A revolution in finance?

Not much good has come out of the global
financial meltdown but there is this:
Investors who watched Bear Stearns, General
Motors and Merrill Lynch destroy billions of
dollars of shareholder value presumably are
ready to focus on what makes companies
sustainable, or at least try to better
understand risk.
But how? How are institutional or individual
investors to know which companies are built to last,
which are managed to serve their customers, workers
and communities, and which of their boards are
fulfilling their obligation to manage risk?
Those were the questions put today before a day-long
conference called Sustainable Stock Exchanges , held
at UN headquarters in New York and convened by
the UN Global Compact (an alliance of responsible
companies), the PRI (an investor group whose initials
stand for the Principles for Responsible Investment)
and UNCTAD (the UN agency that promotes trade and
development). The focus was on gobal stock
exchanges, and the potential they have to require
public companies to disclose their environmental,
social and governance (ESG) risks. But we also talked
about building the business case for so-called
nonfinancial analysis, and about whether companies
with good environmental, social and governance
practices will deliver superior shareholder returns.
I was privileged to moderate much of the discussion,
and so had the opportunity to hear from stock-
exchange officials, investors and regulators from
Egypt, South Africa, the UK, Brazil, Turkey,
Indonesia, Malaysia and New Zealand. Living and
working in the U.S., it’s easy to forget that the
conversation about sustainability is also unfolding in
far-flung locales that don’t often get datelines on the
business pages.
“My own view is that smart companies and smart
stock exchanges recognize the value of ESG in driving
returns,” said Jane Diplock, a New Zealander who is
chair of the International Organization of Securities
Commissions, known as IOSCO . “What was a whisper
in the 20 th century – don’t invest in guns or tobacco –
has become shout – invest to protect the planet!”
James Gifford, the executive director of PRI, described
the forward-thinking corporations, investors and
exchanges as an “ecosystem” in which each part
contributes to the whole. “Clearly there is a huge
amount of momentum among the investors and the
exchanges,” he said. “The business case (for
integrating environmental, social and governance
risk into investing) has been well established.”
Really? I’m not persuaded that we can make the link
between the financial crisis and the need for
companies to be more responsible, more aligned with
society and better governed. If there is a connection,
it’s probably driven—or at least it should be—by a
greater skepticism among investors, a willingness to
dig deeper into risk and the understanding that
neither size nor short-term performance tell you
what you need to know about a company.
As George Kell, executive director of the Global
Compact, put it: “Short-term, quarterly profit
maximization is not sufficient to build long-term
value.”
Here are a few things I learned at the event:
More than ever, companies and investors say they want to
align themselves with society’s needs. The evidence for
that is that the Global Compact, launched less than a
decade ago with 47 companies, now has 6,000
member companies in 135 countries that promise to
align their strategies around human rights, the
environment, labor practices and anti-corruption
principles. (Some companies actually get kicked out
for non-compliance.) The PRI, which began with
about 20 institutional investors in 2005, now has
about 600 asset managers and their advisors as
members. They promise to incorporate ESG analysis
into their investment decisions and be active as
owners.
But corporate disclosure of relevant ESG information
remains spotty. Only about 15% of the 20,000
companies covered by Bloomberg provide sufficient
data about their ESG practices, according to Paul
Abberley, the chief executive of Aviva Investors , a
UK-based asset manager. “The disclosure of
information can be dramatically improved.” Aviva
proposed at the event that stock exchganges make
“good ESG disclosure a condition of listing.”
Most stock exchanges, however, are reluctant to de-list
companies, around ESG issues or anything else. De-
listing is a measure of last resort, as Huseyin Erkan,
the chairman and CEO of the Istanbul Stock
Exchange, explained. De-listing means investors can’t
get access to their money, and it means the exchange
loses revenues. The Istanbul exchange, rather than
enforcing disclosure requirements (a stick), has set up
an index (a carrot) of companies with good
governance practices. It also has nine city-based stock
indices, which lead cities to compete to provide good
business environments and reliable reporting.
A few exchanges in the developing world are pushing
hard on ESG. Egypt de-listed about 750 most-small
companies from its exchange because they failed to
meet good-governance requirements, leaving about
350 better-governed and better-capitalized firms. “At
the end of the day, you have to do things that are
unpopular,” said Maged Shawky Sourial, chairman of
the exchange. The surviving companies, he said, were
better equipped to come through the 2006 crash of
Gulf markets and the 2008 financial crisis.
Most of the exchanges pushing ESG are in the
developing world, where they are competing for risk-
averse foreign investors. U.S. and Western European
exchanges haven’t played much of a role in this
debate.
My own belief is that, more than rules or listing
requirements, the performance of ESG indexes and
SRI funds that drives what is potentially a revolution
in finance. If they outperform over time, more money
will flow to companies with good ESG practices.
“We’re talking about changing the way we value
business,” says Alyson Warhurst, executive chair of
Maplecroft, a firm that analyzes risk.
The financial crisis, at the least, opens up space for
discussion. Antoine de Salins, who is executive
director of Fonds de Reserve pour lest Retraites, a big
French pension fund, said: “It is clear to me that we
investors are obliged to revisit all the classical,
analytical tools we were using in the past to shape
our investment policies.”
After the event, I chatted with Jean-Nicolas Caprasse
of RiskMetrics Group , a fast-growing advisory firm
that seems to be trying to corner the market on risk
analysis. They’ve acquired Institutional Shareholder
Services, Innovest and, most recently, KLD Analytics
—all pioneers of ESG analysis. Caprasse said that
investors, in the wake of the crisis, are ready to ask a
question that should provoke fresh ways of thinking
about business: