From crisis to catalyst

How ESG implementation could be the beginning of a solution to the market meltdown.

The financial meltdown has, to say the least, cast a cloud over the entire finance sector and potentially the global economy. With a few exceptions, most of us working in mainstream responsible investment missed many of the warning signs around sub-prime. And nobody predicted the extent of the catastrophe. But when we look back on this crisis in several years, I think we will see that institutional investors proved much better at finding solutions to the problem than preventing it. Working through initiatives such as the PRI, responsible investors need to focus on the long-term, get back to basics and affirm their role as the providers of capital to productive businesses that provide goods and services which people need and which deliver long-term sustainable returns. The effective consideration of ESG issues within investment decision-making, if conducted on a systematic basis through the investment industry, should lead to a shift towards seeking real value, as-well as a longer-term understanding of risk and opportunity. It might also enable investors to see warning signs earlier than they otherwise would.That is a challenge encapsulated in Principle 1 of the PRI – to incorporate ESG issues into investment analysis and decision making. This Principle ranked by 62% of our signatories as the most difficult to implement.
So how is Principle 1 being implemented?
Signatories to the PRI are very diverse, regionally and in terms of investment styles, so there can be no one-size-fits-all approach. However some of the biggest challenges and the most significant steps forward in the last year have come under what we like to call the ‘three Rs’ – resources, research and relationships. Appropriate resources are essential in implementing Principle 1. This includes both internal staff time and the buying in of investment research to supplement in-house data. We have been delighted with the progress of PRI signatories in investing in their internal capability and capacity-building programs within their organisations. HSBC Investments, for example, last year rolled out training programmes for its 500 front office investment professionals in 18 different countries, in order to ‘hardwire’ ESG considerations in their policies and

processes. This case study is featured in our annual report. A large number of signatories have also appointed dedicated ESG or sustainability managers within their investment teams whose job description is to drive the incorporation of ESG issues into their mainstream investment processes. This is an important development but, as one practitioner recently suggested, the central aim for those working in these roles should be to work themselves out of a job. If responsible investment is embedded in the mainstream culture of what the investor does, there should be no need for a dedicated responsible investment manager. Despite these encouraging signs there remains a skills shortage in the industry globally, particularly in the number of investment analysts who have the skills and experience to evaluate the materiality of ESG issues and incorporate those factors into mainstream valuation models. We hope initiatives such as Australia’s new Responsible Investment Academy and the PRI’s own Academic Network will help address this skill shortage. The skills shortage also relates to the second big challenge of implementing Principle 1 – research.
A concern consistently raised by our signatories is the patchy availability of high-quality, investment-relevant information on ESG issues. While ground-breaking collaborations like the Enhanced Analytics Initiative (EAI) have been successful in opening up the research community to the importance of ESG issues in long-term investment decision-making, there is still a long way to go. While some markets and sectors are beginning to be served well by research providers, there are still large gaps, particularly in emerging markets.Consistent demand signals and the collective voice of PRI signatories will be imperative to mainstreaming the integration of ESG analysis in investment decision-making. The recent merger of the EAI and the PRI will shift this agenda up a gear, and seek to take the cutting-edge work of the EAI to a much larger group of investors. At the end of the day, research providers will provide what they are paid to provide, and if investors want to understand how ESG issues are likely to affect their investments, they have to be willing to incentivize that research.
The third and final ‘R’ – relationships – is about increasing interaction between both investors, their agents and investee companies, and also collaboration between investors themselves. Over 90% of asset owner signatories to the PRI now take part in some form of active ownership activities, which includes engaging in dialogue with companies, voting at company meetings and, where dialogue is unsuccessful, filing shareholder resolutions. While the bulk of these activities remain focused on ‘traditional’ corporate governance issues, increasingly, environmental and social issues are moving up the agenda. Perhaps most encouragingly, in the last two years, the percentage of PRI asset owners involved in collaborative engagement – where investors come together to engage in dialogue collectively with companies – is approaching 50%. This is in recognition that company dialogue is a resource-intensive activity, and it makes sense for investors to pool resources when trying to influence changes in corporate practice.
One example of collaborative shareholder engagement focuses on the reporting commitments made by

companies that are signatories to the UN Global Compact, which is a set of 10 principles of corporate conduct around environmental issues, human rights, labour standards and anti-corruption. The UN Global Compact requires its corporate signatories to report annually on their progress in implementing the Principles. In 2007, a coalition of 20 PRI signatories representing over US $2 trillion wrote to around 100 signatory companies that had failed to report as required, and asked them to fulfill the reporting obligations. This engagement resulted in approximately 20% of the targeted companies responding positively and agreeing to ensure their reporting commitments are fulfilled. The investors also selected 20 of the best reporters and wrote to the CEOs and Boards of these companies commending them for their disclosure efforts. Many of those leaders commented that such public recognition from large, mainstream investors provided a strong internal incentive for them to further invest in their ESG disclosure efforts.
Building on that engagement, there is now a larger coalition of investors worth US$4 trillion in assets that are writing to 5000 listed companies encouraging them to sign up to the Global Compact.
These examples of collaborative engagement were facilitated through the PRI Engagement Clearinghouse,which is an online tool that provides an easily accessible forum for investors to collaborate on a multitude of issues they believe may be affecting their interests.

“Consistent demand signals and the collective voice of PRI signatories will be imperative to mainstreaming the integration of ESG analysis in investment decision-making.”

Momentum is building strongly within the Clearinghouse, with dozens of new collaborations emerging. This tool is now being used by approximately half of all PRI signatories. With all three ‘Rs’ we can see that there is still much to do. However we can all be proud of the progress made so far. Long journeys are made from many small steps and the sector has shown it has the determination and ability to make further impacts in the market despite the difficult conditions.

James Gifford is Executive Director of the Principles for Responsible Investment Initiative.
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Narina Mnatsakianan, project manager PRI emerging markets and developing countries, will be speaking about ESG integration, notably in emerging markets, at the forthcoming RI conference – Integrating ESG into Mainstream Investing on Nov 12 in Amsterdam. For more information: Link to conference programme