UN leads from the front
In the quest to integrate environmental, social and corporate governance standards into investment decision-making, few organisations have been more active than the United Nations. Enlisting influential and powerful partners in from the investment management world, the UN has sponsored major initiatives in several different areas.
In the 21st century, the role of the United Nation has evolved. "In recent years, galvanised in particular by the advance of globalisation and trade, there has been a profound convergence between the goals of the United Nations and those of the private sector and financial markets," explained UN secretary general Kofi Annan earlier this year. "Today it is increasingly clear that UN objectives - peace, security, development - go hand-in-hand with prosperity and growing markets. If societies fail, so will markets."
Following this logic, the UN established two groups in particular: the UN Global Compact is a corporate responsibility initiative with 3,000 participants worldwide. More specific to the financial services industry is the United Nations Environment Program's Finance Initiative, which investigates the impact of environmental, social and corporate governance (ESG) considerations on financial performance.
In May 2006, UNEP FI and the UN Global Compact announced the Principles for Responsible Investment. PRI was developed by a group of international institutional investors, convened by the UN under the auspices of the Global Compact. In early 2005,
20 institutional investors from
12 countries agreed to form an Investor Group; the group was supported by a 70-member multi-stakeholder group of experts from the investment industry, intergovernmental and governmental organisations, civil society and academia.
The process of devising and agreeing to the set of principles took place between April 2005 and January 2006.The PRI offer a framework on how to incorporate ESG issues into investment decision-making. They are not intended to be prescriptive but rather to offer a selection of various actions that investors can take. So far, signatories represent more than $5trn (e4trn) under management internationally: asset owners, such as pension funds, account for more than $2trn, and investment managers more than $3trn; service providers such as consultants and research organisations are also eligible to sign. By signing the PRI, the financial institutions have made a public commitment to implement the principles and also to be active participants in the process of their continued evolution.
Among the signatories is the UN Joint Staff Pension Fund, which has nearly $30bn in assets. In 2005, it was revealed that while the UN was working to promulgate the integration of ESG considerations in institutional investment, its own pension fund did not at the time follow such principles itself. New signatories join regularly: the latest to sign up are Interamerican Hellenic Life Insurance Company of Greece and South Korea's Midas Asset Management.
What gives the PRI particular significance is that this initiative has the public backing of the asset owners themselves. This demonstrates to their investment managers that there is a significant and genuine demand from their clients to incorporate ESG considerations into their investment policies. Whether the principles will be incorporated into the bidding process and into mandates is yet to be seen.
Revising reporting standards in line with ESG considerations is an essential part of what the UN and its partner institutions are striving for. The multiplicity of often conflicting standards makes like-to-like comparisons difficult - and excessive demands for information make corporations baulk at answering yet another request for compliance information.
In addition to its own initiatives, the UN supports the work of other organisations working harmonised and standardised reporting. For example, it supports to Global Reporting Initiative (GRI), which just issued its next generation framework (G3) in October this year. The G3 Guidelines are harmonised with the UN Global Compact's reporting guidelines and will enable the UN Global Compact's Communication on Progress to take the form of a G3 report. The GRI guidelines are widely used - 69% of the Dow Jones Sustainability Index and 60% of the S&P 100 use the GRI Guidelines.
UNEP FI (as well as GRI) also endorsed another reporting framework this October, the Global Framework for Climate Risk Disclosure, which focuses specifically on the financial risks posed by climate change. This was an investor-created framework, with participants including the UK Universities Superannuation Scheme and Calpers.
Behind these various areas of advocacy work is a growing body of research making the case for integrating ESG into investment decision-making. Last year, UNEP FI sponsored a report by international law firm Freshfields Bruckhaus Deringer on the legal framework for the integration of ESG considerations into institutional investment. The report, which caused quite a stir at the time of its launch, examined the laws around fiduciary responsibility internationally and in the European Union, as well as in nine individual countries, made the case that, insofar as ESG considerations impact financial performance, they must be taken note of; additionally they must be recognized if a consensus of beneficiaries agrees that they should be.
The Asset Management Working Group of UNEP FI has also been producing a group of reports in its Materiality series, delivering and analyzing financial research on how ESG issues impact company share price. Making the case for financial materiality is crucial to the UN's mission. As stated in the introduction to the latest report in the series, "Show Me The Money: linking environmental, social and governance issues to company value": "Ask any mainstream investor why they do not consider these ESG issues, and despite the relative documented evidence, most will tell you that ESG issues have little to do with money and profit making or enhancing financial value. Therein lies the most evident blockage to the mainstream integration of ESG issues, : many mainstream investors are unconvinced of their materiality, and unless clear links to financial value are consistently made, it will be difficult to persuade many investors to account for them."
In this report, 10 sell-side brokerage houses contributed reports across various sectors, such as the automotive and aerospace-defence industries, or European media, while others looked at issues, such as demographic trends, obesity and the food industry, or coal power and emissions. CRA Rogers Casey, the US investment consultants, added commentary on whether the ESG links documented in the research were strong enough to make a convincing case to mainstream investors.
The analysis of the broker studies found that indeed "ESG issues are material - there is robust evidence that ESG issues affect shareholder value in both the short and long term", and that "the impact of ESG issues on share price can be valued and quantified". That said, the importance of ESG considerations varies among sectors. For example, in investing in the forestry sector, ESG considerations are obviously crucial; whereas in the automotive industry, governance issues come to the fore.