Rob Lake: Letting the outside world in to institutional investment

Investors are increasingly subject to the same forces that drive company-level sustainability initiatives; essentially, the fact that society cares.

It is a fundamental starting point of responsible investment that the assets investors invest in are influenced by the world around them. If customers, the media and regulators did not care about environmental and social issues, there would be less reason for companies to address them. There are internal drivers too, of course. Smart management teams work hard to cut their energy costs, improve productivity through better health and safety and discover that more engaged employees within the firm and in the supply chain do a better job. But a little pressure from outside strengthens the incentives to innovate and improve in these areas.
Stakeholder expectations have always been a significant driver of institutional responsible investment for some asset owners in particular: norms-based exclusion and engagement are common in northern Europe; state pension funds in Norway, Sweden and New Zealand have legal obligations (framed in different ways) to be ‘responsible’; Australian superannuation funds, operating in a ‘retail institutional’ market characterised by choice for the pension saver and competition among providers are among the world’s ESG leaders; employee representation on the boards of public sector funds in numerous countries (including the US, France and the Netherlands) provides a ‘governance voice’ for social and environmental concerns.
But now investors are being influenced by the world around them more than ever before. The pressures on institutional investors to respond to public concern about a range of sustainability issues are growing rapidly. This can take different forms in different countries. The Australian government’s robust stance against tobacco advertising has fed into public pressures that have caused several of the largest superannuation funds to exclude tobacco. Sweden’s ongoing review of the AP funds, and a public debate about the funds’ future conducted either side of anelection, have helped to spur media coverage of ‘controversial’ investments and calls by politicians and NGOs for tougher legal obligations on environmental and ethical issues. The recent appointment of a Green Party member of parliament as Pensions Minister is unlikely to reduce this pressure. In the UK, legislation giving local authorities responsibility for public health has prompted the Croydon pension fund to divest from tobacco. The UK Law Commission’s recent report on fiduciary duty concluded that exclusion is permissible under defined circumstances, specifically citing the international ban on cluster weapons as a potential basis for action. The fiscal squeeze caused by the financial crisis has led governments in numerous countries to look for ways to encourage and enable pension funds to invest in their own countries to offset public spending shortfalls.
On a different front, the OECD has this year ruled that its Guidelines for Multinational Enterprises apply not just to companies but to investors. This followed NGO complaints, through the OECD’s National Contact Point system in individual countries, against APG and Norges Bank Investment Management over their investments in the South Korean steel company Posco. Under this new interpretation of the Guidelines, investors are expected to conduct ‘due diligence’ on their investments and to ‘seek to prevent or mitigate adverse impacts’. The OECD is still working on the details, and the Guidelines are ‘soft law’ and not hard regulation. But they reflect and amplify society’s expectations on investors, and create risks for those whose approach to sustainability issues falls short of their requirements.
The clearest and most global demonstration of the pressure on asset owners to respond to public concern about sustainability is of course the rapidly accelerating flow of announcements and initiatives on climate change: from commitments to conduct carbon footprints, to divestment of high-carbon stocks and/or those with high-cost fossil fuel project pipelines, to new

allocations to climate solutions. There is no doubt that climate change represents real financial risks and opportunities. At the same time, most financial risks that investors address do not prompt press releases or announcements at high-profile conferences. Public concern about climate change has not directly created the financial risks for investors (though of course if there were no public concern and no pressure on governments to act, one of the most significant sources of financial risk – uncertainty about future policy – would be removed). But there is little doubt that public scrutiny is prompting many investors to focus on climate risk in particular in a way they would not necessarily otherwise have done. Having focused on it, they find it is real. Making their response public – in a way they would not necessarily do with ‘conventional’ financial risks – reflects an understanding of the strength of public concern and allows funds to gain trust.
Some might fear that the CIOs and CEOs of the institutions that are alive to these external influences have abandoned their financial objectives, their professional rationality as investors or their fiduciary duties or other legal obligations, or that boards have ceased to focus exclusively on the interests of their beneficiaries. But my view of what we are seeing is rather different. Organisations and leaders are adapting to the world around them and deploying their investment skills to innovate new ways to achieve their conventional – and important – financial objectives (such as paying pensions) in an environment of changing expectations of ‘how things should be done’ and in response to new kinds of risk.The number of examples is growing rapidly. A few will suffice here. Leading funds are identifying – and in some cases creating – new opportunities to invest in ways that have the risk-return characteristics they need while also supporting the economy, jobs and communities close to home. Examples can be found in Greater Manchester, UK; US states including Wisconsin and California and The Netherlands (though the challenges of investing closer to home have to be acknowledged). Innovative financing structures are being developed to support renewable energy and targets are being set for investments in sustainability solutions and reduced carbon intensity across the portfolio. In the OECD Posco case, APG’s approach to engagement was judged by the Dutch National Contact Point to satisfy the requirements of the Guidelines for due diligence and efforts to mitigate adverse impacts. The plethora of initiatives on long-termism, too, reflects public and government consternation at the dysfunctionality of excessive market short-termism – as well as long-term asset owners’ own recognition of how poorly markets have sometimes served their interests.
In short, leading asset owners are demonstrating that they are social institutions: they are created for a social purpose and they are creatures of the society around them, governed and run by people, not (just) numbers.

Rob Lake is an independent responsible investment advisor. He was previously at PRI, APG and Henderson Global Investors.