Value in sustainability. Investors ratcheting up demands

8 mins  25.10.2017 Keith Rovers
There has been a tectonic shift in how financial capital is allocated. Responsible investment strategies with an environmental, social or corporate governance focus are now a critical consideration for shareholders, investors and asset managers alike, and correspondingly, those seeking to access that capital.

There has been a tectonic shift in how financial capital is allocated over the last decade. Responsible investment strategies with an environmental, social or corporate governance (ESG) focus are now a critical consideration for shareholders, investors and asset managers alike, and correspondingly, those seeking to access that capital.1

As the world population nears 7.6 billion and the earth's ecological boundaries are strained, public and private capital is increasingly being mobilised towards sustainable investment options, as technology combines with financial capital creating a paradigm shift in what constitutes shareholder value.2

Whilst ethical or socially responsible investment has been around for centuries (think the Quakers and Methodist religious movements in the 19th century), the Australian responsible investment market has exploded from its nascent state in the late 1980s to more than $622 billion in assets under management (AUM) in 2016, with nearly half (44%) of Australian assets under management now being invested through some form of responsible investment strategy (whether it be a broad ESG filter or screen or purer, core socially responsible investment (SRI) offerings, including social impact funds and bonds).3 This has also seen an accelerating shift in investment from broad ESG to core SRI funds, with the latter growing at an exponential rate now representing over 10% of SRI and 5% of the total market.4 Recent research also demonstrates outperformance of SRI funds compared to mainstream funds over a 10 year cycle.5

The Australian experience reflects global trends with the United Nation's supported PRI's6 launch of responsible investment (RI) principles in 2006 and a gathering of momentum in the past few years with the UN's Sustainable Development Goals released in 2015, the landmark 2015 Paris Agreement tackling the impacts of climate change and the recent Taskforce for Climate Related Financial Disclosures7 , all highlighting the role of private capital in enabling the economic transformation required to meet sustainable development goals and climate mitigation and adaptation strategies.8

The coming tipping point in RI (where the majority of Australian AUM will be SRI badged or aligned) and the exponential growth in core SRI funds, green and climate aligned9 and social impact bond markets10 are simply a few indicators of this tectonic shift.

The growth of RI reflecting changing community expectations and preferences has led to new financial products and asset classes emerging and marketed to different investor groups, across a spectrum of financial and social risk and reward appetites – from investors seeking maximum financial return, with the "conscience protection" of some ESG or social impact benefit, whilst at the other end of that spectrum, there are those with a focus on maximising social impact, with some capital protection or financial return. Investment products are being developed to cater to these differing appetites and this alternative asset class also provides risk diversification benefits – over and above the social benefits.11

Another factor in the sustainability drive, is the broadening of the fiduciary duty beyond shareholder primacy12 – there has been a long debate over the need to change company directors' statutory and fiduciary duties to broaden the extent to which directors can – or must - have regard to other stakeholders, beyond shareholders (creditors, suppliers, employees, the environment, community and so-on), however, we have now seen a number of prominent legal counsel13 warn of the risks to directors in ignoring ESG and sustainability factors in discharging their due care fiduciary duty if they fail to fully consider the physical impact and economic transition risks posed by climate change on their businesses14 – and, in another emerging trend, recently a class action has been launched against a major bank and its directors in relation to the failure to make appropriate climate risk related disclosures.15

Critically, the market has also moved and we have seen the world's largest shareholders (such as BlackRock and Vanguard) warn investee boards that they will use their influence (money and voting power) to ensure that the companies they invest in appropriately recognise, manage and disclose climate and sustainability risks (and opportunities) in their businesses16 . The consequence for failure – removal from office and denial of capital.

Accordingly, despite allegations of "fake news", the trashing of the media and a broader challenge to reason and the scientific approach, building the evidence base and gathering the data to build the necessary data sets and financial models for informed decision making (and for required market disclosures) has never been more critical. Data analytics, sensitivity analysis and modelling skills are essential for corporate survival and access to capital. This is all heavily dependent on technology and computing power.

