Growing Sustainable and Responsible Investment (SRI) in the EU An SRI Agenda for European Policy-makers September, 2014
General remarks Europe is at a crossroad. In the backdrop of increased global economic competition and still suffering from the recent financial and economic crisis, it needs to strengthen the competitiveness of its industries, create jobs and growth. At the same time, it should create the right type of growth. As identified in the Agenda 2020, this growth should be “smart, sustainable and inclusive”. The political guidelines of President Juncker for the next European Commission (“Agenda for Jobs, Growth, Fairness and Democratic Change”) highlight the need for a new approach to enable Europe to address the regional and global challenges ahead. His agenda highlights in particular the importance of: Stimulating private investment in the real economy in particular in the areas of renewable energy and energy efficiency (policy area 1: A new Boost for Jobs, Growth and Investment); Strengthening the share of renewable energies and harnessing the potential of green growth as both an industrial policy imperative and a climate change imperative (policy area 2: A Resilient Energy Union with a Forward-Looking Climate Change Policy); Capital markets, investors and shareholders can play a critical role in fostering these objectives. Encouraging all participants in the European capital markets to focus greater attention towards long-term performance is a key condition for this. Within this agenda, Environmental, Social and Governance (“ESG”) issues have an important role to play. Sustainable and Responsible Investment is a generic term covering any type of investment process that combines investors’ financial objectives with their concerns about ESG issues. By doing so, SRI requires investors to understand how investee companies manage their environmental and social risks and impacts and develop long-term sustainable growth strategies for their business. Behind SRI is the notion that ESG factors are direct or indirect value drivers that are material to the long-term success and performance of a business, both in terms of risks and opportunities. From that perspective, Eurosif has welcomed and actively advocated for a number of initiatives and legislative proposals initiated and progressed by the past Barroso Commission such as the Communication on Long Term Financing of the European Economy, the Proposal on non-financial and Diversity Disclosure or more recently the proposal for a revised Shareholder Rights Directive.
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Yet, there is still a long way to ensure that sustainability matters are more central to capital markets and give to these a longer term focus. Eurosif contends that the European Colegislators have a unique opportunity to create conditions that will steer capital in this direction. Today, the European SRI market is essentially driven by a few large institutional investors. Eurosif estimates that 94% of European SRI assets are held by European institutional investors, and typically in a very concentrated way1. Most of the retail market is supplydriven or held by high net worth individuals. As a result, SRI is failing to become a widespread investment approach in both the institutional and retail segments. Eurosif policy demands therefore aim to foster a greater dissemination of SRI practices amongst institutional investors, of all types and size, and amongst the retail market, in particular average individual investors and pension plan beneficiaries. Creating the conditions for SRI to grow in the retail market will create a virtuous circle with asset managers being more inclined to consider this investment approach because of its market potential and institutional investors to incorporate these into their investment policies because of beneficiary demand. Eurosif urges the next Commission and the next Parliament to create the conditions that will help investment mind-sets to change and SRI practices to become more prevalent. By doing so, the following EU-driven legislation or initiatives should be considered: 1. Foster greater incorporation of non-financial aspects into institutional investors’ investment decisions. 2. Promote active and long-term oriented share-ownership. 3. Foster transparency, accountability to and awareness of individual investors. 4. Progress relevant corporate transparency. The following section explains why each of these objectives matters and how they can be achieved.
1
Eurosif, European SRI Market Study, 2014.
