Nina Röhrbein reports on how stock exchanges apply pressure on their listed companies to be more sustainable

Companies are under pressure to become more sustainable. Stock exchanges have joined the likes of NGOs, consumers, institutional investors and other shareholders in applying this pressure. The Sustainable Stock Exchanges (SSE) initiative, launched in 2009 by the UN Secretary-General, aims to explore how exchanges can promote corporate transparency and environmental, social and corporate governance (ESG) issues. A focus of the SSE is to assist stock exchanges in promoting ESG disclosure via their listing requirements and other mechanisms.

Five stock exchanges, the NASDAQ OMX, BM&FBOVESPA, the Johannesburg Stock Exchange (JSE), the Istanbul Stock Exchange and the Egyptian Exchange, were the first to commit to the SSE. Since then, India’s MCX and Bombay exchanges have also joined.

“We only started the signature drive seven months ago, so we are hoping to add more members by conducting a much broader outreach campaign,” says Anthony Miller, SSE co-ordinator at the UN Conference on Trade and Development. “We have also been developing the SSE Consultative Group, which will engage with stock exchanges, investors and regulators throughout the year on specific projects. The group is identifying best practices in this space and a draft guide for exchanges and their regulators is set to be published by early November.”

As part of the SSE Consultative Group, the Nasdaq is working with the World Federation of Exchanges (WFE) to develop consensus among exchanges on universal standards that can be brought to the International Organisation for Securities Commissions (IOSCO) and national regulators.

“First, we have to have a consensus around what appropriate standards should be before trying to get exchanges to endorse the concept,” says Sandy Meyer-Frucher, vice-chairman of Nasdaq OMX. “If it is done independently it becomes a competitive issue. We want it to be a universally valid issue and, for that, all exchanges will have to move forward together.” For that reason, Nasdaq has yet to embed ESG in its listing rules.
Emerging market exchanges have been leading the SSE in the public forum. This is partly because they see it as a competitive advantage when trying to attract investors, according to Steve Waygood, chief responsible investment officer at Aviva Investors, which is a founding partner of the SSE.

“Conversely, the fear of the main developed market exchanges relates to the Sarbanes-Oxley Act (SO) in the US, which has been blamed by some for driving companies away from US exchanges,” he says. “With the exception of Nasdaq, major developed market exchanges have not been particularly engaged in the SSE debate, although the Toronto Stock Exchange and Deutsche Börse Group (DBG) have been doing more than others. They fear they might lose companies to other markets if they put a provision in place. However, most modern companies produce sustainability data already, which is why more extensive listing rules should not dissuade them from listing. Moreover. We are advocating a report-or-explain approach, which is a world away from the command and control environment within SO.”

While the DBG requires companies in the listing process to fulfil transparency criteria, and monitors their adherence and sanctions failures or misconduct, it does not require specific listing requirements related to ESG.

“As of today, ESG data availability and comparability in global markets is not mature enough,” says Barbara Georg, head of listing and issuer services at DBG. “An extension of our transparency rules without the existence of an internationally accepted standardised set of key sustainability indicators would not satisfy investors looking for high qualitative, standardised and thus comparable sustainability data. Therefore, we concentrate on promoting voluntary corporate sustainability disclosure with the objective of improving transparency in a number of ways.”

DBG says it encourages best practice in the market through its sustainable index offering. It also facilitates the integration of ESG aspects in the investment processes via its socially responsible investment (SRI) portal on which ESG data and Carbon Disclosure Project scores for 1,800 global companies are published for free.

“Historically, emerging markets have had to contend with challenges of growing their economies and competing fiercely for investment in a global market,” says Corli le Roux, head of SRI index and sustainability at JSE. “Given these dynamics, the incentive for relevant exchanges to walk their listed companies along the path of sustainability, demonstrating both broader risk management and good corporate citizenship may have been greater than in more developed markets. The nature of these economies has also had to confront transformative challenges, socio-economic conditions and environmental imperatives with greater urgency than in developed markets, while working to overcome the preconceived notions of greater investment risk.”

The JSE believes that in a globally competitive environment, markets with strong regulation, solid infrastructure and thriving institutions will be in a  better position to attract sustainable capital flows. It was integral in the development of each of the King Codes on corporate governance since 1992 and did not hesitate to implement the codes’ principles into its listing requirements.

JSE-listed companies have to meet mandatory requirements around specific governance elements, such as the separation of CEO and chairman, the requirement for the appointment of an audit committee and a chief financial director. But the exchange’s listing requirements also incorporate the principles of the King Codes on an apply-or-explain basis. Companies are obliged, on an annual basis, to issue a narrative statement setting out the extent to which they comply with each principle from the King Codes, or provide an explanation why not. Additional provisions in the 2008 Companies Act, such as the composition of the board, audit and social and ethics committee must be complied with, too, although these are not overseen by the JSE. The JSE’s SRI index sets more detailed requirements across ESG criteria, which are measured annually to determine whether companies qualify for inclusion in the index. These do not affect a company’s listing, however, and compliance with the SRI index requirements are voluntary, although the largest companies on the JSE are assessed automatically.

The Hong Kong Exchange (HKE) embeds ESG in appendix 27 of its main board listings rules and in appendix 20 of the growth enterprise market listing rules. Appendix 27 sets out ESG subject areas – workplace quality, environmental protection, operating practices and community involvement – and each subject area has various aspects. For each aspect, an issuer can report on the general disclosure and key performance indicators (KPIs) that indicate its performance. The issuer is encouraged to prioritise ESG subject areas, aspects and KPIs and report on environmental and social impacts material to its corporate strategy. Corporate governance is not included in the appendix, as it is dealt with separately in the listing rules.

It is currently only a recommended practice and applies to issuers with financial year ending after 31 December 2012. Subject to consultation, the exchange plans to move these recommendations to a comply-or-explain approach by 2015.

“With many issuers not understanding ESG issues, they are not ready to report on them yet,” says Mark Dickens, head of listing at HKE. “Requiring issuers to do so will only result in a check-list mentality which is why we do not think that the guidelines should have a comply-or-explain obligation at this stage. “

The paradox is that while many exchanges have yet to include ESG in their listing rules, they have no qualms about promoting their own corporate social responsibility (CSR) credentials.

“But the most significant corporate responsibility issue for a stock exchange is not its energy use,” says Waygood. “It is how it uses its influence to encourage better practices within the companies that it facilitates access to capital. Therefore, stock exchanges should report in their own corporate responsibility reports on how they have gone about improving the quality of corporate responsibility within the companies they allow to list on their exchanges.”

One neglected area, according to Waygood, is the executive incentives of listed stock exchanges, which typically focus on earnings per share (EPS) and total shareholder return (TSR).

“If you motivate purely on EPS and TSR, the unintended consequence is that you encourage exchange executives to increase the frequency of transactions on their exchange in a way that increases short-termism and reduces stewardship,” he says. “They should also have factors that ensure an appropriate level of focus remains on market quality issues such as corporate governance and CR performance.”