DEFINING SUSTAINABLE INVESTMENT

Weekly Viewpoints on Sustainable Investment 

In this week's note a view on defining sustainable investment, sustainability in investment and ESG. 

Language and definitions matter.
PHOTOCREDIT SinCo 2013

DEFINING SUSTAINABLE INVESTMENT: WHAT IS ESG?

Definitions for sustainable investment differ. We choose to define the theme of sustainable investment to explain that ESG issues are in every investment decision. But only some investment professionals proactively manage ESG for increased opportunity set and reduced risks exposure. Definitions and the language of sustainable investment have often been a stumbling block to investment practitioners building more formal ESG approaches. Over the years a broad genre of investment practices that integrate the consideration of ESG issues emerged with a perplexing array of names (see how the names have played out in the academic arena in N.S. Eccles; S. Viviers, The Origins and Meanings of Names Describing Investment Practices that Integrate a Consideration of ESG Issues in the Academic Literature, Journal of Business Ethics. 2011;104(3):389-402). Explaining sustainable investment and the role of environmental, social and governance (ESG) factors in investment management needs context. Sustainability has its own language. Explaining ESG starts by opening up the conversation. Of SinCo's five recommendations in the seminal report on Sustainable Investment in Sub-Saharan Africa (by SinCo + RisCura commissioned by International Finance Corporation funded by the Government of South Africa, published July 2011, see project page LINK), the very first was to articulate ESG in the language of the institutional investor.  

KEY REFERENCE DOCUMENTS

ESG is a useful abbreviation. It is just a simplification, just a tool. The work of developing an ESG philosophy and integrating it into the investment life cycle of a private equity fund or pension fund or listed equity active fund relies as much on the investment philosophy that the investor has of the world (how it see the world as an investor?) as on the definitions of sustainability offered by experts and stakeholders (what material sustainability issues intersect with the stakeholders in the future of the firm?). In framing the best approach to sustainability for a fund, I have used the most recent references (for example the latest IFC sustainability principles launched January 2012 (see also IFC resources for promoting sound environmental, social, governance (ESG) and industry standards) or the Global Reporting Initiative G4 sector guidelines launched in May 2013 or the Kenya Vision 2030 plan in Kenya) in working on design projects for SinCo in private equity in Africa. But we are also mindful of the institutional history through which we have come, for example the 1987 definition of sustainable development by the Brundtland Commission. 

• "Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs" 

But few practitioners are accurate in describing the two riders, namely needs of the poor and technology:

• "the concept of "needs", in particular the essential needs of the world's poor, to which overriding priority should be given; and 
• the idea of limitations imposed by the state of technology and social organization on the environment's ability to meet present and future needs."

The overall investment ecosystem of pension fund trustees, PEOs, advisors, and ratings agencies influence new investment practices. Investors are mostly conservative with a culture of investment-as-usual. Recently, SinCo research in southern Africa (Botswana, Namibia, South Africa) for the IFC and Principal Officers’ Association (POA) indicates that corporate governance, corruption and water scarcity stand out as ESG factors that investors worry may have a significant impact on their funds’ investment performance over the medium term. This research is captured in our forthcoming research paper Defining Momentum:  A Review of the Retirement Fund Investment Value Chain and the Progress of Responsible Investing in Southern Africa (SinCo commissioned by IFC, published July 2013) prepared for the industry-led initiative Sustainable Returns for Pensions and Society Project described in the SinCo portfolio of work LINK.

LINKING HARD LAWS AND SOFT RULES

Sustainable investment has tried hard to find hard ground of definitions, and many have emerged. Considering the carrots and sticks of promoting sustainable investment, definitions are necessary at a very practical level in order to establish the "rules of the game" that allows for policymakers to establish laws and regulations to be administered. The emergence of voluntary investor initiatives has been an important precursor to regulations, and sometimes a practical and pragmatic substitute for laws. These voluntary initiatives are a hybrid between hard rules (direct laws and regulations) and soft rules (moral suasion, stakeholder pressure). So for example, in identifying ESG issues and how they apply to investment, pension fund’s are flagging the realities of how investment happens within a broader investment ecosystem.  A sample of ESG issues include: 

• Environmental - Environmental Performance, Global Sanctions, Toxic Chemicals. 
• Social - Child Labor, Consumer Product Safety, Workplace safety, Diversity, Labor Relations. 
• Governance  - Separation of powers and duties, Publish What You Pay, Extractive Industries Transparency Initiative.

The CFA ESG Toolkit launched in June 2008  (PDF) also lists a good range of ESG issues as reference. Voluntary initiatives play an important role in defining some of the issues and differing perspectives to defining sustainability. For example the UN-supported Principles for Responsible Investment (PRI) (an investor initiative with UN environment Programme Finance Initiative (UNEP FI) and the UN Global Compact), the Extractive Industries Transparency Initiative (EITI), Code for Responsible Investment in South Africa (CRISA), the Equator Principles or the Carbon Disclosure Project (CDP) have played an important role in framing ESG issues. 

From my experience, the ratio of importance of ESG issues, and the exact issues, will vary from region to region, and so will their impact in the investment lifecycle given different asset classes. A positive outcome for institutional investors has been the emergence of investor collaboration. For example, pension funds have used the investor initiatives to increase pipeline of investment opportunities, to increase precision of due diligence, to spread risks in the deal, and co-invest leveraging development financing institutions (DFIs) capital. In shareholder activity the voices of more shareholders and shareholders with greater assets represented helps to generate more influence with companies or policymakers that sustainable investors are trying to influence. For example, this past week has seen the lobbying disclosure resolution filed by the Province of St. Joseph of the Capuchin Order receive 55% shareholder support at Alliant Techsystems (NYSE:ATK), with significant support from collaborating institutional investors. 

Do good work on sustainable investment that matters.

Graham Sinclair

@esgarchitect

linkedin.com/in/grahamsinclair

Skype: graham_sinclair

SinCo - Sustainable Investment Consulting

SinCo designs ESG architecture for long term sustainable investment that matters. 

www.sincosinco.com

@SinCoESG

Based on my work, experience and interactions, all views and opinions expressed are those of the author and do not reflect the named individuals, institutions or SinCo, it's clients or services providers. No mention suggests endorsement. This commentary does not constitute investment advise. Issued by SinCo to professional investors and stakeholders for information only and its accuracy/completeness is not guaranteed. All opinions may change without notice and may differ to opinions/recommendations expressed by other business areas of SinCo. SinCo may maintain positions and trade in collective investment instruments referred to. Unless stated otherwise, this is not a personal recommendation, offer or solicitation to buy/sell and any prices/quotations are indicative only. SinCo may provide sustainable investment architecture and other services to, and/or its employees may be directors of, companies referred to. To the extent permitted by law, SinCo does not accept any liability arising from the use of this communication.

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