The announcement during the summer by NYSE Euronext that it was throwing its considerable weight behind the UN-supported Sustainable Stock Exchanges (SSE) Initiative was the latest – and probably the most highly visible – signpost on the road to closer cooperation between the international responsible investment community and the operators and regulators of the world’s markets. Further important milestones are expected later this year and into 2014, with initiatives such as the UN-supported Principles for Responsible Investment (PRI) playing a key convening role. The SSE Initiative and related work championed by investor coalitions such as CERES currently focus on issues including listing rules on corporate sustainability reporting. Other areas of mutual interest will undoubtedly emerge. The momentum for partnership leading to real change is increasing. Now seems a good time to reflect on why this is, what success would look like in, say, three years time, and what ingredients will be needed? Co-organized by the PRI, the UN Global Compact, the UN Conference on Trade and Development (UNCTAD) and the UN Environment Programme Finance Initiative (UNEPFI), the SSE Initiative explores how exchanges can work together with investors, regulators, and companies to enhance corporate transparency – and ultimately performance – on environmental, social and governance (ESG) issues, and encourage responsible long-term approaches to investment. In addition to NYSE Euronext, exchanges that have signed up to the Initiative consist of NASDAQ OMX, Brazil’s BM&F BOVESPA, the Johannesburg Stock Exchange, the Egyptian Exchange, Borsa Istanbul and two leading Indian exchanges, the BSE and MCXSX. Discussions between responsible investors and exchanges have been taking place for several years, both at the global level and within individual markets. It may be premature to say things are now approaching a tipping point, but change is certainly detectable. Why?Firstly, the increased momentum reflects the priority that a growing number of powerful institutional investors around the world now place on factoring ESG considerations into their long-term investment and ownership decisions. Secondly, sustainability issues are becoming better understood by the exchanges and becoming part of their worldview. Several now have many years of experience (albeit with varying results) in trying to promote responsible investment in their markets and helping their issuers to raise governance standards and improve their ESG disclosure. Some have developed ESG indices and/or introduced ESG guidance for listed companies. In a few markets, such as South Africa, sustainability reporting requirements have been integrated into listing rules. A number of exchanges have also developed dedicated trading platforms in clean-tech and carbon trading. Several exchanges publish their own corporate sustainability reports. The World Federation of Exchanges (WFE) has played a valuable role in raising awareness amongst its members and building dialogue with the responsible investment world, whilst at the same time focusing on the more immediate and fundamental challenges that stock exchanges face as a result of the global financial crisis. This brings us to the third driver, and perhaps the one that will be the most difficult but also the most decisive over the next three years. As important as ESG issues are (or should be) in the investment system, responsible investment is only one piece in a bigger jigsaw dominated by some big themes: financial stability, systemic risk, market fragmentation, principal-agent problems, the social purpose of financial institutions, and the need for smart regulatory reform, to name but a few. Combine these with some of the global megatrends that lie behind responsible investment thinking – climate change, energy security, water security, food security, demographic trends, human rights and poverty, for example. Add in the important –
but often overlooked – mental note that all of this is ultimately about how the savings of millions of ordinary people can be invested safely and responsibly in a way that is aligned with their long-term interests. The big picture that begins to emerge is full of connections, interdependencies, synergies and tensions. As complex is this picture is, it underlines the fact that long-term investors, exchanges and their regulators all have some common issues to grapple with, even if they don’t necessarily agree on all of the solutions. Starting with ESG disclosure is no bad thing.
Given this, what are the critical factors for success?
Responsible investors and the supply chain of specialist research and ratings firms that serve them depend on good quality ESG data on companies in the investable universe. This information, however, is still patchy. Corporate sustainability reporting needs to be improved, and many people feel that voluntary initiatives alone are not going to get us there. Attention is turning to company law, accounting and auditing standards and listing rules. An important output from the SSE Initiative in this respect will be best practice guidance to policy makers and stock exchanges on sustainability reporting initiatives, which UNCTAD is expected to publish later this year under the auspices of the Intergovernmental Working Group of Experts on International Standards of Accounting and Auditing (ISAR). Concurrently, the Investor Network on Climate Risk (INCR) is working with NASDAQ OMX and other exchanges on a Listing Standards Proposal for sustainability disclosure on global stock exchanges. If ESG databases become significantly bigger in three years time, one objective will have been met. Further market development will require exchanges and regulators to adapt and implement the type of recommendations coming out later this year. However, getting them to this point will require continued engagement from responsible investor networks. The PRI is already building this into its public policy work programme. The EU and the OECD are both already focused on policy guidance and regulatory reform that ties in with the agenda around long-term investment. Whether the fact that these wheels are already in motion turns out to be a help or a hindrance remains to be seen: the OECD’s work stream, for example, isperceived by some as being overly focused on getting pension fund money into infrastructure projects and very light on the ESG and other aspects of long-term investment in other asset classes. Getting exchanges and regulators to implement regulatory measures for ESG disclosure, and to do this successfully in a way that actually leads to real improvements in the quality and quantity of corporate ESG information, will also require a focus on companies themselves, both to convince them of the value of such disclosure and to show them how to do it effectively. More data is only part of the story though. As a means to an end, it should lead to more investors making better-informed investment and ownership decisions. In turn, this should manifest both in the composition of investors’ portfolios, in voting records and engagement activities, and in the feedback that listed companies provide as to whether they think investment analysts really take ESG seriously. Importantly, it demands that we have better global systems for measuring and comparing RI implementation that will hopefully manifest in the new PRI Reporting and Assessment Framework. Success in three years’ time will also be measurable by the number of other exchanges that join NYSE Euronext et al in accepting the SSE Initiative’s invitation to partner. Some of the world’s largest exchanges by domestic market capitalisation have so far been notably absent from the table, at least publically. In the case of the London Stock Exchange, this is particularly puzzling given the size and maturity of the UK responsible investment sector and the government’s backing of long-term investment issues. Finally, we should also hope to able to observe success in terms of a broadening of the agenda from its current focus on ESG disclosure to other, related issues of concern (including the possibility that exchanges may have observations and recommendations that they may wish to take up with responsible investors). Some of these issues may not find both sides on common ground from day one. For example, responsible investors are now turning their attention to policy measures to counter short-termism, a topic that will be reflected in PRI’s own work programme. Exchanges, meanwhile, may have things to say about market fragmentation and investors’ use of alternative trading systems. However, both sides are likely to find that a better mutual understanding can only help the shared quest for a more stable and sustainable financial system.
Dan Siddy is Co-founder and Director, Periscope