An interesting coalition of groups joined together for a side event at the Copenhagen climate change summit on Dec. 12. Gathered were the Worldwatch Institute, a respected think tank represented by its leader, Christopher Flavin; the United Nations Foundation, established by Ted Turner, and represented by its head, Tim Wirth, a former Senator and the main US negotiator for the Kyoto Climate Conference during the Clinton administration; and the American Clean Skies Foundation, which promotes natural gas as a clean alternative to coal, represented by its CEO, Gregory Staple.
Their three-hour conference was about a low-carbon energy source that could reduce US dependency on both imported oil and domestic coal: shale gas.
One of the lead speakers was Aubrey McClendon, CEO of Chesapeake Energy, a large natural gas producer. He stated that he was in Copenhagen to drive home the point that shale gas production was a game changer in "de-carbonizing" the US economy.
Mr. McClendon explained the potential of shale gas:
- New technologies, such as hydraulic fracturing ("fracking") and horizontal drilling, have made it feasible to extract vast "new" reserves of gas from underground formations of shale;
- Natural gas emits about 25 percent less CO2 than oil and 50 percent less than coal;
- Installed natural gas electricity capacity is already in place, and could meet current U.S. energy demands (unlike nuclear, wind, solar, or "clean" coal plants equipped with carbon capture and storage, or CCS);
- The steady output of gas plants can help balance the irregularity of solar and wind power; and
- Unconventional US gas would reduce the nation's dependency on foreign (OPEC) hydrocarbons.
While this message has been delivered consistently to investors by many of the US's independent gas players, the industry could do more to make its case to Congress and the public. The coal, electric utility, and railroad industries have employed top lobbyists to represent their interests, but the natural gas industry has been much less involved in the drafting of US climate change regulations.
Natural Gas Share of US Energy Use to Grow
Still, in its assessment of the American Clean Energy and Security Act of 2009 (also known as ACES, and the Waxman-Markey bill), the Energy Information Administration (EIA) projected that the share of natural gas in US electricity production could increase to 31 percent by 2020 from a 2007 level of 21 percent. EIA further projects a 39-percent contribution to the electricity supply from natural gas by 2030. This would lift the share of natural gas in the overall US energy supply to 26 percent in 2020, up 3 percentage points from 23 percent in 2007, and to 28 percent by 2030.
These projections, however, assume that the US will be unable to take advantage of overseas offsets for its domestic carbon output. EIA also assumes limited deployment of other low-carbon technologies, such as CCS and new nuclear plants.
Gas Industry Seeks Higher Profile
The US natural gas industry believes that ACES should have included greater explicit support for gas in the draft carbon regulation, and also taken a less lenient approach to coal, particularly in the allocation of emissions allowances. The gas industry's presence in Copenhagen is an attempt to raise its public-policy profile, as is the decision by 28 of the largest natural gas independents to form the "American Natural Gas Alliance," which is charged with promoting the benefits of natural gas to the public.
Big Oil Moving into Gas in a Big Way
In a sign of great expectations for the gas market, ExxonMobil recently announced a $41 billion, all-stock acquisition of XTO Energy, an offer price that represents a 25 percent premium above XTO's Dec. 11 closing share price. XTO has the largest proved natural gas reserves among the US independents, and Exxon's commitment to natural gas production in the U.S. not only will offset some of the carbon risks inherent in Exxon's portfolio, but it will also bolster the industry's ability to lobby Congress as it takes up climate change legislation in 2010.
The Impact of "Fracking"
While natural gas is set to play a more significant role in the US energy mix, increased domestic production will carry environmental costs. The industry will need to spend as much political capital on addressing these concerns as it will on improving the position of natural gas in carbon legislation. High on the list of these concerns are the environmental impacts of "fracking."
The Sustainable Investment Research Analyst Network (SIRAN) recently conducted a seminar on the implications of expanded fracking operations. In a follow-up to this article, Alan Petrillo will explore SIRAN's perspective on how the fracturing of shale formations could affect the environment, including the nation's water supply. The process of extracting the fossil fuel with the least impact on the atmosphere could have a big impact on the American landscape.
[Ed. Note: RiskMetrics analyst Mario Lopez-Alcala is attending the Copenhagen summit as an official observer.]
As the Copenhagen climate summit draws to a close, many are disappointed by the lack of progress being made here. The biggest announcement is likely to be a plan to compensate countries that preserve forests and other natural landscapes that store carbon dioxide, the main greenhouse gas tied to global warming.
While other agreements could be reached to place carbon regulations on aviation and shipping, other goals to curb industrial emissions of greenhouse gases and set new financing mechanisms to help developing countries mitigate and adapt to climate change remain elusive. Now the hope is to reach a legally binding agreement sometime next year.
Different World From a Year Ago
Still, as US Deputy Special Envoy for Climate Change Jonathan Pershing observed at Copenhagen's Bella Center last week, today's world is very different from the one we lived in a year ago when it comes to climate politics.
The Copenhagen summit has brought developing countries to the fore, with progressive proposals on mitigation, adaptation, and finance. The United States has also undergone a sharp policy reversal, with President Barack Obama here to underscore the US administration's commitment to tackling climate change. This sets the stage for a changing global regulatory environment that will benefit low-carbon investments.
The road ahead will be bumpy, however. In Copenhagen there have been heated debates on the legal outcome of two parallel negotiating paths: one under the Framework Convention on Climate Change, in which the US is a party; and one under the Kyoto Protocol, in which the US is an observer.
A bloc of Small Islands States led by Tuvalu has proposed developing a new negotiating group to work toward a binding treaty to succeed the Kyoto Protocol with even more ambitious targets. The U.S. regards this extension of Kyoto as a non-starter. Another proposal forged by the Mexican and Norwegian delegations would substantially increase the amount of predictable funding available for climate change actions in developing countries. However, beyond a commitment by the European Union to provide $10 billion annually in such funding as a down payment toward larger giving, the pledges have been few.
Significant Forest Protection Program
In any event, the forest protection program expected at Copenhagen (formally known as Reducing Emissions from Deforestation and Forest Degradation, or REDD) should not be overlooked for its significance.
Rainforest destruction and land conversion are responsible for about 20 percent of annual emissions that contribute to global warming. The REDD program puts financial incentives in place for developing countries to preserve these natural habitats effectively as a carbon-storing bank. Industrial countries would be able to purchase credits from this bank to offset emissions that exceed their own reduction targets.
The current U.S. legislative proposal as passed by the House of Representatives would allow up to one-quarter of the nation's emissions to be offset by such credits from international providers. REDD would help assure that a large bank of credits would be available at affordable prices, easing the pressure on domestic industries to achieve emissions cuts from their own operations.
REDD also could be a shot in the arm for the Clean Development Mechanism (CDM), a project-based source of carbon credits that can be used in emissions trading schemes established under the Kyoto Protocol. So far, the CDM has suffered from heavy bureaucratic oversight and limited geographic scope. However, new measures potentially could arise from talks seeking ways to lessen these drawbacks for CDM projects.
By virtue of the location of the world's rainforests, REDD could help disperse funding assistance across Asia, Latin America and Africa. Some representatives at Copenhagen are even lobbying to extend REDD's provisions to northern boreal forests, which also provide a substantial sink for carbon.
However the REDD program works out, it will be a while before the aid starts flowing. Details that remain to be worked out include setting exact targets and timetables for emissions reductions, and what systems should be used to measure and verify carbon storage of various habitats.
Climate Clock Keeps Ticking
Meanwhile, the climate clock keeps ticking. Scientists presenting at Copenhagen stressed the importance of bringing global emissions to a peak within the next decade and then starting a fast decline, led by a 25- to 40-percent reduction by industrial countries from 1990 levels by 2020. Each year of delay heightens the pace at which emissions reductions must be achieved thereafter.
United Nations Secretary General Ban Ki-moon admonished Copenhagen delegates in an address on Dec. 15 as they moved into their final days of negotiations. "We do not have another year to deliberate," he reminded them. "Nature does not negotiate."
Mario Lopez-Alcala is a member of RiskMetrics Group's Climate Risk Management team.
Shrinking the King Kong of Carbon Footprints: Empire State Building Shows Way for Global Property Sector
As part of RiskMetrics' involvement with the COP15 climate conference in Copenhagen, I spoke on a United Nations Environment Program Finance Initiative (UNEP FI) panel called "Construction Counts for Climate." I represented UNEP FI's Property Working Group (on which RMG's Mario Lopez-Alcala has served for two years), and was joined by the Finnish Minister of Housing and other UNEP representatives.
"Construction Counts," as the built environment is responsible for at least 40% of global CO2 emissions, according to the Intergovernmental Panel on Climate Change. This actually represents a great opportunity for emissions reduction, as buildings' emissions can be reduced drastically by making better use of existing technology. COP15 participant Jens Laustsen, senior energy policy analyst (buildings) at the International Energy Agency (IEA), estimates that 75% of the energy used in most buildings can be saved.
Today's Investments Embedded in Long-lived Buildings
Unfortunately, energy efficiency is not always a top priority for property owners, and current construction can embed wasteful practices for decades.
The UNEP FI Property Working Group believes that the building sector will only embrace efficiency with steady guidance from investors and regulators. The Group includes around 20 of the world's largest institutional real estate investors, including AXA, CalPERS, Sumitomo Trust, and UBS. In my presentation, I explained how more aggressive building codes, combined with investor interest due to global carbon pricing, would put needed pressure on property owners worldwide.
The Empire State Building: Once Again, the Latest Thing
Some governments have already acted, including New York City, which just passed one of the nation's most stringent efficiency standards. The most prominent example of its potential is the skyline's most famous landmark: the 78-year-old Empire State Building. Its recent $500 million renovation is a case study of how much can be achieved with current technology.
This renovation includes a package of 8 major programs including chiller replacement, tenant space redesign, new windows, and other projects. These investments resulted in a 38% reduction in CO2 emissions and a net present value savings of about $20 million over 15 years.
"Make No Little Plans"
These tangible, quantifiable returns are too big for investors to ignore. This explains why the 2009 Investor Statement on the Urgent Need for a Global Agreement on Climate Change has attracted support from 191 institutions representing $13 trillion in assets. The construction sector has also committed to efficiency through the World Business Council for Sustainable Development's Energy Efficiency in Buildings program.
Architect Daniel Burnham, leader of the early 20th century "City Beautiful" movement, famously said, "Make no little plans – they have no magic to stir men's' blood." If more governments follow New York's lead, then the Empire State Building could inspire builders to think green, as well as big.
Hewson Baltzell heads ESG product development at RiskMetrics Group. He is a co-founder of Innovest and was president of the firm before it became part of RiskMetrics in 2009. Prior to Innovest, Mr. Baltzell was a commercial and investment banker specializing in corporate finance and real estate.
The climate change scientists whose emails were recently hacked are living their worst nightmare. Like many of their colleagues, these scientists had long been frustrated by a handful of vocal global warming skeptics. The hacked emails gave skeptics a new opening to sow doubts about global warming, just as media attention turned to the Copenhagen climate summit.
These scientists spoke in some private emails of resisting Freedom of Information Act requests and boycotting journals that provide an ongoing platform for the skeptics' views. Neither the hacking nor the censorship should be condoned. But when this dust-up settles, these things will be certain:
- The evidence of human contributions to global warming is so overwhelming that this media sideshow will have no impact on the outcome of the Copenhagen meeting.
- The real issue to be addressed at Copenhagen is how to pay for the ballooning costs of climate change. These costs now include not only trillions of dollars of investments in carbon mitigation, but also spending on adaptation measures, to address warming that will continue throughout our lifetimes. By some estimates, these adaptation costs will rise above $100 billion a year.
The Impact of Dumping "Coal Mines into the Air"
Global warming is a scientific fact. The debate now is at the margins of just how fast and dangerous the warming will be.
Svante Arrhenius won a Nobel Prize in 1896 for his theory that "evaporating our coal mines into the air" would eventually double the atmospheric concentration of carbon dioxide and raise the Earth's temperature by 5 to 10 degrees Fahrenheit. That's still the basic forecast today, except what Arrhenius thought would take a thousand years could well happen in this century.
The World Meteorological Organization has reported that the first decade of the 21st century will be the warmest since modern temperature records began in 1861. The Earth's temperature has risen nearly 1.5 degrees F since then, with another 1 degree F of warming expected within the next 30 years as the warming trend accelerates. By 2100, the Earth could be as much as 8 degrees warmer - a level not seen since the Age of the Dinosaurs 65 million years ago.
While skeptics point out that the global temperature has not exceeded the peak set in 1998, this does not change the fact that the Earth has caught a fever and so far has done nothing to stop it. In fact, all of the years since 1998 rank among the warmest on record; 2009 is expected to go down as the fifth warmest year.
If one wants other physical evidence of this warming, look no further than the North Pole, where the Arctic Ice Cap–a permanent fixture of the Earth over the last 3 million years–is melting so fast that it could disappear entirely during summer months within the next five to 10 years.
Official Scientific and Governmental Consensus
Since 2000, many of the world's most reputable scientific organizations have issued reports or statements supporting the human link to global warming, and the dangers it poses:
- In 2001, the U.S. National Academy of Sciences issued a report at the request of the Bush administration that concluded rising global temperatures in recent decades were "likely mostly due to human activities" (and issued a much more strongly worded report in 2009).
- In 2003, the American Geophysical Union concurred, saying, "Scientific evidence strongly indicates that natural influences cannot explain the rapid increase in near-surface temperatures observed in the second half of the 20th century."
- In 2004, the American Meteorological Society issued its own warning, describing human-influenced climate change as "a global climate experiment, neither planned nor controlled."
- In 2007, the Intergovernmental Panel on Climate Change (IPCC) issued its fourth assessment since 1990 on the state of climate change science. It concluded that there is greater than 90 percent certainty that most of the warming over the past 50 years has been caused by human activities, and that 3.4 degrees F to 8.3 degrees F of warming is likely with a doubling of atmospheric CO2.
- In March 2009, the IPCC provided a disturbing update to its forecast, warning that "[r]ecent observations show that greenhouse gas emissions and many aspects of the climate are near the upper boundary of the IPCC range of projections." Simply put, "the worst-case IPCC scenario trajectories (or even worse) are being realized."
- And on Monday, the U.S. Environmental Protection Agency issued a final ruling that greenhouse gases are endangering the environment and human health, triggering the need for regulatory controls. This finding, too, was driven by the weight of scientific evidence that human activity is largely responsible for the warming taking place.
"We know that skeptics have and will continue to try to sow doubts about the science," remarked EPA administrator Lisa Jackson at the announcement. "It's no wonder that many people are confused. But raising doubts – even in the face of overwhelming evidence – is a tactic that has been used by defenders of the status quo for years."
That is why responsible climate scientists find it so frustrating that public doubts persist, even though the basic premise that human activity is contributing to climate change has not been seriously contested for years or even decades:
- One literature review of 928 peer-reviewed articles published in the 1990s and through 2002 found that 75 percent either explicitly or implicitly accepted the consensus view that human activity is contributing to global warming. The remaining 25 percent of these studies dealt with other facets of the climatological issue, stating no position on this key question, according to the review by the Program in Science Studies at the University of California.
- In another recent survey of more than 3,000 Earth scientists, 82 percent agreed that human activity is a "significant contributing factor" in changing global temperatures. Specialists in the field who actively publish on the issue were in almost total agreement: 75 of these 77 climate scientists–about 97 percent–agreed with the statement.
Fundamentally, responding to climate change is sound risk management. While the chance of our house burning down is highly remote, we still take the precaution of buying fire insurance. Why then would we not take out insurance when there is a greater than 90 percent chance that our world is catching fire?
That is what the Copenhagen summit is really about. The longer we postpone real action to bring down greenhouse gas emissions to address global warming, the higher our premium costs will go.
For another review of skeptics' claims and scientists' rebuttals, see this December 7th Wall Street Journal article: "What global warming? A look at the arguments the skeptics make–and how believers respond"
Doug Cogan is Director of Climate Risk Management for RiskMetrics Group. His 1992 book, The Greenhouse Gambit, was one of the first to address the business and investment implications of climate change. He has since written many other reports and articles on climate and energy topics and helped develop a Climate Change Governance Framework to analyze corporate and fund manager responses to this issue.
This week, world leaders meet in Copenhagen to coordinate their efforts to address global climate change. As summed up by a RiskMetrics fact sheet on the event, the summit's daunting goal is to set fair, achievable emissions reduction targets for both developed and developing nations.
The Financial Times' Martin Wolf has succinctly stated why this will be so difficult:
"…Where [greenhouse gas emissions] abatement occurs must be separated from who pays for it. Abatement needs to happen where it is most efficient. That is why emissions of developing countries must be included. But the cost should fall on the wealthy. This is as much because they can afford it as because they produced the bulk of past emissions."
Private Lenders and Investors in a "Pivotal Position"
How can the global economy equitably share the costs and benefits of climate-related adaptation? Parties to Copenhagen will tackle this problem – eventually – with regulation, taxation and subsidies for carbon-abating investment. Private investors, however, can act now to direct capital towards projects that will thrive in a carbon-constrained economy.
The financial sector will play a crucial role in putting developed-world wealth to work in emerging markets, according to Dr. Peter Thimme and Doug Cogan. In an October Responsible Investor op-ed, they explained why:
"To complete the transition to a low-carbon economy, up to $50 trillion in renewable energy and energy efficiency investments will be required over the next 40 years, mainly in emerging markets. This puts financial institutions in developing and transition economies in a pivotal position: either they find ways to gain from these climate-friendly investment opportunities or face growing adaptation costs that sap available returns."
Best Practices in Emerging Markets
Mr. Cogan, RiskMetrics Director of Climate Risk Management, authored "Addressing Climate Risk: Financial Institutions in Emerging Markets," commissioned by Dr. Thimme's firm, DEG, for shareholder coalition Ceres. As summed up in the RI piece, most of the 64 surveyed firms acknowledge the challenge of climate risk. Far fewer firms are factoring climate risk into their lending and investing.
Still, "Addressing Climate Risk" is subtitled "a best practices report," and it does present instructive examples of climate-focused lending and investing. These examples can be grouped in two broad categories:
1) Focused investment in "clean-tech" projects that reduce emissions, conserve energy, or replace carbon-heavy processes.
2) Research and evaluation of the social and/or environmental impact of all projects seeking financing from the institution.
Examples of the first group include renewable energy investments in Kenya, Romania, and India, and an Argentine firm's conservation of 15,000 acres of forest to offset the impact of a paper mill.
Adding ESG Standards to Risk Management Systems
Beyond these clean-tech plays, there may be greater potential impact from the second approach to climate risk. While only five surveyed firms explicitly study climate risk, 53 of 64 have established a risk management system that addresses overall environmental, social and governance (ESG) risk factors.
"Addressing Climate Risk" presents more details on the risk management system of Mexico's Grupo Finterra, a firm focused on lending in the agribusiness sector. The firm acknowledges that this sector is especially vulnerable to climate change, and its risk rating system reflects this:
"…The rating system assigns clients a grade of A, B, C according to their compliance with a range of environmental and social standards [including climate change-related risks]. Ratings are tailored to the specific project and agricultural activity to capture key risks relevant to the client's business. The company also provides recommendations to help clients increase their scores and comply with the company's standards. These recommendations are tailored to address specific risks to a client's business activities."
Most importantly, the system has teeth: "Low-scoring clients will not receive financing unless these requirements are met," according to the study.
Forging the Missing Link
With an eye on Copenhagen, "Addressing Climate Risk" does assess respondents' involvement with the Clean Development Mechanism (CDM) established by the Kyoto Protocol. So far, trading of such credits has been dominated by developed-world brokerages. Even fewer of the emerging-market firms trade credits than measure climate risk. The prevalence of ESG risk management systems among lenders and investors, however, suggests that these firms already have the tools to account for such risks.
Dr. Thimme and Mr. Cogan believe that the private sector should capitalize on Copenhagen, even if governments fail to do so. As they wrote in RI, "Whatever else comes out of Copenhagen, financial partnerships must be forged to support the huge flow of investment capital intended for the developing world."
[Ed. Note: In preparation for the Copenhagen summit, the KLD Blog will present some perspectives on global climate policy. The following analysis of Australia's rejection of an emissions-credit trading scheme comes from RiskMetrics analyst Mark Barraclough. Mark is based in Sydney and researches Australian firms, with a focus on the energy and extractives sectors.
As the US and other developed-world democracies debate their own "cap and trade" schemes, the case of Australia's Carbon Pollution Reduction Scheme (CPRS) may prove instructive.]
Any chance of Australia taking a legislated emissions trading scheme to Copenhagen evaporated on Dec. 1 as the nation's opposition Liberal party voted down the Rudd government's Carbon Pollution Reduction Scheme (CPRS) for the second time. Earlier in the week, opposition leader Malcolm Turnbull was unceremoniously ousted for supporting an amended emissions trading scheme bill, and Tony Abbott emerged as the new Liberal leader.
The outspoken Mr. Abbott has previously described climate change as "crap" and stands firmly in the camp that Australia should do nothing until major emitters such as the U.S. and China have established their own schemes.
The Political Route Not Taken
As this is the second time the CPRS bill has been rejected in the Senate, the Rudd government had the option to dissolve both the House of Representatives and the entire Senate in what is known as a double dissolution. In essence, Kevin Rudd could break the stalemate and call the world's first election fought entirely over climate change.
With a significant group of Liberal parliamentarians publicly skeptical that climate change is occurring as a result of human activity, and given that the Labor government is already well ahead in opinion polls, a double dissolution election could deliver Labor the balance of power in the Senate. Even were it not to succeed in doing so, the government would still be able to call a joint sitting of both houses of parliament to break the deadlock and push through its CPRS bill.
However, the government's acting Prime Minister, Julia Gillard, has announced that the government is intending to reintroduce the same amended CPRS bill on the first sitting day in late February next year. Mr. Abbott has promptly responded that his party will vote it down again.
The Politics Behind the Impasse
Why didn't the Australian government take advantage of this opportunity? The answer lies in the effect a double dissolution could have on the timing of Senate elections. A double dissolution before July 2010 would put future Senate elections out of sync with the House of Representatives. Such an outcome could shorten the Rudd government's second term in office to two years, due to the way a sitting government will generally choose to put the Senate election cycle back in sync with the House, to avoid exposure to a protest vote via the Senate elections.
Essentially, it makes more political sense for the government to hold off and trigger a double dissolution in the second half of 2010 because this will keep Senate elections in step with the House.
There is also the possibility that an election now could potentially see the Greens win seats from Labor. The government has just negotiated an amended CPRS bill which includes substantial subsidies for coal-fired power generators and other big polluters. A portion of those people who voted for Labor over its climate change policy at the last election could switch to the Greens out of disappointment over this compromise with business interests.
Greens leader Bob Brown has said that the government should "have been negotiating with the Greens for a scheme based on cuts of 25 to 40 percent below 1990 levels by 2020."
The problem for the government has been that any scheme that appeases the Greens would be vigorously opposed by business leaders representing energy-intensive industries, with whom the government has taken nearly two years to reach a fragile agreement.
Implications for Business
Mining companies, which for the most part were not destined to receive significant subsidies under the proposed scheme, may find some relief in this delay. For its part, the peak mining industry association (the Minerals Council of Australia) urged a fundamental re-think of climate change policy this week. But the current policy proposal has found support in the aluminium and petroleum exploration and production industry associations, which see it as the best deal on industry assistance they are likely to achieve.
If the legislation is not passed in the new year, owners of Australian brown coal-fired power generators such as International Power PLC and CLP Holdings are likely to wish they had the proposal's AUD 7.3 billion in electricity sector adjustment subsidies (over 10 years), as debts are up for refinancing.
With carbon regulation still a threat over the medium term, natural gas producers and utilities focused on natural gas power generation may stand to benefit in the policy vacuum. As coal power plants age and no new coal power capacity is added, lower emission natural gas offers the least risk and lowest capex solution. Australian participants in the space include Origin Energy, AGL Limited, Santos, and Arrow Energy.
While these companies may benefit from continued uncertainty over carbon regulation, the effects of the political failure this week are likely to be felt over the longer term, should Australian business lag other nations in developing a lower-carbon economy.
[For more on this topic, see the Climate Change Resource Center.]
The final version of the Walker Report on corporate governance of UK banks and financial institutions was published on Nov. 26. The Prime Minister requested the report, which was issued by the Treasury. Sir David Walker chaired the report team. He is a prominent City banker who has had stints at Lloyd's and Morgan Stanley.
The Report includes, among its recommendations (no. 17, p. 17), one that would require fund managers to adopt the Code on the Responsibilities of Institutional Investors announced by the Institutional Shareholders Committee (ISC) on Nov. 16. The Code, which Walker suggests be renamed the "Stewardship Code," would require, among other things, that managers commit to engagement or explain why they didn't.
The renaming of the Code seems important. Its original name is undescriptive and passive. "Stewardship" implies action, taking charge of assets entrusted to the manager. It is a word of rich significance to mission- and faith-based investors. The oldest UK SRI mutual fund is the Friends Provident Stewardship Fund.
The Walker Report in total has come in for a good deal of criticism from people the Guardian refers to as "campaigners." Nonetheless, in governance and engagement Walker seems a step forward. How large a step will be up to Parliament.
Below are links to the Walker Report, the ISC Code press release, and some background on Walker and the controversy surrounding his work.
A Review of Corporate Governance in UK Banks and Other Financial Industry Entities [PDF]
Press Release from Institutional Shareholders Committee on the Code on the Responsibilities of Institutional Investors [PDF]
Like many of us at RiskMetrics and the former KLD, I belong to LinkedIn groups that address socially responsible investing (SRI). This week, an "SRI Professionals" discussion brought up one of the seminal questions in SRI: What does it cost, compared to investing that disregards corporate environmental, social and governance (ESG) practices?
"There is not much information available that shows the comparative returns of the FTSE4Good indices against their "non-SRI" index counterparts - i.e. an analysis to gauge the perceived cost of being SRI."
The question of comparative returns is part of why KLD, among other ESG research firms, came into being. Our first index, which is now called the FTSE KLD 400, was created as an ESG-screened counterpart to the S&P 500. Many other FTSE KLD Indexes are similarly based on "non-SRI" benchmarks.
Click here to compare the performance of FTSE KLD Indexes to their benchmarks.
In the right-hand column of the Index home page, click on the name of any Index, and then click "Performance." You'll see a table and a graph indicating the relative performance of each Index and its benchmark.
Robert Kropp of SocialFunds.com recently wrote about a new Mercer study of ESG's impact on performance:
Also see these KLD Blog articles on this topic:
Investment & Pensions Europe's Nina R÷hrbein has presented some highlights from last week's TBLI conference in Amsterdam. She quotes RiskMetrics Group's Ran Fuchs, who asked why, historically, environmental, social and governance (ESG) research has primarily focused on equities, rather than fixed-income assets.
Mr. Fuchs' question is about investment horizon, as ESG investment is long-term investment. In considering extra-financial metrics of corporate value, ESG investors act on their skepticism about short-term indicators, like share prices or quarterly returns. As ESG research can uncover longer-term risks and opportunities, Mr. Fuchs believes, its practitioners should apply its lessons to assets with longer time horizons.
"Debt is Vital to the Survival of a Company"
His comments, from the IPE report:
"Fixed income investments last for 10 to 15 years or even longer, so any type of long-term ESG investments should be going straight to debt." … "The short-term performance of such investments should easily convince investors that there is value in this. But the impact on the industry can also be much stronger through fixed income because, while the price of the equities is relevant, the cost of debt and financing is absolutely vital to the survival of the company."
In citing a desire for "impact on the industry," Mr. Fuchs affirms that engagement – or "lobbying the corporation" – remains a priority for the ESG sector. As bondholders, he suggests, investors could help reorient corporate thinking in a more sustainable direction.
Moving Minds with Markets
"Sustainability" is a buzzword that can obscure as much as it explains. A company that sustains a healthy balance sheet may use resources – natural and human – in an unsustainable way.
Within the financial services community, we seek to integrate extra-financial factors into mainstream analysis. For the economy as a whole, we work towards the integration of environmental, social and governance concerns into mainstream corporate management.
From this perspective, financial instruments are only means to an end. We argue that business can only create as much value as the community and environment can sustain. This perspective demands a philosophical shift – a change in managers, not just markets.
Thinking 'Round the Bend
This change has already begun. Tom Konrad at Seeking Alpha recently posted a revealing exchange with Ray Anderson, head of carpet maker Interface:
"Q: In your experience, how does the financial community view corporate sustainability? Does anyone outside of the Socially Responsible Investment community care? Have you encountered much skepticism? Ray Anderson: In the early days of our journey, we definitely experienced skepticism from the financial community. In fact, our former CFO Dan Hendrix (who is now the Interface CEO) was asked on more than one occasion if I had "gone 'round the bend." I explained that as a leader, that was my job, because 'round the bend is where our future lies. … Q: How does sustainability help returns for investors and over what time horizon? Ray Anderson: As with any new thinking there's a time lag between early adoption and mainstream acceptance, and that naturally influences the return horizon for investment in new products, processes and technologies. I believe there are new fortunes to be made as we define this, the next industrial revolution. I also believe that part of what needs to change is our focus on short time horizons, i.e., the focus on the next quarter, for both companies and for their investors. Sustainability by its very nature requires a long view on the future as we consider the impact of our decisions today on future generations."
The Social Responsibility of Business, Part One: Moskowitz Prize-Winning Research on the "Social Pressure Market"
Last month, "The Economics and Politics of Corporate Social Performance" won the 2009 Moskowitz Prize. The Haas School of Business at UC-Berkeley and the Social Investment Forum (SIF) award the annual Prize to research relevant to socially responsible investing (SRI).
Prize-winning Stanford Professor David P. Baron and his team found that the "social pressure market," through its interplay with the markets for products and equities, can reward companies for their corporate social responsibility (CSR) practices. In doing so, Baron confronts a canard that the SRI sector has disputed since its inception: "The Social Responsibility of Business is to Increase its Profits."
Most Executives Sleeping With the Enemy
SRI and CSR skeptics have perennially repeated this assertion, which is the title of a 1970 New York Times op-ed by Milton Friedman. In that piece, Friedman wrote that an executive, as "an employee of the owners of the business," must run a company in its shareholders' interest. He defined this interest in entirely financial terms, and called any belief to the contrary a "fundamentally subversive doctrine in a free society."
Such "subversion" was rampant in 1970, and as Prof. Baron details, it's even more so today. In his paper's introduction, he cites a 2008 Economist poll that found a majority of firms believe CSR "is a necessary part of doing business," while under 4 percent called it "a waste of time and money." This commitment is not cheap:
"The amount business spends on CSP ['corporate social performance'] dwarfs the amount it spends on campaign contributions and lobbying expenditures. Milyo, Primo, and Groseclose (2000) estimated that corporate campaign contributions and lobbying expenditures were $300 million and $3 billion, respectively, whereas charitable contributions alone were $35 billion."
Why do executives give away so much of their shareholders' money? Do such expenditures help corporate profitability? Prof. Baron reviews past research into the impact of CSR efforts on financial performance, and finds a "positive but weak correlation" between good CSP and corporate financial performance (CFP).
If responsible behavior doesn't always lead to increased profits, then why do most executives believe it's necessary? To answer this, Prof. Baron and his team propose "a theory of the underlying economics and politics of CSP."
A Summary of the CSP Theory
Prof. Baron explains:
"The theory and empirical analysis view CFP and CSP as jointly determined by firms operating in three markets: a product market, a capital market, and a market for social pressure as generated by government, NGOs, and social activists. The theory provides the empirical specification and is also used as a framework to interpret the estimates as an equilibrium in the three markets."
Customers form the product market, and the capital market consists of investors. Prof. Baron on the third market:
"Social pressure could come from government in the form of regulation and enforcement or from NGOs and social activists in the form of boycotts, media campaigns, and harm to a firm's reputation or brand equity. … "To investigate the relations among CFP, CSP, and social performance in more detail, social pressure is disaggregated into a component judged to be due to public politics (government) and a component due to private politics (NGOs and social activists)."
What the Theory Means for SRI
Two of the study's core findings are especially relevant to SRI, which can be defined as investment that considers extra-financial metrics of corporate environmental, social and governance (ESG) performance.
