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 Simon Zadek, Visiting Scholar, Tsinghua School of Economics and Management, Beijing, China.
Simon Zadek is Visiting Scholar at Tsinghua School of Economics and Management in Beijing, Senior Fellow to the International Institute for Sustainable Development (IISD) and Senior Fellow at the Seoul-based, international organization, the Global Green Growth Institute. He is on the Advisory Board of Generation Investment Management. He was Senior Visiting Fellow at Harvard`s JK Kennedy School of Government and a Senior Fellow at the Centre for International Governance Innovation. He founded and was until 2009 Chief Executive of the international think tank, AccountAbility. Simon`s work is focused on the intersection of economic policy, business strategy and transformation, and sustainability outcomes. He recently co-authored the report, Green Investment, launched at Davos as part of his input to a G20-catalyzed initiative focused on green finance. He contributed to the UN Secretary General`s High Level Panel on Global Sustainability, focusing on financial market reform and sustainability. He was team leader for the South African Government in the development of the South African Renewables Initiative, an international initiative leveraging international finance to enable South Africa to scale up its renewables ambitions and roll-out. He is currently based in Beijing, where his China-facing policy work is focused on how to embed sustainability into China`s financial market reform program, greening China`s outward investment, advancing green public procurement, and low carbon business in China`s eco-industrial parks. He works with the Development Research Centre of the State Council, the Chinese Academy of Social Sciences, the Ministry of Commerce and the Ministry of Industry and Information Technology. His recently co-authored a publication on the economic opportunity of aging in China. Simon has a PhD in economics from the University of London, a MSc. Econ (London School of Economics) and a BSc. Honours Economics (University of Bristol). Additional, past academic position include Senior Fellow, Science Policy Research Unit, University of Sussex, Visiting Professor, Copenhagen Business School, and Honorary Professor at the University of Southern Africa. Simon was selected to be a `Global Leader for Tomorrow` by the World Economic Forum in 2003 and has been a regular participant at WEF`s annual Davos meeting for a decade. He publishes widely, including the award-winning book, “The Civil Corporation”, and the Harvard Business Review article, “Pathways to Corporate Responsibility”
Emerging Markets ESG: How would you define socially responsible investment (SRI)?
Simon Zadek: It is investment that creates sustainable value into the future, which delivers both a value to the private owner of the capital, if there is one, as well as securing the resilience of the context in which the investment can be made profitable. The context includes the society in which the investment is made and the ecosystems upon which the society depends.
Emerging Markets ESG: What distinguishes SRI from mainstream investment?
Simon Zadek: Definitionally, nothing. In practice, an awful lot.
Most investments today are endemically short term. Even investments being made by so-called long-term investors such as pension funds are serially, short-term investments, being linked to market benchmarks and indexes that require portfolios to mirror market trading practices rather than the underlying long-term performance of investments.
Short-termism, a bias towards short-term trading strategies despite loss of risk-adjusted returns, is commonplace in today`s modern financial markets, driven in large part by inappropriate remuneration approaches to fund managers that reward high portfolio churn and reward short-term gains without claw-back features to account for subsequent declines, demonstrated at a staggering scale by the recent financial crisis.
Such short termism delivers some specific, systemic biases in the pricing of risk. Zero carbon pricing in valuation is the exemplary case. practiced by the vast majority of investors (including many of those belonging to climate-sensitive investor coalitions). Such pricing in effect is betting on a four to six degree world, an approach that at scale is nothing less than shorting civilization itself.
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for companies in China to manage?
Simon Zadek: The integrity of supply chains would definitely figure in my top three challenges, most obviously in food supply chains, but this extends widely. Linked closely to this is the problem of corruption that, for practical purposes, is endemic. It extends backwards into the supply chain and forward to the customer and into the policy arena. My third concerns the lack of transparency, and so distortions, in the rules of the game. Doing business in China means competing with state owned enterprises that have privileged access to finance and policy-making processes; competing in markets where some companies are advantaged as designated national champions; competing for public procurement opportunities where decision-making is not always transparent, and more broadly competing in markets where the rule of law is subordinate to the policy and political process.
How and whether these challenges play out depend on the type of company – multinationals, joint ventures, state owned enterprises, Chinese private companies, and of course scale.
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for investors in Chinese companies to analyze?
Simon Zadek: Without doubt, the biggest problem is governance.
The problem lies in not being able to assess the quality of management, the accuracy of the books, the real performance of the company, the integrity of the supply chain, or changing dynamic between potential investees and the government. All sorts of oversight mechanisms can help of course, but even sophisticated multinationals often do not know what is going on in their own shops, amply illustrated by GSK`s current situation.
Social and environmental dimensions are not secondary, but are integral to these governance issues. Performance failures in the environmental and/or the social spheres are often linked to lack of knowledge, corruption and challenges in enforcing the rule of law. And whilst societal pressures on business to clean up its act are increasing, business in the main remain undisturbed by citizens` actions.
Of course, it all depends upon the type of investor: the experience of an international institutional investor will be quite different from that of a large Chinese bank, a Chinese-led private equity firm, etc.
Emerging Markets ESG: How can China embed sustainability into its financial market? Hasn’t the bulk of China’s growth to date been achieved without consideration of economic, social and governance (ESG) factors and impacts?
Simon Zadek: Let me offer a glass half full response.
China is embarking on a major process of financial market reform that will over the next decade establish the foundations for a sophisticated set of capital markets. Cautiously, its tendency is to follow the liberalization model followed by global financial centers such as Wall Street and the City of London. Whilst a dose of opening up will help to unlock financial innovation and clarify the role of the state, the historic opportunity is for China to avoid the negative unintended consequences of the liberalization of global financial centers by embedding sustainability directly into the reform process itself.
Such an action, which would lift China into a leading global role in greening financial markets, is both technically possible and politically conceivable. The Chinese Government is all too aware of the imperative to green its act domestically and to create the conditions for the same changes internationally if it wants its emergence as a super power to be in an era of stability and potential rather than conflict and catastrophe.
Technically, there are opportunities for greening China`s financial markets today that might not be so easy to reverse engineer tomorrow. Greening the bond market that will play such a critical role in financing the next round of massive urbanization is a case in point. Building out a more sophisticated framework of investors` fiduciary responsibility in law and practice would make a huge difference as a meaningful institutional investor community emerges over the next decade. Getting a regulatory handle on incentives now would make a lot of difference in avoiding sophisticated forms of short-termism, closely linked to the need for regulators to require carbon pricing in asset valuation, just as the Chinese Government is more than willing to insist on non-zero carbon pricing in the real economy.
China has an historic leadership opportunity to advance the public as well as the private purpose of capital markets domestically, and so also internationally. It can design a liberalization approach that learns from both positive and negative international experience, so positioning its own financial regulators as guardians of a broader notion of resilience, the wider economy and the eco-systems on which we all depend.