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Detailed policy recommendations: 1. Foster greater incorporation of non-financial aspects into institutional investors’ investment decisions Why this matters: Within the financial arena, institutional and private asset owners determine capital allocation and are therefore crucial to encouraging both corporations and financial institutions to move towards more sustainable behaviour. Progress will require key decision-makers to abandon conventional approaches to investing, which have thus far been based to a large extent on chasing short-term gains. As holders of some of the largest pools of investment capital with the greatest potential impact on industry practices, pension funds in particular are wellpositioned to effect change. Ownership and power imply responsibility from institutional investors. As evidenced by academic research2, ESG issues can affect the long-term performance of companies. There is a growing recognition in the financial community that taking ESG issues into consideration is consistent with the fiduciary duty of investors when it impacts profitability3, and is further relevant when there is a consensus to do so by participants /members /stakeholders. ESG issues such as climate change, working conditions at suppliers’ factories, misaligned executive compensation, corruption and human rights have material impacts on stock values and investment portfolio performance. As evidence to this growing consensus, more than 250 institutional investors worldwide are now signatories to the Principles for Responsible Investment (PRI). Nevertheless, many institutional investors still argue that there is a conflict between their duties to their beneficiaries and the idea of taking ESG considerations into account. Traditionally, institutional investors have translated the concept of fiduciary duty into the simplistic notion of a ‘duty to maximise (short term) financial returns' leading investors to neglect factors which may affect savers' prospects in the future - including environmental and social issues and stewardship of investee companies. In many instances, pension trustees fear that taking a long view which gives full consideration to such issues will leave them exposed to liability if it causes the fund to perform less well in the short term. Finally, the use of consultants by institutional investors across the EU is significant, about half of them using external investment consultancy services. Investment consultants 2
See for instance the enhanced meta-study by Arababesque Asset Management, From the stockholder to the stakeholder: how sustainability can drive financial performance, 2014; the meta-study by Deutsche Bank Climate Change Advisors, Sustainable Investing: Establishing Long-term Value and Performance, 2012; Serafeim, Ioanis, Cheng, Corporate Social Responsibility and access to finance, Harvard, 2011; Eccles, Ioannou, Serafeim, The Impact of Corporate Sustainability on Organizational Processes and Performance, Harvard, 2011. 3 United Nations Environment Programme Finance Initiative [UNEP FI] (2005), A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment (UNEP FI, Nairobi). [commonly referred to as the Freshfields Report] and United Nations Environment Programme Finance Initiative [UNEP FI] (2009), Fiduciary Responsibility: Legal and practical aspects of integrating environmental, social and governance issues into institutional investment (UNEP FI, Nairobi).
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therefore play a significant role in shaping investors’ strategies, investment practices and asset manager selections: to a certain extent they have become one of the key gatekeepers within the financial industry. Yet, some surveys have shown that few investment consultants proactively raise ESG considerations as an issue to be taken into account and discussed with the client even if the pension fund had not specified it. Consultants should have a more proactive role in raising the awareness of institutional investors about the materiality of ESG factors. How to achieve this: Clarify ambiguity around the compatibility of fiduciary duty and ESG investing and consider a recommendation or a communication on this subject; Be more explicit and specific in the IORP (Pension) Directive about the importance of taking into account non-financial (ESG) risks; Promote SRI with public institutional investors through initiatives similar to the Green Procurement one; Introduce detailed transparency on SRI policies of institutional investors via a mandatory Statement of Investment Principles (“SIP”) in which institutional investors would state on a comply-or-explain basis the extent to which (if at all) non-financial considerations are taken into account in the selection, retention and realisation of investments and explain how they implement such SRI policies; Explore the role and responsibility of investment consultants and how these could more proactively contribute to the dissemination of SRI/ESG practices. 2. Promote active and long-term oriented share-ownership Why this matters: Good corporate governance is critical for the successful execution of an SRI agenda: it allows relevant ESG issues to be debated at the highest corporate level, between board directors and shareholders. Promoting long-term oriented shareholder engagement (incl. voting) should be regarded as a way for mitigating future corporate governance failures and excessive short-termism. Further, ownership and power imply responsibility from institutional investors. With a longterm investor perspective, it is fundamental that shareowners can (and do) actively exercise their rights to vote and engage with the companies they own. An investors’ ability to exercise their shareholder rights is essential. In this respect, Eurosif recommends that the European Institutions ensure greater transparency concerning shareholders rights, in particular concerning the identification of the shareholder, the proxy voting chain and stock lending. Ensuring a smooth operating framework for the (cross-border) exercise of voting rights is therefore for Eurosif an absolute requirement to achieve the objective of having more engaged shareholders: In the EU, the share of intra-EU cross-border equity ownership averages 43% and ranges from 20% to 90% across countries (before the re-classification of Luxembourg
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and Irish funds mentioned above). It is superior to one third in 25 countries out of 27 (below 30% in UK and Latvia)4. The entire proxy voting chain is complex in its nature and involves a great number of intermediaries (custodians, sub-custodians, voting service providers, etc.). The need for transparency in this regard rests with the intermediaries, not only in terms of allowing shareholders to properly identify themselves but also in terms of the account structure they offer and its implication on the ability to exercise shareholder rights. Despite several reports and recommendations made years ago, operational impediments regarding cross-border voting still exist to a large extent according to several Eurosif Member Affiliates. Eurosif already pointed at some of these issues in a joint letter sent to DG Markt in 20105.