" …[The] paper finds support for three hypotheses–consumers, employees, or investors penalize firms for incurring social pressure, social activists and NGOs choose soft targets to which to direct social pressure, and CSP is responsive to social pressure. … "[Also,] disaggregating CSP and social pressure shows that the relations among CFP, CSP, and social pressure are due to social pressure from private rather than public politics."
Here is a clarification of this private political process:
1) A corporation's business practices may attract social pressure from activists.
2) Activists pressure some companies more than others – the "soft targets."
3) When consumers, employees or investors penalize targeted companies – financially or otherwise – companies act to improve their corporate social performance.
In a private-politics-driven market, penalties and rewards are unevenly granted. Prof. Baron writes:
"Dividing the dataset into consumer and industrial industries reveals that the slope of the social market line for consumer industries is positive (i.e., CFP is increasing in CSP), whereas it is negative for firms in the industrial dataset…. "This may be due to rewards that are available to firms that sell to consumers and the absence of those rewards for firms that sell to other firms."
In other words, a consumer-facing firm can profit from its better ESG performance, thereby rewarding its shareholders for its CSP efforts. A firm that sells capital goods has, historically, less market incentive to improve its CSP.
SRI Helps Correct a Market Failure
Why did "The Economics and Politics of Corporate Social Performance" win the Moskowitz Prize? It is a study of CSR, not SRI, and it found only weak financial rewards for good corporate social performance. Why, then, is it of "practical significance to practitioners of socially responsible investing," according to the Prize judges?
The answer, perhaps, is revealed by the discrepancy between CSP's impact on consumer and industrial firms' profitability. In Prof. Baron's tripartite market structure, firms that respond to social pressure will be more profitable – if product market and capital market actors are aware of private political action.
The inability of non-consumer-facing firms to profit from CSP is a market failure. Individuals signal to consumer firms that they will pay for responsible corporate behavior, but for wholesalers, this signal – and its corresponding impact on profitability and investment returns – is muffled.
ESG investors amplify this signal – this willingness of individuals to reward ethical business practices – through the capital markets. By considering the CSP of consumer and industrial firms alike, SRI investors' feedback can help capital markets price the potential value of responsible business practices.
This form of private politics – or "lobbying the corporation," in the words of another 1970s critic – upends the belief that CSR is "subversive" in a market economy.
A follow-up to this KLD Blog article will suggest that social responsibility is a legitimate concern of corporate management, even in Milton Friedman's world. As Prof. Baron's research shows, economic actors in a free society are willing to pay for better corporate ethics.
To understand why, we need only dispense with the "faith and speculation" that, in David P. Baron's words, obscure "the relations between social performance, financial performance, and social pressure."
This week, Congress and the Obama Administration are discussing the future of American energy policy. The outcome of these efforts is unknown, but forward-thinking investors already expect big changes in the energy sector. The markets' preparation for a less-polluting future includes the October announcement that First Solar, a solar-power technology firm, will soon join the benchmark Standard & Poor's 500 index.
Investors expect a bright future for First Solar, a FTSE KLD Index constituent since 2007, partly because they assume that governments will eventually tax carbon emissions. If the carbon output of producers and consumers is taxed, then the relative cost-efficiency of solar and other renewable energy sources will increase.
Dirty Fuels Are Expensive, Even Without a Carbon Tax
To tax carbon, or not to tax? Is that the question?
It's not the only question to ask about our fuel mix. The status quo may be economically unsustainable even before we put a price on carbon: New government research finds that non-carbon emissions annually impose over $100 billion in unaccounted-for costs on our economy.
Keith Johnson of the Wall Street Journal has written about a massive federal study of the unpriced costs, or externalities, of American energy. "Hidden Costs of Energy: Unpriced Consequences of Energy Production and Use" is a 374-page inquiry into this issue by the National Academy of Sciences.
Mr. Johnson writes that while the Academy quantified the impact of particulate and other emissions, they declined to assign a price to carbon. Investors and policymakers should note that, even if we assume that carbon emissions are "free," fossil fuel consumption is not:
"America's current energy mix carries a 'hidden cost' of about $120 billion a year, the report found. And that number doesn't include any tally for the cost of greenhouse-gas emissions or climate change–estimates for climate costs range from $1 to $100 a ton of carbon dioxide emissions, but are so variable the report didn't quantify them. … "The $120 billion figure boils down to coal and cars. Transport costs the country $56 billion. Coal-fired electricity costs the country $62 billion per year, largely in health impacts from particulate matter. Natural gas for power generation, in contrast, adds about $740 million a year in hidden costs. "Looked at another way, coal's hidden price tag adds up to 3.2 cents per kilowatt hour. Compare that to the 2 cents per kilowatt hour that wind power gets from the government–that's less a subsidy than a partial attempt to level the playing field."
The Price of Particulates, SO2, and NOx
"Hidden Costs" lists the pollutants accounted for by the 3.2 cents per kilowatt hour price:
"Regarding Comparisons Among Fuels for Electricity Generation: In 2005 damages per kWh from SO2, NOx, and PM (particulate) emissions were an order of magnitude higher for coal than for natural gas plants: on average, approximately 3.2 cents per kWh for coal and 0.16 cents per kWh for natural gas (2007 USD). SO2, NOx, and PM emissions per kWh were virtually nil for electricity generation from nuclear, wind, and solar plants and not calculated for plants using biomass for fuel."
The Academy also admits that current research does not sufficiently account for environmental impacts beyond combustion emissions:
"Continued improvement is necessary of methods to quantify and monetize ecological impacts of all stages of the life cycle of electricity generation, especially of fuel extraction, emission of pollutants, and land-use changes. Similar needs exist for other types of energy production and use. "For fossil fuel options, more research is needed to quantify and monetize the ecological and socio-economic impacts of fuel extraction, e.g., of mountaintop mining/valley fill."
Coal is Costly, Believe in Climate Change or Not
The Academy concedes that the study hasn't revealed all the "Hidden Costs" of the American energy sector. Still, their work is a valuable policy tool. By reaffirming that carbon isn't the only costly externality of fossil fuels, "Hidden Costs" could support a more productive discussion of our energy future. Even those who don't believe in man-made climate change would concede that $120 billion is a lot of money to send up in smoke every year.
As KLD President Peter Kinder told an investors' forum on energy last spring, "We should be careful not to let 'carbon' become a proxy for 'environment.' Carbon is only one part of the case for change."
In preparation for the upcoming "SRI in the Rockies" convention, the Social Investment Forum (SIF) has posted highlights of its work over the past year. One of SIF's most valuable 2009 efforts is a framework of its "Priorities for Financial Regulatory Reform." Among these directives is a call to overhaul credit rating agencies. An October 19 report on the role of Moody's in the subprime mortgage debacle explains why major changes are needed.
SIF's Reform Agenda
SIF priorities include governance reform, better disclosure of both financial and environmental, social and governance (ESG) metrics, and stronger government oversight of the financial sector. Significantly, the major credit rating agencies are the only private firms singled out as systemic risks:
Improve Rating Agencies: The weakness of [the existing credit rating] system was made obvious by the fact that ratings agencies awarded AAA ratings to thousands of ultimately toxic subprime-related mortgage backed securities and collateralized debt obligations. Additionally, there are inherent conflicts of interest in the current business models for credit rating agencies, including the fact that issuers pay the credit rating agencies for their ratings and that they provide other consulting services to those same corporations they rate. …
Serving Issuers "Swamped Earnings" from Serving Investors
Kevin G. Hall, in an article for McClatchy Newspapers, combines interviews with past and current Moody's employees with a survey of how such agencies' business model has evolved. (Thanks to Salon's Andrew Leonard for directing readers to this piece.)
Mr. Hall writes that even "as Congress tackles the broadest proposed overhaul of financial regulation since the 1930s…lawmakers still aren't fully aware of what went wrong at the bond rating agencies." He explains how Moody's, along with competitors like Standard & Poor's and Fitch, developed the "inherent conflicts of interest" SIF mentioned:
To promote competition, in the 1970s ratings agencies were allowed to switch from having investors pay for ratings to having the issuers of debt pay for them. That led the ratings agencies to compete for business by currying favor with investment banks that would pay handsomely for the ratings they wanted. Wall Street paid as much as $1 million for some ratings, and ratings agency profits soared. This new revenue stream swamped earnings from ordinary ratings.
AAA One Day, Junk the Next
This process may have begun decades ago, but it accelerated over the past ten years. Mr. Hall cites Moody's 2000 public offering as one cause for this, as executives sought to boost the value of their stock options. The firm's role in enabling mortgage-loan securitization led to record profits – and also contributed to the global financial crisis. Mr. Hall quotes a former Lehman vice president:
"In 2001, Moody's had revenues of $800.7 million; in 2005, they were up to $1.73 billion; and in 2006, $2.037 billion. The exploding profits were fees from packaging . . . and for granting the top-class AAA ratings, which were supposed to mean they were as safe as U.S. government securities," said Lawrence McDonald in his recent book, 'A Colossal Failure of Common Sense.' "How on earth could a bond issue be AAA one day and junk the next unless something spectacularly stupid has taken place? But maybe it was something spectacularly dishonest, like taking that colossal amount of fees in return for doing what Lehman and the rest wanted," McDonald wrote.
What Lehman and other investment banks "wanted" was a larger supply of AAA-rated securities. Moody's and its peers faced tremendous incentives to overstate the quality of paper that was backed by now-infamous subprime mortgage loans. The collapse in value of these securities helped precipitate the financial crisis of 2008.
"The Law Doesn't Apply to Us"
Were these incentives balanced by any obligations to the purchasers of Moody's-rated debt? In fact, the ratings agencies were "under no legal obligation since technically their job is only to give an opinion, protected as free speech, in the form of ratings," writes Mr. Hall. He quotes Eric Kolchinsky, a former managing director at Moody's:
"There was an attitude of carelessness, or careless ignorance of the law. I think it is a result of the mentality that what we do is just an opinion, and so the law doesn't apply to us."
The Social Investment Forum, in its priorities for reform, would shift agencies' obligations back towards the investors who purchase agency-rated securities. "SIF believes…that rating agencies need improved supervision and must be held to higher standards of accountability, and changes must be made to their exemption of liability."
I've noted before the revealing names of hedge funds. The most obvious, of course, is Cerberus, named for the two-headed monster guarding the gates of hell in Roman mythology.
Now comes a report from the EuroMoney Institutional Investor Online Network on a Cerberus spinoff:
"Freedom Group is planning a $200 million initial public offering (IPO), The Wall Street Journal reports. Private equity firm Cerberus Capital Management will take the gun maker public with the IPO. The gun maker is planning to use the sale proceeds for general corporate purposes. Cerberus has acquired seven gun and ammunition makers over three years, which have been consolidated into Freedom."
The mythological guard had two heads to keep Hades inmates in and unwanted guests out. And such is freedom….
Still Fighting the Last War: US Chamber of Commerce Responds to "Normal Adversaries" on Climate Change
As corporations have come to recognize growing interest in their environmental impact, most firms have chosen to constructively engage with the public. The "greenest" companies have reduced their energy use and the impact of their products and operations, and many others have at least claimed to do so.
Such "greenwashing" is a concern of investors who consider environmental, social and governance (ESG) factors in their evaluations of corporate sustainability. But even as major firms have chosen, perhaps grudgingly, to work with their ESG stakeholders, at least one business lobby has taken a different tack.
Emily Stone of Green Century Capital Management has shared a telling letter on the climate change debate from David Chavern, Chief Operating Officer of the US Chamber of Commerce, which is reprinted in full below.
The letter's combative tone is certainly a change from most environment-related public statements in 2009. In response to high-profile defections from the Chamber, Mr. Chavern suggests that businesses face a "campaign against us being carried out by our normal adversaries -- trial lawyers, activist unions, environmental extremists, etc."
Ms. Stone has noted, in a message to the Social Investment Forum listserv, that investors are missing from this pejorative collection of bogeymen. In fact, 43 investor groups, representing billions in holdings, have together asked many firms to distance themselves from the Chamber's position. So far, Exelon, PG&E, Nike, and others have done so.
Mr. Chavern's letter calls for businesses to present a unified front against "interest groups [that] are looking for public leverage to force us to do things against the best interests of the business community."
Policy conflicts between interest groups are a natural part of democracy, and the Chamber of Commerce is right to fight for its members' objectives. Still, regarding environmental policy, it seems to have drawn inaccurate battle lines. The threat of climate change has already changed the economic and political climate, and this has helped forge new alliances among many erstwhile "adversaries." The New York Times reports that it has also fractured "once-monolithic" lobbies like the oil and gas industry.
Are these renegade firms in the thrall of lawyers, unions and extremists? Or are they simply responding to business risks that the Chamber is neglecting to acknowledge?
In an October 15 release, Green Century and Walden Asset Management quoted Bruce F. Freed, President of the Center for Political Accountability, about the risks of "misalignment" between businesses and their advocates:
"Climate change is one of those major issues where misalignment between companies and trade associations carries serious bottom line risks for companies. Good corporate governance should lead companies to assure that their trade associations do not engage in activities and use their funds in ways that may damage the company's reputation or be at odds with its stated public policy and business objectives."
In this fight, perhaps the Chamber should reconsider its strategy. If so many shareowners and members are its "adversaries," for whom is it working?
[The full text of David Chavern's letter follows.]
Special Message from David Chavern, Chief Operating Officer, U.S. Chamber of Commerce October 16, 2009 We understand that you may have received e-mails, letters and others communications from various groups asking your organization to end its association with the U.S. Chamber. Please note that these calls against the Chamber are part of a broad-based, multi-source campaign against us being carried out by our normal adversaries -- trial lawyers, activist unions, environmental extremists, etc. It is a "corporate campaign" in the classic sense, where interest groups are looking for public leverage to force us to do things against the best interests of the business community. (In fact, we are going to be sending you some additional information in the near future about the scope and objectives of this campaign.) Frankly, these efforts are simply the result of how effective we have been in opposing Card Check, as well as aspects of proposed healthcare, capital market and climate change legislation that we believe would be onerous to business and impede job creation. Our efforts to fix these key pieces of legislation are not going to stop -- business needs health care reform that focuses on reducing costs, we need (as our Capital Markets Commission Report over two years ago called for) modernization of financial regulation across-the-board, and we need and continue to call for comprehensive climate change legislation. The Chamber staff will continue to work day in and day out to ensure the best possible outcomes for the economy and job creation. And we intend to continue being successful, so we expect the negative messages to your organization may continue. In all circumstances, I and other Chamber staff are available to provide you with more background on our policy positions, along with help in any responses that might be warranted. I do apologize, though, for any annoyance and inconvenience these efforts against us might cause you. Thank you very much for your continued support. Please let Tom Donohue or me know if you have any questions or comments. Many thanks, David Chavern Chief Operating Officer
The industrial workplace can be a dangerous place, and in some factories, the risks go beyond the pace of the assembly line. This week, China handed down 12 death sentences and nine life sentences to participants in July 2009 violence in the Xinjiang region. This lethal riot, which left approximately 200 people dead, was rooted in long-simmering tensions among Uighur and Han workers in a large toy factory.
Could management have done anything to prevent this tragedy? While the factory cannot be blamed for deep-seated ethnic conflict, CSR Asia's Stephen Frost has argued that many employers do too little to defuse workplace disputes:
"The toy factory riot in question was complicated by a recent influx of Uighur workers and the arrest for rape of Uighur workers, but missing from the factory was a basic component of industrial relations; i.e., a workable and effective grievance mechanism. In fact, this basic element of good workplace relations is missing from most factories in China (especially large ones where it is essential; and the toy factory in question is a very large one indeed and supplies to major brands)."
Protecting the Freedom to Complain
Labor relations is a core concern of investors who consider environmental, social and governance (ESG) practices. The globalization of the industrial supply chain complicates the labor relations picture for corporations who may purchase goods from hundreds of contractors. Beyond the moral justification for better workplace relations, a corporation cannot expect to remain untouched by a riot at one of its suppliers.
According to a report from the Corporate Social Responsibility Initiative at Harvard's Kennedy School of Government, supply-chain incidents are a material threat to global businesses:
"There is risk to corporate reputation through national or international campaigns or boycotts as well as through lawsuits, whether under the Alien Tort Claims Act in the US or other states' domestic legislation, which is increasingly being extended to encompass corporate activities overseas. And a legacy of conflict or abuse can jeopardize a company's ability to win future contracts or realize new investment opportunities. "
As the report explains, a well-managed workplace must have a mechanism to address the grievances of all employees, no matter their position on the org chart. It also notes that "matching practice to principle is a challenge for most companies with complex operations or supply chains."
The authors write:
"The limitation of [existing labor relations] tools lies in their top-down structure. They are designed to account to company management and/or external actors about the groups of people who may be impacted by the company's operations, based on sporadic checks and interviews linked to pre-identified standards for compliance. They do not account to those impacted, but leave them as largely passive objects in the process."
A "robust" program to address worker grievances must, first, assure workers of their right to speak up. Workers will, sensibly, remain "largely passive" if they fear retribution by managers or coworkers. This is why the CSR Initiative, along with labor-focused non-governmental organizations (NGO), advocate a "rights-based" approach to conflict resolution.
Some Metals and Mining Firms Take Action
Most companies and industries have yet to implement rights-based grievance mechanisms. The basic materials sector, perhaps due to its inherent capacity for displacement of land and people, has committed to Sustainable Development Principles that include respect for human rights. International Council on Metals and Mining members Freeport-McMoRan Copper and Gold and ArcelorMittal have both made the development and implementation of grievance mechanisms into key components of their employee and community relations.
Oversight is Key
In workplaces where disputes among workers are compounded by distrust of management, third-party involvement is essential. Stephen Frost described the modest but important steps that CSR Asia has made toward this goal:
"CSR Asia works in China to develop these mechanisms (via factory training…and in partnership with NGOs to provide hotline services for factory workers to contact trusted NGOs that can then relay messages to brands and retailers buying from the factory). … "It's clear that a good grievance system is not going to solve Uighur grievances in Xinjiang, nor prevent all ethnic clashes, but if there is no mechanism at all for workers to air complaints (and have them acted upon), then this sort of thing is going to continue (as it has done for the last 20 years or more)."
On October 2, The Motley Fool surveyed the proposed Shareholder Bill of Rights Act. For the benefit of the site's audience of retail investors, Alex Dumortier wrote "Let's Reform Say-on-Pay," a helpful primer on the Act's requirement that firms submit their executive compensation practices to a non-binding proxy vote.
Say on pay (SOP) has gained public attention through a sustained effort by some institutional investors. Major companies – including, recently, Microsoft – have accepted SOP provisions championed by Walden Asset Management and Calvert, among other firms and investor groups. These shareholders' efforts have helped convince the Obama Administration and key Congressional leaders to include say on pay in their reform proposals.
Heading off "Shareholder Rebellion"
The cases of Microsoft and General Mills illustrate two common responses to say on pay campaigns. A SOP proxy resolution at General Mills won majority shareholder support despite management opposition, according to an update from Tim Smith of Walden and Aditi Mohapatra of Calvert. Despite this vote, the firm has yet to adopt SOP. Microsoft's management, by contrast, committed to triennial shareholder review of compensation without the issue ever coming to a vote.
Paul Hodgson has considered management efforts to forestall "shareholder rebellion" at The Corporate Library blog. In his "Brief History of Say-on-Pay," Mr. Hodgson describes a contentious SOP battle in Britain in 2003, the first year in which the UK required a vote on firms' "remuneration reports." After a majority of shareholders rejected a compensation package for the head of GlaxoSmithKline, the firm undertook a third-party review of its practices, resulting in major revisions to CEO Jean-Paul Garnier's pay package.
Mr. Hodgson writes that this could have "been the signal for a new contentious era in UK compensation practices," but this was not the case. He explains why:
"Given the imminent introduction of say on pay in the US, and the fierce corporate opposition to it, a brief discussion of why this period of relative tranquility [in the UK] occurred is useful. … In each of the cases where controversy appeared to have been brewing, behind-the scenes-discussions between the company and major institutional shareholders were taking place. … "In most cases in the UK today, companies regularly work closely with shareholders to ensure that there is full agreement on pay issues – mostly those having to do with equity incentive plans – prior to the annual meeting."
Microsoft Accepts Triennial Review
Microsoft provides an American example of this negotiated approach. In a company blog, the firm's Brad Smith and John Seethoff write of their "open and constructive dialogue with our shareholders."
They also explain why Microsoft has agreed to an every-three-years compensation proxy vote. Their reasoning should interest environmental, social and governance (ESG)-focused investors, who typically advise managers to take a long view of their companies.
Messrs. Smith and Seethoff write:
"Our discussions led us to the conclusion that a three-year cycle is optimal for say on pay votes at Microsoft. Although we acknowledge that some constituencies support an annual say-on-pay vote, a number of considerations led us to our conclusion. Among them: 21bb37598146c54a272be26da55cd7ee "Most compensation programs can't be changed overnight. Triennial votes give the Board and the Compensation Committee sufficient time to thoughtfully respond to shareholders' sentiments and implement any necessary policy changes."
Tim Smith and Aditi Mohapatra note that while Microsoft has chosen "the triennial approach, it is very likely legislation will require an annual vote."
More Fund Managers Should "Think Like Owners"
As for the prospects for federal reform, Paul Hodgson writes that "say on pay now seems an inevitability, given President Obama's manifest support for it."
Perhaps another motivation is the example set by the investors who've led the American SOP movement. It's telling that a voice for retail investors, like Motley Fool, is taking a stand on this issue. Alex Dumortier connects the concerns of individuals to the efforts of institutions who support governance reform:
"…Individual investors are right to question whether their small voices will be heard. But remember: Not all institutional investors are created equal. You have a choice when you buy a mutual fund or select a fund manager in your 401(k). All other things being equal, you should certainly favor fund managers who have a straightforward proxy voting policy and who vote their proxies in a manner that proves they think like owners."
On September 18, representatives of the Gender Equality Project (GEP) described their work at a KLD seminar. The GEP, an offshoot of the World Economic Forum (WEF) Gender Parity Group, studies and promotes the practices of corporate gender-relations leaders worldwide.
"We want to have a global impact, which is why our pilot project will highlight 10 bellwether global companies," said Nicole Schwab of the GEP. "There have been efforts to promote an equal work environment for men and women at the national level, but unless we can engage businesses directly, discriminatory structures may remain in place."
The GEP website presents stark evidence of persistent global gender disparities:
"While there is a strong correlation between a country's competitiveness and its level of gender equality, studies show that there is still a 38% gap between men and women in terms of economic participation and opportunity and an 84% gap in terms of political empowerment (Source: Global Gender Gap Report 2008 – World Economic Forum). "…Even in the most progressive countries, women still suffer from restricted economic opportunities and from discriminatory practices in the labor market. In OECD countries, women are 20% less likely than men to have a paid job and earn on average 17% less than men (Source: OECD's Employment Outlook 2008)."
Looking for Leaders
The GEP's focus on a few leading firms presents an interesting contrast to Pax World's Global Women Investment Index (GWI). The GWI is a benchmark index designed to measure the gender relations performance of thousands of global companies. (KLD was a partner in the development of the GWI, which was funded by the World Bank Group's International Finance Corporation. Pax is seeking to commercialize the index for retail investors. The GWI is unrelated to the Pax Women's Equity Fund.)
While the GWI provides an external perspective on gender relations at a broad universe of companies, the pilot GEP engages in active dialogue with firms' employees and managers.
"Our task is to understand how the best companies encourage, support and promote their female employees," said Aniela Unguresan of the GEP. "We want to work with these firms to raise expectations – and give practical guidance – to businesses in every sector worldwide."
Earning the "Gender Equality Label"
The GEP is incorporated as a Swiss non-profit foundation. The group is in the midst of a two-year pilot project that is intended to attract more supporters and business partners.
At the KLD seminar, Aniela Unguresan gave an overview of the GEP's approach:
We have developed an assessment methodology for measuring gender equality performance. There are five areas of assessment: 1. Equal pay for equal work 2. Equal opportunities for promotions and recruiting 3. Equal opportunities for training, mentoring and development 4. Company policies to promote healthy work/life balance 5. Overall corporate culture To gather evidence for this assessment, the GEP seeks to answer a set of key questions: a) Are equality-oriented policies in place? b) Do workers and managers know and uphold these policies? c) What are the outcomes of these policies? d) Are there mechanisms in place to ensure the sustainability of good practices?
The GEP researches these questions through direct surveys of corporate managers and employees, as well as independent research. Based on the findings of this year's GEP pilot project, the Foundation will launch a certification program in 2010. Companies that meet GEP's standards will receive a "Gender Equality Label."
"We believe it is important to publicly recognize real progress on this issue," Ms. Unguresan said. "Some companies have done good work that's gone unnoticed, while others would like to improve their performance, but may not know how."
Confidentiality a Condition of GEP Methodology
The GEP's use of employee surveys distinguishes it from most attempts to measure corporate environmental, social, and governance (ESG) performance. The Global Women's Investment Index, as KLD's Karin Chamberlain explained at the forum, tracks data gathered by governments, NGOs, and other third-party external sources. This data includes metrics of:
- Female representation on a company's Board of Directors
- Female representation in the workplace
- Programs and policies
- Controversies that led to legal action, fines or other consequences of discrimination, harassment, or a hostile work environment
As these metrics are based on publicly available evidence, many of the GWI's findings (as with most indexes) can be published and repurposed to serve investors' various priorities. The GEP, however, believes that they can get more frank disclosure by promising confidentiality to participants.
"For our approach, communication is key," Ms. Schwab said. "We make clear that the survey is a tool, and we let firms and employees know up front what will and won't be made public."
Ms. Unguresan said that "our scoring is internal, and we don't intend to reveal it or publish a ranking list. Eventually, another entity may take over for the non-profit group that is running this pilot project, and this approach may evolve."
The Business Case for Gender Equality
The GEP believes that the global marketplace will reward better gender practices. The GEP website asserts that gender equality enables companies to "benefit from the widest possible pool of talent, build and consolidate a sound reputation in the marketplace, and potentially improve their competitiveness and financial performance."
KLD's Karin Chamberlain, as quoted by the KLD Blog when the GWI was introduced, concurs:
"We've found that companies where women can excel also tend to be strong ESG performers. We believe that better workplace gender relations may come to be seen as a competitive asset for the best-run global corporations."
After the GEP presentation, attendees at the KLD seminar discussed some of the obstacles faced by any attempt to change cultural standards – especially those across borders. For example, women may be better represented in a European firm's home office than in a division in the Middle East.
"Some companies are at a disadvantage because of the composition of different nations' labor forces," Ms. Schwab said. "The challenge is to present these discrepancies in an unbiased, comparative way, which helps substantiate the case for change."
Businesses Break Ranks Over Climate Change: David Vidal on How Public Pressure Can Change Corporate Culture
This week, in a statement cited at Green Inc., Nike said that it "fundamentally disagrees" with the US Chamber of Commerce's position on climate policy. The shoe giant joins three major utilities in opposing the Chamber's recent lobbying efforts, which include a call for a "Scopes monkey trial of the 21st century" regarding man-made climate change.
Why are some corporations so eager "to boost their green credentials," in the words of Ann Fifield of the Financial Times? Perhaps these firms would rather defy their peers than alienate their customers – or their Senators.
"Social movements shape political power," David Vidal told me last week. Mr. Vidal is Global Corporate Citizenship Research Director at The Conference Board, an independent organization working in the public interest to help businesses strengthen their performance and better serve society. He is also a member of the Newsweek Green Rankings advisory panel. He said his perspective is drawn from personal and professional experience, since the Board takes no official positions on legislation.
Mr. Vidal believes that concerned citizens, supported by empirical tools like the Green Rankings, can move even the most entrenched corporate and political interests.
Will "Coal States" Always Vote for Coal Senators?
While utilities such as PG&E and Exelon have broken with the Chamber of Commerce, others, including American Electric Power (AEP), have not. In my conversation with Mr. Vidal, I relayed a statement made by the head of AEP at a KLD forum last winter. I had found it interesting that CEO Mike Morris, in explaining why coal would continue to power the US economy, justified his position in political terms.
"We have 25 'coal states'," Mr. Morris said. "That's 50 Senators whose states depend on this [coal-friendly] economy."
Mr. Vidal took issue with this calculus:
"The coal industry, and the wealth it represents, doesn't hold those Senators as tightly as it thinks.
"Think of it this way: Before the Civil War, slaves were the single biggest 'asset class' in the American economy. History shows us that the power of wealth, of ownership, can be trumped by the power of social and political change.
"Coal is a big part of the economy, but do the coal interests really hold the constituents of 'coal state' Senators? Public views on the environment, and the urgency of environmental issues, have changed fast. Younger voters have been recycling since kindergarten. They've been hearing about climate change for almost as long. Coal has a negative connotation for many people, even in 'coal states' – think of the Tennessee ash spill last year.
"Will the public continue to vote for Senators who just do what a few companies expect them to do?"
Green Rankings give "Ethical Context"
The Green Rankings, in Mr. Vidal's view, can amplify the voices of citizens and companies that take a longer view of sustainability. He believes that the financial markets have failed to do this:
"Let's stop fooling ourselves. There is no financial incentive, in the current capital markets, for firms to act for systemic benefit – even if it's in their own self-interest. The financial markets have given us the results of this short-term thinking, in the form of the worst economic crisis since the Depression.
"What the Rankings measure are the costs to the community, to society, of a company's operations. This is not morally neutral. The Rankings are creating an ethical context in which to judge a company."
New Language for a New Corporate Culture
The Conference Board, through its engagement with executives and directors, seeks similar goals at the corporate level.
"There is an existing culture of governance, and there is a sustainability culture emerging. These two cultures are seeking common language, but they don't have it yet.
"For the Green Rankings project, we worked to develop terminology that businesses, consumers and policymakers can all use. The bridges between these groups are being reimagined and rebuilt. The language of engaged citizens, investors and managers can supplant financial language as the sole means of describing a corporation's worth."
As noted in a previous KLD Blog post, the Green Rankings encompass qualitative evaluations of corporate culture and reputation. Mr. Vidal sees a company's cultural shift – as we may be seeing at Nike, PG&E, and other firms – as an important measure of success.
"Culture is what you do in the absence of specific external requirements," he said. "You can't measure culture the way you measure carbon emissions, but so what? To rely just on quantitative metrics is to miss the point. As consumers and citizens, we need to ask: Does this company empower smart people to go above and beyond what's expected?
"We aim to shift the center of reference beyond what can be easily quantified. We need a broader measure of what each company demands from the environment, and from the community. These costs may not show up on the bottom line, so we have to find a way to expense them for society."
For more on the Chamber of Commerce dispute, see this article by Pete Altman at the National Resource Defense Council. NRDC research finds that "only 23 members of the U.S. Chamber's board have a publicly stated position on climate change and more than 80 percent [19 members] are not on board" with the Chamber's official position.
Of the other 4 Chamber board members, 3 are coal companies. (Thanks to Scott Stapf for sharing the NRDC story with the Social Investment Forum listserv.)
"We Need Green Companies, Not Just Green Products" ClimateCounts.org's Wood Turner on the Newsweek Green Rankings
On September 21, Newsweek introduced its landmark Green Rankings of the 500 largest publicly-traded US companies. This project, for which KLD was the lead research partner, was guided by an advisory panelof academic and non-profit policy leaders, including Wood Turner of ClimateCounts.org.
The Green Rankings are a recognition that public interest is the key to better corporate environmental practices.
"Without pressure from customers, corporations cannot make the business case for difficult changes to the status quo," Mr. Turner told me last week. He believes that the Newsweek Green Rankings complement his organization's work by spurring consumers to recognize green companies, not just green products.
Building the Business Case
ClimateCounts.org was initially funded by a grant from Stonyfield Farm, and continues to receive support from that climate-focused company. The organization evaluates corporations' commitments to reduce their carbon footprints, and publishes a Company Scorecard that enables consumers to make "climate-conscious purchasing and investing choices." Mr. Turner is a credentialed environmental planner, an experienced advocate for better environmental practices, and a seasoned brand strategist.
He explained how ClimateCounts.org balances its work with companies with outreach to consumers:
"We, as an organization, talk about the dance we do. One day we're working to engage executives on a complete business approach to carbon management. Then we try to motivate consumers with our Scorecard, which is a kind of shorthand description of how well businesses are actually doing. We move back and forth between trying to persuade the business community to take carbon seriously, and trying to raise consumers' expectations.
