Towards an Investment Stewardship Council

Towards an Investment Stewardship Council: Providing Credible Assurance of the ESG Assessments of Investment Products

As the practice of specialist socially responsible investment and impact investing, on the one hand, and mainstream responsible investment on the other, have grown, so has the sector of analysts and raters of the environmental, social and governance (ESG) efforts and performance of firms. In the past decade many claims have been made about the potential public benefits arising from these developments. Yet at the same time, leading companies report little investor support for their leadership on social or environmental issues, and civil society increasingly questions the impact of various voluntary responsibility initiatives. Various flaws have been identified in the methodologies of ESG analysts and raters and some initiatives have sought to improve practices. What has been missing, but may now be emerging, is a process to ensure standards of credible and accountable ESG analysis, ratings and fund management.

In the past year the criticism of ESG analysis and ratings increased in the wake of the Deep Water Horizon disaster. Earlier this year I published in the Journal of Corporate Citizenship an analysis of the flaws of ESG, and an article in the magazine Responsible Investor, which ignited some lively debate. One proponent of the existing industry of ESG analysts and retail funds even suggested my argument that a premium could be paid for certified ESG practitioners or products was somehow “Maoist.” That might come as a surprise not only to organic and fairtrade businesses, but also doctors, nurses and most professionals! Rhetoric aside, some in the industry think that ESG research should be left to continue its natural market-driven evolution. Yet such market-evolution is not satisfying the needs of many in the investment chain, and has not created the change many of us hoped for when promoting responsible investment. ESG professionals who are attracted to simplistic market fundamentalism, may be doing so as it aligns with their own choices and sense of self-esteem (what psychologists would call ‘confirmation bias’, and what less kind commentators might call selfish short-sightedness).

Collaborative innovation on market failures is a key aspect of well functioning markets; and in the ESG field, it is becoming clear we need some collaborative innovation, including some useful standardisation on transparency and governance. A substantive piece of research from the thinktank and consulting firm SustainAbility found that asset managers would also prefer more transparency and continuity in the methods of ESG analysts and raters. So, despite some market fundamentalist critiques, there is growing understanding of the need for new standards.

Aside from ESG analysis, questions are also beginning to be raised about the effectiveness of general commitments from asset owners and asset managers to responsible investment, and this may increase the need for credible information and metrics. The UN-backed Principles for Responsible Investment (UNPRI) is gradually increasing its requirements on its members, and increasing transparency on their performance. However, the question remains: how do we know a more responsibly-managed fund when we see one? Or how do we recognise a highly responsible fund manager when we meet one?

In other industry sectors, the past 15 years has witnessed the creation of voluntary standards on environmental, social and governance issues by processes involving stakeholders from civil society, business and government. In particular, the Forest Stewardship Council and Marine Stewardship Council, which I was once involved in, have grown to have global reach, with 11% and 6% of their respective global trades being covered by their certification schemes. A similar multi-stakeholder standards, accreditation and certification system could play a useful role in the standardising and communicating of both ESG analysis and the practice of responsible asset management – an ‘Investment Stewardship Council’. The conformity assessment industry, and related organisations, including ISO and ISEAL, would be key to informing such a process. Given the importance of investment decisions for incentivising or discouraging voluntary corporate responsibility, more clarity in this area will be useful for responsible companies, investors, civil society and governments. An ‘Investment Stewardship Council’ could complement existing initiatives, such as the UNPRI, and provide a means for pioneers of best practices to be rewarded in the marketplace.

For such an initiative to develop will require significant support to convene asset owners and asset managers, on the one hand, and global civil society on the other, to drive forward an agenda that innovative ESG analysts will be able to respond to help develop appropriate standards. For such a process to develop requires 2 challenges to be overcome.

First, is a shift in thinking by people working in “responsible investment” towards understanding that the core of greater responsibility is to be accountable to a wider set of stakeholders than ones owners, shareholders or clients. Paradoxically, many “responsible” fund managers ask their investee firms to be more accountable to society, without questioning the accountability of the ones who invest, the processes through which they assess companies, or their own systems of incentives and governance.

These issues are avoided by focusing on the ideas that considering ESG issues should be limited to either, on the one hand, what is financially smarter investing, or on the other hand, what the ethical preferences of the investor are. Yet might responsible investing really mean investing in ways that are accountable to those affected by that process, particularly those with little power who are impacted a lot? Might responsible investing not simply mean being a smarter investor, or a more caring investor, but mean being more accountable and promoting accountability of investments in general? I first advanced this idea of “capital accountability” in a UN study in 2004, as the natural maturation of the ESG and responsible investment fields, and have been disappointed to see the lasting ethical immaturity of these fields. Indeed, some new initiatives to improve ESG practices are opaque, focused on the client, and do not involve stakeholders, let alone being accountable to stakeholders.

The reason for this lack of awareness of the ethical limitations of current ESG work, could be the lack of civil society campaigning. This is the second difficulty I see in the development of a process to form an ‘Investment Stewardship Council’. The existing Stewardship Councils required active civil society campaigning over many years, which challenged not only the practices but also the ethical assumptions and responses of companies. In the field of finance, we see NGOs and others are quite limited in their analysis and activism on financial issues, despite its importance. Perhaps that is partly due to the brain-drain of business and economics savvy NGO people into the private sector in the past decade. In addition, those remaining in the campaigning NGOs are increasingly sceptical of what voluntary initiatives can achieve. If more ex-bankers joined NGOs with the aim of transforming investment, this could help build the field of professionals who can engage.

Seeing these limitations, we may rely on wise and committed asset owners and their trustees to move this agenda forward, encouraging engagement and dialogue between NGOs and investors on how to improve the voluntary ESG field, in addition to any regulatory innovations needed on mainstream financial and monetary systems. Such asset owners would do well to look at the Global Initiative for Sustainability Ratings, which was launched in June by CERES and the Tellus Institute. These two organisations previously launched the Global Reporting Initiative, that has become the de facto global standard used by 2,000 companies worldwide for corporate reporting on environmental and social performance. The GISR already includes some leading investors and businesses, such as the Calvert Group and Bloomberg. Its success in dealing with the issues I’ve described above may depend on how well it engages a broader range of civil society actors in elaborating standards.

If you have a vocational commitment to transforming finance, business and economy, for positive social and environmental outcomes, I recommend signing up to the Standards and Governance group at The Finance Innovation Lab and also becoming involved in the GISR.

Professor Jem Bendell

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