A revolution in finance?

2932154987_107fa86e2bNot much good has come out of the global financial meltdown but there is this:

Investors who watched Bear Stearns, General Motors and Merrill Lynch destroy billions of dollars of shareholder value presumably are ready to focus on what makes companies sustainable, or at least try to better understand risk.

But how? How are institutional or individual investors to know which companies are built to last, which are managed to serve their customers, workers and communities, and which of their boards are fulfilling their obligation to manage risk?

Those were the questions put today before a day-long conference called Sustainable Stock Exchanges, held at UN headquarters in New York and convened by the UN Global Compact (an alliance of responsible companies), the PRI (an investor group whose initials stand for the Principles for Responsible Investment) and UNCTAD (the UN agency that promotes trade and development). The focus was on gobal stock exchanges, and the potential they have to require public companies to disclose their environmental, social and governance (ESG) risks. But we also talked about building the business case for so-called nonfinancial analysis, and about whether companies with good environmental, social and governance practices will deliver superior shareholder returns.

I was privileged to moderate much of the discussion, and so had the opportunity to hear from stock-exchange officials, investors and regulators from Egypt, South Africa, the UK, Brazil, Turkey, Indonesia, Malaysia and New Zealand. Living and working in the U.S., it’s easy to forget that the conversation about sustainability is also unfolding in far-flung locales that don’t often get datelines on the business pages.

“My own view is that smart companies and smart stock exchanges recognize the value of ESG in driving returns,” said Jane Diplock, a New Zealander who is chair of the International Organization of Securities Commissions, known as IOSCO. “What was a whisper in the 20th century – don’t invest in guns or tobacco – has become shout – invest to protect the planet!”

James Gifford, the executive director of PRI, described the forward-thinking corporations, investors and exchanges as an “ecosystem” in which each part contributes to the whole.  “Clearly there is a huge amount of momentum among the investors and the exchanges,” he said. “The business case (for integrating environmental, social and governance risk into investing) has been well established.”

Really? I’m not persuaded that we can make the link between the financial crisis and the need for companies to be more responsible, more aligned with society and better governed. If there is a connection, it’s probably driven—or at least it should be—by a greater skepticism among investors, a willingness to dig deeper into risk and the understanding that neither size nor short-term performance tell you what you need to know about a company.

As George Kell, executive director of the Global Compact, put it: “Short-term, quarterly profit maximization is not sufficient to build long-term value.”

Here are a few things  I learned at the event:

More than ever, companies and investors say they want to align themselves with society’s needs. The evidence for that is that the Global Compact, launched less than a decade ago with 47 companies, now has 6,000 member companies in 135 countries that promise to align their strategies around human rights, the environment, labor practices and anti-corruption principles. (Some companies actually get kicked out for non-compliance.) The PRI, which began with about 20 institutional investors in 2005, now has about 600 asset managers and their advisors as members. They promise to incorporate ESG analysis into their investment decisions and be active as owners.

But corporate disclosure of relevant ESG information remains spotty. Only about 15% of the 20,000 companies covered by Bloomberg provide sufficient data about their ESG practices, according to Paul Abberley, the chief executive of Aviva Investors, a UK-based asset manager. “The disclosure of information can be dramatically improved.” Aviva proposed at the event that stock exchganges make “good ESG disclosure a condition of listing.”

Most stock exchanges, however, are reluctant to de-list companies, around ESG issues or anything else. De-listing is a measure of last resort, as Huseyin Erkan, the chairman and CEO of the Istanbul Stock Exchange, explained. De-listing means investors can’t get access to their money, and it means the exchange loses revenues. The Istanbul exchange, rather than enforcing disclosure requirements (a stick), has set up an index (a carrot) of companies with good governance practices. It also has nine city-based stock indices, which lead cities to compete to provide good business environments and reliable reporting.

A few exchanges in the developing world are pushing hard on ESG. Egypt de-listed about 750 most-small companies from its exchange because they failed to meet good-governance requirements, leaving about 350 better-governed and better-capitalized firms. “At the end of the day, you have to do things that are unpopular,” said Maged Shawky Sourial, chairman of the exchange. The surviving companies, he said, were better equipped to come through the 2006 crash of Gulf markets and the 2008 financial crisis.

Most of the exchanges pushing ESG are in the developing world, where they are competing for risk-averse foreign investors. U.S. and Western European exchanges haven’t played much of a role in this debate.

My own belief is that, more than rules or listing requirements, the performance of ESG indexes and SRI funds that drives what is potentially a revolution in finance. If they outperform over time, more money will flow to companies with good ESG practices. “We’re talking about changing the way we value business,” says Alyson Warhurst, executive chair of Maplecroft, a firm that analyzes risk.

The financial crisis, at the least, opens up space for discussion. Antoine de Salins, who is executive director of Fonds de Reserve pour lest Retraites, a big French pension fund, said: “It is clear to me that we investors are obliged to revisit all the classical, analytical tools we were using in the past to shape our investment policies.”

After the event, I chatted with Jean-Nicolas Caprasse of RiskMetrics Group, a fast-growing advisory firm that seems to be trying to corner the market on risk analysis. They’ve acquired Institutional Shareholder Services, Innovest and, most recently, KLD Analytics—all pioneers of ESG analysis. Caprasse said that investors, in the wake of the crisis, are ready to ask a question that should provoke fresh ways of thinking about business:

What is it that we didn’t know that we didn’t know?

