Each week Emerging Markets ESG publishes an interview entitled, “Five Questions about SRI.” The interview features a practitioner’s insights about SRI in emerging markets and through Emerging Markets ESG shares this expertise with a wide global audience. The goals of Five Questions about SRI are fourfold:
- To collect a catalogue of examples of SRI in practice in emerging markets;
- To raise awareness about SRI in emerging markets;
- To reflect on what SRI in emerging markets means to practitioners; and
- To enable SRI practitioners in emerging markets to network with peers around the world.
This week’s interview is with Vipul Arora, Co-Founder and Managing Director, Solaron Sustainability Services, India.
With a team of more than 82 analysts fluent in 23 languages located across 15 emerging markets, Solaron Sustainability Services has been able to conduct ground level primary research directly in the relevant markets. Our name “Solar-On” signifies the work of our global analyst team in bringing light to company policy and performance in areas of the world where disclosure levels are low and transparency is severely limited. Through ground level investment research, Solaron is creating a silent revolution – effectively reducing the investment community’s overdependence on publicly available information and providing an information advantage via primary, direct data collection. Everyone is wiser after a crisis, but it takes much more than hard work, local access and intelligence to highlight risks and opportunities on the horizon before they arise. In June 2010, Solaron published an article predicting many of the informational issues that led to the microfinance crisis in India later that year. This article (available here) also predicts that further crises will continue to appear unless there is a fundamental change in our Investment processes. At a UN PRI webinar in August 2011, Solaron again predicted successfully that the situation in Middle East with the Arab spring was deteriorating rapidly than what was visible in International press. Solaron highlighted a real risk of a regional war in the Middle East and outlined the grave consequences of this possibility. We can all notice that the situation in Middle East is more serious today than what appeared in common press at that time. An engineer and MBA by training, Vipul Arora has worked in several industries ranging from sustainability, non-profit, IT & IT enabled services, food, agriculture, banking, financial services and logistics in India, the US, the UK, Mexico and Brazil over the last decade. In 2004, Vipul was selected as an Emerging Market Fellow of the Reuters Digital Vision Program at Stanford University. Here he conceptualized ‘e-Mandi’, an Agricultural Exchange for Indian Farmers to help double their incomes and reduce the wastage of food in the Indian supply chain. He helped operationalize this exchange by working with MCX in Mumbai. This exchange is now live in the form of National Spot Exchange Limited in India. He later helped Reuters Market Light (RML) as Vice President, Strategy in the roll out. RML shares market prices with farmers on their cell phones. A social entrepreneur at heart, he left Reuters in 2007, to set up Solaron to spearhead sustainability research in India and other emerging markets. He currently handles strategy and business development at Solaron.
Emerging Markets ESG: How would you define socially responsible investment (SRI)?
Vipul Arora: At Solaron, we define it like this: any investment strategy that creates positive returns for all stakeholders of a company (& not just shareholders) would be worth calling SRI. Everything else is just a marketing gimmick or green wash!
Emerging Markets ESG: What distinguishes SRI from mainstream investment?
Vipul Arora: Going by our definition of SRI, most mainstream investors would look typically at financial returns and that too primarily from the perspective of shareholders only.
SRI as it has been just defined is more inclusive and looks at a ‘holistic’ picture of real risks and returns of the business. In the real world, we all know that price is not the only factor in making decisions. And our life is not about transactions every day. There is something called building trust, building relationships and in the end it is an exchange of value over a period of time. I think the framework of SRI as defined above captures that very nicely in the world of investments. A company is not just a bunch of financial transactions and how much value it captures from each transaction. Even from the hard numbers world of accounting, a company is called a ‘going concern’ and therefore is a network of value exchanges with its stakeholders that happen today but also over a period of time.
Hence SRI defined like this is a wonderful framework that captures the real essence of a company. This shows a company as being a web of relationships with different stakeholders. Measuring SRI performance of a company from this perspective and analyzing how much value a company has created for its stakeholders: the community where it operates, customers, employees, NGOs, non-customers, regulators, suppliers, etc. suddenly becomes very meaningful and appropriate as it reflects the ground reality of a company. This is how we define SRI within our research framework at Solaron and this is how we measure it. And I can say with a high level of comfort that assessments that we have done with this framework have shown the real picture of long term risk and return profile of a company. Many companies that appeared ‘good’ publicly turned out to be risky if they showed up as risky as per this framework. Later we were proved right as their stock fell. So we have found good results using this definition of SRI!
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for companies in emerging markets to manage?