How to achieve this: Progress the Proposal for a revised Shareholder Rights Directive; o Strengthen the section on the facilitation of the exercise of shareholder rights; o Ensure that voting costs remain affordable by investors; o Explore ways to mitigate the “free rider” effect. Adopt measures to allow shareholders to keep control of their rights at all times; Ensure that investors are in a position to smoothly and cost-efficiently exercise their intra-European (cross-border) voting rights. o Remove operational barriers to a smooth exercise of cross-border voting rights; o Ensure that EU regulation is consistently applied across Member States. 3. Foster transparency, accountability to and awareness of individual investors Why this matters: In Europe, mutual funds are largely distributed via banks or independent financial advisors. In Europe, Banks are the largest channel for UCITS Funds, with a total share of 75% of European fund distribution (including retail and private banks). In The Netherlands and Italy for instance, 80% and 67% of fund sales happen via retail banks respectively. In the UK, local IFA’s and brokers dominate the market (55.6%)6. Most sales happen in a push situation whereby the distributor recommends specific funds to his/her client. The SRI market remains to date an institutionally-driven market. Eurosif’s latest European SRI Market Study indicates that 94% of European SRI assets are held by institutional investors. While there can be variations across countries, retail investors (including participants to a defined-contribution pension plan such as the French PERCO) are underrepresented indicating a mismatch between the latent demand / interest and purchasing behaviours.
4 OEE, INSEAD, Who owns the European economy?, August 2013 5 http://www.eurosif.org/semantics/uploads/2014/06/888.-sld-investors-position-2010-def.pdf 6
PwC, Ucits fund distribution, 2012
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There are nevertheless indications of growing interest for SRI within retail investors and savers. Yet, this latent demand has largely failed to materialise to date. For instance, a survey carried out by Ipsos on behalf of Eiris and FIR in September 2013 and covering 1001 French 16-75 years old citizens shows that7: 62% of the respondents had never heard of socially responsible investment (SRI) before, that 30% had heard about SRI but wouldn’t be able to define it and the remaining 7% knew precisely what SRI is; Only 2% of the investors have been proposed SRI by their bank or financial advisor; To the question “If it was proposed to you, would you be ready to invest part of your savings in socially responsible investment (SRI)?”, 18% of respondents say they would be ready to invest part of their savings in an SRI fund if it was offered to them, 52% do not know and among respondents knowing precisely what SRI is, 40% would be ready to invest in it. These results show the need to address certain market failures to foster both the awareness and interest of retail investors / beneficiaries for SRI approaches and products. How to achieve this: Support initiatives aiming at growing the recognition and understanding by the retail market of the merits of SRI to incentivize asset manager to focus more attention onto these products, in particular those with the potential to contribute to low-carbon and resource-efficient economy in the context of the ecological transition: o Incentivise Member States to mandate the offering of at least one SRI fund option as part of any Defined-Contribution pension scheme as in France for instance (PERCO). o Support / Fund initiatives that promote SRI in local retail markets such as the National SRI Weeks developed by Sustainable Investment Forums in certain markets. Introduce more transparency for all investment products on the extent to which they take into account non-financial matters in their investment process and the PRIPs text (KIID) needs to be reinforced from this perspective. Ensure that pension reporting to beneficiaries incorporates ESG information since environmental, social and corporate governance (ESG) factors can be material to longterm financial performance. Ensure that distributors and financial advisors play a more proactive role in explaining to investors the importance of non-financial factors when making investment decisions: o Ensure that any financial advisor licensing and/or certification programme would incorporate training modules on ESG / SRI; o Promote product-level transparency initiatives such as the European Transparency Code which applies to all SRI products and offer to European investors an easy and standardised way to understand and compare SRI funds;
7
EIRIS-FIR Survey, French consumers attitude towards SRI, October 2013.
