Five Questions about SRI – Weekly Expert Interview with Duncan Paterson, CEO, CAER – Corporate Analysis, Enhanced Responsibility, Canberra, Australia – February 8, 2013

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 Duncan Paterson, CEO, CAER – Corporate Analysis, Enhanced Responsibility, Canberra, Australia.

CAER – Corporate Analysis. Enhanced Responsibility was established in January 2000, and offers research services on a broad range of environmental, social and governance (ESG) criteria. CAER’s database covers the top 300 companies in Australia by market capitalisation, companies that move in and out of the ASX on a regular basis (smaller members of the ASX300), smaller listed companies invested in by research clients and selected New Zealand and Pacific companies. CAER can also provide consistent sustainability data on almost 3,000 of the world’s leading companies through our relationship with EIRIS, the world’s leading dedicated ESG research firm. CAER operates as an independent, staff and not-for-profit owned research organisation.  CAER is the only Australian research facility offering access to consistent Responsible Investment information on all the world’s major investment markets. CAER utilises world-leading socially responsible investment technology and has an exclusive license to distribute the EIRIS Portfolio Manager (EPM) ESG research platform produced by EIRIS in the United Kingdom. CAER maintains its independence from companies covered and offers an ongoing commitment to the development of the responsible investment market to clients in the Australasian region. CAER is a signatory to the UN Principles for Responsible Investment.  Duncan Paterson is Chief Executive Officer and founder of CAER – Corporate Analysis. Enhanced Responsibility, the staff- and not-for-profit owned ESG research organisation based in Canberra, Australia. He has worked extensively in the field of responsible investment, both in Australia and in the UK with EIRIS – Experts in Responsible Investment Solutions. Duncan enjoys working with a broad range of investors to incorporate environmental, social and governance criteria into their investment processes. In addition to his work with CAER, Duncan was until recently the Chair of the industry body for responsible investment in Australia, the Responsible Investment Association Australasia (RIAA), a Director of the Hong Kong-based Association for Sustainable and Responsible Investment in Asia (ASrIA), and is a member of FINSIA’s Managed Funds & Super Advisory Group.

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

Duncan PatersonDuncan Paterson:  I am always astonished by the power of language, both to inform and in this case to misinform.  In December 2010 CAER, in collaboration with a respected local industry practitioner Phil Preston, released a detailed report evaluating some of the impediments to the broader adoption of responsible investment practices in Australia.  The report was titled “Australian Superannuation Fund Investments: A report on progress made in the implementation of ESG practices”.  One of the key findings in this study was that the language that has traditionally been used to describe responsible investment approaches – ethical investment, socially responsible investment, green investment – posed genuine obstacles to trustees who were new to the responsible investment space.  They felt that investing responsibly would inevitably require them to make moral judgments on issues that society is constantly debating – not a comfortable position for them to be in.

Rather than using the term ‘socially responsible investment’, we proposed in that report that the term ‘ESG-themed investing’ be used instead.  This successfully encapsulates all the different types of language that specialist responsible investment funds use to distinguish what they’re doing from their mainstream counterparts, but doesn’t require anxious trustees to commit to particular social or environmental ideologies.  We proposed the following definition for ESG-themed investment styles:  “An investment style where certain ESG factors are prominent in the chosen investment criteria; typical applications include negative screening, positive screening and best-of-sector.”

Ultimately, ESG-themed investment (read socially responsible investment) seeks to develop financial products that are different from the market as a whole – whether the motivation is to produce better returns, to satisfy particular moral or legal requirements, or as is most often the case a combination of these objectives.

Emerging Markets ESG:  What distinguishes SRI from mainstream investment? 

Duncan Paterson:  This will be one of the most significant challenges for ESG-themed investment over the next decade.  The Principles for Responsible Investment (PRI) have been spectacularly successful over the last few years in persuading mainstream asset owners and asset managers to acknowledge that ESG factors do play an important role in investment returns.  While this is a fantastic outcome and one that will have far-reaching benefits for the global environment and society, we do run the risk of resting on our laurels and saying ‘job done.’  This concerns me.  Well over half of the total FUM in Australia are now managed by bodies that are signatories to the PRI, and yet it is difficult to point to specific examples of where this has improved environmental or social outcomes.  While it is great that mainstream investors are acknowledging ESG factors, we will always need leaders in the finance sector who are telling a story that is ahead of where the market is at the time.  How then does one distinguish between a really well-managed mainstream ESG integration program and a specialist ESG-themed investment product?

