Responsible investment: the challenge of integration

November 2013 | PROFESSIONAL INSIGHT | FINANCE & INVESTMENT

Financier Worldwide Magazine

It is widely recognised that investment by financial institutions is a driving force in the world’s economy. It is their influence and power over companies globally that make their involvement in and contribution to sustainability an essential element to its success. In the financial industry, sustainability initiatives are known as ‘Responsible Investment’ (RI) – a concept which has recently become mainstream in the investment world. However, the challenge now centres around shifting these initiatives from a tick box exercise to full integration into investment practices.

Stakeholders are now increasingly requiring investors to demonstrate sound decision-making in relation to their portfolios, and this agenda now incorporates issues associated with Environmental, Social and Governance (ESG) risks and opportunities. This scrutiny can come from a number of sources, including the investment chain itself, shareholders, employees, consumers or, in some circumstances, lobby groups.

Most investment models have traditionally based performance on compliance, including ESG issues. However, in more recent years, increasing expectations have led investment firms to adopt more formalised RI practices, which have proliferated as fundraising time approaches.

Save for a number of trailblazers who have been involved with RI for quite some time, a large number of firms and funds are now realising action is required as they receive upstream investors’ ESG questionnaires, which are now standard practice and pre-requisite (of course) to those deploying the capital. The temptation has always been to quickly rush through a policy or strategy for submission to these investors. However, firms are increasingly realising that the benefits of ESG extend far and beyond this initial capital raise, to value creation through opportunity maximisation, in addition to business and reputation risk management, which in turn mean that integration becomes key to their success.

A first step towards integration is engaging the investment team in the agreement of the boundaries of the firm’s RI decision-making framework. Dealmaking is complicated as it is; therefore, adding extra layers of bureaucracy to the already demanding protocols in place can result in shortcuts and flaws in its implementation. Consultation of the wider team can yield positive input into integration as well as creating a sense of ownership, which in the long term means increased uptake of ESG policies and procedures. As part of this engagement, most firms soon realise that a number of ESG aspects are already being considered on an ad hoc basis as part of their daily operations as these make ‘business sense’. However, the implementation of a more strategic approach to ESG, together with supporting tools and education, generally ensures more efficient identification of risks and opportunities; that is, enhances the investment process rather than complicates it.

Beyond the deal, through stakeholder influence or active ownership, investors can subsequently engage with investees in promoting ESG values and initiatives. Recent press coverage of news such as the horse meat scandal or the tragedy in Bangladesh, once more, reflect the severe impact that ESG issues can have on reputation and consequently on business and operations. Positive, continuous and pertinent input from informed investors encourages ESG improvements of investee companies both in direct business activities as well as upwards and downwards through the supply chain. Although solid data quantifying the financial impact of strong ESG performance is not widely available, it is commonly recognised that well integrated ESG management can be profitable for both investor and investee. Clear and coherent metrics to measure responsible investment initiatives, which are aligned to the adopted framework, will enable further positive management of investee ESG issues and facilitate reporting back to stakeholders, whether the companies themselves or the investment firms.

As upstream investors (such as asset owners) place increased onus on disclosure, a number of reporting guidance on ESG have also been launched. In particular, the United Nations-supported Principles of Responsible Investment (PRI) has recently launched a new reporting framework following extensive consultation with their signatories and a pilot period. The framework provides a set of standardised indicators, with are complemented by specific metrics based on type of investor. Whilst a good and comprehensive framework, concerns have been raised over its complexity. Other initiatives have included the publication of the ESG Disclosure Framework for Private Equity. This framework aims to assist general partners (GPs) to better understand limited partner (LP) demands in relation to ESG information. For this purpose, it outlines eight objectives common to many LPs who want more structured ESG disclosures. Whether signatory or not to the PRI and regardless of the asset class involved, reporting which takes full consideration of materiality and is integrated with the firm’s strategy and RI framework will form a strong basis for disclosure, which in turn (to close the circle) will facilitate future capital raising.

Overall, as awareness that integrated ESG makes good business sense, the question that remains is whether in 10 years time, full integration will mean we have stopped talking about RI to just know it as ‘Investment’.

Penelope Latorre is an associate director at Waterman Group. She can be contacted on +44 (0)20 7928 7888 or by email: penelope.latorre@watermangroup.com.

Penelope Latorre

Waterman Group