"Companies need to learn how to measure their carbon output, and that won't happen overnight. Clear, universal accounting standards are essential, and that must extend to the supply chain, where most of the climate impacts from large companies lie. The standards-making process has taken years, and we're still not there.
"This process is certainly a vital part of the dance, but some companies will look at both reporting protocol delays and even policy delays as a time when they can basically do nothing."
"No Sustained Interest from Consumers" - Yet
"This is why our other work, on the consumer side, is so important," Mr. Turner said. "If companies feel pressure from their customers, they won't wait for standards – they'll scramble to find some way to act now."
Mr. Turner is an energetic advocate, and an optimist. I quoted a portion of the ClimateCounts.org site stating that they don't practice "doom-and-gloom" environmental reporting, and he laughed, but his voice rose with some frustration at the pace of change:
"Regardless of what we, as activists, do to make management pay attention to climate change, there's really been no sustained interest from consumers. We've all been distracted by what I think is a less-substantive conversation about 'green products.' That's diverted consumer focus away from whether companies are true environmental leaders in all that they do."
"That's why the Newsweek Green Rankings are important. Many companies have said to me, 'We're trying to sell products, not to be a poster child for an issue.' But if they begin to see that a poor ranking hurts the bottom line, they'll take climate action more seriously."
Spurring Corporate Green Envy
I asked Mr. Turner for his thoughts on the Green Rankings methodology, and on some of the issues the advisory panel grappled with:
"The biggest question is weighting: the quantitative data on carbon output (called the Environmental Impact Score) is balanced by qualitative analysis of policies, practices, and history (the Green Policies Score). This is not just about today's emissions levels – it's about a commitment, about having a structure in place for long-term progress.
"The Reputation Score is also important, because every company is concerned about how it's perceived. A lot of companies have come to ClimateCounts, asking to be benchmarked. They want to beat their rivals, or know how much catching up they have to do."
The Most-Admired Brands may not be the Greenest
Can a company maintain a strong brand without strong environmental performance? Mr. Turner notes that plenty of popular brands belong to companies who lag behind their peers on the Newsweek Green list.
"Until brand rankings mirror green rankings, we have more work to do. Apple, for example, is one of BusinessWeek's "100 Best Global Brands", but their Green Ranking (and their ClimateCounts score) is below that of many of their sector peers.
"I think this is a missed opportunity. I've argued before that consumers are much more responsive to well-known CEOs, to a Jobs or a Gates, than they are to most politicians. I know it seems a little crass, but I think we identify more as consumers than we do as voters. We also respond to signals from the marketplace, and a rock-star CEO can send especially strong signals.
"I'd like to see more of those signals focus on climate action and why it will ultimately be good for the 'best global brands.'"
In an interesting coincidence, Apple announced a major environmental initiative last week.
How the Green Rankings Complement the Work of ClimateCounts
Mr. Turner described the Newsweek Green Rankings as "a natural extension of what we're trying to do."
"Green rankings and scoring are a way to move sustainability from the back room to the boardroom. When executives see their environmental practices on the pages of Newsweek, it motivates real interest.
"There are two things that top managers understand well: reputation management and market segmentation. An annual cover story in Newsweek means that corporations' environmental performance will affect their reputations; our job now is to expand green consumers' share of their markets."
On September 16, Senator Max Baucus unveiled a newly revised federal health care reform bill. I'll leave it to others to give the bill a thumbs-up or a Bronx cheer. I was intrigued, though, with one of its provisions: out-of-pocket spending on health insurance would be capped at 13% of household income for most Americans.
This is a recognition that the nation's health crisis is not about cost – it's about price.
To call a price a "cost" is to suggest that it's an expense that's both unavoidable and non-negotiable. In the US, conventional wisdom says that health insurance "costs" always go up.
Massachusetts Solved Half the Problem
The Baucus plan proposes a mandate for individuals to buy health insurance; prevents insurers from denying coverage due to pre-existing conditions; and provides government subsidies for those who need them. All of these elements are part of Massachusetts' 2006 reform plan.
The state's plan has fulfilled one goal of health care reform, which is to reduce the ranks of the uninsured. Insurance prices in Massachusetts, however, have continued to climb.
This Boston Globe piece informs us that the price of insurance will rise 10% next year, after a decade in which such prices have doubled. "It's all about medical costs going up," according to an insurer's spokesman.
One Handshake Can Move a Market
What's driving these "costs"? Mandated coverage and an aging population may only be part of the answer. In a 2008 investigative report that deserves wider notice, the Globe revealed a "market covenant" between a major Massachusetts insurance company and a large hospital chain. In 2000, Blue Cross agreed to increase its payments to Partners HealthCare, and, crucially, also assured the hospital that it would grant similar hikes to the other providers in the state. Partners, in turn, would request increases in payments from other insurers.
The deal was sealed with a handshake between the two firms' top executives.
The Globe wrote that "individual insurance premiums have risen 8.9% a year ever since the 'market covenant,' state figures show, more than twice the annual rise in the late 1990s." The article also includes a comment from Partners, the hospital chain:
"Partners officials stressed that its contract with Blue Cross in 2000 was far from unique, noting that big teaching hospitals across the country cut favorable contracts with insurers in 2000 and 2001, creating a shift in political power from the HMOs to the hospitals."
Corporate bargaining practices affect the price – not the "cost" – of health care. Some practices should raise red flags for policymakers, and for investors who consider environmental, social and governance (ESG) factors in their research. Well-established companies whose margins depend on "market covenants" may be riskier than they seem.
Inflation is Not Inevitable
This is why the Senate price-cap proposal is so significant. It requires healthcare providers to innovate and cut costs, or lose customers to those who do. This is the normal ebb and flow of a market economy, and its action brings us iPods that cost less than phonographs did 30 years ago.
Wiser observers than I have explained why, for consumers, the health care market is not like that for music players. In the context of wholesale bargaining between two companies, however, it really doesn't matter what's being bought or sold; what matters is how their actions affect competing buyers and sellers.
Timothy Noah at Slate has done an excellent job of explaining how the US health care sector's price hikes have contributed to a broader stagnation in American wages. In an economy that remains short of jobs and low on buying power, real reform would shield workers and employers from paying the price of a handshake.
Earlier this year, a powerful business was brought low by its leader's admission of an elaborate fraud, enabled by falsified financial statements. Management had hidden its crimes so well that the firm had won a 2008 award for its good governance. The boss' confession crushed the company's market value, erasing shareholder equity worth billions.
The man described above is B. Ramalinga Raju, and the technology firm he plundered was India's Satyam – "truth," in Sanskrit. To Americans, Satyam's collapse offers an overseas echo of scandals like Enron and Madoff. The multinational flavor of Raju's business – and his fraud – adds a further warning about the globalization of governance-related investment risk.
KLD Consulting analysts Celeste Cole and Marianne Ajayi study environmental, social and governance (ESG) issues in emerging markets, and they recently gave a presentation on the topic. They summed up the Satyam case and explained the work of the Emerging Markets Disclosure Project (EMDP).
By raising shareholders' expectations of transparency– and providing businesses with tools to meet those higher standards – the EMDP could help forestall the world's next Satyam.
How does a firm like Satyam fall so far, and so fast? Celeste Cole provided a recap:
"In December 2008, publicly-traded Satyam attempted to buy two companies that were owned by the family of its founder Chairman, B. Ramalinga Raju. "The acquisitions were sold to the board as a way to diversify beyond Satyam's core business of IT services. They were approved by the board, but prompted a major shareholder revolt. "Investors saw it as an attempt for the Raju family to profit at shareholders' expense. The deals were eventually abandoned. "Then in January 2009, Mr. Raju resigned and confessed to a $1.5 billion fraud. This was perpetrated through overstated profits, understated liabilities and inflation of debts owed to the company. It was later discovered that this fraud had gone on for 8 years."
Satyam earned the sobriquet "India's Enron" for its corruption, and also because, like Enron, its collapse implicated its auditors and surprised outside observers. Satyam's 2008 award from the "World Council for Corporate Governance" has become an ironic symbol of how little investors really knew about the firm.
Building a Cross-Border Culture of Transparency
To suggest the scope of the problem, Marianne Ajayi described other recent emerging market ESG controversies. These include a corporate tax evasion scandal in South Korea, labor abuses at South African gold mines, and development-related threats to indigenous peoples in Brazil. These issues seem as different as the nations themselves, but for investors, they hint at the same problem: opacity.
"Shareholders can't account for risks they can't see," Marianne said. "Governments and activists play an important role in uncovering abuses, but disclosure and enforcement standards vary between countries, and so does the quality of independent oversight."
In India, Celeste noted, investors and regulators have historically held powerful family businesses in high regard. The nation's business press, however, was aggressive in pursuing the Satyam story, and the Rajus' final fall was prompted by an anonymous whistle-blower. (India's Financial Express notes that Satyam was actually "one of the few Indian companies to have a whistle-blower policy in place.")
The Emerging Markets Disclosure Project
Global investors' ESG standards can help improve every market's standards of transparency. If foreign shareholders expect detailed ESG disclosure, the world's Rajus may profit less from cozy relationships with local governments and regulators. (Of course, this applies to the land of Bernie Madoff, as well.)
To act on this lesson, the Social Investment Forum (SIF) and the Principles for Responsible Investment (PRI) consortium launched the Emerging Markets Disclosure Project (fact sheet pdf). This is a multinational effort to make global ESG reporting more objective and more comparative.
The EMDP is a three-phase Project that began in 2007:
- The first phase was a survey of the current state of sustainability reporting in several emerging markets.
- The second phase was a campaign to gather investor signatories to encourage emerging market companies to improve sustainability reporting.
- The third phase involves direct engagement and outreach to companies in Brazil, India, Russia, South Africa, and South Korea.
Marianne and Celeste are active participants in the EMDP. Earlier this year they wrote for the KLD Blog about EMDP's findings on emerging market sustainability reporting. Both are now working on the third phase, Celeste on the India team and Marianne with the group reaching out to South African companies.
Global Standards for Every Market
As the past year's crisis has demonstrated, no nation is immune to the risks of corporate opacity and regulatory laxity. In the future, the EMDP aims to develop methodology for benchmarking nations' environmental, labor, human rights and governance standards. The globalization of trade and finance – and scandal – should be matched by global standards for how every company does business.
On August 31, Fast Company published a critique of socially responsible investing (SRI) by Timberland's Jeff Swartz. The New Hampshire-based shoemaker is rightly famous for its commitment to corporate social responsibility (CSR). But, Mr. Swartz believes that too many investors – including social investors – ignore such efforts. (Timberland has long been a KLD Index constituent.)
Mr. Swartz makes clear his support for SRI. Nonetheless, he argues, SRI focuses too much on "punishing" poor CSR performers, rather than rewarding and encouraging firms that take environmental, social and governance (ESG) issues seriously.
Tom says that Mr. Swartz is right to call on investors to pay closer attention to CSR efforts, and explains how SRI indexes can, in fact, "reward" as well as "punish."
Money Managers Should Sell CSR to Investors
After writing that analysts never ask about CSR during Timberland's quarterly earnings calls, Mr. Swartz wonders why. He notes that "without greater buy-in from shareholders, [Timberland's commitment to] CSR practices faces sharper scrutiny." To show this lack of buy-in, he asks why more SRI investors don't hold Timberland stock. He acknowledges the work of "engaged investors," but asks why more aren't "lining up dollars and values affirmatively."
Mr. Swartz writes:
"Too much 'social investing' seems to me 'screen and criticize' rather than invest behind CEOs and Boards that make real commitments to commerce and justice. "Although many CSR funds have updated their 'screens' in recent years to ensure that they're considering a company based on both positive and negative merit, the punishment is still more powerful--and prevalent--than the reward. … "You expect me to 'sell' social responsibility to my consumer and my Board and my shareholder--why shouldn't you do the same? Sell your concentrated, long view 'bet' on socially responsible companies--to your investors."
ESG Investing is About Responsible Management
Tom Kuh says that many investors do exactly what Mr. Swartz calls for:
"ESG/sustainability is about investing in responsible management. It looks at how executives and boards handle the risks inherent in a company's relationships with its stakeholders, and how they identify and take advantage of opportunities to manage sustainably."
SRI Indexes Make CSR a Priority
Mr. Swartz specifically criticized "index investing," which he described as investors "weighting their entire portfolio as per the market." Tom points out that the screening process is more sophisticated than this. He cites the benchmark FTSE KLD 400 as an index that does, in fact, "reward" Timberland for its ESG performance:
"These criticisms have more to do with market cap weighting than with indexing, per se. Investors who focus on large-cap stocks may hold less Timberland simply because it is small. "The FTSE KLD 400 Social Index is a 'long view "bet" on socially responsible companies,' to use Jeff's phrase. Due to its construction, the FTSE KLD 400 holds Timberland at about twice the weight it would have in the S&P 500 – if it were in the S&P 500, which it is not. "Some active managers and thematic indexes do take the concentrated positions Jeff advocates. There's certainly room for many approaches in this market."
A Joint Call for More "Patient Money"
SRI/ESG investors share Mr. Swartz's hopes for more of what he calls "patient money." Tom says that SRI can have an impact, but only through broader adoption of ESG analysis by investors worldwide:
"Jeff is absolutely correct – there are not enough investors and portfolio managers practicing SRI. Not enough investors look at small, innovative companies, or recognize the difference that CSR and sustainability initiatives make at a company like Timberland. "More mainstream investors should use ESG criteria to identify companies that are managed on a sustainable model. And I believe they will."
Bruce Bartlett of Forbes recently wrote a defense of both John Maynard Keynes' economic theories, and the federal government's $787 billion Keynesian stimulus package. The title was surely meant to raise eyebrows among Forbes readers, but Peter Kinder, in forwarding the story, said that Bartlett's is "a judgment I agree with."
Does it matter what political label we "really" affix to an economist? Or vice-versa? Disciples of Milton Friedman were upset when, in the 1970's, Richard Nixon declared himself a "Keynesian," but should these name games mean anything to the rest of us?
In fact, these categorizations can profoundly influence policy debates. Bartlett writes that Keynesian macroeconomic measures – like the Obama administration's stimulus efforts – protect the "microeconomic" status quo. "At the end of the day," Bartlett asserts, Keynes' "cure for unemployment was to restore profits to employers."
Writing as an alumnus of the Reagan administration, Bartlett tells his audience of capitalists that "the alternative to stimulus could have been something far worse."
A Republican, then, can be "for" the actions of a Democratic government. Bartlett's sort of intellectual reassurance is a necessary part of political discourse. Former Massachusetts Governor Mitt Romney has described the state's health care plan as conservative, because of its mandate that individuals buy insurance. As a Republican, Mr. Romney had to make a "liberal" expansion of health care more palatable to his political base.
This summer's debate over federal health care reform – an important task for the political base known as "everyone" – has shown the damage that the wrong words can do. As Medicare recipients fight "government health care" and protesters wave pictures of Hitler at their Congressman, public discourse is revealing fears and biases, rather than policy questions or opinions.
As an engaged community of investors, what can we do about this? Organizations like the Interfaith Center on Corporate Responsibility (ICCR) have steadily supported productive, bipartisan discourse on health care policy. In our own spheres, perhaps we can take a lesson from Bruce Bartlett, and explain how one side of a political divide can benefit from the other camp's ideas.
Along with the rest of my peers today, I'll invoke the legacy of the late Senator Ted Kennedy, as he lies in state here in Boston. Whether passing school reform or brokering peace in Northern Ireland, the Senator worked at the nexus of distrust and misunderstanding. That's where the right words are most powerful.
A new study offers a novel perspective on the market impact of socially responsible investing (SRI). Researchers at the University of Western Australia (UWA) have looked for "abnormal returns associated with firms being included in, and dropped from" the world's longest-running SRI index, which is now known as the FTSE KLD 400 Social Index.
Interest in SRI's impact on returns is older than KLD. In fact, the FTSE KLD 400 was launched in 1990 to test then-conventional wisdom about the "cost" of integrating environmental, social, and governance (ESG) factors into investment analysis.
"It was widely held that there were inherent costs to SRI, and these costs could not be mitigated," Peter Kinder, President and co-founder of KLD, has said. "We created a benchmark index to empirically study if this was true, and move the discussion forward."
The discussion continues. On August 12, Alain Sherter at BNET compared recent SRI performance to that of the overall equity market. While SRI returns have slumped along with the rest of the market, he found that "businesses that get high marks for their corporate governance, environmental, diversity and other policies have over the years matched, and even marginally exceeded, the returns of other companies."
Mr. Sherter also cited a 2008 Moskowitz Prize-winning study which found that better ESG performers tend to outperform their peers in the market as well.
UWA's Gariet Chow, Robert B. Durand, and SzeKee Koh have approached this question in an unusual way. They've zeroed in on investors' response to KLD's adding or removing a company from the FTSE KLD 400. Their "long-run event study methodology" seeks to isolate the impact of these moves on each company's share price.
The authors write:
"If inclusion (or deletion) is good (or bad) news for investors, we expect to find positive (or negative) abnormal returns. Our sample includes all firms added to, and deleted from, the FTSE KLD 400 index after its inception in May 1990 to the end of December 2007. Over this period, 370 firms were added to, and 370 firms deleted from the index."
They note that most deletions result from mergers and acquisitions, rather than changes in a company's ESG performance. Still, a company's being added to a benchmark ESG/SRI Index apparently sends a signal to investors, including those who do not integrate ESG factors into their decisions.
The authors write that inclusion is good news for all of a firm's shareholders:
"There are positive and statistically significant long-run abnormal returns for firms being included in the FTSE KLD 400."
Click here to download a pdf of Chow, Durand and Koh's working paper, "Are Ethical Investments Good?"
Click here to learn more about the rebranding of KLD's family of indexes, including a table of previous and current FTSE KLD index names.
Also see this interview of Thomas Kuh, Managing Director of KLD Indexes, for a discussion of how SRI has evolved since KLD's founding.
Corporate "Speech" and the First Amendment: Supreme Court May Overturn Ban on Corporate Campaign Contributions
Adam Cohen, writing in the New York Times, recently called attention to a Supreme Court case that "could open the floodgates to corporate money in politics." He notes that since 1907, federal law has banned corporate contributions to political candidates. In September, the Court will hear arguments in Citizens United v. Federal Election Commission. Mr. Cohen writes:
"The court has gone to extraordinary lengths to hear the case. And there are worrying signs that there may well be five votes to rule that the ban on corporate contributions violates the First Amendment."
This case could have profound effects on sustainable/socially responsible investing (SRI) and the corporate social responsibility (CSR) movement.
If the Supreme Court holds that a corporation has a First Amendment right to contribute to candidates, does it have the duty to do so to protect the interests of the corporate person? How might shareholders affect the corporate decision to contribute to political candidates?
First National Bank v. Bellotti (1977) found companies had a First Amendment right to put money into referenda and other efforts to alter public opinion. So in the context of Burger-Rehnquist-Roberts (the Nixon-Bush II Courts) precedents on corporate powers, the result Mr. Cohen fears is a relatively small step. It is only radical when one takes a longer perspective, maybe even an originalist constitutional perspective....
Mr. Cohen on the irony of the Court's position:
"If the conservative justices strike down the ban, they would be doing many things they disavow. They would be substituting their own views for the will of the people, expressed through Congress. They would be reading rights into the Constitution that are not expressly there, since the Constitution never mentions corporations or their right to speak. And they would be overturning the Court's own precedents."
In any event, this is a case to watch. It is not too early to think about suitable responses.
Every Vote Counts, but Who Counts the Votes? Boston Common's Dawn Wolfe on the Integrity of the Proxy Process
"Vote early, vote often," was a cynical dictum for old-time, big-city machine politics. Unfortunately, according to a recent release from Boston Common Asset Management (BCAM), modern proxy voting is also subject to shenanigans.
A recent "say on pay" proposal at Waddell & Reed Financial received majority support, according to BCAM, but the company reported to the SEC that the proposal only received 48.5% of the vote. "This raises questions about the integrity of the proxy voting process, and the lengths a company will go to close out shareholder input," BCAM's Dawn Wolfe wrote to the Social Investment Forum (SIF) listserv.
Proxy reform is a SIF priority, as many investors believe that independent shareowners are not well-served by the status quo.
BCAM explains this particular case:
"On April 8th, Waddell & Reed reported at its annual meeting that 50.6% of shareowners voted in favor of the say-on-pay proposal. This significant level of support was garnered despite a personal plea by the CEO in the form of a letter filed alongside the proxy statement urging investors to vote against it. … "In the intervening months between the stockholder meeting and its quarterly filing, Waddell & Reed Financial continued its active opposition to say-on-pay, culminating in a June 12th argument to the Delaware court that it should be allowed to retroactively count approximately 3.2 million additional votes, more than 2 months after the close of the polls. … "The Court of the Chancery of the State of Delaware granted Waddell & Reed's petition to reopen the polls and count the specific block of votes identified by its proxy solicitor as omitted on June 12th. The majority of those votes were cast against the proposal, according to Waddell & Reed." [Emphasis added.]
Ms. Wolfe believes that the proxy solicitor's efforts amount to "special treatment" for a block of votes that happened to support management's position.
"It's obvious the company feels quite strongly that being able to record a marginally lower level of support than they announced at the annual meeting is somehow significant," she said. "It is significant to discussions of proxy voting integrity, but Waddell is missing the big picture of what is significant for its shareowners."
For more on this issue, see SIF's "Comment Letter to the SEC on Proxy Access". Also, SIF's Peter DeSimone provided their listserv with a link to a proposed SEC rule that seeks to "address issues that have arisen in the proxy solicitation process."
On August 11, the Financial Times reported on the promise of "synthetic biology," including the development of algae that generates biofuels. In July, ExxonMobil entered into a $600 million venture with Synthetic Genomics, a firm founded by biotech pioneer Dr. Craig Venter. "Synthetic Genomics has already engineered strains of algae that secrete oil from their cells," writes the FT's Clive Cookson.
Will oil companies transform themselves into algae companies? Or, a few years from now, could the makers of "Who Killed the Electric Car?" film a sequel about algae?
The Most Promising Biofuel
Algae is a photosynthetic organism, which typically survives under water in much the same way that plants survive on land–by consuming carbon dioxide and sunlight and expelling oxygen. One of the fastest-growing organisms on earth, algae presents remarkable potential as a replacement for fossil fuels. Most notably, it consumes CO2 while it grows and can produce oil that can be burned in ordinary diesel engines.
Algae also has distinct advantages over other biofuels. First, the US Department of Energy reports that algae yields 30 times more energy per acre than land crops. Second, since it can grow in saltwater, and can even be grown vertically, it does not compete with food crops for arable land, unlike ethanol from corn, sugarcane, and soybeans. Third, algae growth does not demand limited resources, like soil or potable water.
As of today, algae's only disadvantages are its cost and suitability for large-scale, industrial use. There are several industry organizations devoted to reducing these disadvantages, such as the Algal Biomass Association. Many small biotech startups are also seeking ways to lower cost.
Algae for Airliners and Power Plants
Though algae has been studied as an energy source for over 35 years, interest has taken off recently – led by the aviation sector. After the world's first biofuels test flight in February 2008, in which Virgin Airlines used a blend of 20% babassu and coconut oil, the airline industry has committed to algae. By early 2009, Continental Airlines and KLM-Air France had operated test flights using 50% algae-blend biofuels. KLM ambitiously plans to fuel 50 of its planes with algae by 2010, and Lufthansa plans to fuel at least 5% of its planes with biofuels by 2020. Aerospace giant Boeing founded the Algal Biomass Organization, which is chaired by Boeing executive Billy Glover.
Algae could also help reduce CO2 emissions by power plants. Utilizing technology created by GreenFuel Technologies, an MIT-based firm, Arizona Public Service has experimented with this since 2006. Algae flourishes when fed CO2 from a power plant's exhaust stack.
A number of firms are researching algae for automotive use. Solazyme, a California-based startup, uses yeast and fermentation to grow its algae. Solazyme is working with Chevron, the second largest oil producer in the United States. Sapphire Energy, a company funded by Bill Gates' investment firm, also plans to turn algae into automobile fuel. And as mentioned above, ExxonMobil has entered into a joint venture with Synthetic Genomics.
"Green Company of the Year"
In August 2009, Forbes magazine awarded ExxonMobil its "Green Company of the Year" award, but that was primarily for its interest in liquefied natural gas (LNG). In a gushing article mostly focused on Qatari gas fields, the magazine described ExxonMobil's algae investment as a "purely political" step to "buy some peace with environmentalists."
Perhaps. It's also possible that oil companies could be purchasing algae-related patents to suppress their application. "Who Killed the Electric Car?" provides an example of how a large corporation could squash technology that it perceives as a threat. In the 1990s, General Motors developed an electric car, but refused to widely market the product despite heavy demand. The company cited high production costs as the reason for discontinuing its EV1, before literally crushing the vehicles.
Today, a post-bankruptcy GM is betting its future on the electric car. There is evidence that ExxonMobil may also be sincere in preparing for a post-petroleum future. In a 2008 KLD Blog article, Alan Petrillo noted that ExxonMobil has sharply reduced its spending on oil exploration. Forbes says plainly that the firm "is running out of oil."
As states control more and more of the world's oil fields, ExxonMobil may be buying algae to protect itself as a refiner and marketer. Forbes emphasizes ExxonMobil's good relations with its Qatari LNG partners, but no major oil firm can rely on only one source. By working with Craig Venter, Exxon Mobil could reduce its dependency on the Hugo Chavezes of the world.
Still, as the firm whose name is forever attached to Valdez, ExxonMobil will always inspire suspicion from some observers, who fear we may someday ask: "Who Killed the Algae?"
Should hedge funds be subject to the same regulatory scrutiny as mutual funds? The Managed Funds Association (MFA), a trade group for private equity firms, would prefer to avoid the surprise audits that mutual funds face.
"In a July 28 comment letter, Stuart Kaswell, MFA general counsel, said an annual surprise exam for pooled investment vehicles advised by registered investment advisers [IAs] would be 'overly burdensome, inefficient and unresponsive to investor demands.' Surprise exams also would be redundant for most hedge funds that already have an independent annual audit, Kaswell said. "Kaswell recommended that the SEC instead require registered IAs to pooled investment vehicles with custody of client funds to arrange for such vehicles to be subject to annual audits by Public Company Accounting Oversight Board-registered audit firms. … "'A mandatory, independent, effective annual audit for each pooled investment vehicle would serve as a substantial obstacle to an adviser attempting to misuse client assets,' he added."
Expected audits are certainly a "substantial obstacle" to malfeasance, but this may not be the best week to argue that regulators should tread lightly around private equity. The Financial Times reports on a court appearance by Bernard Madoff's "senior lieutenant," Frank DiPascali:
"Mr. DiPascali, who has agreed to co-operate with prosecutors, told the court how he, Mr. Madoff and unnamed others manufactured millions of pages of fake documents, regularly lied to investors and regulators, and moved money to London and back to throw watchdogs off the scent of the decades-long scheme."
Bankers' Incentive Pay Didn't Benefit Stockholders, New Study Confirms: ShareOwners.org Calls for Truer Alignment of Managers and Investors
A coalition of investors and advocates has called on Congress to regulate corporate pay practices – especially at banks. In a July 31 letter, ShareOwners.org, Americans for Financial Reform (AFR) and the Social Investment Forum (SIF) expressed support for a House bill to give shareowners "a 'say on pay' for top executives," and also compel financial firms to "disclose any compensation structures that include incentive-based elements."
The groups' focus on incentives comes from a bit of conventional wisdom on the causes of the financial crisis: Pay practices at financial firms encouraged executives to look out for themselves, rather than shareholders. ShareOwners.org conducted a poll which found that "the No. 1" threat to investors' faith in the markets is "overpaid CEOs and/or unresponsive management and boards."
But what if "overpaid" executives believed they were looking out for shareholders? New research suggests that CEOs' interests have been all too well aligned with the short-term interests of investors, rather than the long-term health of their companies.
On the Harvard Law School Corporate Governance blog, RenÚ Stulz of Ohio State University writes:
"Our [research] shows that there is no evidence that banks with a better alignment of CEOs' interests with those of their shareholders had higher stock returns during the crisis and some evidence that banks led by CEOs whose interests were better aligned with those of their shareholders had worse stock returns and a worse return on equity."
Mr. Stulz is referring to "Bank CEO Incentives and the Credit Crisis," a new paper he co-wrote with Rudiger Fahlenbrach. They studied "whether the alignment of interests between CEOs and shareholders can explain the performance of banks…during the credit crisis, and how CEOs fared during the crisis." In particular, they looked for correlation between a CEO's share price-based incentive pay, such as stock options, and the stock's performance:
"Though options have been blamed for leading to excessive risk-taking, there is no evidence in our sample that greater sensitivity of CEO pay to stock volatility led to worse stock returns during the credit crisis. "A plausible explanation for these findings is that CEOs focused on the interests of their shareholders in the build-up to the crisis and took actions that they believed the market would welcome."
In describing their research, Stulz and Fahlenbrach assert that a CEO who focuses on share price is "aligned" with investors' interests. Perhaps this short-term "alignment" distracts managers from creating value for other stakeholders, including workers, communities, and committed "shareowners."
In a June 25 statement, ShareOwners.org, SIF, and AFR called on corporate America to manage for its "long-term sustainability," not high share prices.
Reforming corporate pay practices is only one part of this process. ShareOwners.org's summary of their reform agenda is reproduced below; it is a blueprint for a truer alignment of managers and investors.
"…Shareholders in America's corporations – who more accurately should be thought of as 'shareowners' -- have limited options when it comes to protecting themselves and the long term sustainability of the companies they own. … "The four-part ShareOwners.org agenda is spelled out in detail on the Web and may be summarized as follows: * Stronger regulation of the markets through a beefing up the Securities and Exchange Commission (SEC), ensuring that it has the resources and authority to increase supervision and enforcement of financial professionals, hedge funds, and mutual funds, and also forfeiture of compensation and bonuses earned by management in a deceptive fashion, strengthening state-level shareowner rights, and protecting whistleblowers and confidential sources who expose financial fraud and other corporate misconduct. * Increased accountability of boards and corporate executives by allowing shareowners to vote on the pay of CEOs and other top executives, empowering shareowners to more easily nominate directors for election on corporate boards, requiring majority election of all members of corporate boards at American companies, splitting the roles of chairman of the board and CEO at major companies, stopping the practice of brokers casting votes for shareowners in board elections, and allowing shareowners to call special meetings. * Improved financial transparency, including a crackdown on corporate disclosure abuses used to manipulate stock prices, strengthening corporate disclosures so that shareowners can better understand long-term risks, and protecting U.S. shareowners by promoting new international accounting standards. * Enhanced protection of the legal rights of defrauded shareowners, which means preserving the right of investors to go to court to get justice, ensuring that those who play a role in committing frauds bear their share of the cost for cleaning up the mess, and allowing state courts to help protect investor rights."
On July 27, the Financial Times published "Too Big to Fail." US readers may have expected an article on an automaker, or an investment bank, but Catherine Belton's piece is about Russian industrial tycoons. The economic turmoil of the past year has twisted the fortunes of Russia's oligarchs, its government, and its foreign lenders. The title's irony is that each of these three groups has seemed, for a time, to be "too big to fail" without bringing the others down too.
It's a fascinating chain of events, and it dramatizes the fungibility of power. Monetary transactions between banks, states and corporations can be distorted by non-financial demands; as the global crisis has shown, political considerations can suddenly change the value of loans and companies.
Three Elephants: Banks, Tycoons, and the Kremlin
When commodity prices were high, Russian energy and mining companies made big profits. The Russian government's revenues also spiked. As the global economy slowed in 2008, overextended companies seemed on the verge of default to US and EU creditors. Fearing the social impact of a wave of bankruptcies, the Russian government paid off companies' debts to foreign banks – for a while.
