Mind the Gap: Anticipating the shift in how investors and the financial sector view your company’s environmental and social sustainability
Even though more investors worldwide, particularly institutional investors, now say they assess corporate environmental and social performance in their investment decisions, most companies are still unsure exactly what these key stakeholders want to know and therefore what and how to report.
Similarly, while leading banks increasingly apply environmental and social risk management in their lending practices, it remains unclear how this translates into competitive advantage for their corporate clients who boldly adopt innovative solutions to environmental and social problems.
The importance of risk management remains high in the conversation about corporate sustainability. It will likely continue to be the key focus of sustainability-driven investor activism at shareholder meetings for some time to come. Major accidents, fatalities and environmental pollution are common causes for concern. And with shareholder activism on the rise, companies are seeing more shareholders requesting special meetings with the board on the issues that concern them most. Governance and executive remuneration currently top the lists of responsible shareholder concerns, but environmental and social issues are growing in visibility.
According to Ceres, 110 sustainability- focused shareholder resolutions were filed with 94 US companies during 2013. Many called for board oversight of sustainability and comprehensive disclosure of data through sustainability reports. Issues of interest were climate change, greenhouse gas emissions, supply chain issues and water-related risks.Investors withdrew more than 40 of the 110 resolutions after the companies responded affirmatively to their specific requests.
That said, investor activism on sustainability issues inevitably clashes with two entrenched business realities: firstly, the majority of shareholders still want to see superior financial returns, preferably on a quarterly basis; and, secondly, company executives manage a multitude of shifting priorities to maintain their companies’ competitiveness and profitability – with environmental and social responsibility being relatively new arrivals.
Consequently, there is still resistance on the part of companies when it comes to really innovating in the sustainability space, even though the massive rise in integrated reporting has brought more firmly to the foreground the real risks and costs of not doing so. Part of the problem may be that the stakeholders with the most leverage, namely investors and financial institutions, don’t yet systematically demand such innovation.
It’s not surprising then that the really interesting conversation between companies and investors – the one about sustainability and business value creation – still needs to get off the ground. For instance, first-movers in this space are testing if they can improve investment returns by focusing on sustainability leaders – companies with a track record of good environmental and social management, high-level commitment, and proactive stakeholder engagement. Research by RobecoSAM, covering a ten-year period, revealed superior long-term results. This confirms academic findings which tie sustainability leadership to good management, innovation and financial outperformance.
So why isn’t sustainability being adopted more systematically as a lens to identify well-managed, innovative companies with lower business risk? Fortunately, several major shifts in the financial ecosystems of emerging markets indicate this situation may be set to change.
Banks getting serious about sustainability
Currently 79 financial institutions in 35 countries have officially adopted the Equator Principles, a financial industry benchmark for determining, assessing and managing environmental and social risk in projects. It is estimated the Principles now apply to over 70 percent of international project finance debt in emerging markets. Ten African banks have adopted the Principles, including Nedbank, Standard bank, and FirstRand.
While the Principles apply to project finance above US$10 million, the community of Equator Banks are increasingly exploring ways to integrate sustainability into all aspects of how they do business, including green finance products and managing their own corporate footprints as a way to build brand visibility.
Nedbank’s journey is a powerful example. In 2005 Nedbank became the first African bank to adopt the Equator Principles. Since then, Nedbank has rolled out a green affinity program with WWF, funded projects under South Africa‘s Renewable Energy IPP programme, actively manages its own carbon footprint, launched South Africa’s first Green Index in 2011, created the Nedbank Capital Green Mining Awards, and most recently held the first Nedbank Capital Sustainable Business Awards.
Businesses can see this trend as a signal that banks are building capacity to take a market-based approach to sustainability. New products and screening tools will offer incentives as well as penalties to stimulate better sustainability performance by loan recipients.
Transparency is a first requirement to make this engagement between banks and companies work. So anticipate more interest from banks in the quality and details of integrated reports. As banks become more astute in assessing particular aspects of performance – such as energy, water use, waste management, and labour practices, for instance – expect to see more specific requirements in these areas. Bigger picture questions about license to operate and stakeholder support will no doubt take centre stage and quickly mature as a discourse.
Pension funds join the conversation
South Africa was one of the first countries to introduce a regulatory requirement for pension funds in 2012 to actively consider environmental and social risks and opportunities in their investment strategies.
New regulation 28 of the Pension Fund Act, in conjunction with the Code for Responsible Investing in South Africa (CRISA), triggered an industry wide response over the past two years to design a practical approach for pension funds.
Sustainable Returns for Pensions and Society, an initiative led by the Principal Officers Association of South Africa, the IFC, major pension funds, the Institute of Directors of South Africa, the Financial Services Board, Labour, and other key stakeholders, resulted in the publication in September 2013 of “Responsible Invesment and Ownership: a Guide for Pension Funds in South Africa”.
