As published on Emerging Markets ESG on Friday, March 11, 2011
Emerging Markets ESG: How would you define socially responsible investment (SRI)?
Peter Clifford: Any exchange – not just those in emerging economies - needs to listen carefully to what issuers (ie listed companies), analysts, investors and regulators want from the market in relation to ESG issues. For most of our members, the main ESG agenda is the integration of non-traditional risk factors into the long-term investment strategies of institutional investors, reflected by the growing importance of the UN Principles for Responsible Investment and global initiatives on integrated reporting. For many exchanges, ‘socially responsible investment’ also means catering to the needs of specific environmental markets, such as carbon trading or cleantech. And for some exchanges, the topic can also embrace impact investment, such as microfinance and social enterprises.
Emerging Markets ESG: What distinguishes SRI from mainstream investment?
Peter Clifford: It’s probably now over-simplistic to draw a neat distinction between SRI and mainstream investment, although there will always be a place for ‘niche’ investment products that are specifically marketed as SRI or ethical, especially in the retail investor and mutual fund segments of the market. In the institutional investor and wealth management sector, ESG issues have begun to enter the mainstream DNA as a normal part of good investment practice and fiduciary duty. Although there is still tremendous variability in the extent and implementation of this ‘mainstreaming’, the pace of change and the business drivers behind it point towards a fundamental shift in long-term investment practice, rather than a temporary trend or ‘bubble’. Rather than talking about ‘SRI versus mainstream’, it’s probably now more relevant to look at the relevance of ESG issues to different investment strategies and asset classes.
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for companies in emerging markets to manage?
Peter Clifford: Generalizations have to be treated with caution. Every emerging market is different and so are the ESG issues that are most important. International investors often struggle with this when looking at numerous emerging markets from far away. Exchanges play an important role by facilitating better knowledge of the country-specific ESG investment climate and strengthening the ESG information environment. Speaking generally, however, corporate governance issues have the longest history and are the most deeply embedded both in investors’ awareness and in the consciousness of listed companies. Environmental criteria, especially climate change and water, are arguably amongst the most important long-term planning challenges for emerging market companies. Social issues – such as labor standards and land rights – are often the ESG issues that have the most potential for causing short-term crises.
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for investors in emerging markets to analyze?
Peter Clifford: Good fishermen have good instincts where to catch fish, and the others try to follow the good ones. Investing is similar. Once a particular method or strategy pays off, it creates momentum. What I hear from investors is that they are interested not only in how companies can comply with ESG metrics or respond to questionnaires, but also they hope to hear from companies how these issues are rooted in the strategy of the company and how they provide the company with an advantage over their peer group. But I go back to my previous remark: the biggest challenge for foreign investors is probably to manage the diversity of ESG issues across different emerging markets, rather than the differences of the three extra-financial themes. For local investors, the ESG analysis challenge is probably more about using the information in practice to differentiate between companies in stock markets that are often dominated by a relatively small number of industries and companies.
Emerging Markets ESG: Stock exchanges played a major role in implementing corporate governance codes. What can stock exchanges do to promote listed companies’ reporting on environmental and social indicators?
Peter Clifford: Core activities for all stock exchanges include promoting their listed companies; developing their markets; and standardizing information. Improving corporate ESG disclosure is an important aspect of each of these goals, and many exchanges have already been working on this successfully for several years. Exactly how exchanges go about this varies, depending on the regulatory framework and other country-specific factors. The World Federation of Exchange’s September 2010 report, Exchanges, ESG and Investment Decisions, provides a comprehensive overview of the different strategies and initiatives our members are taking. Many emerging market exchanges have introduced sustainability indices to increase access to ESG information and strengthen corporate ESG disclosure practices. Exchanges have also integrated ESG disclosure into corporate governance guidelines for listed companies, and in some markets the regulators have formalized this through listing rules and/or company law. Several exchanges – and WFE itself - are actively involved with international initiatives such as the Global Reporting Initiative, the Carbon Disclosure Project, the International Integrated Reporting Committee, the UN Principles for Responsible Investment, and international accounting and auditing standards. At the same time, exchanges (and regulators) are heavily involved in post-crisis financial stability and regulatory reform initiatives, and so it’s important to recognize that ESG reporting is just one of many priorities on the table. To some extent, the momentum of exchange-led efforts to promote corporate ESG reporting depends on investor demand and feedback from companies on how analysts are actually using the information being generated.