Ms. Belton describes how, as 2009 has progressed, some Russian companies have stopped repaying foreign debts. Government pressure, she writes, is driving these decisions by private firms:
"Part of the reason for the oligarchs' stay of execution lies in a partial recovery in commodity prices. But mainly it resides in the Kremlin. Officials fear a social backlash if bankruptcies and ownership upheavals come at a time when output has fallen by its steepest in almost two decades and unemployment has touched eight-year highs. As the government stretches to put out economic fires, pragmatism is prevailing over how far it should extend its management capabilities. … "At a time when global banks are being squeezed all round, the government and Russia's tycoons have come to believe that they may have the upper hand. As a person familiar with the matter quotes one hardnosed Russian tycoon as saying: 'If I can't pay [a large French bank] $4 billion, is it my problem or is it theirs?' … "In January this year, things looked much safer for the international banks and more dangerous for the oligarchs. Bankers from Merrill Lynch, Credit Suisse and BNP Paribas were still congratulating themselves on winning a $4.5 billion [Russian] government loan last October…"
Look Out Below
In fact, it's our problem, as investors, taxpayers and citizens. "When elephants fight," says a proverb, "it is the poor grass that suffers."
If a French bank's loans are stuck in a non-performing limbo because of Russian politics, what is that bank's stock worth? What is the value of a pension fund that owns that stock? No amount of purely financial analysis can reveal the value – or risks – hidden inside a firm. A corporation is inevitably a political animal, and its value is shaped by politics – at home and abroad.
In this context, investors must "learn to deal in grays," KLD President Peter Kinder recently said, describing extra-financial responsible investing analysis. "Investors cannot judge companies without looking at past performance, and they also can't read too much into any one measure of performance. Sound analysis depends on a bigger picture."
The hard numbers of a financial statement, or a share price, can hide more than they reveal. In a world where states and corporations grapple, and teeter, the investors below need a better view.
A new study of water companies' ESG disclosure finds that, with some exceptions, utilities in developing nations "disclose far more performance data" than their EU and US counterparts. The Interfaith Center on Corporate Responsibility (ICCR) reviewed water suppliers' reporting of environmental, social, and governance (ESG) metrics. "Liquid Assets: Responsible Investment in Water Services" also surveyed a representative sample of 12 major global water utilities, scoring them on 21 "key disclosure issues."
In the report's executive summary, ICCR notes that control of the global water supply is a sensitive topic, but also says that "it is not the purpose of this report to debate the merits of public versus private ownership." Instead, "Liquid Assets" explores how well utilities – whether investor- or government-owned – communicate with stakeholders. In calling for better disclosure of comparative ESG data, ICCR says:
"Creation of a 'data commons' is essential for protection of the water commons."
The Law is Not Enough
How do we know our water is safe? In most nations, the answer is that the law requires it to be. "Liquid Assets" argues that this is not enough. Chapter 5, "Benchmarking ESG Performance," explains that government regulators cannot always find hard data on service levels, water quality and costs – and neither can citizens or investors.
While utilities in New York City and New South Wales, Australia scored well on ICCR's tests, developed nations actually lag emerging markets in the overall quality of their water firms' ESG reporting. ICCR cites World Bank standards as a crucial factor in this disparity:
"Public and private water services utilities in most developing countries and emerging market nations disclose far more performance data via the World Bank's International Benchmarking Network on Water and Sanitation Utilities (IBNET) than do the utilities operating in OECD countries. … "The reports from the large utility companies surveyed indicate that their ESG disclosures are driven by regulatory, rather than corporate mandates."
Corporate Reporting May Not Describe Local Conditions
The Global Reporting Initiative (GRI) is a multi-stakeholder effort to improve sustainability reporting by corporations worldwide. GRI disseminates reporting guidelines to support the "transparent and reliable exchange of sustainability information," according to their website.
"Liquid Assets" explains why a firm's GRI-compliant reporting may not reveal the true state of its water-related holdings:
"The principal problem with use of the GRI by the water services sector is that the data are aggregated and reported globally, whereas water resources must be managed locally or regionally within a given watershed. Globally aggregated information about water supply, for example, is of little use to investors seeking how to understand how well a utility in a water-stressed area is managing supply risk."
The ICCR authors note that GRI guidelines call for reporting companies to disaggregate some data, but that none of the surveyed water utilities did so.
What Should Water Utilities Tell Us?
On behalf of investors, ICCR says that adequate disclosure would show that:
"Management systems are in place to capture data needed for protection of water supply, maintenance of infrastructure, and early identification of ESG risks; appropriate risk management policies exist and are being followed; and data are being used to monitor trends and progress in attaining benchmarks for continuous improvement. "This is critical information that should inform investment decisions by governments as well as private investors. It is a failing that must be cured."
Institutional investors may have a fiduciary duty to consider environmental, social, and governance (ESG) factors, according to a new study from the United Nations Environment Programme Finance Initiative (UNEP FI). In reporting on "Fiduciary Responsibility," Social Funds' Robert Kropp expressed the uncertainty that still surrounds the question of ESG-related fiduciary responsibilities:
"The report argues that consultants may well have a legal duty to proactively raise ESG issues with their clients. The report also recommends that ESG issues be embedded into legal contracts between asset owners and asset managers."
As the case for managers' ESG-related obligations under securities and trust law is still open, UNEP FI says, ESG proponents should encourage clients to demand integration from their advisors. For now, asset owners, not courts, must drive ESG integration – though lawmakers may yet embed responsible investing into managers' obligations.
"We need to live off the interest"
In his introduction to the 101-page report, Achim Steiner of UNEP FI says that the economic crisis "requires us to review the economic models this century has inherited from the last one." He places particular emphasis on the environment, declaring that "we are living off the Earth's capital – we need to live off the interest."
Towards this end, "Fiduciary Responsibility" describes how some shareholders have begun to consider the ESG performance of the companies they invest in. While the report does not prove that ESG integration is a fiduciary duty, it does offer practical reforms that would help create such duties. For example, UNEP FI calls out signatories of the Principles for Responsible Investment (PRI): "…In order to maintain their membership, all asset manager and asset owner signatories [should be required to] embed ESG issues in their legal contracts."
UNEP FI also says that government should redefine the work of fiduciaries:
"Global capital market policymakers should also make it clear that advisors to institutional investors have a duty to proactively raise ESG issues within the advice that they provide, and that a responsible investment option should be the default position. "Furthermore, policymakers should ensure prudential regulatory frameworks that enable greater transparency and disclosure from institutional investors and their agents on the integration of ESG issues into their investment."
Commentary on ESG and Fiduciary Duty
"Fiduciary Responsibility" is the sequel to a 2005 UNEP FI study, called the "Freshfields report" after the consultants who prepared it, that helped spur the creation of the PRI. The new report includes a literature review of "practical developments" in ESG integration; the results of a survey of how major investment managers approach the topic; and commentary from UK and US experts in fiduciary law.
Quayle Watchman Consulting describes how attitudes and laws have changed since 2005. In the UK, the law now impels corporate directors to consider the broader effects of their decisions:
"Under current United Kingdom company law legislation, the Companies Act 2006 (the '2006 Act') imposes duties on company directors to report on the environmental and social impacts of their business activities. "[Guidance] on the duty of directors to promote the success of the company under section 172 of the 2006 Act, which is the principal replacement duty for the common law fiduciary duties of company directors, also adds that 'success' is to be judged in terms of long-term increase in the value of the company rather than short-term gains."
The obligations of directors have changed, but Quayle Watchman notes that "the government declined to introduce amending legislation to clarify the position of pension fund trustees." While trustees may consider ESG factors in their investment decisions, there is no legal imperative to do so. Quayle Watchman considers the roots of trustees' "short-termism":
"There appears to be resistors to responsible investing which relate to deeply-rooted characteristics of the investment decision-making system including: the mandates that pension funds and their investment consultants set; the systems for measuring and rewarding performance (which focus on peer comparison and beating benchmarks rather than on fulfilling the long-term liabilities of pension funds); and the competencies of service providers (e.g. sell-side analysts). "The effect of this resulting short-termism is that less attention is paid to responsible investment matters than is appropriate–these issues are too long-term in nature to affect the day-to-day behavior of fund managers."
Asset Owners Must Lead Their Managers
Quayle Watchman explains how investors, "in the absence of government legislation or regulations, codes of practice or guidance," can build a long-term perspective into capital markets. They note the impact of the PRI program, which has attracted more than 550 signatories, representing approximately $18 trillion in assets under management.
Responsible investment, conducted at this scale, has helped shift the financial sector's priorities. "Fiduciary Responsibility" cites Bloomberg's placement of carbon emissions data on its terminals as evidence that sustainability is now a mainstream concern.
In the aftermath of the global financial crisis, fiduciary duties may undergo a broader philosophical shift. According to Quayle Watchman:
"The courts accept, despite the widespread use of mathematical modeling, that investment is an art rather than a science, and that there is a wide spectrum of opinion on investment which may be held by advisers without an adviser acting negligently."
The socially responsible investing (SRI) market is poised to grow dramatically, predict the authors of a new report from Robeco and Booz & Company. According to Responsible Investing: A Paradigm Shift, socially responsible investments will reach $26.5 trillion assets under management (AUM) by 2015–over 15% of the global total.
Responsible Investing Grows Faster than the Overall Market
As of 2007, global SRI AUM was $5 trillion, with $2.7 trillion of that total invested in the United States, according to the Social Investment Forum's 2007 Report on Socially Responsible Investment Trends in the United States. SRI assets increased more than 18% between 2005 and 2007 in the US, while the broader universe of AUM increased less than 3%. Globally, the SRI market has grown at an annual rate of 22% since 2003, while global AUM growth rates have stagnated around 10%.
Growth Factors: Governments, UNPRI, and the Public
Robeco and Booz studied industry projections and also interviewed experts throughout the financial services industry. They found that SRI's growth drivers include growing demand from consumers and investors for corporate responsibility and government efforts to curb greenhouse gas (GHG) emissions. Also, more firms have sought to sign and comply with the UN Principles for Responsible Investment, and pension disclosure regulations in the UK have forced money managers to expand the scope of research on the impacts of their investments.
Some Big Players Still On Sidelines – For Now
SRI has room for even more dramatic growth, partly because many large players haven't actively pursued it yet. According to the report, "The top [SRI] fund managers are not necessarily the [mainstream] market leaders in terms of AUM."
But by 2015, niche players will have to grow considerably to remain competitive as major global players enter into the space. A Paradigm Shift notes that Deutsche Bank already has three funds with $2.8 billion AUM, and BlackRock seeks to increase its SRI holdings to 15% of its total AUM by next year. The report predicts that many more institutions of similar size will begin to take action in the near future.
Growing Market, Shifting Tactics
The authors of the Robeco and Booz report predict that as big new players enter the SRI space, the practice of responsible investment will evolve. The European Sustainable Investment Forum (Eurosif) already segments the market into "Core" and "Broad" SRI:
"Eurosif continues to segment the SRI market with Core SRI estimated at €512 billion and Broad SRI at €2.154 trillion. Core SRI consists of elaborated screening strategies systematically impacting portfolio construction and often implying a values-based approach while Broad SRI partly represents the mainstreaming of SRI and the growing interest of responsible investors, particularly large institutional investors, in this area."
Despite this segmentation, Robeco and Booz believe that the growth of SRI will accelerate: "This trend will significantly reshape the asset management landscape over the next few years…SRI will become mainstream within asset management by 2015."
Environmental Leader, along with most major news outlets, reports that Walmart is preparing to develop a sustainability index for its suppliers and products. The index will try to account for the environmental, social and governance (ESG) performance of Walmart suppliers "in such a way that consumers [can] easily discern the sustainability of one product over another." Marc Gunther at The Big Money writes: "For the [Walmart] index to work, consumer-goods makers will need to understand the origins of everything they put into their products."
Recent news about the global supply chain has made me think about my own origins.
I don't usually refer to myself on the KLD Blog, but on this topic, I'll make an exception. I was fortunate enough to attend Carnegie Mellon University in Pittsburgh, Pennsylvania – an industrial town, and a school founded by an industrialist and a financier. I was able to do so because my father, a manufacturer's representative, had a productive understanding of the 1980s market for truck equipment in the Northeastern US.
College's big ideas and relationships (including my marriage) were, in a sense, brought to me by a stream of dump bodies and liftgates from a plant in Council Bluffs, Iowa.
The power of the industrial supply chain is both personal, and profound. Perhaps this is why I found this New York Times report, on the roots of recent violence between ethnic Uighurs and Han in China, especially painful. Andrew Jacobs describes a hellish brawl, and also the stage for this tragedy:
"During a four-hour melee in a walkway between factory dormitories, Han and Uighur workers bludgeoned one another with fire extinguishers, paving stones and lengths of steel shorn from bed frames. … "Li Qiang, the executive director of China Labor Watch, an advocacy group based in New York that has studied the Shaoguan toy factory, has a different view [of the cause of Uighur/Han violence]. He said the stress of low pay, long hours and numbingly repetitive work exacerbated deeply held mistrust between the Han and the Muslim Uighurs, a Turkic-speaking minority that has long resented Chinese rule."
The setting for this madness was a toy factory. All this suffering is at the front of a supply chain that leads to me, and my kids' allowance money.
Labor activists might scold me for needing to be reminded of this, and a new book will make more Americans less comfortable with all our cheap stuff. In "Cheap: The High Cost of Discount Culture," Ellen Ruppel Shell considers our culture's "insidious human costs," in the words of Salon reviewer Stephanie Zacharek.
Accounting for such costs, Ms. Zacharek writes, is "impossible" without China, but she also points out that "China isn't the source of the 'cheap goods' problem":
"[Author Ellen Ruppel Shell] quotes Mark Barenberg, a professor of law at Columbia University and an expert on international labor law: 'The severe exploitation of China's factory workers and the contraction of the American middle class are two sides of the same coin.'… "In other words, employers in the United States can easily use the threat of downsizing and outsourcing to gain more power over, and squeeze more juice out of, their employees -- who, in turn, enjoy increasingly less protection from unions."
"Cheap" author Shell explores the role of retailers like IKEA in maintaining "discount culture." Ms. Zacharek makes an example of IKEA's purchases of timber. While the firm is the third-largest buyer of wood in the world, it employs only 11 forestry experts to monitor its suppliers. Many of them harvest in remote regions where wages are low, working conditions are poor, and "half of all logging is illegal."
Ms. Zacharek asks the question that Walmart is now attempting to answer:
"Would enlightened consumers pay a little more, maybe, to buy products made from wood that had been, unquestionably, legally harvested? Maybe -- but it's not the consumer's choice to make, at least not right now. And if there's one thing that makes reading this eye-opening book an ultimately frustrating experience, it's that Shell can't offer many helpful solutions to this tangle of economic and moral problems, aside from urging us to be more aware as consumers."
I would argue that, rather than becoming "more aware as consumers," we should remember that there is no such animal as a "consumer." Each of us produces, consumes, and benefits from the work of others – past and present. The money I spend at IKEA, like my education and my career, came from the labor of my Dad, and also people in Council Bluffs and Shaoguan.
My life's good fortune was brought to me by a certain sort of economy; the world's supply chain makes our lives, not just our stuff.
As the Senate deliberates over the House's Waxman-Markey cap-and-trade bill, Politico has presented a debate on the bill's potential impact on the US economy. Mindy S. Lubber, of the environmental coalition Ceres, argues that Waxman-Markey "deserves our support." In response, William L. Kovacs of the US Chamber of Commerce tells why he believes the economy will be harmed by the bill's provisions.
Their discussion is a useful summary of pro- and anti-Waxman-Markey arguments. It also shows that a productive public policy debate depends on data. While both sides marshal projections and estimates to make their case, neither can present hard numbers on the cost of carbon emissions by American business. Many companies disclose some data, but without standardized, economy-wide reporting, no one can know the real costs or benefits of a cap-and-trade scheme.
To fill this void, Federal regulators are considering a plan to force "public companies to report the dangers they face from releasing carbon dioxide and its warming aftermath," according to Evan Lehmann in the New York Times. He cites Ceres research that found "76 percent of Standard & Poor's 500 companies failed to mention climate change in their annual reports to the [Securities and Exchange] Commission last year."
Mandatory, comparative reporting is essential to the business case for – or against – Waxman-Markey, or any future attempt to set a price for carbon emissions.
The Business Case, Pro and Con
In their arguments, both Ms. Lubber and Mr. Kovacs focus on the societal cost of carbon pricing. Ms. Lubber cites a Congressional Budget Office estimate that the direct costs of Waxman-Markey will "average about $175 annually per family by 2020." She argues that this cost would be justified by the growth of a "clean energy economy," and that opponents are discounting "the costs of doing nothing":
"Perhaps the most maddening aspect of debate over the Waxman/Markey bill has been the consistent omission by opponents of the costs of doing nothing -- the enormously high and disruptive price science tells us we'll pay if we don't act now. Disrupted agricultural patterns, more and stronger storms, rising sea levels, a scramble for dwindling resources -- all propelling population shifts and requiring massive emergency spending as we try to cope."
Mr. Kovacs, representing the US Chamber of Commerce, accepts that "a feasible cap-and trade system might work." His rebuttal focuses on the flaws he sees in this particular bill, arguing that it will create unfair burdens on consumers and businesses. "Carbon-based fuels are and will remain for decades the backbone of the U.S. energy system," he says, and he believes that carbon caps would hurt US competitiveness:
"Imposing limits on our own energy use and driving up our own costs – while developing nations like China and India pollute with abandon – will neither reduce global greenhouse emissions nor improve America's competitive position. … "Now, regarding the cost, let's go to the CBO pricing mentioned: 'The resource cost does not indicate the potential decrease in gross domestic product (GDP) that could result from the cap.' … In other words the $175 figure is merely a fraction of the cost, as it does not include economic impact."
The Hidden Costs of the Status Quo
Ms. Lubber takes issue with many of these contentions. She also says that not assigning a price to carbon distorts our analysis of its cost:
"This bill, even in its present form, is not about distorting the workings of the carbon market, as Mr. Kovacs says. In fact, it's very much about correcting a massive existing distortion long-embedded in our current market system -- the fact that the price of emitting global warming pollution has been zero. "Why doesn't a business group see this distortion? Once polluting costs are honestly counted we'll innovate our way to less polluting – transparency and honest accounting make markets work."
The Investors' Case for "Honest Accounting"
Evan Lehmann, in explaining why the SEC is taking a "a very serious look" at mandatory disclosure of exposure to climate-related risk, sums up investors' concerns:
"Institutional investment groups with trillions of dollars in assets could use the disclosures as the basis for withdrawing money from companies they consider unprepared for rising risk related to regulation and climatic convulsions. " 'It's reasonable to expect that companies would fail to focus on long-term risk posed by climate change, and more forced disclosure would correct a potential market failure,' said John Echeverria, executive director of Georgetown University's Environmental Law and Policy Institute. 'That seems like incredibly important information that investors might have.'"
Argue from the Facts
The Chamber's essay suggests that business presents a unified opposition to Waxman-Markey, but the Wall Street Journal has reported that some companies have charted their own path. Mindy Lubber notes that many major firms support "carbon reduction targets, carbon caps and immediate steps to improve energy efficiency." Also, while Ceres and many environmental groups support Waxman-Markey in its current form, Friends of the Earth, Greenpeace, and Public Citizen oppose the bill for not being strong enough.
This diversity of opinion is welcome, especially if all sides can agree on the terms of debate. In moving to require uniform disclosure of climate risk, the SEC recognizes that sound investment – like productive policy debate – is founded on facts. Mindy Lubber quotes the late Senator Patrick Moynihan: "While people are entitled to their own opinions, they're not entitled to their own set of facts."
For more on this topic, see The Risks of Climate Change are Already Material: New Ceres/EDF Study Calls for SEC to Mandate Better Disclosure
Social Funds recently published a two-part article on corporate responsibility for fighting human trafficking and forced labor, especially commercial sexual exploitation of children (CSEC). Reporter Robert Kropp writes that corporations have an important role to play in the prevention of child sex tourism, but American companies appear reluctant to act: of 623 global signatories of a Code of Conduct for Protection of Children from Sexual Exploitation in Travel and Tourism, only 5 are American.
The World Trade in People
Globalization has spurred the growth of international human trafficking and CSEC. According to International Labor Organization estimates, the global sex industry is worth $28 billion annually. The United Nations Global Initiative to Fight Human Trafficking (UNGIFT) estimates that approximately 2.5 million people are trafficked annually. Of those trafficked, the United Nations Children's Fund (UNICEF) finds that approximately 1.2 million are children. According to the UN, 30% of women and children trafficked each year are from Asia.
This month, the US Department of State released a report that finds that the global economic crisis is exacerbating the international demand for human trafficking.
To fight the global trade in people, both public and private organizations must act. Governments must protect their citizens, but human trafficking is a profit-seeking enterprise that depends on legitimate tourism-related businesses. While some such firms have developed promising initiatives, real progress depends on pressure from citizens and investors.
Government Part of the Problem, and the Solution
The rights of the child are institutionalized in the UN Convention on the Rights of the Child (UNCRC). Article 34 specifically compels states to protect children from "all forms of sexual exploitation and sexual abuse," but these rights are too frequently violated for economic gain.
Some national governments have announced initiatives to mitigate the risks of human trafficking. In May 2009, the Chinese government announced efforts to develop a DNA database for use as a tool to trace missing children. Human trafficking has thrived in China due to cultural gender bias and a government-imposed one-child policy. Both poverty and the imbalanced ratio of men to women in rural areas have contributed to this problem.
Governments can also better regulate citizenship and legal standing. Burkina Faso announced an initiative to prevent further trafficking in children in May 2009, with a $5 million plan to provide free birth certificates to five million people. Almost 1 in 3 Burkinabe children lack proof of identity and age, leaving them more vulnerable to kidnapping and slavery.
Defining the Role of Business
Corporations – especially those involved with travel and tourism – play a pivotal role in resisting, reporting and educating the public about the practice of human trafficking. Globe-spanning human trafficking would be impossible without anonymous transportation, venues, and access to funds. And yet, the global business community has not fully defined what responsible firms should do to protect human rights.
In May 2009, the UN proposed guidelines for a "protect, respect, remedy" stakeholder framework for human rights. The framework, based on a 2008 report, first calls for governments to protect against human rights abuses within its jurisdiction. Secondly, the framework recognizes the corporate responsibility to respect human rights and avoid complicity in abuse. The third part of the framework calls on companies to provide access to remedy, particularly in places where judicial and non-judicial mechanisms are underdeveloped, by instituting grievance processes.
The Social Funds report indicates that European airlines and hotels have been more proactive to educate customers about child sex tourism. In April 2009, the Vienna Hilton announced a partnership with UNGIFT aimed at victim support and rehabilitation. The hotel proposed to hire a victim of human trafficking and present the results to the business community, and to train existing staff on telltale signs of trafficking.
Investors Act to Change American Firms' Approach
Robert Kropp also notes that American airline and hotel companies have been far more resistant to incorporating sex trafficking awareness into their customer outreach. To the extent that American companies have actively fought human trafficking, they've responded to pressure from shareholder advocates. For example, hotelier Marriott addressed human trafficking in its human rights policy after a shareholder resolution drew attention to a specific incident at a Marriott hotel.
Investors' efforts have also led to the Financial Coalition Against Child Pornography, which monitors the movement of funds and closes payment accounts that are linked to child pornography. FCAP has also assisted with the development of corporate anti-trafficking policies, as in the case of Marriott.
Corporations Can Speak Louder than Governments
Poor publicity helped spur Marriott to fight human trafficking, but such motivation cannot be taken for granted. ECPAT, a network of organizations and individuals working to eliminate CSEC, argues that the general public is not broadly aware that sex tourism is illegal in every nation; that many countries have extraterritorial legislation allowing them to prosecute nationals for acts with children outside a country's borders; and that procedures are in place to report inappropriate actions.
Companies can play a proactive role in changing public perceptions. For example, MTV's EXIT (End Exploitation and Trafficking) campaign has worked with USAID to raise awareness about the seriousness of human trafficking in Asia. The anime film "Intersection," which has an anti-trafficking message, was produced in Thai, Mandarin and English and shown on MTV's Southeast Asia channels.
Perhaps this is the most distinctive contribution that business can make to the fight against human trafficking. Firms cannot make laws, but they can reach audiences that know little about UN resolutions or organizational initiatives. By stimulating public disquiet about this shadow economy, corporations can help build a mandate for its exposure, and elimination.
Last week, Responsible Investor reported that Adam Seitchik, former CIO of Trillium Asset Management, is joining London-based Auriel Capital Management. RI's Hugh Wheelan wrote that in hiring Mr. Seitchik, Auriel "is joining a growing number of hedge funds building strategies in the responsible investment space."
Why are absolute return managers becoming more interested in environmental, social and governance (ESG) analysis? According to Mr. Seitchik, the Principles for Responsible Investment (PRI) have spurred broader investor interest in ESG research. In a conversation on June 22, he discussed the impetus behind his move:
"Over the past few years, I've been intrigued by the growing interest of institutional investors in ESG. We're seeing more and more asset-owner signatories of the PRI, and more institutions that have joined the Investor Network on Climate Risk (INCR). "We're also seeing more ESG investors who are not [self-described] ethical investors, but pursue ESG integration in the context of risk mitigation and fiduciary duty."
Adding to the ESG Toolkit
Mr. Seitchik said that Auriel will serve these investors with "our institutional investment platform, focused on risk-adjusted return. Our firm focuses on absolute return investing, but we can also deliver long-only strategies." To explain how Auriel could integrate ESG factors into its strategies, Mr. Seitchik described a hypothetical long/short fund:
"Investors are currently offered long-only themed strategies like clean-tech, or green energy. We are adding to the toolkit – ESG research can help support a strategy that goes both long and short. "If you are able to hedge, you can reduce risk across a portfolio. Let's say an institution is interested in risk management around ESG in general, or specific areas such as biodiversity loss, or sustainable forestry. You can construct a two-part portfolio – an active long-short portfolio attached to an index fund. You might get exposure by tracking an index, but then go short on a particular holding. You can reduce overall portfolio risks without having to disrupt the existing index fund strategy. "What really matters to investors is their overall risk and return. We look to provide not a single fund, but an investment platform that can be adapted to the needs of clients."
In our conversation on Monday, I mentioned another recent RI article on Philips' commitment to more responsible investment of its employees' pension fund. Mr. Seitchik agreed that this is an important step: a private, for-profit institutional investor is joining the nonprofits and governments that have traditionally pursued ESG integration. Asked to speculate on why Philips might be doing this, Mr. Seitchik laughed and said, "They're Dutch."
He was only partly joking. Mr. Seitchik cited broad European involvement with PRI, INCR, and other multi-stakeholder initiatives as an impetus for ESG integration. He also mentioned Philips' role as a leader in energy efficiency technology. "Hopefully this will spread to more US companies as well, though US capitalism really does follow a different model than European or Japanese capitalism, and is evolving in its own way," he said.
The Commitment to Advocacy
I pointed out that along with committing signatories to change their own practices, the PRI also ask them to promote responsible investment by others.
"That's right," Mr. Seitchik said. "PRI signatories have signed on to a broader project, beyond changing their own practices. They've joined a network of investors, and PRI provides progress reports and does other work to sustain and expand that network."
In that spirit, I asked if Auriel will promote ESG integration to all of its clients. Mr. Seitchik gave an intriguing response:
"Auriel will be agnostic on this question. Our ESG efforts are focused on those institutions that are seeking these types of solutions, such as PRI and INCR signatories, and foundations interested in mission-related investing. We think it would be presumptuous to approach the market and say: you should definitely integrate ESG into your strategies. We surely will have clients who do not, and this is a client-focused initiative, responding to what we believe is real and enduring demand."
At Auriel, ESG strategies will only be integrated into client portfolios where there has been a specific request to do so. "Now, if we're successful, and better returns can be attributed to our ESG strategies, then that will expand demand."
"That said, I've staked my career on this," Mr. Seitchik said. "I think the commitment to mitigating ESG risks and seeking opportunities will mature, and become more widely shared. As more asset owners participate in ongoing initiatives like PRI, responsible investing will become a permanent and pervasive feature of the global economy."
The Risks of Climate Change are Already Material: New Ceres/EDF Study Calls for SEC to Mandate Better Disclosure
As the Obama Administration seeks to overhaul financial regulation, a multi-trillion-dollar coalition of investors has argued that the government should require corporate disclosure of climate change-related risks. Climate Risk Disclosure in SEC Filings – a deceptively modest title – calls for replacing the current hodgepodge of voluntary disclosure with a federally mandated reporting regime.
Ceres, the Environmental Defense Fund, and other sponsors of this Corporate Library-produced study formally presented their findings to the Securities and Exchange Commission (SEC) in a June 12 letter.
Perhaps the most provocative assertion in Climate Risk Disclosure is that voluntary disclosure, much like the "self-policing" practices that have supplanted direct regulation in many industries, is inadequate to its task.
"Climate change is for many companies a material risk," the authors write. They argue that the SEC, in its role as guarantor of the transparency of American securities markets, is already obligated to demand broad, uniform reporting of corporate climate-related risk exposure.
What are the Risks?
Climate Risk Disclosure authors Beth Young, Celine Suarez, and Kimberly Gladman sum up the risks that corporations should prepare to face:
- Physical risk from climate change
- Regulatory risks and opportunities related to existing or proposed GHG [greenhouse gas] emissions limits
- Indirect regulatory risks and opportunities related to products or services from high emitting companies
- Litigation risks for emitters of greenhouse gases
Broad Exposure, Limited Disclosure
Most companies, even those from the sectors that emit the most GHG, do not do enough to inform shareholders of how climate change threatens their business models. The report's authors reviewed climate risk disclosure in SEC filings from Q1 2008:
"[The study] evaluates the current state of climate risk disclosure by 100 global companies in five sectors that have a strong stake in preparing for a low carbon future: electric utilities, coal, oil and gas, transportation and insurance…. "Fifty-nine companies made no mention of their greenhouse gas emissions or their position on climate change, 28 had no discussion of climate risks they face, and 52 failed to disclose actions to address climate change. Even more telling, the very best of disclosure for any of the companies could only be described as 'Fair'–and only a handful of companies achieved this ranking."
It is significant that Climate Risk Disclosure looks at the insurance sector, along with industrial sectors that directly produce and consume large quantities of fossil fuels. Assessing, pricing and managing risk is what insurers do, yet US firms made little mention of their exposure to their customers' climate change risks:
"Eighteen out of 27 [researched insurance] companies (67%) had no mention of climate change or related risks anywhere in their SEC filings. Twenty-three out of 27 companies (85%) failed to disclose their emissions or a statement on climate change, while 24 out of 27 companies (89%) omitted disclosure on actions to address climate change, despite the wide range of opportunities for new, climate-related insurance products."
Climate Risk Disclosure notes that non-US insurers like Swiss Re, Munich Re and Zurich Financial did a better job.
Why are US firms lagging? The Ceres/EDF study suggests a simple answer: European companies face climate change in a more demanding regulatory climate.
What does Voluntary Disclosure Hide?
Climate Risk Disclosure provides a useful summary of why voluntary disclosure, like other forms of "self-regulation," tends to fall short of its promises:
"First, because it is voluntary, companies without a positive story to tell can simply decide not to disclose. In this way, disclosure will be skewed toward companies that are better positioned to address the risks and opportunities presented by climate change. … "Second, voluntary disclosure tends to focus on opportunities related to climate change while omitting or downplaying the risks. [A] 2007 KPMG/GRI study found that in sustainability reports, 'companies reported far more on potential opportunities than financial risks for their companies from climate change.'… "Third, voluntary disclosure is not uniform, frustrating efforts to benchmark companies against one another. … "Fourth, companies making voluntary disclosure tend not to quantify the financial impact of risks and opportunities. … "Finally, voluntary disclosure lacks the enforcement mechanism that comes with mandatory disclosure requirements."
Largest Investors Must Prepare for the Broadest Risks
In a preface to Climate Risk Disclosure, Anne Stausball of the California Public Employees' Retirement System (CalPERS) writes:
"CalPERS has a widely diversified portfolio that is impacted by all segments of the economy. The fund also has a long-term perspective, since it must meet beneficiaries' retirement needs now, and long into the future. As such, we must be aware of shifting conditions and liabilities affecting companies in our portfolio."
CalPERS is a leading member of the Ceres-led Investor Network on Climate Risk (INCR), a coalition of investors managing around $7 trillion of assets. Ms. Stausball notes that in 2007, CalPERS and the INCR petitioned the SEC "to ensure that publicly traded companies disclose material financial risks from global warming in securities filings, as required under existing securities law." [Emphasis added.]
The new Ceres/EDF research supports this contention: the SEC is already obligated, by the terms of existing rules, to require mandatory disclosure.