Comments

  1. Marc,

    Great to hear about this event that you moderated! Interesting to see that “de-listing” was a focus of the discussion, especially because the sponsoring organizations, Global Compact and Principles of Responsible Investment, have struggled so much with the de-listing issue themselves as they try to balance having enough “teeth” to be perceived as credible with their desire to host a big enough scope to allow ALL companies and investors “under the tent.” And it also hearkens back to the old “Wall Street walk” argument that investors should divest from companies that don’t meet their social, environmental, or economic standards. Of course these are the blunt tools of change.

    I’m interested in your notion of ESG indexes and SRI funds providing the kind of leverage necessary to actually make change. Sure, ESG integration is “mainstreaming” (according to recent reports from Robeco and BSR), but pace and scale is really the question — at what point will the mainstream “tip” into factoring ESG issues at the core of investment decisions? And how much “teeth” will the ESG integration have — window dressing or fundamental change?

    These are not rhetorical or academic questions, given the pace and scale of climate change, and the role of traditional business and investment models in creating and now exacerbating the “positive” feedback loops of climate change.

    Finally, did the RiskMetrics dude realize he was channeling Rumsfeld with this quote?

    Best,
    Bill

  2. marc,

    thank you very much for moderating this panel and providing us with a report. what you learned was very important to share with our audience. and, risk metrics obvious attempts at ‘consolidating’ the esg data will be fun to watch. interesting that bloomberg wasn’t prominently mentioned.

    it seems strange that the u.n. convened this event without any fanfare. with 6,000 global compact companies in 135 countries, it seems reasonable that they could convene a much larger group, attract attention, give it some type of vibe and create some momentum for change. the socap conference in san francisco convened over 1,000 people and their ‘alternative stock exchange’ session was ‘standing room only’. if we really want to effectuate change, we need a little more energy and action and a little less ‘closed door’ discussions.

  3. Marc,

    Thanks for this excellent article. As Bill Baue also cautions in his comment, the “de-listing” aspect of the UN Global Compact is pretty much non-existent. We at Investors Against Genocide learned this when we filed a formal complaint with the Global Compact against its member, PetroChina, due to its complicity in helping to fund the Darfur genocide. Together with over 80 civil society organizations, we asked the Global Compact to employ its own “Integrity Measures” to help us engage with PetroChina in the hopes that it would use its influence to help the people in Darfur. The Global Compact was unwilling to employ its Integrity Measures and stressed in its explanation that the Compact does not monitor compliance of companies to uphold the values of the compact. The only reason that a company will get de-listed is for failing to turn in their “COP” or “communication on progress.” As a result, many companies become members to spruce up their image knowing full well that they will not be held to any clear standard of behavior. I’ve included a couple of links below for further information on our complaint.

    http://investorsagainstgenocide.net/2009-0107%20ungc%20and%20petrochina%20press%20release.pdf

    http://globalcompactcritics.blogspot.com/2009/10/john-ruggie-global-compact-is-safe.html

    Susan Morgan
    Director of Communication
    Investors Against Genocide

  4. B N Ramamurti says:

    No doubt, there is talk everywhere nowadays, of potential for investment in the field of green energy. Most of the talk here relates to Wind and Solar energy. There is tremendous scope for bio fuels from vegetative source, with prospects of projects based on non edible seed oils playing a great role as bio diesel, in supplementing use of fossil diesel. This is also attracting attention in International seminars on this subject.

    In India, there is plenty of scope for raising non edible seed oil plants on arid and semi arid lands on a large scale— for feed stock of seeds for the end product of a bio diesel. Such programs are going on in Africa.

    If investors come forward, these projects can be organized for betterment of the environment, involving the services of NGOs who are working for the social cause of rural agricultural families.

    Needless to say, such projects will serve as many- in- one, for meeting social, economical and environmental considerations.
    B N Ramamurti
    Consulting Agroeconomist ( Herbal products Industry and wasteland evelopment)
    Chennai, INDIA
    e-mail: bnramamurti@gmailcom

  5. Hi Marc: I was aware of this meeting and , since our company Ethical Markets Media ( USA and Brazil ) is a signatory of UN-PRI, we asked to cover it or get a report. I wrote an editorial for InterPress Service and Other News , ” Curbing Financial Trading” and sent it that morning, Nov 2nd to Georg Kell, Gavin Power , Paul Clements-Hunt , et al.

    Did they circlulate this, as I requested ? It’s up om http://www.EthicalMarkets.com on our homepage , along with my “Changing the Game of Finance ” , which Steve Schueth asked me to write for SRI in the Rockies 20th anniversary.( also on our site )
    May we post your report ? I’ll also ask Bill Baue for his, Thanks, Hazel

  6. Hazel, I don’t believe that your editorial was circulated although I can’t be sure. I have followed your work for years and look forward to reading the reports that you mention. Afterwards, pehaps we can talk and I can revisit this topic. Thanks for your comment.

  7. I used to have a site like this once, but I got so much spam I had to close it. You seem to have a better spam filter! Kudos!

  8. I hate to play the cynic, but I agree with your more skeptical perspectives, Mark. I’m sure that it’s not hard to find CEOs and exchange officials more than willing to talk about ESGs at this time of frightened investors and major news about global sustainability issues, but I fear that it’s a love of convenience for them. A bit of follow the wind, jump on the bandwagoneering to curry the favor of the recalcitrant investor dollar. When the pendulum swings the other way we’ll likely see both companies and investors back-burnering the environmental/humanist issues, and the exchanges as always will follow their revenue down that same path.

    Sorry, but it’s human nature, and borne out by history…

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