The clamour for more responsible investment (RI) is probably only second in terms of volume to the call for better governance of the international banking industry following the financial markets collapses of the past couple of years. While banks have drawn the most ire from governments and central banks, regulators are looking increasingly at the role of institutional investors in the downfall of the global financial system and grappling with ways to ensure past mistakes are not repeated. While encouraging noises and draft initiatives are being proposed, what’s required is a fundamental change of view that puts responsible investment at the heart of any broad-based international governance changes.
There is no question that the financial crisis has highlighted the need to put sustainability issues at the core of investment decisions. The drive for unrealistically high, continuous returns was one of the key factors behind the markets’ collapse. By definition, responsible investment means investing in sustainable businesses with long-term visions and returns.
What is required is for institutions to focus on a ‘quadruple bottom line’ of: financial, environmental, social and governance factors. To achieve this I believethat there are five main challenges for investors to overcome:
• Identifying and communicating issues on which companies must report.
• Defining the manner in which these issues must be reported – content, format, comparable statistics, etc.
• Defining the nature and regularity of reporting – e.g. annual report, separate ESG report, quarterly, annually, electronically.
• Bringing greater influence to bear on companies and how they conduct their business in line with ESG principles.
• Finding suitable tools with which to manage, monitor and report on RI investments and be able to influence the content of the tools used.
The Global Reporting Initiative (GRI) has done much work with regard to the first three points, and recently released a report on how companies can present their environmental, social and governance data, known as ESG disclosure, to meet the needs of mainstream investors. Most Fortune Global 250 companies now issue relevant reports. Around 15% of total, global capital markets – US$15 trillion – are managed by signatories to the United Nations Principles for
Responsible Investment (UNPRI) that have committed to seek appropriate corporate disclosure on ESG issues. But, apart from the purely technical reporting aspects of this process, what is also needed are practical actions for investors to bring their influence to bear, and suitable tools to monitor and benchmark this activity. As a starting point, the UK governance review by Sir David Walker – with final submissions due at the end of next month – highlighted the need for institutional investors to engage more productively with investee companies to support long-term improvement in performance. Walker focused on ways to encourage major investors to see engagement as a form of discharging their obligations to their clients and act as responsible investors. His proposal endorses the Statement of Principles prepared by the Institutional Shareholders Committee in 2007 on best practice for institutional shareholders. This, together with the relevant parts of the combined code, would, he said, provide a “sound foundation for engagement policy”, and act as a possible example for other countries. The final piece in the jigsaw, however, is finding suitable tools to manage, monitor and report on this RI approach. A recent survey carried out by the Business Intelligence Unit of the Economist found this to be one of the major challenges for stakeholders: i.e. howto find some way of benchmarking the level of progress with regard to governance implementation. Furthermore, investors should have the ability to influence and guide the benchmarked issues. For regulators, an electronic solution would provide the means to be able to apply some form of standardised approach to ‘engagement’ monitoring via current corporate data and financial institution reporting.
One finding of a recent OECD report on the global financial crisis , was that there was no effective flow of governance information to management, the board, investors, regulators and other stakeholders. Without such a tool, this state of affairs will continue. Corporate governance has rarely been such a high-profile, weighty issue. Getting it right is important. Let us hope that governments and regulators don’t ‘waste a good crisis’, as I heard one regulatory official say recently. What they must do is maximise the opportunity to deliver the real and meaningful change that would transform the governance of our financial and investment markets and mitigate against the likelihood of the kind of global financial crisis that we have witnessed over the past two years ever happening again.
Jonathan Lewis is founder and managing director of Governance Integrity Solutions (www.informgis.co.uk).