Vipul Arora: Though all three are a bit difficult, I would say governance is the most difficult for companies to manage, speaking generally. This is because of various reasons. The primary reason is that the legal and regulatory environment in several emerging markets (Ems) has not stayed in tune with the current times. Secondly, if it happens to be good in some emerging markets, its enforcement usually lags far behind. Even if this were to be handled by some regulators well, several companies tend to not see this as a long term risk and do succeed in finding ways to ‘look good’ or ‘window dress’ as they say in accounting terms, while still retaining large amount of risky governance practices in the background. And if you have a management like that, you can be sure that it leads to risks on the environment and social sides as well. The problem in such cases is that of a mindset. Companies that do this do not understand the long term implications of risky corporate governance and are there to make a short term success in the market, relatively speaking. Engagement with such companies may not give the desired result, even though they may look receptive to it. Having said this, there is a certain percentage of companies in each EM that fall in this category.
There is another category of companies that are genuinely aware of the ESG risks, especially governance risks and are taking meaningful long term steps to manage it well. These companies lead their sectors in corporate governance performance and more often than not, in the environment (E) and social (S) parameters as well. They are the ‘long term stars’ you can bet on.
Of course, there is the big ‘middle class of companies’ with a large number of them that just intend to follow what the market leaders are doing, but at their own pace. We cannot expect them to have world class governance practices in the near future, but they will not act as sinks of investment value. This ‘middle rung’ of companies is more suitable for engagement by investors. If the investors can make a good business case for stronger governance practices, these companies could get the message and if they do, could make a lot of progress.
So, the important thing for investors is to distinguish which category a company falls into and deal with it accordingly. However, this cannot be done merely by looking at their policies and programs (the official stand) but requires looking at their ‘real world performance’.
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for investors in emerging market companies to analyze?
Vipul Arora: Governance again! For all the reasons described above. Mainly because the companies fall across an entire spectrum of a few leaders, the big middle and sizeable laggards.
A second reason is the lack of meaningful disclosure in EMs. Because a large number of companies do not see the importance of first having good governance and secondly disclosing what they actually have, you won’t get data easily.
A third reason is the viewing lenses of western investors themselves. Most norm based frameworks that work well in developed world context would give poor results in EM governance evaluation. This is because the ground realities in EMs are very different and investors many times need some exposure to this truth. They should in the minimum not expect to use the same lens.
A fourth reason is linked to how the domestic markets in most EMs view the ESG parameters. Most domestic investors in different EMs do not yet value ESG; hence companies find no incentive to disclose. They see it as some sort of a new ‘alien’ imposition driven by Western investors. It is not that the cultures in each of the EMs do not encourage ESG. Most EM countries have had glorious civilizations in the past and have cultures that still value good manners and sound ethics in society. However, they do not connect it to the ‘return-seeking’ business and financial world. There is a communication challenge here. We have found that in most EM countries where our analysts are based, while doing research, we have to ask for information from people in a very simple and easy to understand language, typically avoiding any ESG terms. The moment we are able to communicate with the backdrop of the ethos and culture of the local country where our analysts conduct research, we get a very good response. However, to do this, we had to have local team members in each location where we do research from and this was not easy to build and is not easy to maintain. It has taken us five years to reach this level. This is very difficult to do remotely and that is why investors face difficulty in analyzing the governance risk in most emerging markets.
Emerging Markets ESG: According to conventional wisdom, SRI is developing slowly in emerging markets because of the low percentage of emerging market equities owned by Western institutional investors? What is your view? In your opinion, what is driving SRI in India and other emerging markets?
Vipul Arora: This is absolutely correct. This is one big reason but only one half of the story. The other half of the story is that domestic investors in each EM do not yet understand the connection between ESG and financial returns and hence do not value it. In most EMs domestic investors have a much bigger share of the market but they do not understand SRI or ESG, hence SRI is growing slowly. This fact is reflected in in the number of investor signatories to the UN PRI. If you look at the break-up, you will see very few EM investor signatories. Unless that changes, SRI growth will remain slow in EMs.
A good sign though is that most Western institutional investors are now reviewing their EM strategies and some progressive ones are already increasing their EM equity exposure. This has been helped to a certain extent by the risk / uncertainty increasing in US and European portfolios over the last four years. As a result, this is starting to change the expectations from EM stocks and managements of at least a few progressive firms are starting to realize the value of ESG.
A multi-stakeholder approach is needed to make more progress in this direction and we cannot expect results very quickly. The initiative to work with the stock exchanges is a step in the right direction. That is a good first step but more are needed. We need to get the stock market regulators on board. Since you mentioned India, just recently there, the Securities and Exchange Board of India (SEBI) passed a regulation requiring the 100 largest listed Indian companies to disclose their performance on a certain number of ESG criteria. That is a huge step forward! It took more than two years of campaigning to get this regulation moving. And clearly the scope of ESG parameters to disclose will increase over a period of time. Similar efforts in other EM’s will get us going. Beyond this, the task of making a business case in ‘local cultural contexts’ to domestic investors in each EM is a must. We have been working on this for last 2 years, having made e-learning modules to communicate ESG in simple terms to domestic Investors in their own cultural contexts. This will take years to show the desired results, but we are in no hurry as well! Once all this is done, there is no looking back for ESG / SRI growth in EMs!