Item 303 and the Materiality of Climate Risk
Climate Risk Disclosure explores the various regulations that define what all publicly-traded companies must tell their shareholders, including "Item 303." The report says that the obligations of this rule, according to SEC statements, "encompass both financial and non-financial factors that may influence the business, either directly or indirectly." In summing up the implications of Item 303, the authors issue an unequivocal challenge to the SEC:
"The risks and opportunities created by climate change clearly fit within the range of factors to which Item 303 applies. The scientific consensus and improved ability for scientists to quantify likely climate change impacts preclude an argument that climate change is not a 'known' trend or uncertainty. The rapidly changing [environmental] regulatory environment introduces the possibility that past financial results will not be indicative of future results, and the effect is certainly material for many companies."
Also see these related KLD Blog articles:
Help Us Make Boards Work for Shareholders: Nell Minow Testifies Before Congress on Executive Compensation
Executive pay practices have recently drawn scrutiny from both Congress and the Obama Administration. Last week, Nell Minow of The Corporate Library testified before the US Committee on Financial Services on "Compensation Structure and Systemic Risk."
In her June 11 testimony, as in her previous work, Ms. Minow emphasized that boards of directors bear ultimate responsibility for corporate pay practices. While many sustainable/socially responsible investors (SRI) welcome "say-on-pay," she spoke frankly about the limits of this and other tactical reforms:
"Even if I could come up with an ideal template for executive compensation at financial companies, we have to recognize that there is no structure that cannot and will not be immediately subverted. The corporate community and its service providers, including lawyers and compensation consultants, will always be more motivated and more agile than any legislator or regulator can anticipate."
Ms. Minow's testimony included an overview of how past and current reforms have been "subverted." Perhaps what's most notable about her speech, though, is her stark presentation of boards' culpability in "pernicious" rewards for questionable executive performance. She asserts that government's key role in reform is to "remove impediments to shareholder oversight of the board":
"We speak of this company or that company paying the executives, but it is really the boards and especially their compensation committees, and until we change the way they are selected, informed, paid, and replaced we will continue to have the same result. Until we remove the impediments to shareholder oversight of the board, we cannot hope for an efficient, market-based system of executive compensation. "The government has done a poor job of making it possible for regulated institutional investors like mutual funds, banks, money managers, pension funds, and foundations to cast proxy votes in an economically optimal manner. Due to the collective choice problem and conflicts of interest, proxy voting has too often been compromised and 'rationally ignorant.' "As we look at the 'supply side' of executive compensation, management and boards, we must also look at the 'demand side' to make sure our investor community has the information, tools, and ability to respond effectively."
For more "information and tools" for executive compensation reform:
Related KLD Blog articles:
The Madoff Madness and the Banking Crisis: At one extreme, trustees must dodge sociopathic fraudsters; on the other, they must avoid the hubris of "the smartest guys in the room."
Modern Portfolio Theory and the legal thinking it's influenced address the problem by means of risk analysis and diversification. This approach has limits, as Investments & Pensions Europe reported recently: "Dutch pension funds have lost €166m to the Ponzi scheme run by Bernard Madoff, Wouter Bos, the Dutch finance minister has claimed."
The Age Before the "Prudent Man"
In other times, courts have taken different views of how a trustee should deal with risk.
Harvard College v. Amory, 9 Pick. (26 Mass.) 446, 461 (Mass. 1830) was the case that first stated the Prudent Man Rule. The Massachusetts Supreme Judicial Court said that trustees should model their stewardship "on how men of prudence, discretion, and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested."
The Court rejected Harvard's argument that the trustees should have invested in an annuity which would have been less risky than common stocks, but would have provided the beneficiary a much lower income. Harvard's position seems ludicrous today. It wasn't in 1830.
In rejecting Harvard's position, the Court quoted critically an English case (Trafford v. Boehm, 3 Atk. 440, 444, 26 Eng. Rep. 1054, 1056) decided 86 years earlier:
"Neither South-sea stock nor Bank stock[s] are considered as a good security, because it depends upon the management of the governors and directors, and [both] are subject to losses; for instance, it is in the power of the South-sea company to trade away their whole stock while they keep within the terms of their charter…. "But South-sea annuities and Bank annuities are of a different consideration; the directors have nothing to do with the principal, and are only to pay the dividends and interest till such time as the government pay off the capital, and it is not in their power to bring any loss upon them, and therefore are only and properly good securities."
Two things one should note here. First, the court held that annuities backed by government debt were appropriate trust investments. But stock shares issued by the same entities that sponsored the annuities weren't. It's this very limited scope of trust investing the Prudent Man Rule overturns.
The Lessons of the 18th Century's Bubble Economy
Second, note how the court contrasts the relative investment merits of "South-sea stock" and "South-sea annuities." Here one sees the aftershocks of probably the greatest financial and political crisis in Anglo-American history between the English Civil Wars and today.
The collapse of the South Sea Company in 1720 shook the British state to its core. The South Sea Bubble combined a completely fraudulent investment scheme with political intrigue and mad speculation in everything from real estate to trading voyages. (See generally Malcolm Balen, The Secret History of the South Sea Bubble (New York: Fourth Estate, 2002) and James Macdonald, A Free Nation Deep in Debt (New York: Farrar, Straus & Giroux, 2003), pp. 206-219, 223-29.)
It would be hard to identify an area of commercial law or of political and social history that the Bubble did not affect. Trust law certainly changed.
In 1723 the South Sea Company shareholders began receiving perpetual annuities backed by government debt (the Company's only asset) in exchange for their devalued shares. The "Bank" mentioned in Trafford is the Bank of England, then still a private institution but, from the South Sea Bubble onward, the unquestioned central bank for the Empire. It too issued annuities backed by government debt. But even its stock, the Trafford court held, was not a proper trust investment.
I can't imagine a swing in the law back to Trafford. But the devastation of pensions and other trusts, such as the Harvard University endowment (see Richard Bradley, "Drew Gilpin Faust and the Incredible Shrinking Harvard", Boston Magazine, June 2009) – whether caused by fraud, hubris or faith in failing models – will lead to changes in trustees' fiduciary duties.
Miller-McCune is a new magazine whose tagline is "Turning Research into Solutions." On its website, it reports on a 30-year study of green attitudes among adolescents. The results are sobering.
"A research team led by Laura Wray-Lake of the Pennsylvania State University's Department of Human Development and Family Studies examined data from the 'Monitoring the Future' study, a sophisticated survey of the beliefs and behaviors of American secondary school students. The scholars mapped trends in a variety of environment-related areas, including conservation-conscious behaviors, feelings of responsibility for the environment and faith in technology. "'We found a precipitous decline in high school seniors' reports of conservation behaviors across the three decades,' they report. 'These trends clearly indicate that youth in the past two decades were not as willing to endorse conservation behaviors of cutting down on heat, electricity, driving and using bikes or mass transit as were young people in the 1970s.'"
After a blip of environmental consciousness in the 1970s, awareness crashed over the next 30 years.
"'Clearly, the average high school student across the past three decades has not viewed himself or herself as the first line of defense in protecting the environment,' the scholars conclude. "They add that the high school seniors surveyed 'tended to see government, and people in general, as more responsible for environmental problems than they themselves felt.'"
We have our work cut out for us.
Disclose Carbon Emissions by Companies, Not Just Facilities: Social Investment Forum on new EPA Disclosure Rules
In May, the Obama Administration announced new fuel economy standards for cars sold in the US. According to activist Daniel Becker, as quoted in the New York Times, "This is the single biggest step the American government has ever taken to cut greenhouse gas emissions."
More big steps are to come. The EPA has been soliciting public comments for "the first comprehensive national system for reporting emissions of carbon dioxide and other greenhouse gases (GHG) produced by major sources in the United States."
The Social Investment Forum (SIF) has developed a comment letter on the proposed rules. Reporting rules may not seem as momentous as anti-gas-guzzler laws, but the EPA's proposal could remake the energy policies of every industry. By helping investors account for corporations' carbon-related liabilities, SIF argues that disclosure will enhance the "pricing [of] such risks into the valuation of securities."
SIF does note one potential obstacle to this process: While the EPA calls for reporting of emissions by major carbon-emitting facilities, it does not require every corporation to disclose company-wide emissions. This could complicate the work of shareholders, who seek to make informed judgments about corporate exposure to emission-related risks.
90% of Greenhouse Gas Emissions to be Reported
According to an EPA fact sheet:
"The proposed rule calls for suppliers of fossil fuels or industrial greenhouse gases, manufacturers of vehicles and engines, and facilities that emit 25,000 metric tons or more of GHG emissions per year to submit annual reports to EPA…. "85-90% of total national U.S. GHG emissions, from approximately 13,000 facilities, would be covered by the proposed rule. Most small businesses would fall below the 25,000 metric ton threshold and would not be required to report GHG emissions to EPA."
EPA addresses the question of facility vs. company-wide reporting as part of an FAQ on the proposed rule:
"Q: Would EPA collect data at the unit-, facility-, or corporate-wide level? "A: For the majority of reporters, EPA would collect data at the facility level. There are a few exceptions where there would be reporting at the corporate level. The exceptions are vehicle and engine manufacturers, fossil fuel importers and exporters, and local gas distribution companies."
Disclosure Itself is a Regulatory Tool
SIF is careful to note that the "EPA has not proposed to establish a regime that would result in a carbon price." Government-mandated disclosure can still serve a regulatory purpose, however.
Emissions data enable investors to make "distinctions between relative security valuations based on companies' liabilities and regulatory risks," in SIF's words. Relatively high carbon output may indicate that a company is unprepared for a future "cap-and-trade" regime, or for potential spikes in fossil fuel prices.
Investors Buy Companies, Not Facilities
SIF offers a glimpse of how this process works, and why company-wide emissions reporting is important:
"When investors buy equities, they are investing in companies, not facilities. Facility-specific datasets, such as those proposed in this Rule, must have readily identifiable information that allows investors and their research providers to link facilities to the ultimate parent company (the investable entity). With such linkages, investors are able to aggregate information from multiple facilities to represent the company with a single GHG emissions number. …"
If investors could compare equities with a "single GHG emissions number," then the market could more readily price carbon-related risks into current share values. As SIF explains, disclosure could help long-term risk exposure have an immediate material impact:
"Most discussions of materiality, like most things in finance, tend to focus more attention on the short term, and, because of this ingrained myopia, longer-term or persistent issues tend to disappear from view in securities law enforcement and legal proceedings. But habit is not a good reason to perpetuate the situation. We believe that EPA's proposed rule on disclosure of greenhouse gas emissions is a very positive step in the right direction."
For more information, please see:
EPA's presentation (pdf) to SIF on the proposed rule
On May 26, Responsible Investor reported on a new study calling for pension funds to better prepare for climate change. Pension trustees may even have a fiduciary duty to account for climate-related risk, according to study authors Craig Mackenzie and Francisco Ascui of the University of Edinburgh Business School.
Investor Leadership on Climate Change, written on behalf of the United Nations Principles for Responsible Investment (PRI), explores the role of investors in reducing global carbon emissions. As reported by RI's Hugh Wheelan, the study finds that this role will be immense:
"$10 trillion in capital, much of it expected to be private, will be required by 2030 to maintain carbon dioxide emission levels at a stable 450 parts per million in the atmosphere."The authors of Investor Leadership on Climate Change argue that this is achievable, but add an important caveat:
"The good news is that even such large sums of money are within the long-term capacity of the financial sector, as long as the appropriate public policy incentives are in place."In "The Long-Term Investment Case," a preamble to their study, Mackenzie and Ascui explain why trustees must prepare for climate change, and why their preparedness depends on government action. A Universal Risk for "Universal Investors" Why must pension funds, in particular, confront climate change? The authors argue that these funds' long-term perspective exposes them to "systemic risks":
"[Climate change risks] will have impacts across the entire economy. This will make them difficult to hedge or avoid…. "Pension funds, particularly large pension funds, are universal investors, and they are so large that they tend to have long-term investment exposure to the whole economy…. Prudent pension funds have good reason to pursue cost-effective strategies to support climate change mitigation and adaptation."Neither the Public nor Private Sector Can Go it Alone Mackenzie and Ascui confront the argument that climate change and carbon regulation are beyond the ken of fund trustees. They describe the assumptions behind "business as usual":
- "['Business as usual'] assumes policy-makers will deliver the appropriate carbon pricing regimes....
- It assumes capital markets will be efficient at pricing risk and allocating capital....
- It forgets that equity investors are not merely providers of capital – they are shareholders and therefore owners of companies. …They have a unique position of leverage over the entities that, in one way or another, are accountable for most of our carbon emissions."
Investor Leadership on Climate Change explores the risks inherent in these assumptions, and how investors such as CalPERS are actively preparing for such risks. This preparation necessarily includes support for national and global carbon-pricing schemes. As Hugh Wheelan wrote, "Investors need to collectively influence public policy to correct what [the PRI report] says is an inability of markets to properly price climate change-related systemic risk."
For more information, see Investor Leadership on Climate Change at the PRI site.
Few professors or pundits have worn the title of guru better than Peter Drucker. Here is an excerpt from his 1976 book, The Pension Fund Revolution, on the revolutionary General Motors Pension Plan of 1950:
"The union [the United Auto Workers] feared, with good reason as subsequent events have proven, that the pension fund would strengthen management and make the union members more dependent on it. "[GM President Charles] Wilson's major innovation was a pension fund investing in the 'American economy.' . . . And while this made financial sense to the union leaders, their strong preference until then had been for pension funds invested in government securities. . . . "The union leadership was greatly concerned lest a company-financed and company-managed private pension plan -- negotiated with the union and incorporated into the collective bargaining agreement -- would open up a conflict within the union membership between older workers interested in the largest possible pension payments, and younger workers interested primarily in the cash in their weekly pay envelope. "Above all, the union realized that one of the main reasons behind Wilson's proposal was a desire to blunt union militancy by making visible the workers' stake in company profits and company success. . . . "But Wilson's offer was too tempting, especially to the rapidly growing number of older workers in the UAW. And so, in October 1950, the GM Pension Fund began to operate."
Source: Peter F. Drucker, The Pension Fund Revolution  (New Brunswick, N.J.: Transaction Publishers, 1996), pp. 5-6.
This passage provoked a few thoughts:
- What would our economy look like today had pensions invested in "the American economy" rather than exotic credit derivatives and off-shore markets?
- How different would our economy and economic prospects look had GM not aggressively off-shored jobs and investments, rather than investing where its stakeholders were?
- Standards of fiduciary responsibility as to the types of investments a pension could hold changed from ultra-safe securities (mainly bonds) in the early 1950s to include a broader investment universe by the 1990s. If older fiduciary standards had been maintained, how would our economy look today?
- Should we conclude, from our private pension and healthcare experiences since the 1940s, that society must treat some risks as absolutes – and provide for them as such?
As the auto industry debacle slowly reveals itself, we will have many questions of this sort to ponder. We welcome your thoughts in the comment section of this post.
In March 2009, KLD Consulting sought to identify which emerging-market nations were improving their environmental, social, and governance (ESG) disclosure. Through a review of Global Reporting Initiative (GRI) data, the lead researchers noted efforts by emerging-market companies to comply with GRI's reporting guidelines.
Brazil, South Korea, South Africa, India, and Chile all made significant progress towards broader, more detailed ESG disclosure.
Nations Vary in Commitment to Reporting
Research-driven investment analysis depends on reliable, comparable data. KLD collects information from thousands of government, NGO and media sources, but corporate disclosure is an important part of a fair assessment.
GRI, a nonprofit network headquartered in Amsterdam, provides universal reporting guidelines to firms worldwide. This uniformity enables direct comparison of companies' efforts to protect the environment and better serve their employees, customers, and communities. GRI's 2008 International Survey of Corporate Responsibility Reporting (prepared by KPMG from GRI data) found that nearly 80% of the world's 250 largest companies issued reports, and three-quarters of them followed GRI guidelines.
Still, in many countries, a majority of companies do not yet report on their ESG performance. In the 2008 GRI Survey, the percentage of the total sample that reported varied from less than 20% in Mexico to more than 90% in Japan.
Some Companies Claim Compliance, but Don't Provide Reports
For its March 2009 survey, KLD Consulting considered GRI's nation-by-nation evaluation of companies' reporting. Of those firms who registered with GRI, Brazil had the most whose reports met the GRI standard, followed by South Korea, South Africa, India, and Chile, respectively.
GRI assesses the quality of each company's reporting and assigns a score of A+ through C. The "+" rating indicates that company scores were verified by objective third-party observers. "Undeclared" companies told the GRI that they've published an ESG report, but did not provide reports or disclose the detail level of their reporting.
12% of Brazilian companies earned GRI's A+ rating, and only 10% of companies claiming to report failed to share their work with GRI. By contrast, almost half of Chilean companies were "Undeclared."
Compared to Brazil, fewer Indian and South Korean companies reported to GRI, but a higher percentage of them issued complete, detailed reports that fully complied with GRI guidelines. (For comparative tables, please see International Survey of Corporate Responsibility Reporting 2008.)
The Task Ahead
While the circumstances of each market vary, the global trend for sustainability reporting remains positive. As noted above, 80% of the largest global companies issued sustainability reports in 2008. Three years earlier, the KPMG/GRI Survey said that only half of companies reported. As detailed, compliant reporting becomes the norm for the largest firms, smaller competitors worldwide will have to follow suit.
For more background info on this topic, see this 2008 SIRAN/KLD report:
Only 24% of voters know that "cap and trade" describes an environmental policy proposal, according to a new Rasmussen poll. Matthew Yglesias at ThinkProgress cited the results this week, and also noted that 46% of respondents guessed that cap and trade involves Wall Street regulation or health care.
The KLD Blog is not typically concerned with opinion polls, but this survey hits close to home. As stated on our "About" page, "KLD analysts stay apprised of economic, financial and political developments worldwide, and the KLD Blog shares our expertise with you."
Why do we do this? Because KLD's business of environmental, social and governance (ESG) research serves informed, engaged investors. The practice of sustainable investment can't be separated from the major public policy questions of our time.
A global commitment to regulate carbon emissions – by direct government restriction (the "cap") and the pricing and "trade" of the right to emit – could remake the oil- and coal-powered global economy. Some of the world's largest publicly-traded companies have a stake in the outcome, and so does everyone else.
The public's shaky grasp on cap and trade may have major policy implications, Rasmussen writes:
The New York Times reports that Rep. Henry Waxman, the California Democrat who is pushing cap-and-trade legislation, is now facing challenges from within his own party on the issue and that many want to "turn the Energy and Commerce Committee's attention over to health care." That is clearly the direction most American voters would like to go. Sixty-nine percent (69%) say health care issues are more important while just 15% say global warming is a higher priority.
Leave aside, for now, the false dichotomy between "health care issues" and "global warming." Instead, consider how policy debates may be driven not by informed public opinion, but by the public's unfamiliarity with the subject matter.
As sustainable investors discuss cap and trade - or heath care policy, or a hundred other topics - we should remember the importance of explaining our work to the public. Our success depends on ordinary people who share our understanding of ESG issues.
In his commentary, Mr. Yglesias wrote, "Polls that attempt to directly probe the public's views about cap and trade wind up measuring a lot of pseudo-opinion."
The KLD Blog promotes no one position on major policy questions, but we do try to lessen the sway of pseudo-opinion.
To learn more about the debate over cap and trade, please see the KLD Blog articles listed below.
As noted by Robert Kropp at Social Funds, 2009 is witnessing a dramatic increase in "say on pay" shareholder resolutions. He gives some credit for this to "public outrage" over executive compensation levels during a worldwide recession. Shareholder engagement is also driven by sustainable and socially responsible investment (SRI) advocates, who help investors work together to achieve common goals.
Green America (formerly Co-op America) recently launched a "proxy education center" for shareholders. With support from Ceres, the AFL-CIO, and the Interfaith Center for Corporate Responsibility, the site offers guidance on proposed resolutions in four topic areas at 23 major companies.
Even for those who don't own stock in any of these firms, Green America's list provides a snapshot of what issues top the SRI agenda for the 2009 proxy season. The center's four topic areas are:
All of these subjects are perennial concerns of social investors, and the second two seem to address particular anxieties of this recession. Green America's favored resolutions call for better reporting of corporate practices in all four areas, while "say on pay" resolutions seek non-binding shareholder votes on executive compensation.
Green America notes that non-binding resolutions may still have teeth, as Entergy agreed to "say on pay" before the issue came to a formal proxy vote. Robert Kropp writes that so far this year, 22 companies have agreed to shareholders' resolutions in advance of a proxy vote.
For a Canadian perspective on this issue, see Ethical Funds Company's Shareholder Action Focus List (thanks to Alicia Woods).
The British journal Responsible Investor has published an interview with Gro Nystuen, chair of the Norwegian state investment fund's Council of Ethics. Norway's government is a leading advocate and practitioner of sustainable/socially responsible investing (SRI).
Ms. Nystuen speaks frankly about how the Norwegian state pension fund puts its good intentions into practice. "The Council consists of five persons who are all experts in the different areas covered by our guidelines," she says. "This expertise means that we know what we are talking about. It is not a 'prominent-persons-have-been-politicians' kind of council, as it could easily have been."
I was intrigued by her explanation of how the Council defines standards for corporations' environmental, social, and governance (ESG) performance. Norway excludes companies from its fund if they violate certain laws and treaties, but the Council also considers corporate actions that may not be illegal.
For Norway, as for many sustainable/SRI investors, conforming to laws is only part of the obligation of companies – and shareholders.
Ms. Nystuen points out that the world's patchwork of governments can never sufficiently define what constitutes ethical corporate behavior. She illustrates how the fund's environmental standards, among others, cannot simply follow the letter of the law:
"…The third point [of research] concerns environmental damage. The environmental criteria are absolutely not attached to any treaty, because if they were, they would be very narrow. For example there is no international prohibition against cutting down every tree in Norway, although it would be clearly bad to do it. [Emphasis added.]"
This applies equally to human rights, governance, and every other aspect of business: laws and treaties can proscribe certain actions, but they cannot anticipate everything a company might do, nor can governments conclusively establish what ethical business practice is.
The law's arm is even shorter when companies and investors cross national borders. Ms. Nystuen cites the example of child labor, which is not universally illegal. She notes that India "has very good general legislation on child labor, but implementing it is difficult in many areas. We have to be specific about who is responsible and who has obligations…"
It is this specificity, this establishment of practical, consistent ground rules, that ESG research helps to achieve. This process depends on a commitment from investors. Ms. Nystuen is emphatic about shareholders' obligations:
"If you asked anybody on the street if they were for or against child labour in India, they would obviously answer that they were against it. "Even if you asked them directly whether they would be willing to have their governments use tax money to prevent child labour, they would still agree because they think that child labour is a very bad thing. They would not hesitate, even if it were to cost them something. "But the problem is they are not asked directly!"
Growing interest in ESG research, in Norway and elsewhere, proves that shareholders will take responsibility – if they're asked.
The mining and refining of metal is an industry with ancient roots, and it remains essential to the global economy. Even supposedly "clean" industries like electronics depend on mining and smelting, as gold, tin and other metals are found in cell phones, computers and other ubiquitous consumer products.
Industrial mining can have a dramatic impact on the environment, and metals profits also help finance violent unrest in poor nations like the Democratic Republic of Congo (DRC). Developing nations such as Indonesia, Colombia, and the DRC bear the brunt of mining's costs, yet downstream consumers – and investors – share responsibility for industry practices.
To better assess these practices, the Global Reporting Initiative (GRI) recently solicited comments for its Mining and Metals Sector Supplement (MMSS). The MMSS will support better environmental, social and governance (ESG) disclosure by mining companies and metal processors.
GRI recognizes that the global economy's appetite for metal has overwhelmed many efforts to protect workers and the environment, and that the relationship of metal producers and consumers must change.
Even Responsible Mining Scars Land, and People
In a recent sector report, KLD Analyst Lesley Fleischman notes that even relatively well-run mining operations still have an impact:
"There are mining companies who operate some of the most sophisticated environmental and community programs of any of the companies I've researched. Many follow high standards for waste disposal, operate programs to hire indigenous people, and provide education and health service to communities. "But even relatively well-run mining operations can have severe environmental consequences, and many miners' communities see only a fraction of the income from their work."
Congo's "Blood Minerals"
The Democratic Republic of Congo (DRC) is a tragic example of what "blood mineral" wealth can do to a society. KLD Analyst Benson Hyde, who has studied the DRC, writes:
"'Blood minerals' include not only gold for jewelry, but also tin for electronics; tantalum, used to store electricity in cameras, phones, and other devices; and tungsten, which helps make cell phones vibrate. "The same Congolese groups are responsible for both the mineral trade and violence in the DRC. Mining operations generate hundreds of millions of dollars each year. Armed groups profit both from forcibly controlling the mines and by demanding bribes from traders, shippers, and border guards. "The regions where these minerals are mined have the world's highest rate of sexual violence, which is often used to control inhabitants. Children are also forced to work in mines and join the militants."
Mixed Messages from Developed Nations
Sustainable and socially responsible investors (SRI) have sought to hold metals companies accountable for their ESG practices worldwide. This week, Canada's Ethical Funds Company announced that it has secured nearly 20% shareholder support for an independent ESG audit of Barrick Gold. Ethical Funds says that Norway's pension fund has already divested from Barrick, "citing concerns with human rights violations and community unrest at operations."
Developed-world governments are also concerned with mining companies, but they may not share ESG/SRI priorities. Canada's Embassy magazine reports:
"The Conservative government has rejected joint civil society-private sector calls to tie diplomatic and economic support for Canadian oil, gas and mining companies operating in developing countries to socially responsible conduct abroad. "As a result, there are charges the government–allegedly influenced by mining giant Barrick Gold and the Canadian Chamber of Commerce–has given the green light for misbehavior abroad, and killed the temporary peace between NGOs and mining companies."
The article describes how, over the objections of NGOs and activists, the Canadian government reduced the power of a proposed "extractive sector CSR counselor."
Embassy quotes Karyn Keenan, of activist coalition the Halifax Initiative: "The response basically perpetuates the status quo. There's no incentive for corporations to change their behavior."
Rich Nations Buy Gold – and Sell Mercury
Part of the metal supply chain's status quo is for developed-world corporations to source raw material in poorer nations. Trade is not a one-way street, however. Miners in Indonesia import illicit mercury for gold mining use – and the US and Europe are major sources for this toxic material.
The Jakarta Post reports:
"The use of mercury in gold mining is illegal in Indonesia because it is toxic to both human health and the environment. But the price of gold has tripled since 2001, and mercury is the easiest way to extract it… "Despite the hazards, buying mercury at gold mining sites is as easy as purchasing toothpaste. The international trade in mercury is largely unregulated. And most of the 55 countries where small-scale gold mining is rife lack the political will or capacity to prevent the toxic metal from falling into the hands of 10 to 15 million poor miners."
KLD's Lesley Fleischman explains that while large mining companies don't use mercury to extract gold, they do play a role in creating demand for the chemical. "Typically, the small-scale miners who buy mercury illegally are former farmers whose land has been ruined by large-scale mining."
Millions of Miners, Billions of Consumers
To their credit, the GRI does not shy away from the geopolitical complexity of this sector. As defined by their guidelines, three of the sector's "main contextual issues" are explicitly political:
- The control, use, and management of land
- The contribution to national economic and social development
- Community and stakeholder engagement
- Labor relations
- Environmental management
- Relationships with artisanal and small-scale mining
- An integrated approach to minerals use
The last-listed issue may have the broadest implications for investors and consumers in the developed world. Individuals' demand for useful and attractive products is already "integrated" into the world economy; can their concern for human rights and the environment also shape the metals sector?
The Jakarta Post notes that the US, UN, and EU have all committed to banning mercury exports. Sustainable/SRI investors, in concert with independent observers like the GRI, can also help guide the practices of both buyers and sellers of metal.
Resisting the Rare and the Beautiful
Still, the struggle for sustainable use of metals is a struggle against consumerism itself. The difficulty of tempering human appetites – of persuading people to pay more, or use less – is an issue that goes beyond jewelry or iPods.
For a poignant expression of what we're up against, here is a consideration of a consumer good seemingly unrelated to metal: fresh, store-bought food.
Jon Garvie, writing in the Times of London, reviews Susanne Freidberg's Fresh: A Perishable History, a social history of consumers' demand for "permanent global summertime." Mr. Garvie emphasizes the part of Ms. Freidberg's story where a desire for social justice collides with baser appetites:
"…[Companies] envelop their activities within promises of corporate social responsibility and greater self-regulation. But the consequences of this attention are as nothing compared to international consumer demand for 'permanent global summertime' in which all fruits and vegetables are made available all of the time. The universal impulse to fetishize the (increasingly) rare and the beautiful leads back unerringly to inequity and despoliation. [Emphasis added]"
Whether it delivers something permanent as metal or as ephemeral as food, the supply chain's reform must begin with the buyer.
Carbon Counts USA, a new report from research firm (and KLD partner) Trucost, studies the "carbon intensity" of 91 major mutual funds. Trucost found wide variation in funds' carbon footprint, as the highest-carbon fund they studied was 38 times as carbon-intensive as the best performer.
Perhaps due to the Obama Administration's stated commitment to a national carbon emissions market, Carbon Counts USA (available here) has attracted attention from the business press. Dow Jones' Daisy Maxey writes that major fund managers are "responding cautiously" to the implication that they should consider companies' carbon footprints:
"In carefully worded statements, some companies shied away from ideas like explicit environmental screening but contended that, to the extent that carbon emissions are affecting a company's profits, it would be included in a fund manager's evaluation."What about investors who embrace "explicit environmental screening"? Carbon Counts USA studied 16 funds that incorporate environmental, social, and governance (ESG) factors into their strategies:
"Of the 91 analyzed funds, 16 include sustainability or socially responsible investing (SRI)considerations. These 16 funds comprise holdings valued at over $24 billion and have the smallest aggregated carbon footprint [of any researched fund style]..."While the overall carbon efficiency of SRI funds is welcome news, Trucost found some notable outliers:
"…Sustainability/SRI funds have the smallest carbon footprint. However, within this category, carbon efficiency varies widely – some of the largest SRI funds are more carbon intensive than the S&P 500."Why do some funds that seek to hold strong environmental performers actually deliver worse-than-average carbon efficiency? To understand this, consider how Trucost constructed its study, and also note that there is more than one way for investors to support lower global carbon emissions. Some companies' products and services may reduce their customers' carbon output – but not their own. How Trucost Measures Carbon Intensity Carbon Counts USA presents a concise summary of Trucost's methodology:
"The equity fund carbon footprint is calculated by measuring each constituent company's GHG emissions. Quantities of each GHG are converted into their carbon dioxide-equivalent (CO2-e) emissions. CO2-e emissions associated with a company are allocated to the fund in proportion to ownership. The carbon footprint is expressed as metric tons of CO2-e emitted by the companies within each fund per million dollars of revenue."By this measure, a fund's carbon intensity reflects the business models of its constituents. Trucost notes that the five most carbon-efficient funds all avoid energy-intensive businesses like mining, energy generation and food production:
- "Four of the funds do not invest in the Basic Resources sector.
- The top three do not invest in the carbon-intensive Utilities and Oil & Gas sectors, and have 80%+ invested in low-carbon sectors such as Financial Services, Banks, and Healthcare.
- Three of the funds are underweight in Food & Beverage companies relative to the S&P 500; the other two do not invest in the sector."
Portfolio Footprint vs. the Economy's Footprint
To their credit, Trucost acknowledges that its carbon intensity metrics may not account for the ancillary benefits of a "dirty" company's work:
"Where climate change criteria are included in stock selections, managers may focus on clean technology or renewable energy developers rather than carbon performance from operations. Since operations to develop environmental 'solutions' generate greenhouse gas emissions, these production processes are exposed to carbon costs which are likely to apply across industrial sectors and energy users. [emphasis added]…"
KLD Senior Analyst Andrew Brengle cites the Global Climate 100 index as an example of a solution-driven environmental investment strategy:
"The GC100 is not a carbon-intensity index. Its objective is not to seek out a 100-constituent group with the smallest carbon footprint. Instead, it identifies companies that are pushing the global economy toward a less carbon-intensive state.
"It certainly includes companies with small carbon footprints. But it also includes those with large footprints who are leading the way in carbon intensive industries, such as utilities who have committed to wind and solar power.