The market is demanding that company's (both big and small) demonstrate their long-term sustainability and management of capital, not simply financial capital – but human, intellectual, natural, social, reputational and other capital forms that go to social licence, brand and reputation. Larry Fink, CEO of BlackRock, the largest asset manager in the world (with over USD5tn in AUM), in a letter to CEOs noted that “ESG factors relevant to a company’s business can provide essential insights into management effectiveness and thus its long-term prospects".17

This push to gather evidence and undertake the required analysis as part of the corporate survival strategy, feeds into the other major tectonic shift - the rise of 'big data' or the data ecosystem. Advances in computing power and storage (the proliferation of the internet, APPs, the advent of the cloud), 10 years of the smartphone, computer sensor ubiquity, the emerging Internet of Things and Artificial Intelligence - all embodying the power of Moore's Law – have provided new tools to extract economic value from data. Data analytics provides new means of identifying trends or correlations, develop preventative strategies, shave costs, increase revenues or change or disrupt business models – all delivering value.

The increasing and integral role of technology and data analytics is combining with responsible financial capital to tackle social and ecological issues and drive innovation and new approaches to such issues.

The power, agility and mobility of private capital and the emerging business for purpose models18 , coupled with the speed and depth of technological advancement and human ingenuity, provides a reason for optimism in our ability to tackle the many social and ecological challenges we currently face.19 

Increasingly, business decisions are evaluated as sound and sustainable choices when they serve to deliver not just a financial return, but also positive impact on the environment and society. Decisions purely intended to create financial shareholder value, but which destroy environmental and societal value, will place any business' long-term viability in jeopardy.

The shift in shareholder mindset from a traditional focus solely on financial outcomes, to choices in terms of environmental and social outcomes and best practice governance20 will impact all levels of the market, from small business to multinationals, for profit and non-profit entities alike and clearly has broader societal and community benefits.

Quantifying environmental and societal risk and reward is a difficult process in terms of monetary value, particularly within current economic models and historic cost management and financial accounting frameworks, but international accounting bodies and standard setters21 – are developing and refining those accounting frameworks and standards for measuring the use of natural capital in supply chains, GHG emissions and other externalities to bring those costs into the pricing and value chain.22 Likewise, social impact measurement is a burgeoning discipline seeking to evaluate the social return on investment of programs.23

This again reinforces the role of technology and the importance of collecting data and building databases to enable more granular decision making and a transition to a more sustainable economic model, better accounting and reporting frameworks and pricing approaches.24 Without under-estimating the scale of the challenge of adaptation25 , over time this approach will lead to better and more sustainable resource allocation – and allocation of capital to truly sustainable business. This will take time, but the process needs to start somewhere.26

Those businesses which are able to adapt in this environment will be rewarded with capital and will survive and thrive, others will fall by the wayside. The benefits to society from this approach will be manifest, and as BlackRock's stewardship statement makes clear, this is being demanded by those who hold the financial capital of those who seek access to it.

Big data can help paint a picture that executives can understand and act on. Those businesses that choose to act, develop and scale will be rewarded with access to capital, those that can't will be denied. This approach provides a pathway to a more sustainable and productive global economy and one which can meet the challenges we currently face.27

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[1] This is impact corporates and the not for profit sector alike.  NFPs are accessing returnable and donation based capital for social missions and individual and institutional investors alike are looking at the ESG impacts of organisations they invest in to mitigate harm and encourage more sustainable practices.

[2] There is also a broad recognition that 'shareholder primacy' or the shareholder value maximisation philosophy as the sole corporate purpose is not the ultimate corporate aim and that truly sustainable organisations build loyalty and capability through delighting customers and employees. Milton Friedman's 1970's mantra that businesses only social responsibility is to make profits has been superseded by organisations taking leadership roles and seeking to build stronger communities and bringing 'purpose' and 'meaning' back into the heart or core strategy of their enterprises. See the Accenture and Sears stories as great examples. See also RL Martin's Fixing the Game and the critique of the shareholder maximisation theory

[3] Social impact or benefit bonds enable governments to procure innovative social solutions and NFPs to monetise those services, providing access to capital to provide and expand their models.  There are currently 10 SIBs in the market, dealing with recidivism, mental health, out of home care, restoring families, homelessness etc – seeking to combine financial return and social impact.  The Commonwealth Government announced a $30M package in its most recent budget to facilitate and develop this market.  It has also set up a $100M Try, Test & Learn Fund to encourage innovative approaches to tackling social problems.

