More ‘E’ than ‘S’ in Paris

The emphasis was on the ‘E' for environmentally rather than the ‘S' for socially responsible investment at this year's European triple bottom line investing (TBLI) conference.

Climate change dominated the conference held last month in Paris, as the issue is high up on political agendas in the wake of the Stern report and the Kyoto protocol meeting in Nairobi, and speakers highlighted environmentally responsible investment opportunities.

Antoine de Salins, member of the executive board at FRR and speaker at the conference, said awareness was growing among asset providers to tackle responsible investment. He added that times were changing rapidly and that socially responsible investment (SRI) figures were growing in terms of market share and diversification.

TBLI Europe 2006 tried to establish the definition of fiduciary responsibility and find out whether companies were promoting sustainability and whether SRI was becoming mainstream.

Keynote speaker Paul Watchman, partner of LeBoeuf Lamb, said that the UNEP FI report established a legal framework for the integration of environmental, social and corporate governance (ESG) issues into institutional investments as a critical supplement to the UN's principles of responsible investment (PRI). It linked ESG with the financial health and vitality of companies. The report said that fiduciary trustees should respond to changes in society and established that pension fund trustees' duties are loyalty, prudence, acting fairly and the duty not to crusade unless the trustee is a bona fide crusader. A trustee also has a duty to take a long-term view and to act in the interests of all beneficiary classes. Watchman concluded that ESG considerations were mainstream investment decisions and not just an SRI niche. He said ESG should be seen as an additional valuation tool, not just as a substitute for existing ones. It provides opportunities as much as risks and is consistent with fiduciary duties.

Martin Skancke, director general and head of the asset management department at the Norwegian ministry of finance, said financial returns were also a fiduciary responsibility. He claimed his organisation, as one of the world's largest owner funds, were striving to apply best practice and were trying to benchmark risks and costs, but added there was no meaningful way of benchmarking ethics. Wal-Mart's vice-president Andy Ruben suggested that the integration of sustainability was about the direction business was taking and the creation of more value.

Although most conference speakers believed that SRI had already become mainstream and that mainstream was becoming sustainable, investments in SRI funds are still small. AGF-AM's general's manager and CIO Thierry Deheuvels said two different types of SRI existed today: financial and ethical SRI. And he is convinced that the letter will not become mainstream.

According to asset manager Robeco's CEO George Möller sustainability is a container concept which in itself brings with a lot of conflict. He said that the ‘E' and the ‘S' would compete with each other, for examples, with regards to biofuels as crops would be cultivated for energy rather than for the combat against hunger in poor nations. He predicts that SRI will become mainstream but that it will shift to environmental investments. Speakers agreed that SRI is split between the ethically- and socially-motivated niche and the sustainability- and profit-driven mainstream but witnessed an increased SRI awareness of investors.

For SRI to become mainstream they agreed that evaluation and measurement - such as in the carbon-market - must be undertaken by the market and sustainability and a long-term view be taken seriously by companies. Regulations, which force companies to integrate SRI, pressure on asset managers, public attention and positive engagement will also help to mainstream SRI.

arbon markets are already moving forward, in Europe via the Kyoto-driven European emission trading scheme (EU ETS) and in some US states via legislation, such as in California, and via trading schemes such as the Chicago carbon exchange (CCX). But the ETS scheme is far from perfect. TBLI speakers criticised that in the scheme's pilot phase the biggest polluters were rewarded with over-allocation of carbon credits, which leaves utilities in long positions and weighs on the carbon price. However the second phase of the EU ETS scheme should see revised national allocation plans of carbon. Companies' investment in clean development mechanism (CDM) projects in developing countries is awarded with tradable emission credits but these have also been affected by the low price of carbon credits in the European ETS.

The biggest problem threatening new investment is post-2012 uncertainty, which clashes with the call on long-term investments and sustainability. According to Daniele Cesano, founder of consultancy CO2nnect, only 4m tonnes of post-2012 credits have been sold so far. He said that the highest credit-delivery projects would deliver the least amount of sustainability and suggests certifying CDMs according to sustainability. The future of carbon markets depends very much on the next allocation of carbon credits, the inclusion of India and China as well as sectors such as aviation, new technology and the possibility of carbon capture and storage. Investors will also look at the outcome of November's Kyoto meeting for a plan beyond 2012.

While carbon markets are concerned with the ‘E' in ESG, microfinance deals with the ‘S' as it is a tool for economic inclusion in the fight against poverty. A popular definition is that microfinance is the provision of safe savings and appropriately designed loans for poor and low-income households, which can reduce poverty and enable access to finance, knowledge and markets. But it also needs to move beyond offering loans and credits and invest in developing skills in people, according to TBLI speakers. And to attract institutional investors to microfinance, corporate governance, transparency and expertise are needed.

However, microfinance has
emerged as a profitable business opportunity and a way to build local economies. To create a rate of return in microfinance, institutional assets are low default rate and are pooled through a special purpose vehicle. Risk is reduced through diversification and low correlation, while the typical life of a microloan is just one year. The expected returns of the investment depend on whether they are high- or low-risk. Aiming microfinance at enterprises rather than consumption also appears to be safer.

Microfinance's new challenge now lies in the support for entrepreneurs as they grow and extend their business, which has created a new opportunity for innovation and investment. A greater retail capacity in microfinance with regards to housing, pension and insurance is also needed. Peter Johnson, a partner at US-based Developing World Markets, predicts a future in microfinance but calls it a drop in the bucket. He said: "It is socially very positive investment. It's a niche, but a growing one."

The UK's Environment Agency's pension fund, part of local government scheme, applies an SRI environmental overlay strategy to 100% of their assets. The organisation's research has shown that good corporate environmental governance helps to deliver better financial performance and found a link between pension funds and climate change. Howard Pearce, head of environmental finance and pension fund management at the Environment Agency, said they wanted to do a best-in-class, not a negative screening approach. Their latest investment strategy includes property, private equity, gilts, bonds, other equities but no cash. The organisation's first year financial results showed their fund was 0.8% above the fund benchmark, while they had a 4% increase in solvency, several managers exceeded their benchmarks and beat performance targets.

Michel Lemonnier, head of SRI at Groupama insurances, said that Groupama tried to optimise the ESG dimension. The company tried to use the niche approach as a filter and combine it with different experiences and the mainstream approach. Mitsubishi UFJ Trust and Banking Corporation group also used a best-in-class approach. Their senior manager Masahiro Kato said that by focusing on extra-financial factors, their new SRI fund would actively seek out companies who combine earnings growth with corporate social responsibility. He added that social responsibility needed to be looked at from two sides: from the fiduciary duty point of view and from a performance point of view. Pearce said as the definition of ‘environmental' broadens, it has become easier for mainstream companies to invest in the sector.

TBLI 2006 also pointed out the lack of attention the ESG impact on corporate bonds has received although the consequences of climate change would be felt during the lifetime of a bond. Jean-Phillipe Desmartin, SRI research manager at Oddo Securities, said that his firm had different SRI approaches, which depended on the bond type: a macroeconomic approach was used for government but a microeconomic approach for corporate bonds. Desmartin added that SRI bonds had just started to emerge but did this at a faster pace than the more political equities. And investors who have shown awareness towards SRI can be as easily be convinced about bonds as about equities.

TBLI 2006 concluded that the investment industry was looking for sustainability and that companies were going mainstream with their sustainable efforts. Speakers agreed that transparency was a critical component for the change to SRI. But the reporting of ESG investment, policy implementation and the inclusion of ESG in emerging markets, as well as the slow movement in the retail sector about bonds, were still a challenge.