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GreenMoney Journal - publishing since 1992
Fall 2010 issue
Socially Responsible Investing – Better Companies, Better Communities
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SRI in Europe and the UK
Matt Christensen
Socially Responsible Investing (SRI) has undergone tremendous developments in Europe in the last
few years. Indeed, one of the hottest debates has been about the impact of CSR policy on long-term
investment performance. This certainly is a key, if unresolved, issue as regards to the shape of
this industry's future. People argue about the costs and benefits generated by socially responsible
management and policies. Some see it only as a cost generating budget item. Others wonder whether
companies could also be reaping the fruits from sound long-term management as embodied by social
and environmental performance and quality corporate governance. While the latter is not a direct
SEE (Social Environmental and Ethical) concern, it empowers stakeholders with SEE concerns to make
their voices heard. Several contradictory studies have been published, most of which deal with SRI
mutual fund performance. However, SRI funds have not been in existence long enough to be able to
clearly define its impact.
SRI now seems to be at a fork in the road, with some of its
practices creating a niche market, while other issues it deals with are becoming standard elements
of financial analysis because they reflect the quality of a company's management and corporate
governance.
Socially Responsible Investing
SRI is applicable to any
type of financial product (stock, bond, public debt, etc.) though in practice it is mostly applied
to stocks. Although recent studies have tackled the issue of SRI in private equity, the current
focus is on financial markets, both in reality and in this article.
The qualification of
CSR performance in Europe and elsewhere is now a largely professionalized system using a
combination of resources:- Specialized rating agencies provide non-financial analysis to the
market,
- More and more financial companies set up their own SRI analysis departments,
- Market indexes, such as the FTSE4Good or DJSI 600 supply fund managers with dedicated
investment universes, where selection for an index is based both on financial and non-financial
performance,
- NGOs provide their own expertise and assessments of issues and
corporations.
Depending on the fund's orientation and commercial scope, each asset
manager practicing SRI uses a combination of these resources to pick stocks within a fund's
universe using mathematical models. Alternatively, funds practicing engagement may use information
a posteriori.
Of course, funds that use simple negative screens will rely on less elaborate
sources.
Retail vs. Institutional
The SRI market is usually split
between retail and institutional investment. Retail covers individual savings and investments,
while institutional covers basically everything else.
For the purposes of this article, we
will focus on the European institutional SRI market, mainly because retail information is more
freely available in many countries and is therefore not so urgently required at present. Another
significant reason is the comparative weights of the retail and institutional sectors. Frankly,
European institutional SRI in its various forms has taken the lead on many of the sector's trends
and issues.
There is a major difference between retail and institutional SRI. Retail
investment reflects an individual's financial and non-financial choices, which means it is possible
to tailor one's investments to one's views and principles. Institutional investment on the other
hand, where volumes per investment are presumably larger than on the retail front, is more complex
in SRI terms: - The most restrictive vision of institutional investment applies to companies
investing with their own funds (shareholder's funds, equity). These could be insurance companies,
banks, corporations, etc.
- To this we add a category of investors considered as
institutional because they are not individuals: churches, foundations, and charities, whose
investment capacity is somewhat smaller than the above category, but who do represent an
"individualized" vision of ethics.
- The third layer is made up of investors on behalf of
others: these are mainly pension funds and other retirement financing systems. While the volumes
they invest may reach very large proportions and be decisive on markets, their noticeable
difference with the prior examples is the fact that they represent multiple stakeholders. In
effect, investment decisions are not made by a sole financial officer, but rather by a college of
empowered people very often including union and investor representatives.
And as we
will see these are decisive elements in the issues of why institutional investors have become
active on the SRI front.
What pushes institutional investors to be active on the
SRI front?
There are multiple reasons for the development of institutional SRI. These
include the players, legal issues and the regulatory framework.
PLAYERS
Demand-side
The first movers on the market were institutions, such as
religious groups, with strong identification with their values acting on internal agendas.
Some
other sensitive groups, such as unions, later began using their powers in order to push their own
SRI agenda where possible. As it turns out, in several countries such as the UK, France and the
Netherlands, employee representatives nowadays have been granted significant power in the
management of pensions or employee savings plans. This has been a deciding factor in the move of
these latter funds towards SRI.
Supply-side
From a supply-side
perspective, the offer of SRI products by asset managers has grown rapidly in volume as well as in
diversity.
Product differentiation is manifold:- Across investment vehicles: mutual
funds, segregated funds, funds of funds, multi-management, trackers (ETFs),
- Investment
universe: sector, area, SRI criteria,
- Range of SRI criteria application across financial
instruments (stock, private debt, public debt, monetary),
- Typology of SRI method used:
screening, engagement etc.
