Until recently, the role of capital and investment markets in sustainable development was little understood and widely discounted. While it has been clear for many years that financial liberalisation and cross-border investment grease the wheels of globalisation and help to fuel growth in mature and developing economies, the ways in which investment – particularly private investment – relate to the triple-bottom-line agenda have remained largely unexplored.
Two specific projects have helped to break the ice – the UN Global Compact’s Who Cares Wins initiative and the UN Environment Programme’s Finance Initiative (UNEP FI), both unique public-private partnerships within the UN system. Working in close collaboration, these efforts brought together a range of financial-market actors – principally fund managers and analysts – to explore the materiality of environmental, social and governance (ESG) issues to investment returns. Their work led to what we consider to be a breakthrough in understanding how various ESG issues – through transmission factors such as operational risks, reputation risks, innovation, and access to resources – relate to the value drivers of the underlying investment asset.
In many ways, these projects complement other initiatives in the financial world – such as the International Finance Corporation’s Equator Principles, the Carbon Disclosure Project, the Global Reporting Initiative, and the Enhanced Analytics Initiative, the last of which focuses on stimulating more mainstream research on ESG issues.
Most importantly, all these efforts helped investment markets “catch up” to the rapidly growing corporate sustainability agenda, reflected in initiatives such as the UN Global Compact, which today includes more than 3,900 corporate participants and hundreds of other stakeholders in more than 120 countries. Indeed, a major source of frustration for corporate sustainability leaders has been the apparent lack of interest by investment markets in corporate efforts to manage the risks and opportunities of ESG issues – be they related to climate change, human rights, or anti-corruption, to name just a few areas.
However, it has become clear that targeting the financial intermediaries would not be enough to truly move the agenda forward – asset owners would need to be mobilised on a much larger scale. This belief led the Global Compact and UNEP FI to form a special partnership with a small group of institutional investors. The aim was to develop an international understanding and associated framework related to a new concept of responsible investment – one that placed the materiality of ESG issues at the centre, while recognising the broader societal benefits of such an approach.
Launched in April 2006, the Principles for Responsible Investment (PRI) are in essence a set of global best practices for responsible investment. Rising numbers of institutional investors – from all regions of the world, and today representing more than $10trn – have embraced the PRI, marking a major advance in mainstream financial markets. The growth of this initiative has been extraordinary, and the principles – endorsed by both asset owners and asset managers – have quickly become the global benchmark for responsible investing.
By incorporating environmental, social and governance criteria into their investment decision-making and ownership practices, the signatories to the PRI can directly influence companies to improve performance in these areas. This, in turn, can contribute to our efforts to promote good corporate citizenship and to build a more stable, sustainable and inclusive global economy.
Two examples point to the potential of this approach: Recently, a group of PRI signatories – through the initiative’s Engagement Clearinghouse – began to engage with 33 automobile and steel companies that face supply chain risks related to slave labour in Brazil. And in January 2008, another group, representing approximately $2.13trn in assets, wrote to the chief executive officers of 103 companies in more than 30 countries to recognise frontrunners in the integration of ESG issues, while pressing laggards to improve their performance.
It is clear that we are essentially witnessing an evolution beyond the ethical for SRI movements – one based on the notion that ESG issues are material to long-term value creation and must thus be considered. And, by definition, this has special appeal to long-term investors – many of whom have long wished to break out of what’s been called the “tyranny of short-termism” – a situation that, in its most extreme form, sees asset owners – pension trustees, for example – pressuring fund managers to outperform quarterly indices rather than taking the long-term view for the benefit of their fiduciaries.
To be sure, these short-term pressures can also lead companies to behave irresponsibly. Indeed, the entire philosophy of the Global Companies is based on the long-term benefits of corporate citizenship and sustainability, which can also be recognised if companies diffuse universal values and principles deeply throughout their organisations and value chains – within boards, subsidiaries, and business partners.
The good news is that new dialogues are starting. More and more companies in the Global Compact are actively communicating their sustainability strategies and performance to the mainstream investment community.
In the meantime, it is clear that companies need to do a better job of disclosing information on potentially material issues. Many of the glossy CSR and sustainability reports we have seen in recent years still fall short of presenting meaningful data on performance and impact. The Global Reporting Initiative’s G3 guidelines are a significant advancement. And we are continuously refining the Global Compact’s Communication on Progress policy so that it is more relevant for the investment community. What is also clearly needed is more research on emerging and frontier market companies, particularly given the rising prominence of Southern transnationals. Here, the PRI initiative has once again taken the lead by launching a special push into emerging markets.
What should also be noted is the importance of asset classes beyond the listed ones – including fixed-income, real-estate, and private equity. How sovereign wealth funds may or may not pick up on the responsible investment agenda will be a fascinating area of discussion and study moving forward.
Another powerful development is the convergence of corporate sustainability and corporate governance. Indeed, more and more companies in the Global Compact see sustainability as an essential component of good corporate governance, from the vantage point of risk management, transparency and sustainable long-term value creation. This is an expanded notion of corporate governance and one that goes much farther than many compliance-orientated schemes currently in use.
There are, of course, many challenges ahead. The majority of corporations in the world have yet to make a serious commitment to sustainability. Scaling up good practices thus remains both a challenge and an opportunity. And there is a danger that the ESG islands of activity within investment houses get pigeon-holed. Mainstreaming must be a priority.
Stock exchanges, too, have a role to play, through awareness-raising, the development of special indices, and even through listing criteria – an area that should be more actively explored. Unfortunately, the exchange industry generally seems reluctant at this point to take up the challenge and opportunity.
Overall, the leadership of those institutions that have committed themselves to this agenda deserves our recognition. Other investors around the world should join this historic effort to make investment markets truly responsible.
For further information:
Websites: www.unglobalcompact.org and: www.unpri.org