Businesses are recognizing the heightened importance of minimizing both their impact on the environment and the impact that environmental legislation has on them.
Fox:Profit motive and principles are becoming more closely aligned
A landmark year occurred in 2003 in terms of what was once a closed door being left slightly ajar. In June that year a group of 10 banks representing seven countries were among the first signatories of the Equator Principles, a voluntary set of guidelines for assessing and managing environmental and social risks in project financing deals worth $50 million or more. An additional 34 banks have since signed up to the principles.
But 2005-2006 may go down as even more of a watershed in terms of putting environmental and social issues at the top of the corporate agenda. Last year some of the most conservative and biggest names in financial services and manufacturing signed up to “green” causes. Goldman Sachs’ chairman and CEO Henry Paulson, who is also chairman of the Nature Conservancy, promised his company would invest $1 billion in renewable energy projects, establish an environmental policy thinktank and expand its role in what it does best—trading, or more specifically carbon emissions trading. Last year Ford Motor issued a climate risk report, a move that Chris Fox, director of investor programs at Ceres, which runs the Investor Network on Climate Risk, a network of 50 institutional investors with $3 trillion in assets under management, describes as a first for any company in the automotive sector.
Companies are utilizing market instruments such as qualifying GHG (greenhouse gas) emissions reductions and renewable energy certificates to achieve more cost-effective compliance with emission reduction targets outlined in the Kyoto Protocol. The volume traded in the GHG emissions market in Europe ballooned to more than 300 million tons last year thanks to the introduction of the EU Emissions Trading Scheme, which requires 12,000 installations throughout the EU25 to reduce their carbon dioxide emissions in the period from 2005 to 2012.
Investors Join the Party
The pièce de résistance, however, came in April and May of this year when 50 pension funds representing more than $4 trillion worth of assets signed up to the UN Principles for Responsible Investment, a set of six voluntary principles accompanied by 35 possible actions that investors can take to ensure that environmental, social and corporate governance (ESG) principles are considered in investment decisions and activities. “The $4 trillion now backing the principles confirms that the integration of environmental, social and corporate governance considerations is now an essential part of good business,” remarked Monique Barbut, director of the UN Environment Program at the principles’ launch in Paris. Perhaps for the first time a link was being clearly made between the financial performance of a company and its environmental and social obligations.
Caisse des Dépôts, one of the signatories and drafters of the Principles for Responsible Investment, stressed that it applied the principles to most of its investment management policies. “We opted to take these factors into account across the board in our portfolio management, rather than limiting ourselves to a few funds invested in accordance with SRI principles,” comments Francis Mayer, Caisse’s CEO. Asset4, a Swiss-based firm that tracks information pertaining to the economic, environmental, social and corporate governance of 500 companies on the MSCI World Index, which it sells to pension funds, says it is not just about ethical investing any more. “Pension funds are monitoring this from a risk perspective,” says Henrik Steffensen, vice president, marketing and business development, Asset4. “Some investment managers are looking at having, for example, a carbon dioxide emissions layer integrated into their mainstream investment management process.”
But is the profit motive of pensions, investment funds and ultimately the companies they invest in likely to override the significance of overarching ESG principles? “Investors need to achieve a balance,” says Steffensen. “They cannot just focus on financial performance any more. It goes beyond ensuring companies are behaving nicely, but also that they are taking advantage of these extra financial aspects [carbon dioxide emissions certificates] and product innovation in terms of environmentally efficient products.”
Johan Frijns, coordinator of Netherlands-based BankTrack, an international network of advocacy NGOs, says that the “honest” banks that led adoption of the Equator Principles have made significant leaps forward in terms of incorporating ESG principles within their business management. “The honest banks have come to the conclusion that profitability and environmental principles are not incompatible,” he says. “Overall it is beneficial to a bank if they take these things on board. They are seen as being responsible, which pays off in terms of client satisfaction and customer reputation.”
Fox believes that the profit motive and ESG principles are becoming more closely aligned. “They used to be separate domains, but with Enron there was a recognition that there were other off-balance-sheet risks that needed to be addressed, including the risks and threats posed by environmental and social issues.” Pointing to the example of the devastating damage wrought by Hurricane Katrina, Fox says environmental and social issues can have a negative impact on a company’s balance sheet. “The physical risks are becoming clearer because of the link between global warming and hurricanes that cause massive property damage,” he says. “That’s helped move this issue out of the investment box into a major financial risk issue.”
Walking the Walk
When it comes to the nuts and bolts of investment or project financing decisions, there is some concern that banks and companies are unlikely to forgo certain deals or projects just because they don’t comply with ESG principles. Paul de Clerck of environmental group Friends of the Earth (FoE) says it is difficult to judge the success of initiatives like the Equator Principles, as there is little information available as to whether banks have adhered to them. “Banks do not disclose when they do not finance a project because of the Equator Principles,” he says, referring to the example of Dutch bank ING Group, which withdrew from a financing deal for a paper mill in Uruguay but did not attribute its decision to the principles. “The problem with the Equator Principles is that there is no monitoring system, which makes it easy for a bank to sign on to it without doing anything,” he adds.
De Clerck believes that oil companies such as BP and Shell, which have been associated with environmentally sensitive projects, should not be considered as good opportunities for sustainable investment. But investors are clear that it is not about divesting from companies but instead engaging with them. The Investor Network on Climate Risk’s strategy is more one of “gentle persuasion” such as supporting shareholder resolutions and writing concerned letters to the largest insurance or power companies in the US in an effort to gain wider disclosure of their environmental credentials. This is what Fox terms the “PR effect,” which he says has prompted companies such as GE to re-think their strategies around climate change.
Increasingly, however, it is not just anxiety about investor or reputation risk, but regulatory and legal pressure that may force companies to disclose how they are addressing environmental and social issues. “Climate change has the potential to be the new asbestos,” Fox asserts, alluding to the potential for litigation against those companies that continue to ignore environmental and social issues. A recent seminal study published by Paul Watchman, a partner at US law firm Freshfields Bruckhaus Deringer, concluded that investment firms have a fiduciary responsibility to incorporate ESG issues in their investment decision-making. “Far from preventing the integration of ESG considerations, the law clearly permits, and in certain circumstances requires, that this be done,” Watchman stated at the launch of his study last October.
De Clerck also anticipates future legal action by NGOs against investors whose investment decisions have a negative impact on the environment. “We could see that kind of litigation in the next five years,” he says.