• 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 Amr Addas, Adjunct Professor of Finance, John Molson School of Business, Concordia University, Montreal, Canada.

Following a generous donation from the Molson Family and the Molson Foundation, in November 2000 Concordia’s Faculty of Commerce became the John Molson School of Business, Concordia University.  Together with the David O’Brien Centre for Sustainable Enterprise (DOCSE), also at Concordia University, it offers the Sustainable Investment Professional Certificate (SIPC).  The SIPC is the first professional designation of its kind, offered through a University Business School, specifically geared towards investment professionals.  The SIPC was created in response to the growing interest in sustainable investment approaches. Designed to provide professionals in the finance, investment and corporate world with a unique set of skills, knowledge and analytical thinking; the SIPC prepares holders to take full advantage of new professional opportunities created by the potential of sustainable investing.  Amr Addas is an Adjunct Professor of Finance at the John Molson School of Business, Concordia University.  Amr is also the manager of the Formula Growth Trading Room at the JMSB and a Research Associate with the DOCSE.  Amr is a member of the core faculty for the SIPC program and an Advisory Board Member for the Coalition of Universities for Responsible Investing (CURI).   He is also a lecturer at McGill University’s School of Continuing Studies.  Amr received the Merit Teaching Award for Outstanding Teaching from McGill University in 2009.  He obtained his MBA from the University of Michigan at Ann Arbor in 1995 and his B.Sc. in Mechanical Engineering from the American University in Cairo in 1991.  In March 2010, Amr became a regular active member of the CFA Institute and he is a Level III Candidate in June 2012.

Emerging Markets ESG:  How would you define socially responsible investment (SRI)?

Amr Addas:  Socially responsible investment (SRI) is the integration of environmental, social and governance (ESG) considerations into the management and selection of investments.  Perhaps an updated definition would be that SRI is an investment approach that integrates long-term Environmental, Social and Governance (ESG) criteria into investment and ownership decision-making with the objective of generating superior risk-adjusted financial returns.

Emerging Markets ESG:  What distinguishes SRI from mainstream investment? 

Amr Addas:  SRI can be described as undergoing a so-called second phase, SRI 2.0 if you will.  Historically, SRI was mainly concerned with negative screening, whereby investors with certain social values would invest according to those values by eliminating firms that don’t meet their social screens, thus effectively reducing their investment opportunity set and their potential returns.  Today, SRI has evolved into a more sophisticated screening process that encompasses both positive and negative screens.  The positive screens result in the selection of companies that achieve superior performance along two dimensions, financial and sustainable.

Thus the main difference between SRI and mainstream investment is that added layer of screening that SRI utilizes.  But the gap is narrowing as evidence mounts that SRI investment strategies often result in benchmark outperformance.

Emerging Markets ESG:  Which extra-financial theme – environmental, social or governance – is the most challenging for companies in emerging markets to manage?

Amr Addas:  The most challenging theme for emerging markets in my opinion is the governance theme.  Corporate governance in emerging markets, including the most advanced ones such as Brazil, China and India lags significantly behind developed economies.  Ownership of public companies is rarely as dispersed as it commonly is in developed markets.  The share float is often a fraction of total shares outstanding.  Furthermore, many of the most successful companies in some emerging markets are family owned and controlled.  Minority shareholders have little say in the governance or management of such firms.  This applies to Brazil and India, but not China.  In China, the problem is more related to state control of most large publicly traded companies, where politics and toeing the party line often take precedence over good governance practices.  China’s philosophy seems to be more oriented towards so-called state capitalism.  Minority shareholders essentially have no say over how such firms are managed.

Corruption is also endemic in many emerging markets.  That amplifies already existing principal-agent conflicts and often results in management awarding themselves excessive perks and/or making investment decisions that do not always have the maximization of shareholder wealth as an objective.

Emerging Markets ESG:  Which extra-financial theme – environmental, social or governance – is the most challenging for investors in emerging market companies to analyze?

Amr Addas:   The social theme is in my opinion the most difficult for investors in emerging market companies to analyze.  Labor codes are often severely lagging in those markets.  Weaknesses are often prevalent in one or more areas such as the right to strike or even organize, work conditions, safety, minimum wages, minimum age, overtime pay, or maximum hours per week.  Furthermore, community involvement is often neglected by large corporations in emerging markets.  The problem with analyzing those issues arises because of the lack of disclosure by emerging market corporations on their labor practices and policies.  Legislation needs to be introduced in most emerging markets to bring labor codes up to par with developed market labor codes.  Similarly, disclosure rules need to be not only improved, but more importantly enforced.  Lack of enforcement of laws already on the books is often a problem in emerging markets.

Emerging Markets ESG:  Would you please introduce the Sustainable Investment Professional Certificate (SIPC).  What role do emerging markets play in the SIPC curriculum?

Amr Addas:  SIPC was created in response to the growing interest in Sustainable Investment approaches.  It is designed to meet the needs of a new breed of investors who want their investments to generate positive financial returns while creating positive environmental and social impact.  This rapidly developing area requires a new set of investment and risk management skills.  SIPC thus contains six modules that address this demand.  They are Sustainability Overview, Governance, Ethics, Social Sustainability, Environmental Sustainability, and Sustainable Investing.

The focus is on practical self-learning from a well-designed curriculum.  Our testing approach is not to test overall knowledge through traditional examination but rather to evaluate the participant’s ability to apply the knowledge learned from the modules. The program aims at developing research skills, critical thinking, creativity, and decision-making skills.  Modules consist of learning materials and readings. The learning materials create a coherent discourse and guide the learning process. The readings reflect relevant theory, research, and examples of the topics. At the end of each module a project is assigned where the student is expected to engage in scenario driven reports or case studies and draw on the material learned in the module to come up with solutions and decisions.