"These 'big-footed' companies make a big impact, because they offer leadership where it's needed most."
Investors Look to Government
While some investors already seek to reduce our economy's carbon intensity, many more are concerned with emissions' potential impact on the bottom line.
In assigning a dollar value to companies' carbon output, Trucost assumed a price of $28.24 for each metric ton of greenhouse gas emissions. This cost is, in the US in 2009, purely hypothetical. A national carbon emissions market will make the need for proper accounting more acute.
Though major carbon producers remain politically powerful, the Obama Administration has reaffirmed its commitment to a "gradual, market-based cap on carbon pollution." Even though Congress has blocked the President's attempt to include cap-and-trade in the budget, he continues to promote the idea. Here, thanks to Chris Fox of Ceres, is a portion of the President's April 14 address:
"Some have argued that we shouldn't attempt such a transition until the economy recovers, and they are right that we have to take the costs of transition into account. But we can no longer delay putting a framework for a clean energy economy in place. If businesses and entrepreneurs know today that we are closing this carbon pollution loophole, they will start investing in clean energy now."
As the world's economy has become more deeply integrated, some investors have sought to hold companies responsible for labor practices throughout their global supply chain. Norges Bank Investment Management (NBIM), which manages pension funds for the government of Norway, released a report in March on corporate initiatives to fight exploitation of child labor. The Sector Compliance Report, which considers firms' compliance with NBIM labor-practice guidelines, supports a "rights-based approach" to the protection of children.
The rights-based approach in international development is a step beyond traditional "philanthropy-based" efforts. Philanthropy provides resources to those in need, while the NBIM Investor Expectations on Children's Rights urge companies and investors to protect children's rights through advocacy both within their supply chain and in the countries where they do business.
Corporate Social Responsibility and Children's Rights in South Asia, a 2007 report from Save the Children (STC), explored the limitations of the philanthropic approach. Children have benefited from corporate contributions to their communities, but in many developing nations, this is not enough.
For example, children in Bangladesh, Nepal and India have long struggled with high rates of child mortality, poverty, and abusive labor practices, and many children worldwide lack access to education and safe drinking water. While these nations' governments have ratified the United Nations Convention on the Rights of the Child, STC notes that they have made little substantive progress.
NBIM's Expectations encourage companies to move "beyond compliance." The rights-based approach commits corporations – and their shareholders – to a more active social and political role in developing nations.
The NBIM study considers corporate initiatives to protect children's rights in four global economic sectors: cocoa, mining, steel and apparel.
Some firms in these sectors already have programs that go "beyond compliance." Apparel retailer H&M now works to free children from labor without depriving their families of needed income. Some past corporate reactions to the use of child labor led to mass layoffs of children. This reduced family earnings and did nothing to prevent these children from finding work elsewhere. H&M helps suppliers mitigate the loss of a child's income, either by continuing to provide income or by hiring an older member of the family.
While there are a few such success stories, much work remains. NBIM found no outstanding performers in the four researched sectors:
"Between sectors, the level of compliance with NBIM Investor Expectations on Children's Rights varied significantly. A relatively larger proportion of the companies in the apparel and mining sectors report that they have child labor policies and systems in place. "Overall, however, the number of companies that address children's rights and the risk of child labour in their own operations or supply chain is low. Apart from the cocoa sector, the reporting on continuous risk analysis is very limited."
NBIM's Commitment to Accountability
NBIM has emphasized the promotion of children's rights, not only out of ethical concern for children, but also to strengthen developing nations' economies and societies. Neglect of the next generation perpetuates the cycle of poverty, stifling investment and much-needed economic growth. NBIM has pledged, as a shareholder, to hold companies accountable for their future children's rights efforts:
"...[We] will on an annual basis perform a systematic assessment of our holdings in these sectors and markets against the NBIM Investor Expectations on Children's Rights criteria. The aim of the assessment is to provide both NBIM and the companies with a guiding tool with regard to the work that is being done on children's rights and what remains."
Is it possible that traditional macroeconomics and ecological economics (or sustainability theory) are converging?
Two articles published Sunday morning, April 12, taken together, suggest to me that these fields share an emerging understanding of debt and its essential elements: collateral and leverage. Through these lenses, debt's charge on the future is coming to be understood as never before.
Money & Sustainability
In 1936, John Maynard Keynes observed, "Money and its significant attributes is, above all, a subtle device for linking the present to the future; and we cannot even begin to discuss the effect of changing expectations on current activities except in monetary terms."
In 1987, the World Commission on Environment and Development's Brundtland Report defined "sustainable development": "Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs."
Properly understood, debt links not just the present but the past to the future. By definition it compromises the ability of future generations to meet their needs.
Warsh on Geanakoplos
The first article I read was by David Warsh, "This Time They Are More Interested." (1) It appeared on his invaluable website, www.economicprincipals.com. Mr. Warsh draws on "Leverage Cycles and the Anxious Economy," by John Geanakoplos of Yale University and Ana Fostel of George Washington University in the September 2008 American Economic Review, and a lecture Mr. Geanakoplos gave at the National Bureau of Economic Research last week.
According to David Warsh:
For at least a century, Geanakoplos said, economists have been accustomed to thinking of the interest rate as the most important variable in the economy – lower it to speed things up, raise it to slow them down. Yet especially in times of crisis, collateral demands – alternatively, margin requirements, loan-to-value ratios, leverage rates or "gearing" – become much more important. Everybody knows that when interest rates go down, prices rise. Less widely recognized is that when margin requirements go down – say, the down payment on a house – prices rise too, often even more. Without some form of control, leverage becomes too high in boom times, and asset prices soar disproportionately. When they crash, leverage crashes with them, and then prices suddenly are too low. This is the leverage cycle, Geanakoplos says, and the current crisis is the result of a particularly virulent specimen.... **** And the fundamental insight – that a single loan requires not one but two terms to be negotiated, and that one may become much more important than the other in certain situations was clear enough to Shakespeare four hundred years ago. Wrote Geanakoplos: "Who can remember the interest rate that Shylock charged Antonio? But everybody remembers the pound of flesh that Shylock and Antonio agreed upon as collateral. The upshot of the play, moreover, is the regulatory authority (the court) decides that the collateral level Shylock and Antonio agreed upon was socially suboptimal, and the court decrees a different collateral." The trick, Geanakoplos says, is to recognize that the tendency to increasing leverage is part of the process – and that collateralization generates bigger and bigger effects on assets prices as the cycle rolls on, until, in due course, for one reason or another, participants eventually become uneasy with the situation, and the cycle comes to a crashing halt. Then, he says, the Fed, like Shakespeare's judge, should sometimes decree different collateral levels....
Zencey on Ecological Economics
Now consider Eric Zencey's April 12 New York Times article, "Mr. Soddy's Ecological Economy."
Mr. Zencey's piece springs from the insights of Frederick Soddy, an all-but-forgotten Nobel Prize-winning nuclear chemist (1921) who abandoned science for economics:
He offered a perspective on economics rooted in physics – the laws of thermodynamics, in particular. An economy is often likened to a machine, though few economists follow the parallel to its logical conclusion: like any machine the economy must draw energy from outside itself. The first and second laws of thermodynamics forbid perpetual motion, schemes in which machines create energy out of nothing or recycle it forever. Soddy criticized the prevailing belief of the economy as a perpetual motion machine, capable of generating infinite wealth – a criticism echoed by his intellectual heirs in the now emergent field of ecological economics. A more apt analogy, said Nicholas Georgescu-Roegen (a Romanian-born economist whose work in the 1970s began to define this new approach), is to model the economy as a living system. Like all life, it draws from its environment valuable (or "low entropy") matter and energy – for animate life, food; for an economy, energy, ores, the raw materials provided by plants and animals. And like all life, an economy emits a high-entropy wake – it spews degraded matter and energy: waste heat, waste gases, toxic byproducts, apple cores, the molecules of iron lost to rust and abrasion. Low entropy emissions include trash and pollution in all their forms, including yesterday's newspaper, last year's sneakers, last decade's rusted automobile. **** Following Soddy, Georgescu-Roegen and other ecological economists argue that wealth is real and physical. It's the stock of cars and computers and clothing, of furniture and French fries, that we buy with our dollars. The dollars aren't real wealth, but only symbols that represent the bearer's claim on an economy's ability to generate wealth. Debt, for its part, is a claim on the economy's ability to generate wealth in the future. "The ruling passion of the age," Soddy said, "is to convert wealth into debt" – to exchange a thing with present-day real value (a thing that could be stolen, or broken, or rust or rot before you can manage to use it) for something immutable and unchanging, a claim on wealth that has yet to be made. Money facilitates the exchange; it is, he said, "the nothing you get for something before you can get anything." Problems arise when wealth and debt are not kept in proper relation. The amount of wealth that an economy can create is limited by the amount of low-entropy energy that it can sustainably suck from its environment – and by the amount of high-entropy effluent from an economy that the environment can sustainably absorb. Debt, being imaginary, has no such natural limit. It can grow infinitely, compounding at any rate we decide. Whenever an economy allows debt to grow faster than wealth can be created, that economy has a need for debt repudiation. Inflation can do the job, decreasing debt gradually by eroding the purchasing power, the claim on future wealth, that each of your saved dollars represents. But when there is no inflation, an economy with overgrown claims on future wealth will experience regular crises of debt repudiation – stock market crashes, bankruptcies and foreclosures, defaults on bonds or loans or pension promises, the disappearance of paper assets. **** One way to stop this cycle, suggests Herman Daly, an ecological economist, would be to gradually institute a 100-percent reserve requirement on demand deposits. This would begin to shrink what Professor Daly calls "the enormous pyramid of debt that is precariously balanced atop the real economy, threatening to crash."
What Professor Daly suggests is not just increased collateral, but his concept is close enough and directed toward the same end.
Economics: Coming Together
Whether we understand "debt" in the terms of macroeconomics or of environmental economics, it is the same debt created from the same transactions. These understandings could help us mitigate the massive sustainability deficit the leverage binge – which lasted more than 20 years – has left for the future. Separately, they just make interesting reading.
Warsh and Zencey have much more to say than what I've quoted. And, they're worth reading.
- I've read David Warsh for at least 20 years. He was a business reporter for The Boston Globe, then its economics columnist. Today he is the proprietor of an essential website and author of a must-read weekly column. He is a first-rate translator of very complicated ideas. He is unfailingly thoughtful, thought-provoking and for someone of my politics, at times, simply provoking. If you do not subscribe to www.economicprincipals.com, log on and then wheel out that credit card.
Given what we now know about the effects of finance economics models on the markets – that they create portfolios that mimic each other – Keynes' observations in his General Theory on Americans and how they invest seems strangely prophetic:
"Even outside the field of finance, Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market. It is rare, one is told, for an American to invest, as many Englishmen still do, 'for income'; and he will not readily purchase an investment except in the hope of capital appreciation. This is only another way of saying that, when he purchases an investment, the American is attaching his hopes, not so much to its prospective yield, as to a favourable change in the conventional basis of valuation, i.e., that he is ... a speculator." Source: John Maynard Keynes, The General Theory of Employment, Interest and Money (photo. reprint 1997) (New York: Harcourt, Brace & World, 1936), p. 159.
Whether in stocks or real estate, we Americans speculate. The Securities Acts and other finance legislation of the 1930s sought the transformation of the markets from places of speculation – like racetracks or casinos – to places of informed investment.
Under Presidents Reagan through Bush II, the dismantling of New Deal legislation and the gelding of the regulatory agencies meant to implement it marked the triumph of culture over experience, of impulse over deliberation.
Two years ago, The Economist opined:
"Instead of saying that those who cannot remember the past are condemned to repeat it, George Santayana might have better said that those who misinterpret the past are condemned to bungle the present." Source: "An Affair to Remember," Economist, July 29, 2006, p. 25.
What Santayana actually said is far more disturbing:
"Progress, far from consisting in change, depends on retentiveness.... Those who cannot remember the past are condemned to fulfill it." Source: quoted in J.S. Gordon, "The Freedman's Bank," American Heritage, December 1993, pp. 18, 20.
For Americans, culture seems to be destiny. We are fulfilling the past, the past of the 1920s, because we could not retain the lessons of the 1930s.
Why read the ever-growing pile of stories of tricksters and con men (and women) in our industry?
Schadenfreude – a delightful German word meaning pleasure from others' misery, especially of those more rich, famous, etc. than you – is probably why readers devour these stories. But financial services professionals should be reading them for the same reasons that law students and business school students study cases: to develop their instincts.
Madoff madness has all but hidden the stories – very different from his – of other apparent predators brought to ground in last fall's crash. Marc Dreier is one of those.
Dreier, a Harvard Law School alumnus, headed a 250-lawyer firm when arrested in Toronto on December 3 of last year. Allegedly, he stole from or defrauded clients and investors of at least $400 million. An exceptionally well written and reported article, "The Impersonator" by Robert Kolker in the April 3 New York magazine, reminds us:
"We live in an age of white-collar villains. But of all the financial bad guys out there, Marc Dreier is arguably the single greatest character of them all. … Dreier isn't just accused of swindling more than $400 million from thirteen hedge funds. Prosecutors say he carried out the deception by inventing $700 million in financial assets out of whole cloth, staging fictional conference calls, and impersonating executives, sometimes personally, sometimes with the help of an associate, all while snapping up Warhols and waterfront homes, partying with pop stars and football players, and chasing an endless parade of much-younger women. He also allegedly stole some $40 million from his clients' escrow accounts, a brazen legal sin."
Robert Kolker contrasts Madoff and Dreier implicitly and explicitly. These alleged confidence men used very different techniques toward the same end.
To my eyes, Madoff and Dreier fit archetypes embodied by Charles Ponzi and Alexandre Stavisky in the 1920s. Their stories – and the hundreds like them over the intervening 80+ years – remind me how easy it is to see frauds after the fact. And, that is why we in financial services should read and re-read them.
The only real protections we have from Ponzi-Madoffs and Stavisky-Dreiers are established processes, due diligence and our instincts – which are more learned than innate. We must ask hard questions and test the answers we get. Read these stories closely. Absorb them.
For more on Alexandre Stavisky, see this Wikipedia article, which quotes Janet Flanner's ("Genet") famous New Yorker articles on him. Those 1934 articles are well worth finding and reading. Excerpts appear in Janet Flanner, Paris was Yesterday 1925-1939 (New York: Viking Press, 1972), pp. 109-16. Also, Alain Resnais' Stavisky (1974) is among the best films of its time.
For more on how careful research protects against fraud, also see this KLD Blog article: Research that Raises Red Flags:Michael Markov's Due Diligence Cast Doubt on Madoff in 2006]
Global financial regulatory reform is a priority at this week's G-20 summit in London. What Bloomberg calls "an effort to rewrite the rules of capitalism" was called a "non-negotiable goal" by French President Nicolas Sarkozy and German Prime Minister Angela Merkel.
This is welcome news for investors represented by the Social Investment Forum (SIF), which has argued that regulatory reform is a necessary response to the global recession. "Systemic weakness after a generation of deregulation is a significant factor in the crisis," said Damon Silvers, AFL-CIO Associate Counsel and vice chair of the Congressional Oversight Panel (COP).
As part of an April 1 SIF conference call, Mr. Silvers described the priorities of COP, which Congress created in November as part of its bank bailout plan. He was joined by Smeeta Ramarathnam, Counsel to SEC Commissioner Luis A. Aguilar, who presented her view of the prospects for regulatory overhaul.
Both speakers emphasized that reform must address questions of jurisdiction: Who regulates what, and in whose interests?
Protecting Investors, Not Just Institutions
Mr. Silvers said that reforms should improve both crisis management and "day-to-day regulation of the financial system." While Treasury Secretary Timothy Geithner and others have focused on "systemic risk," Mr. Silvers asserted that better "day-to-day" oversight would forestall crises that threaten the entire economy.
"How you define systemic risk defines your approach to regulation," said Ms. Ramarathnam. She described the SEC as investors' "first line of defense," and faulted regulatory efforts that "focus on institutions, not investors."
Mr. Silvers believes that this focus on shoring up individual banks, hedge funds and other financial institutions was a hallmark of the "generation of deregulation." He said that there can be tension between bank regulators (such as the FDIC and the Federal Reserve) and the SEC. Consumers and investors often seek more transparency from banks, insurers and credit card issuers. Conversely, Mr. Silvers said that if, as a regulator, your first priority is the stability of individual banks, "you resist full disclosure of every bank liability."
For too long, pro-institution regulators have held the upper hand, Mr. Silvers believes. Mr. Silvers cited the example of the home lending market, where "regulating mortgages was not a job for grownups to do."
The problem was not confined to the public sector. He also criticized credit rating bureaus for understating risk because they had "a stake in increasing volume in the bond markets."
The Prospects for ESG-focused Reforms
Both speakers believe that coming reforms will reflect the priorities of SRI/ESG investors. Mr. Silvers endorsed new SEC head Mary Schapiro, and approved of her appointments to "key policymaking positions."
A key question for SIF members is how the government defines the fiduciary obligations of trustees. In the past, some SRI opponents have argued that trustees of pension plans may violate their fiduciary duty by considering non-financial ESG factors in their decisions. In response to a question from Jonas Kron of Trillium, Mr. Silvers said that attorney Phyllis Borzoi was now responsible for such questions as would arise under the Employee Retirement Income Security Act (ERISA). He said that there was "no better person on the planet" for the job.
"I'm confident she will do the right thing by this group," Mr. Silvers said.
Mr. Silvers is wary of proposed reforms that may actually enhance the power of the Federal Reserve – an idea that he called "peculiar." In response to a question from SIF Chair Lisa Woll, Mr. Silvers said that investors should be concerned "if bank regulators, who we've already seen are too close to the banks, are given power over a consumer protection agency like the SEC."
"Is the lesson of the crisis that we should give the Fed more power? We think the Fed is an insufficiently public institution for the power it already has."
A Call to Act Globally
To coincide with the G-20 summit, SIF and five of its global sister organizations issued a joint release on building a more sustainable world economy. The forums' release described a platform of "long-term financial re-regulation," and then summed up what's at stake:
"Without recognition of these issues and measures to 'hard-wire' them into the stimulus and financial re-regulation packages, we believe that world leaders will miss an historic opportunity for reform. Such neglect will permit fundamental conditions that contributed to the current downturn to remain in place. Unchanged, these conditions could herald the next catastrophic episode for financial markets and the global economy."
Executive compensation practices have recently drawn attention from both the public and the government. Bailed-out insurer AIG depends on taxpayers for its survival, yet it has chosen to spend millions on retention bonuses.
Why are struggling companies – including the bailed-out, and even the bankrupt – rewarding some employees? "Greed" is a popular answer, but an insufficient explanation. In a March 20 column at CNN.com, The Corporate Library's Nell Minow argues that compensation practices are symptoms of a broader corporate governance crisis.
It's Not Just AIG
John Carney at The Business Insider has reviewed the actual AIG employee retention agreement. He notes that "employees were guaranteed a minimum bonus regardless of performance." And the bailed-out insurer is not the only company where compensation has uncoupled from performance:
- Nortel, a Canadian telecommunications firm, is paying retention bonuses to eight top executives. Nortel is bankrupt. It also faces a lawsuit from 60 laid-off employees who, despite recent protests about the inviolability of contracts, were denied severance under the terms of Nortel's bankruptcy.
- The Washington Post has reported that, rather than denying bonuses to executives, "Firms Move Performance Goalposts." Among other examples, the Post's Tomoeh Murakami Tse writes that "FBR Capital Markets failed to reach its performance goals in 2008. But the board of the Arlington [VA] investment bank awarded six-figure payouts to its executives anyway."
Where was the Board?
Nell Minow asks why corporate boards haven't attracted more attention - and blame:
"Why haven't we learned that it is the boards who are responsible for the massive failures of strategy and risk management at these companies? Regulators, journalists, securities analysts and investors routinely ignore the most obvious indicators of investment risk that are presented by bad boards of directors. "This is particularly obvious in the case of AIG, which has been a serial offender in corporate governance, especially in executive compensation."
Compensation is a key factor in environmental, social and governance (ESG) investment analysis, and Ms. Minow justifies investors' concern with corporate governance. While many observers have faulted compensation practices at individual companies, she cites "overboarding" as a common failing of many "troubled" firms:
"The Corporate Library released a report in February about the boards of the bailout companies, many of which were outliers in their governance and compensation practices. … In several cases, we found individuals who not only sat on more than four corporate boards but also sat on more than one of these particularly troubled boards during this period…. "We call the phenomenon of directors who serve on four or more corporate boards 'overboarding.' "In all, 11 of the 27 companies we identified as "troubled" had at least one overboarded director. Six had more than one; at Merrill Lynch, there were five. By comparison, fewer than 30 percent of S&P 500 companies have even a single overboarded director, and fewer than 5 percent have more than one." [Emphasis added.]
Weak Governance is a Measurable Risk
Such ESG metrics helped some investors steer clear of these companies – before they were visibly "troubled." Could better analysis of governance and other investment risks help prevent future crises? Sustainable/SRI investors believe so, and there are signs that governance risk is now a mainstream concern.
Here is an excerpt from a Wall Street Journal interview with MIT Sloan Professor Dr. Andrew Lo:
"WSJ: What's the most important implication of the financial crisis? DR. LO: For CEOs and other corporate leaders, the single most important implication is about the current state of corporate governance. … "The current crisis is a major wake-up call that we need to change corporate governance to be more risk-sensitive."
As for AIG, Congressional pressure to tax their bonuses may have eased. Nell Minow has already asserted that punitive taxes won't address the root of our governance crisis. She proposes a more direct "wake-up call":
"Badly designed compensation is an indicator of poor corporate governance, and poor corporate governance is an indicator of investment risk. Instead of trying to tax the bonuses at AIG, the government and the shareholders should insist on new directors."
The Social Investment Forum has posted a list of thoughtful answers to the "Top 10 Questions about SRI." I especially like SIF's responses to some skeptical questions about our industry, such as:
Is the performance of SRI funds competitive with mainstream funds and with their benchmarks? What evidence is there that SRI shareholder resolutions have an impact? Is there growing demand among individual and institutional investors for SRI products? What is driving that demand?
Answers to these and the rest of the "Top 10" are presented at the SIF site. Their taxonomy of "the major elements" of SRI, which addresses misconceptions about "screening" of funds and portfolios, is especially salient to KLD's work.
To build on SIF's answers (click to download pdf), here are some links to relevant KLD Blog articles (in quotes below, with month of publication) and other resources.
SOCIALLY RESPONSIBLE INVESTING: SIF'S TOP 10 QUESTIONS 1. How large is the socially responsible investing (SRI) marketplace? Is it growing? Where is the growth taking place?
2. What are the major elements of socially responsible investing?
Socially Responsible Investing Facts [from SIF]
3. Is the performance of SRI funds competitive with mainstream funds and with their benchmarks?
4. What are responsible investors doing to invest in clean energy?
"Financial Times on 'Green Giants': Clean-Tech Leaders Capitalize on Sustainability" [December, 2008]
5. What new products are there in the world of SRI?
6. What evidence is there that SRI shareholder resolutions have an impact?
Shareholder Advocacy Success Stories [pdf from SIF]
7. What are the major trends in SRI shareholder advocacy?
8. Who are socially responsible investors?
"Socially Responsible Investing": An Evolving Concept in a Changing World [White Paper by Peter D. Kinder]
9. Is there growing demand among individual and institutional investors for SRI products? What is driving that demand?
"FA Green: New Sustainable Investing Site for Financial Advisors" [February, 2009]
10. How can SRI investors find products and information about socially responsible investing?
Thanks to SIF's Kristin Lang for her assistance.
Last week, Investors Against Genocide (IAG) announced that Vanguard will now screen its funds' constituents for human rights practices – including companies' involvement with the government of Sudan. Vanguard says that its new policy, which applies to all 157 of its funds, is "substantially identical" to IAG's shareholder proxy proposals.
"While the SRI mutual fund industry has had policies like this in place for decades, I know of few mainstream firms which have such a clear and explicit human rights policy," Walden Asset Management's Tim Smith told the Social Investment Forum.
Even Passive Funds can Manage ESG Risks
Vanguard is a $1 trillion mutual fund firm that is known for its index funds. IAG notes the significance of Vanguard's application of environmental, social, and governance (ESG) analysis to "passive" investing strategies:
"By applying its new policy to all its funds, Vanguard is demonstrating the feasibility of divesting not only from actively managed funds, but also from funds that track an index. Managers of funds that oppose genocide-free investing have sometimes cited index funds as a reason that they are unable to take action. Vanguard's action demonstrates that both actively and passively managed funds may be structured to avoid complicity in genocide."
"ESG risks, like Sudan involvement or questionable lending practices, can also be red flags for potential financial risks," KLD Index Manager Karin Chamberlain commented. "ESG analysis presents fund managers with a more detailed picture of each corporation's risk profile."
Why, in 2009, has IAG been able to make headway on this issue? One theory, as proposed in a recent Financial Times column, suggests that the economic crisis is a cause. "A Need to Reconnect" asserts that "the cult of shareholder value" – with its focus on short-term financial results – is a casualty of the meltdown:
"The corporate social responsibility movement, on the rise before the crisis, is likely to receive fresh impetus from investors' recognition that companies' narrow search for profits was not always the best strategy."
Confirming that mainstream investors are now taking a more activist stance, here (courtesy of Mr. Smith) is an excerpt from Vanguard's proxy statement:
"…Although the trustees believe that mutual funds are not optimal agents to address social change, they acknowledge that there may be instances when it is appropriate to assess such issues. Accordingly, the trustees directed Vanguard to implement a formal procedure for regular reporting to the trustees on portfolio companies whose direct involvement in crimes against humanity or patterns of egregious abuses of human rights would warrant engagement or potential divestment."
Vanguard's New Policy in Practice
IAG notes that Vanguard's willingness to engage or divest will soon be tested. On March 31, the firm is expected to release an SEC filing on a fund that holds millions of PetroChina shares. PetroChina is a major business partner of the Sudanese government.
"If Vanguard's Emerging Markets Stock Index Fund shows a significant reduction in its holdings of PetroChina, then we will have a clear signal that Vanguard's Trustees are serious about not connecting their customers with the genocide in Darfur," said IAG's Eric Cohen.
For more on the implications of Vanguard's new policy, see Robert Kropp at Social Funds.
Click here for more on the "Sudan and Iran Divestment Campaigns" by KLD Managing Director Randy O'Neil.
Investors Join State, Federal Push for Cleaner Cars: Ceres Publishes New Emissions Reporting Guidelines
Ceres, the Boston-based activist investor group, has joined governments, trade organizations and global investors in calling for automakers to measure and disclose their products' greenhouse gas (GHG) output. Autos account for 10% of global carbon emissions, according to International Energy Agency figures cited by Ceres. Despite this, "it is extremely difficult for investors to assess properly the risks and opportunities posed by climate change policy to individual companies," according to Ceres' new report.
Shareholder and environmental advocacy groups have long called for better transparency and more disclosure of environmental, social, and governance (ESG) performance. Now state and federal governments are poised to require automakers and other industries to report their GHG emissions. Environmental Leader reports that a new EPA rule will affect 13,000 industrial facilities, including chemical plants, utilities and the paper industry, as well as automakers. According to the EPA, these sources account for as much as 90 percent of greenhouse gases emitted nationwide.
The Ceres report, "Global Climate Disclosure Framework for Automotive Companies," provides guidelines for automakers' reporting efforts. (KLD's Elizabeth Horan Edgerly and Alex Lamb reviewed and commented on a pre-release draft of the report.) It sums up the limitations of current reporting by the auto industry:
" - Information provided is unrelated to core business aspects (e.g. disclosure that focuses on greenhouse gas emissions from company operations as opposed to vehicle usage). - Lack of quantitative or comparable data. - Company strategy and technology choices are unclear. "As a result, it is extremely difficult for investors to assess properly the risks and opportunities posed by climate change policy to individual companies, and to understand the manner in which auto companies have structured their business strategies and R&D plans to reduce greenhouse gas emissions from their vehicles."
Global trends heighten the urgency of building cleaner cars. "The world's car fleet is expected to triple by 2050 with 80 percent of this growth in developing economies," according to Achim Steiner, executive director of the U.N. Environment Program, as quoted by James Kanter in the New York Times. In recognition of the worldwide scope of the problem, Ceres developed its guidelines in conjunction with investors' organizations in Europe and Australia/New Zealand. Together, these organizations represent investors with trillions of dollars in funds under management.
Despite this, the US auto industry and its supporters are engaged in a more parochial fight over states' right to regulate auto emissions. "Global warming is not unique to California," said Michigan Senator Carl Levin, as he argued for Congress to deny states the power to set their own GHG emissions rules. California has indicated that it would accept this, but only if federal standards are as stringent as those proposed by state regulators.
The Los Angeles Times notes that struggling General Motors, which actively fought emissions regulations in the past but has recently requested billions from taxpayers, has now "taken a quieter role in the debate." As the industry faces a more-active EPA and an uncertain future, downstream stakeholders like states – and shareholders – could drive a more active response to the challenge of climate change.
Also see this EPA report on US automotive fuel efficiency trends from 1975 to 2008.
On February 11, a team from American Electric Power (AEP), including CEO Mike Morris, spoke to KLD about its preparations for a carbon-constrained US economy. The KLD Blog article "Coal is Still King, For Now" presented an overview of AEP's presentation, including the company's positions on utilities regulation, carbon credits trading, and the prospects for "clean coal" technology.
As Alan Petrillo wrote in "Part One":
AEP's multibillion-dollar cleaner energy initiatives show that the company takes sustainability seriously, as does its willingness to engage stakeholders such as Ceres, KLD and our clients. AEP's ongoing commitment to coal, however, is a bet on future technological and political developments that are by no means certain."
This article will consider AEP's positions in the context of a broader political perspective. While the regulatory environment in AEP's service area has been favorable for coal interests, the industry's future may hinge on federal policies, and federal tax dollars.
Coal States, Coal-Friendly Regulation
The Obama Administration plans to set national goals for reducing carbon emissions, but the states have been in charge of emission reduction programs thus far. The Pew Center on Global Climate Change reports that as of January 2009, 35 states had developed climate action plans. As of February 2009, 21 states had set specific targets to reduce emissions.
Mike Morris told the KLD forum that AEP offers "zero resistance to the idea of state-by-state renewable energy standards."
Mr. Morris's support for this approach is understandable. While many states pursue aggressive carbon dioxide (CO2) reductions and renewable portfolio standards (RPS), the states in which AEP operates are not among them. Of the 11 states in AEP's service area, only Michigan, Ohio, Texas, and Virginia currently have any RPS. Only Virginia has set specific emissions reduction targets.
Protecting the Status Quo, 1: AEP's Position on Cap and Trade
President Obama proposes more stringent federal standards. He has stated plans to increase the US market share of renewable energy to 10% by 2012 and 25% by 2025. Obama's plan also calls for a reduction of greenhouse gas (GHG) emissions to 1990 levels by 2020.
To meet its ambitious goals, the Obama Administration seeks to expand the market for carbon emissions credits. The President calls for a cap-and-trade system to support an 80% reduction in GHG emissions by 2050.
Mr. Morris told his KLD audience that "I'm not against a carbon cap," but he does have reservations about the auction of carbon credits. "An auction would be a massive revenue machine," Mr. Morris said, and he fears that the government will misallocate this revenue.
AEP would prefer an allowance-based system that would distribute carbon credits, free of charge. More credits would be granted to companies that have greater current carbon emissions. As AEP is one of the nation's top emitters of carbon, allowances would sustain both AEP and the nation's coal-burning status quo.
Protecting the Status Quo, 2: AEP on Federal Emissions Standards
If new federal emissions standards supersede states' rules, AEP would seek exemptions that would effectively maintain the current regulatory patchwork.
Mr. Morris stated, "If the federal standard is 20% [of total energy use coming from renewable sources] by 2020, okay. But if West Virginia can't hit 20% because of its particular circumstances, then there shouldn't be any penalties. I don't want to see my customers pay a fee, really a tax, for something they can't do. … Paying a fee because we can't hit an unrealistic target is unfair to our customers."