The guide provides a roadmap to introduce policies and systems that anticipate risk and inform proactive investment strategies.
As major investors in companies listed on the Johannesburg Stock Exchange, pension funds could therefore be set to play a much bigger role in moving South Africa’s private sector towards more responsible business practices.
South Africa’s Government Employees Pension Fund (GEPF), with 1.2 million active members and assets worth R1 trillion, already has a responsible investment policy in place and engages directly with major listed companies on ways to improve environmental, social and governance performance. South Africa’s example is being closely watched by other emerging markets, and could signal a global trend. Other parts of the financial ecosystem are also likely to follow suit.
For the most part, pension funds are still in the early stages of incorporating sustainability issues into decision making. With policies and priorities in place, they will hand implementation to asset managers who invest on their behalf.
Businesses can therefore expect to see an increase in interest from the asset management community in a wide range of environmental and social issues prioritised by their clients.
Thanks to the naturally long-term view of institutional investors, the emphasis will be on issues that have a medium and long-term impact on investor returns, while still seeking to avoid any significant short- term losses. As pension fund beneficiaries become more aware of sustainability, special interests may lead pension funds to seek out specific types of investments that have social and environmental benefits, such as renewable energy and affordable housing.
Companies’ integrated reports should therefore reflect a mix of:
- appropriate sustainability risk management,
- resource efficiency to reduce costs and dependencies; and
- quantifiable positive impacts on people and the environment that can be shown to reinforce strong financial performance over the medium and long term.
Green building practices are one such example. With pension funds able to invest up to 25 percent of their assets in property, implementation of green building standards can reduce energy and water costs, improve the health and well being of occupants, enhance the urban environment, and increase property value and rent premiums . From a portfolio perspective the value proposition is clear.
A major role for regulators
Another strong signal that sustainability has taken root in the financial landscape is the move by banking regulators in emerging markets to introduce national policies and incentives that promote sustainable banking.
A key factor is the creation of a level playing field to ensure banks retain their competitiveness when taking innovative steps towards a green and inclusive economy.
China introduced a national green credit policy in 2008 and technical guidelines in 2012 which now apply to all Chinese banks and include requirements related to international lendin. Bangladesh introduced a similar policy in 2011 and provides incentives to proactive banks who the meet the new standards.
In 2012, Nigerian banks collaborated with the Central Bank of Nigeria to introduce voluntary principles for sustainable banking, focusing in particular on financial inclusion and supporting women entrepreneurs. These leading countries are part of a community of regulators who now meet annually to share their experiences in creating enabling frameworks for sustainable banking. Member countries are learning from each other and replicating successful models.
Still in early stages of testing and implementation for many countries, this trend is moving quickly. South Africa’s example in the pension fund industry and the presence of three leading Equator banks locally, make it well suited to adopt similar policies. Businesses can therefore expect more active participation by regulators in establishing monitoring and incentive structures to track and promote private sector sustainability. Rating agencies will assist this process by making data more easily available. Eco-labels and industry standards will become more common and nuanced to measure performance on specific aspects and help businesses position themselves in the marketplace.
Shifting the conversation
With these various trends taking shape, conversations between companies and their financial stakeholders are likely to get much more interesting in the near future. While this may mean an additional reporting headache for companies initially, it may also quickly evolve into a more collaborative partnership between companies and their investors or lending institutions.
There is a growing spectrum of business benefits from improved sustainability, such as reducing resource costs, improving employee productivity, reducing absenteeism and staff turnover, avoiding business interruptions, strengthening relationships with suppliers, adding market share, and protecting license to operate.
The main problem is that for too long these aspects haven’t been measured and the business case hasn’t be clear.
South Africa’s adoption of comprehensive integrated reporting opens the door to a much more informed conversation about the different ways sustainability adds value. While comparability and consistency of data are important, the links with value creation are going to be as diverse as the companies that implement them.
Consequently, it remains for companies to tell their story of sustainability well, to articulate what they have tried and what the results have been, to explain how sustainability is a driver of their future business success, and how they are preparing for a changing climate and shifting social and economic conditions.
As more success stories of value creation surface, there’s a good chance investors and banks will be first to promote replication within and across industries and to seek out clients that demonstrate sustainability potential. Some of the questions already front of mind for conscious investors include: • Are water or energy costs significant contributors to business overheads and how is the company managing them?
• Is the company getting left behind in terms of new technology that could dramatically increase efficiencies or even change the game in terms of market position?
• Is the company treating workers fairly, maintaining high standards of health and safety, and offering fair pay?
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