[4] Funds under management in SRI as at 31 December 2001 were under $2 billion - Ali, Paul and Gold, Martin L., An Appraisal of Socially Responsible Investments and Implications for Trustees and Other Investment Fiduciaries (June 2002). U of Melbourne, Public Law Research Paper No. 32. Available at SSRN. The Ethical Investment Association which became the Responsible Investment Association Australasia (RIAA) reported SRI at $14 billion in 2002, rising to $21.3 billion in June 2003. By December 2015, RIAA reported total AUM at $633 billion, $581 billion in broad ESG and $51.5 billion in core funds (at 31.12.2016- $557 billion broad and $65 billion core).  See RIAA Responsible Investment Benchmark Report 2017Similar trends can be seen in philanthropy, with a move away from donations to impact investing – see "Philanthropy 50", AFR Magazine 28 April 2017.

[5] See ABC News report, 'Ethical' investment funds outperforming mainstream counterparts: study and RIAA Benchmark Report 2017. This logic also extends to the business level, where businesses with a clear purpose outperform. See findings from Firms of Endearment by R. Sisodia referred to in EY Beacon's –purpose and  The research points to companies operating with a clear and driving sense of purpose outperforming S&P500 by a factor of 14 between 1993 and 2013.

[6] Principles of Responsible Investment (PRI) is an investor initiative involving over 1,400 investor signatories in more than 50 countries (managing assets in excess of US$60 trillion) in partnership with the United Nations Environment Programme Finance Initiative (itself a coalition of the UNEP and over 200 financial institutions) and the UN Global Compact.

[7] The TCFD released in December 2016 and finalised in June 2017 sets out a voluntary framework for reporting financial implications of physical and economic transactions risks (and opportunities) associated with climate change and calls for sensitivity analysis and modelling around the 2°C Scenario and associated transition risks and opportunities.

[1]  Paris Agreement Art 2 para 1(c) with a current target of US$100 billion pa earmarked to be mobilised for climate finance and a target reset in 2020 and US$90 trillion to be mobilised by 2030 to help build low emission, climate resilient economies (Brookings Inst).  The UNEP's Finance Initiative – Principles for Positive Impact Finance released on 30 January 2017 by 19 leading global banks (including Westpac) estimates US$5-7 pa investment to help meet UN SDGs by 2030.  Green sovereign bonds have been “the talk of 2017”, the Climate Bond Institute (CBI) reported on 18 September 2017, and are increasingly seen as a tool to help governments implement infrastructure plans in line with their commitments under the Paris Agreement on climate change. Labelled issues continue to meet strong investor demand, the CBI noted, with “oversubscription being the norm”. An extreme example was France’s sovereign bond in January which was upsized to €7 billion from €3 billion after receiving orders of more than €20 billion.  See

[8] Climate Bonds Initiative is an international, investor-focused not-for-profit working solely on mobilising the US$100 trillion bond market for climate change solutions. Its July 2016 5th Annual State of the Market Report references the US$694 billion green and climate aligned bond market, with US$120 billion labelled green bonds and notes the proposed 10 fold increase in climate smart investments by 2020 (page 2).  Australian issues accounted for 30% of global bond issuance in Q1 2017, with CEFC playing a key role as cornerstone investor in many of those issues.

[9] Social impact bonds have now been issued in NSW, South Australia, Queensland and Victoria over the past few years, establishing programs to tackle out of home care, recidivism, homelessness, mental health, drug and alcohol and other social issues. The broader social impact market is over $4 billion, growing at over 10% with a number of dedicated impact investment funds and community finance from both dedicated providers and the big 4 banks.   

[10] Ali & Gold (p4) note the diversification benefits to investment portfolios from alternative asset classes, such as SRI funds, with returns less strongly correlated to the performance of conventional equity investments.

[11] See Governance Institute of Australia discussion paper by Judith Fox – "Shareholder primacy: Is there a need for change?",  December 2014 for a summary of the issues and law reform recommendations.  The concept of "Shareholder primacy" is not legislated, it is a norm – the current scope of the law allows boards to have regard to other stakeholders (customers, employees, society more broadly etc), as well as its purpose and to take a longer term view of what is in the company's best interests.  There is growing evidence that a focus on customers, rather than shareholders should be the primary goal and, in fact, drives better long term outcomes for shareholders.  

