coverage and distribution capabilities. “Can these institutions sell bonds if they are asked to?”
Authenticity. “What’s your diversity level inside the firm?” one AT asks companies. One red flag: too many people who are not part of minority groups attending a meeting to represent a minority-owned institution.
- Another AT wants to know, “What are they doing for the communities they represent? How are they engaging and giving back? How are they using the fees they generate—do they use some to hire staff and do charitable work?”
Performance questions. The same member evaluates a firm’s performance in a deal by asking questions that include:
- What is the quality of the order book they brought in?
- Are they bringing in hedge funds who are going to flip the bonds?
- Are they bringing in large players who already submitted orders to lead underwriters but are trying to meet diversity mandates?
- Are they instead bringing in a number of small, high-quality investors not covered by the leads. “That’s where diversity firms can add value,” he said.
Allocation game plan. One AT receives “constant pushback” from lead underwriters when he asks for information about the orders placed by minority-owned banks and allocation decisions. After one bank proposed allocations the company didn’t agree with, “we ended up saying ‘here are the allocations; forget your allocation’.”
- Another member’s company instructs the lead underwriter to “quarterback diversity orders” and lets them know “how well they do interfacing with the diversity firms will affect our view of the lead underwriter’s performance on the transactions.”
- He added, “By evaluating the lead underwriter on this basis, the banks know that future lead-managed transactions are at stake.”
- The company requires the lead to explain their allocation decisions. “We’re not looking for a billion dollars of orders,” from minority-owned firms, he said. “We want 15 orders of $10 million that we can allocate $7 million to,” he said.
- In a follow-up interview, one of the ATs said, “I would add that companies should set out their expectations up front with both the leads and diversity firms. That way everyone has a clear understanding of what is expected, how you will measure their success, and how to explain the deal to their teams and investors.
- “Then, do not be shy about pushing the leads to give allocations that you want. We set aside time on every deal to talk to the lead and make them justify their recommended diversity firm allocations and then either accept it or make them adjust as needed.”