The Responsible Investment Association Australasia (RIAA), the peak body for responsible investment in Australia & New Zealand, has been addressing this issue for a number of years through their SRI Certification program.  Investors in Australia are able to look for the SRI Certification Symbol on the product disclosure statements of a range of investment products, and be confident that those products have systems in place to back up their claims as to ESG performance.  Ultimately it will be up to industry itself to demonstrate that ESG-themed products are different to mainstream offerings, in portfolio outcomes, in management styles re engagement and voting, and in terms of superior returns.

While communications and labeling are important, so is education.  RIAA has launched an innovative new online learning offering called the Responsible Investment Academy.   The Academy provides a solid grounding in responsible investment practice, and if offered to staff across an organization can foster a shared understanding of what is meant by responsible investment and how it is practiced within the orgnisation.  With strong support from the US-based Highland Good Steward Management, the Academy has attracted enrolments from all around the world, and proven to be a great success in its first couple of years of operation.

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

Duncan Paterson:  In my experience, governance is the ESG factor that poses the most difficulties for emerging market companies.

While one can make a reasonable intellectual case for environmental improvements, and Western clients are increasingly pressing for more action on supply chain and other social issues, dealing with core governance issues forces a company to ask questions which are often very uncomfortable within an emerging markets context.

Why shouldn’t the Chair and the CEO be the same person?  This is a very difficult conversation to have in an environment where many companies have significant shareholdings from family offices, and major family involvement in the history and ongoing operations of the company.

What is the relationship between the company and government?  In countries where centralized governments wield a great deal of power, and corruption is a challenge faced on a daily basis, it can be difficult to justify a Western-based understanding of how these issues are to be managed.

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

Duncan Paterson:  As noted above, issues relating to governance are problematic for companies in emerging markets, and for investors as well.

More broadly, however, investors grapple with a lack of disclosure on key ESG metrics, making it a challenge to properly evaluate investment risks.

It is important that initiatives like the Global Reporting Initiative get a strong foothold in emerging markets, and that investors in those markets put pressure on companies to improve disclosure.

Emerging Markets ESG:  From your perspective, what are the three most important ESG issues in Asian emerging markets at present?  How will these three issues influence SRI in Asian emerging markets during the next decade?

Duncan Paterson:  When I think about issues that we’ve looked at over the last decade for emerging market companies, the ones that really stick in my mind revolve around stakeholder relations.  In Western economies we have hundreds of years of experience of industrialization, much of it very damaging for local communities and local environments.  We need to work to ensure that emerging market economies don’t repeat the historical mistakes of the developed world.  This relates to issues like pollution, impacts of mining operations on indigenous communities, and ensuring that employees can get access to a living wage.  There is a risk that if these issues are not managed well, the sorts of localized conflicts that we’ve already seen in places like China could become more widespread.

From an environmental perspective, the two most serious issues that emerging markets will need to address are climate change and water issues.  Emerging markets have an opportunity to leap-frog developed nations’ electricity generation models, moving straight to a distributed energy system based on renewables.  We are already seeing signs of this in India, and if the widespread adoption of mobile telephony in developing countries is anything to go by, there is a lot to be optimistic about here.  Management of environmental, social and political risks relating to regionally shared water resources is a much more intractable problem.  Recent announcements re the development of large-scale dams on the Mekong by Laos raise the specter of future state-level conflict over water resources.  Other areas where this is a problem are India/Pakistan, the Middle East and Eastern Europe.

The major governance issue, and one that CAER has been doing a lot of work on over the last few years, is bribery and corruption.  In many ways this issue set has a powerful influence on a range of other ESG factors.  As is repeatedly identified by the leading NGO in this space Transparency International, the practice of corruption is an enormous brake on the development of emerging market economies.  Western business has a responsibility to better manage their practices in this area – it should not be regarded as simply an additional cost of doing business in such markets.  Recent regulatory changes in the US and UK have made global business sit up and take much more notice of this issue, so it is to be hoped that we will see fewer scandals and more positive news on this front in the years to come.