[12] See opinion by Mr Noel Hutley SC and Mr Sebastian Hartford Davis, 7 October 2016, briefed by MinterEllison.  Freshfields, UK published the seminal paper on Fiduciary Duty in 2005 and Sarah Barker, MinterEllison and others recently published Climate change and the fiduciary duties of pension fund trustees – lessons from the Australian law, 14 August 2016

[13] Sarah Barker and Maged Girgis, MinterEllison Alerts note physical impact and economic transition risks are financial in nature.

[14] Commonwealth Bank faces legal action over failure to disclose climate change risk in report

[15] Responsible investment is promoted by PRI, which was established in 2006 as an investor initiative and partnership with UNEP Finance Initiative and UN Global Compact representing asset managers managing over US$25 trillion – BlackRock managing in excess of US$5 trillion AUM in its most recent annual letter to CEOs highlighted its approach to climate change risk governance and its expectations of its investee board

[16] See How BlackRock Investment Stewardship engages on climate risk – March 2017

[17] Social enterprise, community interest corporations, B Corps and other business for purpose models continue to evolve and there is calls on lawmakers to create legal structures which sit between the for profit (company limited by shares) and not-for-profit (company limited by guarantee to promote mission or purpose based organisations. Interesting and market leading models, like Adara Partners, which is a boutique investment bank created by Audette Exel with Australia's leading bankers and corporate advisors generating fees on corporate advisory mandates that are donated to the Adara international development aid platform is but one great example.  The shared value movement originating out of the Michael E Porter and Mark R Kramer report in the Harvard Business Review (Jan 2011) has inspired these approaches and promotes innovation and cross sector collaboration around a broader conception of value creation - see – B Corps.  See also EY Beacon's the business case for purpose on strategy and metrics 

 [18] See Thomas Friedman's recent book – Thanks for Being Late – An Optimists Guide to Thriving in the Age of Accelerations

[19] Consider, for instance, the CBA shareholder "first strike" against its executive remuneration report in 2016 due to a perception that he proposed culture and engagement metrics were too soft and the subsequent cultural issues that have since emerged and have been the subject to recent media and regulatory comment

[20] National Capital Protocol, ISO GHG Protocols, Climate Disclosure Standards Board, Sustainability Accounting Standards Board,, Green Bond Principles and the TCFD are all examples of the work being done in this area to create management and external accounting and reporting frameworks that can accommodate climate related risk, value and disclosures.  The TCFD has called on bodies to reconcile and rationalise these frameworks 

[21] See the Natural Capital Protocol, which sets out a framework for understanding the use of natural capital in an organisations value chain – both pre and post-sale

[22] Organisations like Sparks, Social Traders and Social Ventures Australia, as well as the big accounting firms provide consulting services in relation to impact measurement frameworks, whilst software providers such as Socialsuite have developed useful software to establish metrics and measurement systems.  

[23] One critique of Natural Capital as a concept is assigning a 'value' to nature that looks dangerously like a 'price' which promotes the treatment of the environment as an 'ecosystem service' or commodity to be captured as natural capital in national and company accounts and to be exploited for market growth. This approach whilst introducing a pricing and rationing mechanism may continue to place unsustainable burdens on the earth's ecological boundaries.  Doughnut Economics – 7 ways to think like a 21st Century Economist, p439.,

[24] Christina Figueres and colleagues in Nature International weekly journal of science (28 June 2017) look at the Paris Agreement commitments, the 'carbon budget' and achieving peak carbon with a road map for turning the tide of the world's carbon dioxide by 2020 to meet the 2050 neutrality goal.

[25] Spratt & Dunlop in What Lies Beneath, Breakthrough Publishing, September 2017 put the case that current processes will not deliver either the speed or extent of change required to meet the ecological challenge, whilst Kate Raworth in the Doughnut Economics – 7 ways to think like a 21st Century Economist, runs through the competing schools of thought as to whether the transition to sustainability (restoring ecological in a socially just manner) can occur within the confines of the present GDP growth focussed economic model or more fundamental structural changes to the economy, society and political processes are required to enable ecological sustainability.

[26] The views expressed in this article are the personal views of the author. Current as at 24 October 2017.


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