Not 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 global 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 exchanges 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:
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