Readings on emerging markets feature mostly in Modules 4, 5 and 6.  In Module 4, examples of social development schemes in African countries are discussed.  In Module 5, sustainable forest development programs are examined, specifically the REDD initiative which has had some success in Indonesia.  Finally, in Module 6, a study by Mercer and the IFC examines the integration of ESG factors into investment processes in emerging markets.  Another study by Trucost analyzes carbon risks and opportunities in emerging markets by focusing on the exposure of different regional equity strategies to carbon costs.

• 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 interviewis with Professor Hu Ruyin, Director, Research Center, Shanghai Stock Exchange, China.

The Shanghai Stock Exchange (SSE) was founded on November 26, 1990 and started trading on December.19, 1990. The SSE is directly governed by the China Securities Regulatory Commission (CSRC). The Shanghai Stock Exchange is the main board in China. As of 2011, there were 931 listed companies with a total market value of RMB 14.8 trillion. Total share turnover value is RMB 23.7 trillion.  The Shanghai Stock Exchange is the third largest stock exchange globally in terms of both market capitalization and trading value. Professor Hu Ruyin joined the Shanghai Stock Exchange (SSE) as director of the Research Center in 1997.  He is also a member of the Academic Committee of the China Finance Association, the Asia Corporate Governance Roundtable (organized by the OECD and the World Bank) and the Advisory Council of Shanghai Municipal Government. Prior to joining the SSE, Hu was The Director of the Institute of Economic Development at East China University of Science & Technology from 1988to 1993.  As an expert in corporate governance and the stock market as well as the foremost proponent of Chinese corporate governance reform and investor protection campaign, Hu participated in amending China’s Company Law and Securities Law and put forward many important policy recommendations to the  leadership  of  China’s  stock market. He led the efforts to launch China’s   first   corporate   governance   index and corporate social responsibility index at the SSE. Hu also led research team at the SSE to publish an annual report on China’s corporate governance that is focused on a specific topic each year. He publishes extensively in leading journals and is the twice winner of Shen Ye Fang Prize, China’s most authoritative prize in economics.

Emerging Markets ESG:  How would you define socially responsible investment (SRI)?

Professor Hu Ruyin: SRI, also known as Ethical Investment and Sustainable Investment, takes into account environmental, social and financial factors in selection of companies. Specifically, it contains the following aspects:

1. Incorporate environmental, social and governance criteria into the investment analysis and investment portfolios, such as developing some indexes and derivative products associated with social responsibility.
2. Shareholders and company managers have a good understanding of ESG, and take them into the daily corporate practices.
3. Deposit or invest in banks, credit markets, venture investment and credit funds that have a good performance of social responsibility.

Emerging Markets ESG:  What distinguishes SRI from mainstream investment? 

Professor Hu Ruyin: First of all, the salient feature of SRI is to integrate the financial, social and environmental theme into investment while the mainstream investment mainly focuses on financial performance. Second, the principle of SRI is sustainable development, whereas mainstream investment cares about maximum profit, regardless of social performance. Third, SRI focuses on long term value creation, such as environmental performance which might make sense after several years, while the mainstream investment only emphasizes short term results, such as profit or revenue, etc.

Emerging Markets ESG:  Which extra-financial theme – environmental, social or governance – is the most challenging for companies in China to manage?

Professor Hu Ruyin: Compared to the other two, corporate governance is more familiar to us. People, including managers, investors and regulators believe that good governance is important to the sustainability of companies. Early in the 1990s, the China Securities Regulatory Commission (CSRC) introduced a series of corporate governance rules. Today, the quality of the governance of China listed companies is much better than years ago, although some companies are still struggling with some governance issues.

As far as environmental and social themes are concerned, China just started to tackle them. In particular, environmental theme is the most challenging one for companies to manage. As China is at the stage of heavy industrialization, a lot of listed companies are in the sector of heavy polluting industries such as mining sector. Companies hide problems such as environmental pollution.

Emerging Markets ESG:  Which extra-financial theme – environmental, social or governance – is the most challenging for investors in Chinese companies to analyze?

Professor Hu Ruyin:  Listed companies in China are required to disclose corporate governance reports in the annual report for a few years. In addition, there is a full array of rules released both by the CSRC and stock exchanges on governance. Therefore, it is easy for investors to analyze governance quality. Also, the ‘Corporate Governance Index’ enables them to evaluate the governance performance. However, it is difficult to analyze environmental performance because there is a lack of detailed environmental information disclosure guidelines. As a result, investors cannot have accurate and consistent information for valuation purpose. Most environmental information is narrative and is quite difficult to assess. In addition, there is no local ESG report assurance agency.

Emerging Markets ESG:  What is the Shanghai Stock Exchange doing to improve both the quality and quantity of ESG disclosures made by Chinese companies?  Which SRI products are available on the Shanghai Stock Exchange?

Professor Hu Ruyin:  The Shanghai Stock Exchange (SSE) is spearheading efforts to improve Chinese listed companies’ ESG disclosure. In 2008, SSE released a social responsibility disclosure guideline, requiring three types of companies to disclose CSR reports and encouraging other companies to voluntarily disclose CSR reports. In 2008, 290 companies released CSR reports.  In 2009, the number was 318 and in 2010 the number was 327. Meanwhile, in order to improve the disclosure quality, the SSE encourages companies to follow the GRI standard and have the reports audited by an independent institution.

For the SRI products, we have the SSE Corporate Governance Index which was released in 2008 and the SSE Social Responsibility Index released in 2009. The latter index contains companies that are doing well in governance and social responsibility. Both indexes are tracked by ETF launched by domestic fund companies.