AEP's position, then, is that federal regulation is acceptable if it still permits states to set their own standards. Mr. Morris's "particular circumstances" would seem to undermine national targets with piecemeal, state-by-state exemptions. Interstate utilities would still be able to pursue a kind of regulatory and legislative arbitrage, ensuring that states whose economies depend on coal mining and burning – like West Virginia – could deviate from federal rules without sanction.
It's Still Coal
AEP's public statements indicate that the company believes that human activity contributes to climate change and that GHG emissions must decline. Carbon capture and sequestration (CCS) and other clean coal technologies would protect AEP's investments – and AEP itself. But is what's good for AEP good for America?
Clean coal is still coal. Compare the CO2 emissions of a clean coal plant to those of a wind farm or solar array. We also must account for the coal plant's sulfur dioxide (SO2), nitrous oxide (NOx), particulate matter, and mercury emissions. Finally, consider the ecological impact of mountaintop coal removal, ash disposal and other ancillary costs of coal-powered utilities.
For an integrated utility like AEP – one whose entire business model has been built around generating and transmitting coal power – these are costs that governments, companies and citizens must share. Stakeholders outside the "coal states" cited by Mr. Morris, however, might prefer to direct scarce resources elsewhere.
To take only one dramatic example, General Electric claims that the entire energy demand of the U.S. could be satisfied by covering 7% of Arizona with solar panels. Also, there is great untapped potential in the "fifth fuel" – energy efficiency. A McKinsey study has shown that if the entire US used electricity as efficiently as California already does, 40% of US electricity demand could simply vanish.
These measures would be expensive, and their practical application would be a daunting task. But even AEP acknowledges that clean coal initiatives like FutureGen would also require massive federal investment.
Power: Electrical and Political
As citizens – and investors – consider the prospects for clean coal, they should keep in mind that the question is as political as it is technological. AEP concedes this. For example, here is a public statement on the potential for market-based carbon pricing:
"…Our stakeholders are divided on having a price ceiling, or "safety valve," in the [carbon pricing] legislation. The Environmental Defense Fund, for example, strongly opposes a safety valve and has urged us to abandon our support for that provision. Our customers, however, could be severely affected by escalating energy rates if carbon prices were entirely market-based, and would pay more for their energy, through no fault of their own, than customers of utilities that derive less of their power from coal." [emphasis added]
It follows from this position that if AEP's customers are not ultimately responsible for reducing carbon emissions, then neither is AEP. The cost of coal power, however, is not only borne by AEP's customers. Coal-burning utilities concede that their future depends on friendly federal regulation – and federal subsidy. In evaluating the prospects for these companies, investors should note that the industry's fate may be out of the coal states' hands.
On March 9, Pax World Management launched the Global Women Investment Index (GWI) as part of its gender investment index series. Pax, creator of the first SRI mutual fund in 1971, is working with KLD Indexes to develop and maintain the GWI. The new series, which is sponsored by the World Bank Group's International Finance Corporation, seeks to measure and compare corporate performance regarding gender relations in the workplace.
Pax believes that the GWI will demonstrate that gender equality is an important indicator of effective management.
"Competitiveness can be achieved more readily by companies that recognize the talent of the entire workforce," said Julie Gorte, Pax Senior Vice President for Sustainable Investing. "There are still too many in finance who doubt that gender empowerment has any effect on performance, but the evidence suggests there could be a premium for those companies that best advance women as leaders."
Karin Chamberlain, KLD Index Manager for the GWI project, said that the new index "will quantify the financial impact of gender-related corporate practices and provide opportunities to invest in the leading companies in this area."
The Construction of the Global Women Investment Index
KLD has designed the GWI to provide exposure to large and mid cap companies that take affirmative steps to attract, retain, and promote women and to advance gender equality.
The GWI's eligible universe includes companies listed in the FTSE All-World Developed Index series. To select GWI constituents, KLD tracks corporate performance according to four major indicators: Board Representation, Workplace Representation, Programs and Policies, and Controversies.
Board Representation – How many members of the corporation's board are women, and how does the company compare to sector and regional peers?
Workplace Representation – What percentage of senior line executives, non-line executives, and managers are women?
Programs and Policies – KLD constructs this metric from data on corporate commitment to mentoring, leadership development, alternative work schedules, and benefits for mothers, fathers, and children.
Controversies – This metric accounts for gender relations problems at each company, including lawsuits and incidents related to discrimination, harassment, or a hostile work environment.
Next Steps for the GWI
The complete GWI series will include an index of the top 100 global performers, plus regional sub-indexes for Europe, North America, and the Asia Pacific region. KLD has completed development for the North American Women Investment index (NAWI) and can calculate and maintain other sub-indexes to meet client demand.
Considered as a whole, the GWI indicators could become a core environmental, social and governance (ESG) metric, believes KLD's Karin Chamberlain.
"We've found that companies where women can excel also tend to be strong ESG performers," explains Ms. Chamberlain. "We believe that better workplace gender relations may come to be seen as a competitive asset for the best-run global corporations."
Is the recently-passed economic stimulus bill a down payment on a greener economy, or does it reaffirm the carbon-centric status quo? The answer, as could be expected from a $787 billion omnibus bill, is "both."
The New York Times, BusinessWeek, and ProPublica have posted surveys of the stimulus, whose potential impact could be felt for generations to come. It could also take a generation to determine the bill's ultimate winners and losers, but some trends are apparent. The table below compares ProPublica's House, Senate and final numbers for initiatives that could have a significant environmental impact.
Positive signs include:
- Support for battery and "smart grid" research and development.
- A commitment to energy efficiency, both in the private sector and in government-owned facilities.
- Increased funding for freight railroads, which move goods more efficiently than trucks.
Other commitments in the bill seem likely to ensure that carbon-heavy fossil fuels will retain their importance to the US economy. The final bill includes billions for fossil fuel energy research, which could include clean coal initiatives such as carbon capture and sequestration (CCS). While these programs could reduce the atmospheric impact of coal-burning, they also reinforce a long-term commitment to this "dirtiest" fossil fuel.
Also, funding for mass transit, clean water initiatives, and renewable energy research and loans all declined in the final compromise. For more details, please see the ProPublica site and Kate Sheppard in Grist.
Data Source: http://www.propublica.org/special/the-stimulus-deal
Active Ownership Can Help Stop Market Failures: New PRI Board Statement Calls for Responsible Investment
The Board of the Principles for Responsible Investment (PRI) has issued a new statement on the current economic crisis. The PRI codify a framework to help investors support "well-functioning markets, which are based on high levels of trust, accountability and transparency among market participants." To promote more responsible investment, PRI signatories worldwide (including KLD) call on investors to incorporate environmental, social and governance (ESG) factors into their investment practices.
The PRI Board statement says that investors "can, and should, be part of the response to this crisis and that responsible investment has an important role in mitigating future such market failures."
The Board explains each Principle's relevance to the global economic predicament:
"Principle 1 is about better analysis of risk. It calls for the integration of a broader range of environmental, social and governance (ESG) issues into investment processes. This crisis demonstrated a clear lack of understanding of our underlying investments, and how they may have been putting not only the companies involved at risk, but the entire economy. "Principle 2 calls for active ownership, whereby investors actively monitor companies and ensure that risks are being managed properly through active shareholder engagement and voting. Greater active ownership may have resulted in investors seeing warning signs earlier and being able to mitigate some of the inappropriate practices, including short-term and high risk investment strategies, opaque investment vehicles, and inappropriate compensation structures. An increase in active ownership will enhance accountability, lessen the need for one-size-fits-all regulatory responses and ensure that assets are being managed in the best interests of end beneficiaries and customers. "Principle 3 points to investors seeking comprehensive and systematic disclosure of ESG risks and opportunities from investee companies. Lack of transparency was clearly a contributor to the severity of this crisis, and this Principle, if implemented broadly, will enhance investors' understanding of their underlying investments and enable to them to address risks earlier. "Principle 4 calls on investors to ensure that their agents also abide by the philosophy behind the PRI. This crisis was, in part, a failure of agents to act in the interests of their principals. Investors need to incentivize their agents to act in their long-term best interests, and this includes ensuring that fund managers have the capability to integrate ESG risks and brokers and other ESG research providers are incentivized to produce research that analyzes these issues in a systematic way. "Principle 5 calls on investors to work together. If we are to address the problems facing the economy, we must have a collaborative approach, particularly around addressing systemic issues and working together with policy makers to ensure an appropriate regulatory response that enhances the goals of the PRI. "Principle 6 is focused on investors' own transparency. Going forward, there will be increasing demands on investors to show they are well governed and indeed part of the solution to this crisis. As investors, we need to be transparent about how we are addressing the crisis, both to our members and to the broader community. …"
Click here to learn about KLD's support for PRI compliance.
Coal is Still King, for Now: American Electric Power Discusses Sustainability at KLD Forum - Part One
On February 11, a team from American Electric Power (AEP), including CEO Mike Morris, spoke to KLD analysts and clients. AEP is a utility company that runs the nation's largest electricity transmission system and owns 36,000 megawatts of generating capacity. It's also the largest user of coal in the Western Hemisphere. The company's executives visited KLD to explain how they're preparing for a future of sharply constrained carbon emissions.
This article will summarize AEP's policy positions as presented to KLD. Part Two will provide more detail on the technological, political and economic challenges facing coal-burning utilities, which power much of the US (and global) economy.
"Our window for timely action on climate change is fast closing, which makes it essential for investors to engage bellwether companies like AEP," said KLD Senior Analyst Andrew Brengle.
As part of its engagement efforts, AEP has committed to annual sustainability reporting and dialogue with stakeholders, including activist investors represented by Ceres. At the KLD forum, Mr. Morris presented an overview of his company's efforts to produce and/or purchase more renewable energy for its more than 5 million customers.
He also asserted the continued importance of coal as a source of electricity. Mr. Morris was candid about the political calculus behind AEP's position:
"We have 25 'coal states.' That's 50 Senators whose states depend on this economy."
The heart of AEP's response to a carbon-constrained future is "clean coal" technology. This is a controversial topic – pro and con recently dueled on the New York Times op-ed page – and AEP has bet its future on clean coal's potential.
AEP's Commitment to Coal
In response to a question from KLD Analyst Sharon Squillace, Mr. Morris described AEP's involvement with two clean coal R&D initiatives: carbon capture and sequestration (CCS) and integrated gasification combined-cycle (IGCC). CCS prevents carbon from being released into the atmosphere, while IGCC converts coal into a cleaner-burning gaseous hydrocarbon.
AEP was also a key participant in FutureGen, a government-sponsored pilot program that would combine IGCC and CCS at a single plant. FutureGen is currently in limbo, but AEP and others would like to see the project revived under the Obama stimulus plan.
Mr. Morris on CCS:
"[We're] demonstrating that carbon capture works. If CO2 emissions reduction is the law of the land, that's what we'll do. Nobody in our space is moving as aggressively on this issue. "Through the chilled ammonia process, we capture exhaust and re-segregate it into pure ammonia and pure CO2. Opening this September is a 20 megawatt plant with capture and storage capabilities. [In 2011 AEP will have a] 235 megawatt plant with CCS."
Mr. Morris said that AEP will incur a cost of $600 million for the first plant, with five additional plants planned at a cost of $200 million each. To keep this in perspective, he made clear that "We still have a massive investment in our existing facilities," he said. "We have $5 billion invested and we will not just walk away from that."
The as-yet-unbuilt FutureGen plant is designed to employ carbon capture and storage and also uses IGCC. Gasified coal burns more cleanly than solid coal, allowing for a smaller carbon capture system than is required for a conventional coal-burning plant.
Mike Morris explained AEP's position on FutureGen:
"Our Mike Mudd is president of the FutureGen alliance. We believe that the government made a massive mistake by pulling the plug. It's designed, bid out, shovel ready, ready to go. "The formula they used to use [to cancel FutureGen development] is no longer viable. Back then, $2 billion was a lot of money. In this stimulus package, they ought to build out the whole thing. It would mean 3,500 big time jobs. Put $2 billion towards something that really matters."
Carbon Credits: Auctions vs. Allowances
The KLD Blog has previously considered plans to account for carbon emissions, including the "cap and trade" concept that President Obama endorsed as a candidate and includes in his first budget. Mr. Morris told his KLD audience that "I'm not against a carbon cap," but he does have reservations about the auction of carbon credits. He would prefer the free distribution of allowances to utilities:
"Allowances should come after the cap [is defined and implemented], not before. The feds should come back to utilities with allowances to apply towards supplies of carbon. We believe that allowances should be distributed to those of us who need to put capital to work."
If carbon credits were to be auctioned, Mr. Morris does not believe the resulting revenue should be disbursed to ratepayers, as some have proposed in a "cap and dividend" program:
"An auction would be a massive revenue machine. The reallocation of that capital will look like a handout program, for better or for worse. If your goal is redistribution, that would do it….If funds were collected from auctions and sent out to customers, we will miss an opportunity to do the right thing."
Pat Tomaino, an analyst at F&C Management, asked, "Could there be a 'middle ground' between allocations and auctions?"
Mr. Morris replied:
"We need to target monies back to those forcing technology in the field. If we don't force new technology into the field, we're going to run out of energy. Our 'middle ground' is a sacrosanct funnel back to local distributors [such as AEP]."
"A states' rights issue"
In response to a question by Anita Green of the General Board of Pension and Health Benefits, Mr. Morris described AEP's position on the balance of regulatory power between states and the federal government. As an interstate company, AEP must work with many separate regulatory regimes, but the company is concerned that greater federal involvement could lead to other problems:
"We provide zero resistance to the idea of state by state renewable energy standards. …We argue strongly against the notion of penalties if standards aren't met. This is a states' rights issue. … Anything else is a cost to our customers without any benefit. "If the federal standard is 20% [of total energy use coming from renewable sources] by 2020, ok. But if West Virginia can't hit 20% because of its particular circumstances, then there shouldn't be any penalties. I don't want to see my customers pay a fee, really a tax, for something they can't do. … Paying a fee because we can't hit an unrealistic target is unfair to our customers."
AEP also supports greater federal investment in the long-distance electric grid. Increased transmission capacity could help distribute power from renewable-rich states to those with less potential for wind or solar generation.
Again using West Virginia as an example, Mr. Morris said, "I would accept higher standards for renewable use in West Virginia if I could sell them wind energy from Oklahoma."
AEP's Positions in Perspective
AEP's multibillion dollar cleaner energy initiatives show that the company takes sustainability seriously, as does its willingness to engage stakeholders such as Ceres, KLD and our clients. AEP's ongoing commitment to coal, however, is a bet on future technological and political developments that are by no means certain.
While CCS, IGCC, and other processes show promise, they have never been applied on the scale envisioned by AEP. Politically, the company is urging the US government to revamp the entire interstate regulatory structure, while also funding FutureGen and a massive expansion of the transmission network. AEP also resists the auction of carbon credits and the disbursal of fee revenue to consumers, rather than utilities.
Company CEO Mike Morris indicated his willingness to work with the Obama Administration, but his company's positions are at odds with many of the President's stated priorities. Still, the President's home of Illinois is one of the "coal states," and to judge by his recent address to Congress, the interests of coal producers and users will continue to shape US energy policy.
Can the US build a sustainable economy while remaining a coal-burning nation? AEP's policy positions and investments show that it believes we can. In Part Two, KLD Analyst Benjamin Blank will consider the implications – and risks – of this commitment to clean coal.
You see our problem. Trans-Atlantic business partners can turn dollars into pounds, exchange labor for labour, and enjoy both kinds of football – but what is the plural of index? Tom Kuh, Managing Director of KLD Indexes, put the question to some of us at KLD world headquarters in Boston. On one side: FTSE. On the other: my New York Times style guide, which says simply: "indexes (not indices)."
"Facts are generally overesteemed. For most practical purposes, a thing is what men think it is. When they judged the earth flat, it was flat. As long as men thought slavery tolerable, tolerable it was. We live down here among shadows, shadows among shadows."
For those who think there's only one right answer to the question, "Which word?" note that MS Word doesn't think John Updike should write "overesteemed."
And for those who deny that such questions should lead to a good-natured discussion, Mr. Updike again:
"We take our bearings, daily, from others. To be sane is, to a great extent, to be sociable."
Indexes or indices? Feel free to cast your vote, sociably, in the comments.
"SRI is Thinking Ahead": Nobel Winner Joseph Stiglitz on Investing, Regulation, and Corporate Governance
Last week, President Obama and Congress committed US taxpayers to a $787 billion economic stimulus program. Alan Greenspan has told the Financial Times of his qualified support for bank nationalizations, and this week, the US "signaled that it was willing to raise its equity stake" in Citigroup. A giant Swiss bank has admitted to "conspiring to defraud" the IRS and is turning some customer data over to Federal regulators. A recent Newsweek cover even declared, "We Are All Socialists Now."
Before the fall of 2008, did anyone think it necessary for government to expand its economic role so dramatically? Some observers did, and one – Nobel Prize winning economist Joseph Stiglitz – believes that socially responsible investment (SRI), in concert with better regulation and corporate governance – is essential to broadly shared, sustainable prosperity.
"If as much effort went into wealth creation as theft," Mr. Stiglitz has said, "we'd have a much more productive society."
This quote is from an address Mr. Stiglitz delivered to an August 2008 symposium organized by the Norwegian Ministry of Finance. (His speech, along with Norwegian Finance Minister Kristin Halvorsen's introduction, can be viewed here.)
As described by Minister Halvorsen, Norway's state pension fund is a world leader in the development and application of SRI. Not only does Norway consider companies' human rights and environmental practices as part of its investment decisions, but it seeks to actively influence corporate policies. Minister Halvorsen explained that through the "silent work" of the state's Norges Bank, "we may convince companies to change their behavior."
In his address, Mr. Stiglitz supported Norway's active use of its sovereign wealth fund to support important social goals. He said that he first met the Finance Minister at Davos, at "the one session every year where the many socially irresponsible investors get together to assuage their guilt, and listen to what they ought to be doing."
Mr. Stiglitz then presented a thorough survey of what "they" have gotten wrong about the global economy. The following is a small sample of his insights:
On the practice of SRI, based on his experience as a trustee of Amherst College:
[SRI depends] on "due processes that look at investments in a careful way. We didn't want to hurt the people we were trying to help. To consider the consequences of our investments entails macroeconomic analysis of companies' impact on local economies."
On the impact of SRI on investment returns:
"Many studies have asked whether, if we exclude companies from consideration for our portfolio, do we do worse? Remarkably, the answer is no. …In many ways, SRI concerns anticipate broader social movements, by excluding stocks due to trends that the entire market will have to respond to. "So SRI is thinking ahead."
He was no less emphatic regarding the role that SRI must play in a healthier global economy:
"As Chief Economist at the World Bank, I saw that foreign direct investment could actually make countries worse off; there was a lot of socially irresponsible investment…. "When firms serve a broader purpose, they may also wind up increasing shareholder value. The notion here is similar to that of efficiency wage theory, which says that paying workers better may increase productivity."
On corporate governance:
"In its simplest form, corporate governance is a statement by shareholders that management shouldn't steal. You would be amazed at how many subtle – or non-subtle – forms of theft occur….If as much effort went into wealth creation as theft, we'd have a much more productive society."
On some causes of the current crisis:
"A big innovation in the 1970s and 1980s was that companies figured out how to cheat the government [out of tax revenue]. The big breakthrough in the early 1990s was that the same process used to cheat the government can also be used to cheat shareholders. "To do these things simultaneously is not easy. You want to tell your shareholders you're doing well, but tell the government you're doing badly."
Mass High Tech has published an overview of enterprise carbon accounting, defined by reporter Efrain Viscarolasaga as the trade of "a tangible commodity representing a positive step in improving the environment." These credits include carbon offsets and renewable energy credits, or RECs.
3,000 companies now participate in enterprise carbon accounting, and this number will jump to 12,000 by 2012, Mr. Viscarolasaga writes, citing new research from consultant Groom Energy Solutions. He also helpfully distinguishes between carbon offsets and RECs:
"Carbon offsets are measured in metric tons of greenhouse gas emissions, while RECs are measured in kilowatt hours. RECs focus solely on power generated from renewable sources of energy, such as solar and wind, while carbon offsets represent the emissions displaced through any number of methods, from renewable energy generation to carbon sequestration."
Some observers, including carbon producers like ExxonMobil, prefer a direct carbon tax to any sort of trading system. Still, the Mass High Tech piece notes that Lockheed Martin, a major aerospace firm, recently purchased 147,000 RECs from World Energy, and carbon offset trading is already well established:
"On the carbon offset side, the Chicago Climate Exchange (CCX) was established in 2003 as a public, voluntary trading exchange for greenhouse gas emissions and has since built an impressive portfolio of participating organizations, including Amtrak, Bank of America, Eastman-Kodak and IBM Corp., as well as [Boston-area] entries such as Tufts University, KLD Research & Analytics of Boston, engineering firm Vanasse Hangen Brustlin Inc. in Watertown and waste resource management firm CommonWealth Resource Management Corp. of Boston."
To learn more, see the Chicago Climate Exchange site, and also these related KLD Blog articles:
In January, Financial Advisor launched a magazine called FA Green. This new print and web journal analyzes sustainability issues for FA's target audience of "financial planners, registered investment advisors and independent broker-dealers."
This is good news for the practice of sustainable and socially responsible investment (SRI). While sites such as Social Funds and JustMeans serve investors and consumers who are concerned with environmental, social and governance (ESG) issues, FA Green can help familiarize mainstream financial professionals with ESG concerns.
Towards this goal, FA Green editor Dorothy Hinchcliff and other contributors tackle some perennial questions and misconceptions about sustainable investing/SRI. Jeff Schlegel's "Investing: A Look at Performance," for example, considers the supposed performance penalties of an ESG-screened portfolio:
"Critics say it puts investors at a disadvantage to exclude certain sectors such as tobacco, booze and gambling (the so-called sin stocks), or any other businesses with questionable environmental, social or governance records. Taking these companies out of the game limits investment choices, they contend. "But the data suggest that SRI isn't necessarily the portfolio killjoy its detractors say it is…. "…A collaborative report published in October 2007 by the United Nations Environment Programme Finance Initiative and the Mercer consulting group reviewed 20 academic studies on the impact of environmental, social and governance (ESG) factors on portfolio performance. The result: Half of them found a positive relationship between ESG factors and investment returns, while seven studies found a neutral effect and three found a negative correlation. "In June 2007, Goldman Sachs launched its GS Sustain focus list of 96 companies…that satisfy Goldman's own list of ESG requirements. … In a June 2008 report, Goldman said the list had outperformed the MSCI World Index by 20.8% since its launch. The report noted Goldman found 'a positive relationship between ESG, industry positioning and return on capital over time'…"
For more about FA Green, see editor Dorothy Hinchcliff's blog.
Also see these KLD Blog articles that discuss the relationship between ESG-driven investing and performance:
Last week, the KLD Blog considered efforts by both shareholders and the Obama Administration to curb executive pay. Investors such as Walden Asset Management have actively sought management support for non-binding advisory votes on executive compensation.
For a closer look at investors' thinking on "say on pay," Walden Executive Vice President Tim Smith has shared the text of his February 5 letter to "Colleagues in the Business Community."
Mr. Smith explains why a management-supported advisory vote may be "a moderate, reasonable response to the executive compensation issue, and is not the fringe proposal it was perceived to be 2 or 3 years ago."
He also notes the mood in Washington and across the country.
"Proposed 'solutions to the executive pay issue' now range from the reasonable to the zany, from small specific reforms to large systematic changes," Mr. Smith writes. "I am sure some of these "solutions" are causing tremendous angst among many in business dealing with compensation as new Congressional legislation is discussed or Treasury Department regulation is promulgated."
As if to confirm Mr. Smith's point about angst-causing "solutions," the CEO of Netflix wrote a February 6 New York Times op-ed calling for the government to raise his taxes.
Perhaps the specter of such a "zany" reform will inspire a warm response to shareholders' call for transparency and accountability.
(Also see Steven Syre's column on this issue in the Boston Globe.)
The full text of Mr. Smith's letter follows:
Dear Colleagues in the Business Community involved in Advisory Vote Discussions: As you know, Walden Asset Management is actively involved in promoting the Advisory Vote on executive compensation. In addition, I also served as co-chair of the Working Group on the Advisory Vote so I have been deeply involved in this issue for the last several years. I write with a sense of urgency as the issue of executive compensation is on the front pages of our newspapers and floods our airwaves as never before. Proposed "solutions to the executive pay issue" now range from the reasonable to the zany, from small specific reforms to large systematic changes. I am sure some of these "solutions" are causing tremendous angst among many in business dealing with compensation as new Congressional legislation is discussed or Treasury Department regulation is promulgated. Some of these changes are moving so swiftly that they don't offer time for rational dialogue about the implications. Obviously, a series of missteps by some companies and business leaders have prompted a populist urgency that new solutions need to be enacted and enacted now. Certainly the context for discussing new steps regarding executive compensation has changed significantly in the last 2 months, and even within the last week. With this backdrop, I write to urge you to reconsider your position on the Advisory Vote. Business leaders have raised a number of concerns about the Advisory Vote. Proponents have worked hard to respond as best they could to many of these stated concerns, sometimes successfully, sometimes with continuing quizzical responses from some company management and Boards. However, it seems clear that the Advisory Vote increasingly fills the space of a moderate, reasonable response to the executive compensation issue and is not the fringe proposal it was perceived to be 2 or 3 years ago. Other reforms like clawbacks, golden parachutes, golden coffins, even salary caps, are now front and center in the compensation debate. I believe the time has come for businesses to embrace and put the Advisory Vote into effect. The business case for companies to move in that direction is orders of magnitude stronger today than even a few months ago when you received your shareholder resolution. Points worth considering are: 2f08a68517137c4357d1200a75b99663 In summary, the pendulum is swinging toward the inevitability of the Advisory Vote. I write to urge your company and Board to embrace the Advisory Vote as a fair, middle-ground approach that will help gain credibility and support in the investor community and to step back from the traditional statements of opposition in your proxy. The timing is right for a shift in position by your company and others. Timothy Smith Senior Vice President Walden Asset Management
President Obama Limits Salaries at Bailed-Out Banks, Investors to Seek Say on Pay at 100 Corporations in 2009
This week, many national headlines describe an issue that has long engaged the social investment community. President Obama has announced new limits on the pay of bank executives "just days before" another round of Federal investment in banks, reports the New York Times. His announcement follows news of Merrill Lynch rushing big bonuses to its executives, even as bailout recipient Bank of America took over the failed brokerage.
In his Feb. 5 comments, the President said that "what gets people upset – and rightfully so – are executives being rewarded for failure. Especially when those rewards are subsidized by U.S. taxpayers."
Investors Want Pay for (ESG) Performance
Shareholders shouldn't subsidize failure, either. Long before the current crisis, investors have pushed for a bigger voice in determining executive compensation. The Christian Science Monitor's Laurent Belsie, in a story comparing CEOs' millions to those earned by NFL stars, explains why shareholders – even more than Presidents – are the key to reform:
"Star athletes are rewarded by the marketplace; CEOs are rewarded by their peers."
"Peers," in this case, refers to corporate boards (often staffed by other CEOs) that have typically done little to restrain executive compensation. Due to both the economic climate and the determined efforts of major shareholders, this may be changing.
Companies like Intel and HP have already agreed to endorse "say on pay" resolutions in recent months, writes Robert Kropp at Social Funds. Mr. Kropp has tracked these and other shareholder campaigns, and his reporting provides a valuable overview of the broader "say on pay" campaign. He writes that the Interfaith Center on Corporate Responsibility (ICCR), in an effort organized by the American Federation of State, County and Municipal Employees (AFSCME) and Walden Asset Management, intends to request a non-binding advisory vote on executive compensation at over 100 US corporations in 2009.
It is important to note that for ICCR and its allies, performance is not only measured with quarterly financials. A firm like Walden considers corporations' environmental, social and governance (ESG) practices as part of its investment strategy, which means that "say on pay" resolutions could lead to broader discussions of how American executives manage their companies. (By comparison, many European nations have stronger "say on pay" policies. See this report from Swiss foundation Ethos to learn more.)
Some Pay Cuts are More Equal than Others
Perhaps seeking to forestall more active engagement by shareholders, some companies have already moved to rein in executive salaries. FedEx, for example, has cut salaries to "minimize job loss" while reducing costs, according to Steven Taub at CFO.com. FedEx CEO Fred Smith will face a 20% salary reduction, while rank-and-file salaries will be cut 5%.
While this is welcome news, KLD Analyst Eric Benjamin points out that the pay structure at FedEx, like that at many American companies, remains severely unbalanced:
"In 2008, FedEx reported in their proxy statement a CEO pay package worth $10,940,253. Next year the CEO's total pay could still exceed $10 million, because the 20% reduction is in base salary, not total compensation. Base salary made up 13% of Fred Smith's compensation in 2008. Compensation committees have historically offset salary reductions with increases in other components of pay, such as restricted stock. This is still possible under the President's new guidelines, which also only apply to banks receiving federal bailout money."
Eric, who in 2006 co-authored United for a Fair Economy's annual report on pay inequality, Executive Excess, puts this in perspective:
"$10 million is almost 500 times the average worker's earnings in FedEx's industry in 2007. Workers in the courier industry earned an average of $21,000 in 2007, according to the Bureau of Labor Statistics. A further 5% salary cut would bring this down to about $19,950."
Clearly, all salary cuts are not created equal. Laurent Belsie noted that last year's "say on pay" proxy resolutions attracted support from 43% of voters. As unemployment climbs, inequity persists, and more shareholders seek answers, that number is sure to increase in 2009.
The January 28 newsletter from the E.F. Schumacher Society presents an inspiring and instructive story. The Society is based in Great Barrington, MA, and is named for the author of Small Is Beautiful: Economics As If People Mattered. As their website explains:
"Building on a rich tradition often known as decentralism, the Society initiates practical measures that lead to community revitalization and further the transition toward an economically and ecologically sustainable society."
In the fall of 2008, the Society purchased and rehabilitated a building for its staff. This "practical measure" would not have been possible without the creativity and commitment of Main Street Resources, a small venture capital firm, and the people of Protective Armored Systems, a local manufacturer.
The Society's Susan Witt introduces her story with a quote from urbanist Jane Jacobs: ""Economic life develops by grace of innovating; it expands by grace of import-replacement." She continues:
"In October the E. F. Schumacher Society bought a house for staff and interns. It was not a simple transaction, rather a complex and marvelous adventure weaving our work lives together with the story of a small manufacturing company: the innovation of its founding, the history of its employees, its significance in the regional community, the role of a regional equity fund in financing its growth, and the power of the vision of the fund's founder. It was (though we did not know it at first) a story about ingredients for building strong regional economies and the grace of that process. ..."
Click here for the complete story.
The Business and Human Rights Resource Centre has posted a new research paper by Liz Umlas, independent researcher and former KLD senior research analyst. "Human Rights and SRI in North America" was prepared to inform the mandate of Professor John Ruggie, the Special Representative of the United Nations Secretary-General on business and human rights.
The following is the introduction to the Executive Summary of "Human Rights and SRI in North America." Click here to download a PDF of Liz's paper.
This paper provides an overview of human rights issues and the Socially Responsible Investment (SRI) community in North America. In particular, it focuses on social investors – those for whom environmental, social and governance (ESG) factors are integral to their investment decision-making – and the human rights-related due diligence that they apply to the companies in which they invest. The paper examines who these investors are, why they matter to business and human rights, which human rights issues they focus on, and how they do their work, touching also on the question of fiduciary duty and human rights. It concludes with a brief look at recent developments and trends and provides a few recommendations, including how the work of the UN Special Representative for Business and Human Rights (SRSG) can help advance SRI's own work on human rights. Research for the paper was based in part on a short survey of representatives of the Canadian and US SRI communities. Human rights have long been a fixture among social investors' concerns. However, in comparison with environmental and corporate governance issues, progress within the private sector on most human rights issues has been slower. Reasons for this include the fact that a business case for human rights is not always possible or appropriate; the relative difficulty of measuring and reporting on human rights; and the particular sensitivities that surround many human rights issues. One can argue, however, that now is a particularly good time for social investors to push for progress on companies' performance in the area of human rights. The emerging global framework for business and human rights spearheaded by the SRSG, the political shift occurring in the United States, and the triggering of debates about regulation and corporate ethics due to the financial crisis could provide a window of opportunity for social investors.