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4. Progress relevant corporate transparency Why this matters: The availability of ESG data tracking the sustainability performance of companies could have a beneficial effect on corporate, investment and market performance. According to a new survey by the Integrated Reporting Council and Black Sun, Integrated Reporting (<IR>) 92% of respondent companies that have implemented <IR> say it has improved their understanding of value creation; 79% are already finding that business decision-making has improved; 68% report better understanding of risks and opportunities and 78% see better collaborative thinking by the board about goals and targets. The same survey shows that <IR> helps to build stronger relationships and better understanding with providers of financial capital. For instance 79% of responding companies believe that it has led to greater confidence of provider of capital into the long-term viability of their business model.8 Should investors conclude that companies with thoughtful long-term management of ESG issues are better-run companies, a sort of virtuous circle can be imagined: in this scenario, investors would reward stock prices where sustainability is integrated, and companies would respond by further improving their sustainability performance. Accordingly, a fixation on meeting quarterly earnings estimates and other short-term measures would give way to longer-term thinking as a broader sustainable business agenda is recognised and rewarded by investors. Without mandatory disclosure of non-financial elements that can affect positively or negatively a companyâ&#x20AC;&#x2122;s performance and strategy, investors will continue to lack the means of assessing substantial numbers of material factors as they arise. Incomplete data makes for inefficient markets and a lack of transparency leads to unstable financial systems. Investors require reliable, comparable data on a broad range of potential risks and opportunities. A disclosure framework that does guarantee significant, timely, relevant and comparable data from all issuers is needed. Information is often provided selectively and very often, with the absence of common standards, the information cannot be compared with other companies, or over time. From a broader perspective, publicly reporting on the financial and non-financial impact/results/risks can be a means by which companies will help restore the societal confidence that was challenged during the current global economic slowdown. From a more practical perspective, integrated reporting increases company efficiency, improves innovation, has positive brand positioning effects and can improve supply chain sustainability.
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Black Sun, <IR>, Realizing the benefits: The impact of Integrated Reporting, 2014.
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How to achieve this: Ensure that investors have access to timely, comparable and material non-financial information. While a key milestone has been achieved with the adoption of the nonfinancial and Diversity Disclosure Directive, European policy –makers should continue to progress legislation that ensures that: o Non-financial information is comparable; o Management reports include a set of core (e.g. sector-based) non-financial KPIs as this represents a key need for investors; o Financial and non-financial information are published simultaneously as this is not guaranteed by the current Directive; o Assurance mechanisms will be put in place for non-financial data; o Disclosure around climate risk exposure is mandatory.
About Eurosif Eurosif is the leading pan-European sustainable and responsible investment (SRI) membership organisation whose mission is to promote sustainability through European financial markets. Eurosif works as a partnership of Europe-based national Sustainable Investment Forums (SIFs) with the direct support of over 65 Member Affiliate organisations drawn from the sustainable investment industry value chain. These Member Affiliates include institutional investors, asset managers, financial services, index providers and ESG research and analysis firms totalling over €1 trillion assets. Eurosif’s indirect European network spans across over 500 Europe-based organisations. Eurosif is also a founding member of the Global Sustainable Investment Alliance, the alliance of the largest SIFs around the world. The main activities of Eurosif are public policy, research and creating platforms for nurturing sustainable investing best practices. www.eurosif.org Eurosif’s EU Transparency registration number with the European Commission is 70659452143-78. Detailed information can be found here: http://ec.europa.eu/transparencyregister/public/consultation/displaylobbyist.do?id=70659452 143-78
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