Five Questions about SRI – Weekly Expert Interview with Paul Clements-Hunt, Head, United Nations Environment Programme Finance Initiative (UNEP FI) – February 11, 2011

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 reflect on what SRI in emerging markets means to practitioners;

  • To collect a catalogue of examples of SRI in practice in emerging markets;
  • To raise awareness about SRI in emerging markets; and
  • To enable SRI practitioners in emerging markets to network with peers around the world.

This week’s interview is with Paul Clements-Hunt, Head, United Nations Environment Programme Finance Initiative (UNEP FI).

UNEP FI is a strategic public-private partnership between the United Nations Environment Programme and the global financial sector. It is the oldest partnership between the United Nations and the financial sector. Through UNEP FI, UNEP works with nearly 200 banks, insurers and investors worldwide to understand the impacts of environmental, social and governance issues on financial performance and sustainable development. With a global work programme encompassing research, training and events, UNEP FI carries out its mission to embed best sustainability practice in core strategies and operations of financial institutions. UNEP FI is based in Geneva, Switzerland.

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

Paul Clements-Hunt:  The term socially responsible investment (‘the traditional SRI’) has evolved over the years, as manifested by new terms such as ESG investment, sustainable investment, responsible investment, and sustainable and responsible investment (collectively ‘the new SRI’).

Without getting lost in semantics, the evolution of terms follows an evolution in thinking on ESG issues, which has broadened the appeal of the new SRI to many investors. The major shift in SRI thinking has been the move from traditional negatively screened or mission-related ethical investing approaches (often in the form of industry or sector exclusions without referring to their financial implications) to the systematic integration of material environmental, social and governance risks and opportunities into the investment process (including portfolio construction, analysis and ownership practices) in order to enhance company value and investment returns.

Accordingly, SRI has evolved from a niche style of investing to an investment discipline that can be applied to all asset classes.

Emerging Markets ESG:  What distinguishes SRI from mainstream investment? 

Paul Clements-Hunt:  While the tide is starting to change, many mainstream investors do not yet routinely integrate ESG issues into fundamental financial analysis and investment decision-making. The objective of the new SRI is to cast a brighter light on the impact of all material considerations on investment value and to reinforce economic and valuation tools to improve investment performance.

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

Paul Clements-Hunt:  Before anything else, “extra-financial” appears to be an inappropriate term to use as we are, in fact, highlighting the financial materiality of ESG issues.

Disclosure (as part of corporate governance) of ESG performance data in a transparent, standardised, integrated and comparable manner is a very challenging issue, particularly for emerging market companies and financial institutions, because of lack of appropriate regulatory frameworks and standards.

However, sustainability reporting standards, such as the Global Reporting Initiative, and more recently, the world’s first integrated reporting guidance document released in South Africa and the current work of the International Integrated Reporting Committee are helping address this fundamental problem. Related to this is the Sustainable Stock Exchanges Initiative, which is led and supported by investors, the Principles for Responsible Investment and several UN agencies. This initiative is exploring how exchanges can work with investors, regulators and companies to improve corporate transparency and, ultimately, ESG performance.

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

Paul Clements-Hunt:  Same comment on “extra-financial” above.

Because of the disclosure and transparency problem mentioned above, many ESG issues are difficult for investors in emerging markets to analyse.

Environmental externalities such as biodiversity loss and ecosystem degradation are challenging as these costs are hardly accounted for; hence, they rarely show up on corporate balance sheets.

Human rights issues (e.g. abusive workplace conditions, gender or racial discrimination, child or forced labour in supply chains, forced relocation of communities) are equally challenging to analyse as they encompass employees, customers, suppliers, and the communities and countries where a company operates. This situation is made more complex, for example, by increasingly globalised supply chains.

Emerging Markets ESG: What is the business case for SRI by financial institutions in emerging markets, or, to paraphrase the UNEP FI website, why should emerging market financial institutions internalize environmental, social and governance externalities?  

Paul Clements-Hunt:  Ultimately, investment returns and economic capital are sourced from and based on natural and social capital. However, our existing financial system allocates capital to activities that degrade our natural capital (e.g. clean water, climate regulation, biodiversity) and are harmful to social capital (e.g. human rights, social equity, stable communities). In other words, our current systems of valuing assets and returns on investment do not account for the degradation of assets that underpin our lives and economies. By protecting natural and social capital, we are maintaining economies and investment returns over the long term. In the final analysis, this is the bottom line argument of the new SRI—and it applies to all investors.