Change We Can Believe In, for Now: Will Government, Corporations Sustain their Concern for ESG Risks?
In his first week in office, President Obama proposed major overhauls of environmental and financial regulations. These changes have long been championed by investors concerned with companies' environmental, social and governance (ESG) performance, and few were surprised that a new regime has brought a new policy agenda.
In this time of recession and scandal, however, some familiar faces in American business – including former SEC Chairman Harvey Pitt and Wal-Mart's Lee Scott – are also setting a different tone. Mr. Pitt has announced ten lessons that investors should learn from the current crisis, while Mr. Scott has committed the world's largest retailer to "a sustainability program to remake the entire company." These are welcome moves, but ESG investors should ask whether this new attitude will outlast today's crisis mentality.
"A Friend in Need is a Pest"
In his presentation to the third annual "Distressed Investing Conference" in Las Vegas, Mr. Pitt invoked terms that will be familiar to the sustainable and socially responsible investment (SRI) community. His ten lessons mentioned "transparency," "due diligence," "trust" and "risk management." These themes are in tune with members of the Social Investment Forum and mission-driven advisors like Gary Moore, but Mr. Pitt's eighth lesson may hit a false note:
"8. If you don't speak up, no one will hear you. There will be a window that will strongly influence the outcome of the regulatory landscape and what it should look like at the end of the process. A friend in need is a pest, like a wedding crasher. Get to know regulators and legislators before you need them."
This seems to suggest that regulatory capture is part of the cure, at a moment when it seems like more of the disease. Among those not attending the "Distressed Investing Conference," there is broad support for stronger regulation. Investors should remain wary, however, of how "friendly" regulators and regulated may become.
In this context, the Wall Street Journal's Kara Scannell notes that as new SEC Chair Mary Schapiro was sworn in Tuesday, "the Senate Banking Committee probed the role of her former organization, the Financial Industry Regulatory Authority, in missing Bernard Madoff's multibillion-dollar scandal."
The Social Responsibility of Wal-Mart
"As businesses, we have a responsibility to society. Let me be clear about this point. There is no conflict between delivering value to shareholders, and helping solve bigger societal problems."
This affirmation of corporate social responsibility (CSR) is not a quote from Timberland's Jeffrey Swartz, or Van Jones of Green for All. Surprisingly enough, this rejection of Milton Friedman's limited view of CSR comes from Lee Scott, the CEO of Wal-Mart, the world's largest retailer. The New York Times reports that under Mr. Scott, Wal-Mart "has begun to democratize environmental sustainability."
Reporters Stephanie Rosenbloom and Michael Barbaro detail Wal-Mart's commitment to greener practices in its stores and throughout its supply chain. They also emphasize that Wal-Mart does not consider this effort to be an act of altruism. Increased energy efficiency and less wasteful packaging reduce overhead, and perhaps more importantly for Wal-Mart, they also reduce "headline risk."
Bad publicity for Wal-Mart's labor and environmental policies had turned customers and community leaders against the company, according to a 2004 study done for the firm. This realization helped motivate a crucial shift in corporate culture: Wal-Mart has committed to engaging outsiders, from climate scientists to its Chinese suppliers.
This spirit of engagement is encouraging, but as with the investment world's embrace of transparency and risk management, it is important to note what hasn't changed. The Times piece notes that labor leaders are still critical of Wal-Mart's compensation and health care practices.
It also describes a more subtle parallel with Harvey Pitt's call to "get to know regulators and legislators before you need them":
"[Mr. Scott] … intends to increase the retailer's lobbying muscle in Washington, especially regarding health care, energy and sustainability."
In other words, ESG policy discussions among investors, companies and governments will - and should - continue. Changes at agencies like the SEC and companies like Wal-Mart are welcome, but investors' commitment to research, engagement and accountability remains vital, no matter how green corporations get – or who's in the White House.
Pursuing Ponzi Protection From Financial Wolves in Sheep's Clothing: Insights from Guest Author Gary Moore
[Note from the Editor: Gary Moore was a senior vice president of Paine Webber before founding his own firm as "counsel to ethical and spiritual investors." He has written five books on the ethical management of money and has been a financial commentator for UPI. He has very graciously permitted us to post his perspective on the Madoff case. Also see a link to his organization at the end of this article. The following is Mr. Moore's work. – AP]
Bernie Madoff has apparently perpetrated a fifty billion dollar Ponzi scheme that has devastated investor confidence, as well as several charities in Palm Beach. A hedge fund operator in my hometown of Sarasota has apparently perpetrated another swindle of three hundred and fifty million dollars. It too has affected hundreds, as well as the Y on whose board I serve, and several other charities. The more things change…
Thirty years ago, I trained at Merrill Lynch with a broker who, after leaving Merrill, perpetrated the largest Ponzi scheme in the history of Florida until Madoff. We attended church together and played tennis at his country club.
Later, I served on the board of an international ministry affected by the New Era funding scandal, probably the largest Ponzi scheme to hit our nation's charities. I then served on another major Christian board with Ken Lay of Enron, who was considered a most gracious and generous man.
It's inevitable that you will lose some money during thirty years of investing. But I've thus far avoided the worst Ponzi schemes and scandals largely by understanding these realities:
1) Financial con men never look and act like con men. (And they are usually men, though they usually have gracious and sociable wives.) Their schemes depend on confidence, so they go to great lengths to look and act impeccably respectable.
2) So with the possible exception of a heavily regulated major trust company, never, ever, entrust one person or organization with all your investments. If you do use one financial advisor, have that person or institution diversify among non-affiliated investments.
3) Ponzi operators always insist on secrecy and total control, so always separate the management and custody of your money. The custodian can therefore provide a valuation of your holdings that is independent of your manager's assurances.
4) The victims of financial schemes are usually motivated by fear or greed, rarely caring how prudently or ethically their returns are generated. Look deeper, perhaps even utilizing "socially responsible" investments that look very deeply. That might help you avoid not only Ponzi schemes but Enron, WorldCom and so on.
5) Never believe it won't happen again or to you. Note I said I've avoided such scandals "thus far." I know all too well we live in an age of synthetics, when wolf fur can be made to look remarkably similar to wool.
Click here to learn more about Gary Moore and his work.
A Wish List for the Obama Administration: Social and Sustainable Investors Seek Change for Finance, Governance, Health Care
The day after the Inauguration, the Wall Street Journal marshaled an impressive array of leaders – from Newt Gingrich to Al Sharpton to The Nation's Katrina vanden Heuvel – to give advice to the new President. The sustainable and socially responsible investing (SRI) community has also recently offered its counsel on investing, corporate governance, and health care policy.
The Social Investment Forum called for "New American Leadership" on many of these issues in a comprehensive January 14 letter to the incoming Administration. For a concise summary of the six-page letter, see this article in Financial Advisor.
SIF calls for better corporate reporting of financial and environmental risks, strengthening of shareholder proxy rights, executive compensation reform, and more. The letter also urged the rejection of recent SEC guidance that sought to prevent fiduciaries from pursuing "economically targeted investing," which includes the consideration of environmental, social and governance (ESG) factors.
While SIF's efforts focus on the financial system, other investors are seeking even bigger changes in the American social contract. The Interfaith Center on Corporate Responsibility (ICCR) has declared 2009 "The Year of Health Care Reform," and plans to more than double its health care-related shareholder resolutions. These efforts are not aimed directly at the Administration, but ICCR has drawn an explicit link between corporate and government policy. Its release quotes SRI consultant Cathy Rowan:
"Shareholder interests and the public's interests are aligned on the need for comprehensive health care reform. We hope to see corporations present on the day when President Obama signs into law a bill that resolves the lack of access, affordability, quality and accountability in our current health system – and are recognized for the positive role they have played in the public debate."
The WSJ's Jacob Goldstein said that ICCR's pitch emphasizes that reform "could help the bottom line and be good for shareholders, given the high burden health costs place on employers." This argument is valid no matter who's President, but note that Cathy Rowan spoke of the day "when," not if, President Obama signs a sweeping reform bill.
This subtle shift in language understates a dramatic change in investors' expectations.
Ethical Pressure on the Global Supply Chain: The Principles for Responsible Investment and the Ethical Trading Initiative
On November 26th, the Secretariat of the United Nations Principles for Responsible Investment (PRI) held a webinar on its Ethical Trading Initiative. The PRI call on investors to incorporate environmental, social and governance (ESG) factors into their investment practices, and to work together for better reporting and disclosure of ESG performance. (KLD is a charter signatory of the PRI. For more information, see the About PRI page at KLD.com.)
The Ethical Trading Initiative is a PRI-led coalition that works for better labor and environmental practices throughout the global supply chain. The Initiative is a recognition that investors alone cannot raise global ESG standards. Real progress demands that manufacturers, distributors and retailers commit to industrywide improvements. Shareholder activists play a vital role in this effort, which requires coordination on a massive global scale.
Speaking to the webinar, Initiative Director Dan Rees explained why companies are willing to participate. "They're driven by the demands of risk management. They're worried about their reputations. But that's not enough. There needs to be a clear business case, and companies need to fully understand the market demand for responsibility on these issues."
Joining Mr. Rees for the webinar were Louise Nichols and Fiona Sadler of British retailer Marks & Spencer, and Lauren Compere of Boston Common Asset Management (BCAM). Each speaker also responded to questions from webinar participants.
The Scope of the Supply Chain
Marks & Spencer is a well-established British retail chain that is a founding ETI member. Louise Nichols and Fiona Sadler described how the company works to sustain an ethical supply chain. It is a dauntingly huge task. Marks & Spencer's supply chain encompasses:
- 35,000 product lines
- 20,000 factories
- 2,000 farms
- 88 source countries
- 55 different languages spoken by suppliers
To manage this vast assemblage, Marks & Spencer has conducted 1,224 supplier audits. The company enforces its supplier code of conduct with on-the-ground support and the sharing of best practices, even among competing suppliers. Marks & Spencer reports to the Ethical Trading Initiative annually. In the spirit of the ETI, the company has also shared its supply chain management expertise, including case studies of key issues, with other retailers.
Globalizing a Local Problem: The Role of the ETI
The Ethical Trading Initiative engages these issues at a systemic level. Mr. Rees explained that the best-run global companies can identify labor issues on their own without intervention from shareholders or customers. However, the complexity of the global supply chain compels a growing number of companies to work together on these issues, Mr. Rees said.
Since its inception ten years ago, the Initiative has grown to include 52 corporate members and 16 non-governmental organizations (NGOs) that focus on labor, environmental and product safety issues. This relatively small number belies the influence that leading corporations can have on the broader global economy. In 2007, 38,000 suppliers were operating under workplace codes of conduct, and suppliers had made 55,000 significant improvements to worker health, safety, wages, and hours, said Mr. Rees.
These codes of conduct have made a tangible impact. Mr. Rees said industries that employ some of the world's poorest workers – such as agriculture and the garment and footwear industries – are now paying better and relying less on forced overtime and child labor.
Mr. Rees added, "We need to define and measure what companies could or should do to drive change in the supply chain. We also need to show evidence of improvement and give credit where it's due." This publicity drives growing global awareness of the need to improve conditions for these workers.
Still, there is much to be done. Along with better pay and conditions, Mr. Rees mentioned other urgent needs:
- Too many workers are still denied freedom of association and the right to organize – rights that would allow workers to better advocate for their own interests.
- While more nations now regulate minimum wages, the minimum is too often less than a living wage.
- Ethnic, racial and gender discrimination persists.
- Too many work without formal contracts, leaving them vulnerable to abuse and summary dismissal.
Lauren Compere of BCAM noted that many larger firms in China, in particular, have made progress over the past five years. Problems persist further down supply chains, at small companies that are difficult to monitor. The Initiative, and activist investors, work to engage large manufacturers in better supervising their subcontractors.
The Tools of Engagement: Confrontation and Collaboration
Ms. Compere, who is also affiliated with the Interfaith Center on Corporate Responsibility (ICCR), said that to have a real impact, shareholder activists must understand the global scope of modern manufacturing. She presented examples of direct confrontation with individual companies as well as activist-led industry-wide initiatives.
In 2007, investors engaged Toyota regarding allegations of abuse in its factories, including reports that it brought guest workers from southeast Asia to Japan to work under sweatshop conditions for far less than minimum wage. Over 20 institutional investors signed on to a letter about this issue, which led to unflattering media coverage and a commitment to reform from Toyota.
BCAM also wrote to Samsung in 2002 about its supply chain, asking them to join the Electronic Industry Citizenship Coalition (EICC). Compere met with Samsung management, and the company established a CSR management process, which includes a committee that reports to the board.
While single-company campaigns have made a difference, multi-stakeholder initiatives can better leverage the strength of activists. For example, in 2008, BCAM and other U.S. social investors wrote to 110 companies concerning the use of child labor in harvesting cotton in Uzbekistan. In their letter, they described the best practices of the most ethical companies. Several major retailers then threatened boycotts of Uzbek cotton, and before the 2008 harvest the Uzbek government announced a plan to prevent children under 15 from participating.
The multi-stakeholder approach works for companies, as well as activists, because it offers economies of scale for costly monitoring and auditing operations. Ms. Compere also emphasized the important role played by Oxfam, Amnesty, Amazon Watch, and other NGOs.
Ms. Compere concluded by saying that shareholder activists need to remember that while labor rights are a global issue, each situation is unique. "Success depends on what's being asked of a company," she said. "Often there are baby steps, and engagement that goes on for years. Sometimes activists decide they're not getting anywhere, and they stop and decide the engagement has been unsuccessful." Indeed, the ultimate success of the Uzbek initiative is still in doubt.
The Business Case for the Ethical Trading Initiative
A webinar participant asked if companies join the Initiative simply to improve their public image. "There's always a risk that companies will join the Initiative to create the appearance that they're actually doing something," Mr. Rees said. "But if they don't do anything, they're asked to leave. The Initiative does its best to hold companies to their commitments. We monitor companies with a tripartite review panel made up of corporate, NGO, and trade union membership."
Participation in the Initiative, which requires third-party oversight and collaboration with other companies throughout the supply chain, is not an act of altruism. Lauren Compere explained why: "The business case for participation is that if companies don't meet high industry standards, they could lose their license to operate." By helping set and maintain these standards, investors and PRI signatories help the global supply chain work for workers, not just employers.
Time for Financial Markets to Tell the Truth about the Real Economy: A Review of "Sustainable Investing" by Cary Krosinsky and Nick Robins
Sustainable Investing: The Art of Long-Term Performance, a collection of articles from 22 contributors including co-editors Cary Krosinsky and Nick Robins, was released in the fall of 2008. SI challenges investors to look beyond what contributor Steven Lydenberg calls "the fast-paced speculative nature of today's financial markets." Socially responsible investors (SRI) have been striving to meet this challenge for decades, and now current events have exposed the financial system's myopia as an urgent global crisis.
If it had been released last year, this book would have been a valuable primer on how some investors integrate environmental, social and governance (ESG) factors into their strategies. In the winter of 2009, however, Sustainable Investing now offers answers to questions the whole world is asking. Consider this diagnosis from a January 3 New York Times article by Michael Lewis and David Einhorn:
"Our financial catastrophe, like Bernard Madoff's pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today's financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that's the problem: there is no longer any serious pressure from outside the market." [Emphasis added]
Outside the Market, Inside the Real Economy
Mr. Krosinsky and Mr. Robins, their authors, and the SRI/sustainable investment sector worldwide could reply: We are the pressure from outside the market.
"Outside the market" is the real economy of workers, customers, communities and the natural environment. Sustainable investors balance the short-term demands of capital markets with the long-term needs of society itself.
Cary Krosinsky is vice president at Trucost PLC, and Nick Robins is head of the HSBC Climate Change Centre of Excellence. The editors and their contributors are industry insiders, but their view beyond quarterly returns, and beyond those Warren Buffett called "geeks bearing formulas" – reintroduces "outside" global concerns to finance. (For more about the editors, see the end of this article.)
What Share Prices Don't Tell Us
Defenders of the "efficiency" of modern capital markets might argue that the information embedded in a share price tells the outside world all it should know about a stock, or a company. In "The Emergence of Sustainable Investing," Nick Robins presents statistics that say otherwise.
In 1986, investors held a London Stock Exchange-listed share for an average of nine years. In 2006, the average stock was held for only eleven months. How much can a share price convey about a corporation's long-term value when stockholders, as Mr. Robins writes, "cannot wait between one annual report and another before trading"?
Another number offers a clue about who really benefits from the computerized churning of modern capital markets. In 1981, the US finance sector earned 14% of total corporate profits. In 2001, its share had grown to 39%. "A growing share of global output is taken by the finance sector and its employees," Mr. Robins notes.
SI contributor Steve Waygood, in his article "Civil Society and Capital Markets," acknowledges that markets "hold the scorecard, allocate and price capital, and provide risk coverage and price risks." Unfortunately, he argues, their "current structure undermines long-term sustainable development goals."
Sustainable Investing argues that the inequities generated by a myopic, ever-expanding finance sector are not only unfair – they're unsustainable. SI's contributors explain why, and they also outline a model for the integration of ESG factors into investment decisions.
How Sustainable Investors Help Prices Tell the Truth
When investors incorporate ESG factors into their analyses, they introduce new information into capital markets. Corporate environmental practices (such as energy consumption or carbon emissions), social policies (including employee benefits and customer relations) and governance (such as executive pay and responsiveness to shareholders) may be "outside the market" concerns, but they matter to governments, investors and ordinary citizens.
"SRI is a form of consumerism, which resonates with global common values that anywhere from 5 to 20 percent of every nation cares about," explains Tessa Tennant in "The Global Agenda." Such percentages may not add up to a political majority, but they do represent millions of people and billions of dollars of investment, labor and consumption.
Investment analysis cannot afford to ignore these global common values. Such ignorance distorts capital markets and may be a risk to the market system itself. To dramatize this risk, Nick Robins quotes Ernst Von Weizsacker: "The system of bureaucratic socialism can be said to have collapsed because it did not allow prices to tell the economic truth."
Prices in a capitalist system may also obscure the truth, if buyers or sellers neglect to measure and disclose relevant information. ESG factors represent relevant risks and opportunities for corporations, and quarterly statements and share prices may not account for these risks. For example, over the past three years, some US utilities with otherwise strong financials have been forced to cancel new coal-fired power plants. These setbacks – driven by political concern about carbon emissions, which is a key ESG metric – demonstrate the market risk of external societal forces.
Sustainable investors help equity markets tell the economic, political and ecological truth.
Sustainable Investing: Two Conflicts in Focus
SI is organized into four distinct sections. Parts I and II present the past and present of sustainable investing, and Part IV considers future trends. Part III is an intriguing look at asset classes beyond the publicly-traded equity markets. Each section could be the subject of its own review, but SI's treatment of two particular sources of tension is especially relevant to the current economic situation.
First, SI's authors, especially Cary Krosinsky and Julie Fox Gorte, distinguish between "socially responsible" and "sustainable" investing. Their work suggests that while both approaches rely on the sort of ESG research that KLD (and Trucost) provide, sustainable investors may use somewhat different methods than traditional SRI investors.
Second, SI considers the global forces that promote sustainable investing, and also the persistent obstacles to its broader mainstream acceptance. While public concern about issues like climate change has made sustainability a buzzword, Steve Lydenberg (among other contributors) finds reason to "wonder how real these changes are, how deep their roots."
SI complements high-level macroeconomic thinking with pragmatism. For example, contributors Valery Lucas-Leclin and Sarbjit Nahal, in "Sustainability Analysis," tackle the practical problem of creating price signals to incorporate ESG factors into mainstream quantitative analysis. Other contributors also consider integration's impact on real-world problems and processes.
Mr. Krosinsky and Mr. Robins conclude their book with a qualified endorsement of sustainable investing's – and the economy's – future.
On the Sustainable and the Socially Responsible
When mainstream academics and journalists consider ESG investing, they typically ask a variation on one simple question: "Will it hurt returns?" Some observers are certain that it will, while other studies have found that investment returns may even benefit from ESG integration. Cary Krosinsky – both in his GreenBiz blog and his contributions to SI – emphatically promotes sustainable investing as a "market-beating strategy."
In "Investors: A Force for Sustainability," Julie Fox Gorte argues that sustainable investing can outperform the market through "fidelity to long-term drivers of…superior sustainability." She writes:
"…Sustainable investing is defined positively by seeking to invest in companies whose practices and policies include sustainability goals, where classic SRI was often defined negatively by what industries or companies were excluded."
Long-time practitioners of SRI could argue that exclusions of cigarette manufacturers, for example, also serve the goal of sustainability. From this perspective, smoking's externalized costs to society, when considered over a longer time horizon, would outweigh any short-term financial returns.
In their introduction, the editors help explain why they believe that any tension between these perspectives is outweighed by their shared priorities:
"Sustainable investing…provides an agenda for action for purely financially motivated investors eager to mitigate risk and benefit from upside opportunities, as well as for civil society organizations [or individuals] aiming to achieve social and environmental progress."
Sustainable Investing's Growth Drivers
SI's authors are an impressively multinational group, and their breadth of perspective reinforces the sense of global momentum for ESG integration. They consider sustainable investing's growth drivers in depth:
Political and Regulatory Pressure – Abyd Karmali, in "Observations from the Carbon Emissions Markets," studies the European Union's carbon-credit trading scheme, and in "Carbon Exposure," Matthias Kopp and Bjorn Tore Urdal model the future impact of emissions reduction regulations on German utilities. Both analyses offer insight on how global business could respond to public impetus for a more sustainable economy.
New Asset Classes – In "Fixed Income and Microfinance," Ivo Knopfel and Gordon Hagart describe how institutional investors' increased appetite for bonds – combined with public pressure on investors like colleges and governments to invest sustainably – will shape the strategies of fixed-income managers worldwide. Other Part III articles consider sustainable property investing, "social businesses" and private equity investment. The private equity article, by Ritu Kumar, illustrates the potential for this sector with case studies of firms that already focus on clean tech, clean energy and emerging markets.
New Markets – China and India, as emerging economic superpowers, each merit articles in SI's section on future trends. Ray Cheung explains how the environmental impact of China's rapid growth has finally drawn a government response. He focuses on the huge potential that new Chinese regulations offer for clean tech suppliers and investors. India faces similar ESG problems – including not only labor and environmental concerns but also relationships with regimes that violate human rights, such as Burma and Sudan. As Dan Siddy describes in his piece on India, these issues may not have concerned investors in the past, but they will in the future:
"ESG problems related to Indian, Chinese, and other emerging-market companies are likely to become more frequent, more acute, more visible and more frequently associated with shareholder value destruction."
Obstacles to Sustainable Investing's Growth
Overall, SI makes the case that sustainable investing can, and should, redefine the practice of investment itself. As the editors write in their conclusion, "The challenge…is not to become like today's mainstream, but, rather, to replace it." But to the credit of the editors and their contributors, SI also describes the ongoing resistance to ESG integration.
Political and Regulatory Pressure – The same force that encourages better Chinese environmental practices – the power of an authoritarian government – is also a threat to the human rights that are of equal importance to traditional social investors. Ray Cheung explains:
"…[As] with everything in China, the buyer must beware. … Given the country's one-party political system, Chinese and international firms must be willing to make dubious compromises with authorities; for example, Google censored a local Chinese search engine, and Yahoo! turned over to police email records of a Chinese journalist, leading to his arrest."
This case may seem unique to China, but political considerations may inhibit sustainable investment in democracies, as well. Even regimes that support better environmental practices are subject to pressure from political blocs, such as fossil fuel producers, who support the status quo. As a result, the case for sustainable investing depends on political action from individuals and interest groups.
In "Civil Society and Capital Markets," Steve Waygood explains how non-government organizations (NGOs) play an important role in both mobilizing political pressure and helping companies implement divestiture campaigns and other initiatives. However, he writes, "To date, capital market campaigning has mainly targeted investors as a way of influencing corporations rather than attempting to change the structure of the capital market itself."
This may be changing. Government complicity in the current banking crisis – or, at least, the public perception of such complicity – has already motivated some sustainable investors to direct more effort towards regulatory reform.
Limited Thinking – Since sustainable/SRI investing first emerged, its skeptics have questioned its value. Nick Robins sums up the stock objection from adherents of "conventional financial theory":
"The assumption is that the introduction of non-financial factors will harm diversification and thereby incur penalties in terms of risk returns."
Mr. Robins explains that while not every ESG factor has an immediate impact on a company's bottom line, "investments selected on the basis of identifiable ESG factors…do tend to outperform." Each of SI's contributors presents evidence of the opportunities represented by ESG integration, or of the risks of neglecting these factors.
Still, conventional wisdom persists. Stephen Viederman confronts a still-strong redoubt of anti-SRI bias in "Fiduciary Duty." He cites the example of ExxonMobil, which acknowledges the reality of climate change but "refused to respond to a shareholder proxy resolution asking the company to 'adopt a policy on renewable energy research, development and sourcing.'"
How should investors – especially trustees who are bound by fiduciary obligations – respond to this recalcitrance? "Conventional financial theory" would suggest that a trustee who sold ExxonMobil stock because it wasn't prepared for climate change has violated his fiduciary duty. After all, the company's share price is steady and its record of dividends is strong.
Mr. Viederman proposes a contrary understanding of fiduciary duty. He asks:
"Although highly profitable now, are ExxonMobil's profits going to be sustainable, and is ExxonMobil in its pursuit of profit now limiting options for future generations?"
Until a critical mass of investors agrees with Mr. Viederman – that "advancing social, environmental, and financial benefits is the new fiduciary duty" – then their limited thinking will continue to limit the growth of sustainable investing.
Limited Resources – This obstacle to sustainable investing is rooted in a concept that its adherents are already familiar with: wealth, both human and natural, is finite. Most of SI's contributors convey at least some optimism about humanity's future, but Julie Fox Gorte concludes her piece by sizing up the task ahead of us.
"In order to stabilize the climate…emissions must be reduced 70 per cent below the levels of 1990 – a profoundly greater step than the 5 to 8 percent reductions called for [by]…the first Kyoto Protocol."
What tools can we use to accomplish this task? Ms. Gorte presents the conundrum of an extractive, industrial, corporate civilization choosing, perhaps, to stifle the source of its power. Hers is a sobering but necessary perspective:
"…For decades, the average profit margin in the US hovered around 8 percent. The simple arithmetic of this is that the amount corporations and investors have to spend on saving the planet is less than 10 per cent of what they spend to get that power, which is largely responsible for creating the problems in the first place. …We are accustomed to thinking…that our transformations…make things better for us. But we are at the threshold of a transformation that makes things profoundly worse, at least for the two or three generations whose faces we will see during our allotted spans."
Conclusion: The Sustainability Moment
In the face of such an awesome task, Sustainable Investing's editors and contributors offer no easy answers. Instead, they describe the steps that have been made towards a sustainable economy, propose further steps, and perhaps most importantly, they confront the objections of a still-skeptical world.
Mr. Krosinsky and Mr. Robins conclude by acknowledging that the recession has "put sustainability concerns on the back burner" for many leaders, citizens and investors. They describe this mentality as one that sees sustainable investing as a fad, as "merely a cyclical bull market phenomenon." Sustainable Investing is a thorough, much-needed refutation of this mistaken belief.
As the editors explain:
"This [belief that sustainability is a fad], however, is not just a misreading of history, but a strategic misinterpretation of the structural, secular nature of the sustainable investing phenomenon. ... Not only is the investor case [now] much better understood and embedded among the world's leading institutions, but sustainable investing strategies are increasingly seen as essential to the recovery itself."
As the UN proposes a "Green New Deal," and old economic assumptions fade throughout the world, this could be the moment when the mainstream becomes sustainable.
About the Editors:
Cary Krosinsky joined Trucost as Vice President in 2008 to help represent Trucost in North America. He was previously a member of CapitalBridge's Operations Committee, providing leadership on data and analytics. He maintained many of the largest banking and corporate relationships for the company in the US, Europe and Asia. He has also been a member of the 70 person Expert Group that led the creation of the United Nations Principles for Responsible Investment (PRI).
Nick Robins is head of the HSBC Climate Change Centre of Excellence. He has 20 years experience of promoting sustainability in business practice, financial markets and public policy. He joined HSBC in October 2007 from Henderson Global Investors, where he was Head of SRI Funds. During his time at Henderson, he helped to design and launch its pioneering "Industries for the Future" fund, and is a member of the UK Government's Sustainable Development Panel.
At BusinessGreen, Danny Bradbury reports that even as Apple launches new "green" products, the company is resisting shareholder requests for better sustainability reporting. Apple's board has asked its shareholders to vote against a resolution calling for the company to measure and disclose its environmental impact in a formal corporate social responsibility (CSR) report. The resolution is proposed by environmental advocacy group As You Sow, who also called on Apple to design its computers for end-of-use recycling in 2007. Mr. Bradbury writes:
"The [current] resolution would require the company to publish a CSR report detailing its approach to greenhouse gas emissions, toxics and recycling by July this year. The report would also require Apple to define 'sustainability,' and would include a company-wide review of policies contributing to sustainable operations. "As You Sow claimed in the resolution that there were strong commercial reasons for Apple to produce such a report, arguing that over 2,700 companies now produce formal CSR reports, including many direct competitors such as Dell, IBM and HP."
As You Sow's work is a reminder that even well-respected companies may not meet the reporting standards of the Global Reporting Initiative or other CSR guidelines. A 2008 SIRAN/KLD study found that while 86 of the largest 100 US companies addressed sustainability on their websites, only 49 produced complete sustainability reports for 2007.
While this represents considerable progress, it highlights a gap between US companies and their peers in Europe, where many governments require CSR reporting. As noted by Boston College Professor Sandra Waddock in her January 9 presentation to KLD, companies in France, Sweden and other nations must formally disclose their social and/or environmental performance.
While new taxes are always a difficult sell, a carbon tax program that disbursed some income to utility customers could be politically palatable. Entrepreneur Peter Barnes proposed such a "cap and dividend" program to Congress in September, and the stalled economy has increased the appeal of any plan to send cash directly to struggling voters.
The cap and dividend concept combines a tax on carbon producers with tangible benefits for utility customers. The program would tax fuel producers if the carbon released from the use of their product exceeded a defined limit. If a coal mine's carbon output exceeded this limit–the "cap"–its taxes would go up. The producer would then pass along its increased costs to coal-burning utilities, encouraging those companies to develop alternatives. The customer rebate–the "dividend"–is a recognition that raising the price of fossil-fuel power would raise the retail price of all power, at least until new sources come on line. (The Carbon Tax Center provides a helpful FAQ on the concept.)
While this makes sense in theory, there are high hurdles for any program that could be blamed for raising the cost of energy–especially when memories of $4-per-gallon gas are still fresh.
For any carbon tax plan to succeed, the public must accept both climate change and the immediate costs of mitigating its impact. Surveys in the US and Europe reveal that this acceptance is incomplete. "There is a clear gap between what citizens are saying and what they are doing on climate change," EU Environment Commissioner Stavros Dimas told Reuters, in response to a 2008 poll of 30,000 people in 30 countries.
In the US, a 2008 ABC News poll found that a majority acknowledge that climate change is real. Unfortunately, our desire to do something about it collides with our attachment to the status quo, as detailed by the poll results:
"Majorities…support oil drilling in protected coastal and wilderness areas. … "64 percent now rate 'finding new energy sources' as more important than improving conservation–up 9 points since 2001. … "There's also an 8-point drop [from 2006 to 2007] in this poll, to 33 percent, in the number who think rising temperatures are caused mainly by things people do, rather than natural causes or both about equally."
The public's conflicting beliefs have real political consequences. If Congress or the President proposed a cap and dividend program, we could expect carbon producers to launch a PR campaign calling carbon taxes an unacceptable burden on a weak economy. The fight would mobilize voters and political leaders from oil- and coal-producing states and exacerbate tensions between producers and consumers. Tax rebates could be a popular cause, but politically, the threat of job losses is a powerful counter-argument.
Still, there is some cause for hope. Even as the public seems unwilling to fight climate change, we look to government for leadership–61 percent in the ABC poll said that our leaders can do more. If the President-elect's picks for energy and environmental leadership live up to their promise, there is the potential for a productive discussion of cap and dividend and other policy options. A little honesty–or at least honest debate–among those who pull the levers of power could help set the table for smart but difficult decisions.
To meet the climate challenge, we are going to have to confront some hard truths, including our own denial.