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Page 2 - Philippe Desfossés, Director, RAFP: Governments must design regulations that value ESG/long term
Considering governance, we cannot but acknowledge that misalignment of interests and short-termism have gone hand in hand. In large companies, management has behaved as if they own the business. Large compensation incentive packages that reward success without punishing failure created a culture of “unaccountability”. Why pay attention to the future when there is no claw back mechanism on stock options? How governments run their states has also suffered from increased “short-termism”. Until the moment the sovereign debt crisis blew up investors relied on rating agencies. It is easy to accuse them of all sins when, as they rightly say, they are just providing opinions, meaning that every investor has to exert their own judgement. We should also remember that those same agencies sent many warning shots to governments. Finally, stopping environmental destruction is obviously one of the most pressing challenges humankind has to address. World population reached 1 billion in 1804. This is the amount by which it increased during the last 12 years. We are reaching the point where it is more than urgent to ensure that prices take into account the cost of the damage our activities inflict on non renewable assets: water, farmland, biodiversity. As long as we maintain prices that ignore negative externalities, all the economic agents will keep on behaving “rationally” to achieve an irrational objective. To summarise, addressing the challenges of tomorrow in the 3 areas that will reshape the economy of the 21st century means being able to overcome “short-termism” and to adopt the quite simple principle of sustainability to enlighten our decisions. It is where big long-term investors have such a large responsibility.
To adopt this new approach means being able to reassess many of the ways we used to work. First, one cannot be a responsible investor if you are not responsible in the way you calculate “the price” of benefits or promises you sell to clients or beneficiaries. Obviously an annuity will be much more attractive (i.e. cheaper) if optimistic assumptions on the expected returns of the assets that back it can be used. But the crisis reminds us that discounting future revenues with overoptimistic expected returns generates explicit and implicit debts that will be long and hard to wind down. Is it responsible for a retirement benefit scheme to distribute benefits whose generosity is made possible only by the sacrifice of the young or the future contributors? When a pension fund discounts its liabilities with a rate that is treble the rate of growth of added value has it any choice but to invest in assets delivering high returns but also proportional risk? This widespread “under pricing” of social benefits has encouraged putting more pressure on the businesses so they reach double digit ROE. The risk a financial intermediary accepts to bear is always borne on the liabilities side of its balance sheet. Regulators should pay more attention to this issue! Second, for big long term investors, assuming that they cannot (should not) anymore rely on expected returns that a sustainable economy cannot deliver, the question they have to answer is: can responsible investment remain a slice or the icing on the cake, a marginal share of their investment, or should it become an integral part of their investment process? This can be discussed, but more and more long-term investors consider that an SRI approach (fine tuned to their specific situations) should be
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