The invested amounts on the institutional market make
custom-made products more profitable. Asset managers are very much ready to tailor investment
products to the needs of their customers. As a consequence, the SRI institutional market offers two
faces: one is quite visible, as it comprises market-tradable products such as mutual funds. The
other is not so readily visible as SRI takes place within the framework of party-to-party mandates
and in every day investment practice.
European Legal and Regulatory
Context
Most of the regulatory developments took place in the late 1990's and early
2000's. One reason is supposedly that demand for SRI products was growing at a fast pace. Also
paving the way were welcome regulatory changes in several European countries in the fields of
transparency and disclosure.
Disclosure laws compelled listed companies to be transparent about
their SEE policies across the continent. Alternatively, investments can be the object of disclosure
policies as in the case of the Statement of Investment Principles (SIPs) in the United Kingdom or
Germany.
During the same period, more powers were given to unions in pension investment
policies in the Netherlands and in France. These in turn used this power to create labels or
dedicated investment policies reflecting their SRI interests.
Moreover, one should not forget
the series of financial scandals that took place in recent years, mostly across the Atlantic.
Enron-type events opened the public's eyes to transparency and corporate governance issues. As a
consequence, management and shareholder responsibilities have gained importance on the political
agenda. Switzerland has a law on reporting obligation about the use of voting rights. At this
level, as at many others, mainstream corporate financial concerns meet with those of the SRI world.
Interestingly, self-regulation is also part of the picture, as insurance companies in the
United Kingdom or in the Netherlands created SRI guidelines through their trade bodies. These
initiatives either make up for the absence of local regulation, or simply add to the arsenal of
available rules on SRI markets.
Tables 1 and 2 take a closer look at the current regulatory
framework and key dates in SRI history.
Table 1: Framework drivers and their local
applications.
#1 - Law / Rule and which country it applies to:
Corporate
Disclosure - France
Investment Disclosure (Pension Fund or equivalent) - UK, France, Germany
Reporting of Voting Rights - Switzerland
Corporate Goverance - Uk, France, Germany, Italy,
Spain, Switzerland
Union Empowerment - UK, Netherlands, France
Trade body Guidelines - Uk,
Netherlands, Switzerland
Union Codes - Netherlands, France
Source : Eurosif Analysis
Table 2: Key dates in European SRI development
July 2000: Amendment to
1995 Pensions Act requiring SRI disclosure issued in United Kingdom
July 2000: UN Global
Compact
July 2000: Dutch union FNV calls for pension funds to draw up investment codes
January 2001: Regulation requiring disclosure in Belgium
May 2001: French Law makes SEE
reporting mandatory
June 2001: European Union begins development of CSR Strategy for Europe
October 2001: Association of British insurers issues SRI disclosure guidelines
January
2002: Regulation requiring statement of SEE principles for private pension funds in Germany
June 2002: Dutch insurance companies create Code of Conduct including social responsibility
Sources : Morley Insight and Eurosif Analysis
Definitions, Data and
Analysis
There is no single definition of SRI from a pragmatic point of view. Rather,
there are layers. We chose to differentiate three of those layers:
- The first layer, or
the core, is made of elaborate screening practices. This includes both positive screens (such as
best-in-class) and extensive exclusions.
- The second layer is made up of simple negative
screening. Typically, this includes screening for tobacco only or activity in Myanmar (Burma) only.
Almost all Dutch pension funds use these kinds of screens.
- The third layer consists of all
engagement practices. These do not establish a selection of funds through criteria as in screening,
but rather exert their power at corporate governance level to push for issues that are connected
with CSR among other things. On occasions engagement may be combined with screening. Many UK
pension funds practice engagement.
This segmentation becomes remarkable when looking
at the size of the SRI institutional market in Europe:
Table 3: Views of the
Institutional SRI market in Europe (in € billions)
CORE SRI - €34 billion
Adding
SIMPLE EXCLUSIONS - €218 billion
Adding ENGAGEMENT - €336 billion
Source : Eurosif Analysis
As we see, the market in the wide sense is almost ten times larger than that of the
'core' definition. These different analyses open the way for two complementary visions of the
market.
Vision 1: SRI remains a niche but growing market
At its
core, institutional SRI is approximately €34 billion. This approach removes engagement practices
and simple exclusions of asset managers. This view reflects the difficulty of measuring engagement
in the absence of a common definition, law, or reporting obligation, as is the case in the UK as
well as in other European countries. Asset managers are free to do and report what they want and
investors are free to believe them. There is no doubt about the existence of dialogue and other
exchanges between asset managers and corporations, and some of the former are known for their
sophisticated engagement policies. Yet in most cases, their extent and efficiency (as is the case
for simple negative screens) as bolstering good SEE practices or sustainable management is not
explicitly known.
Similarly, the core approach to SRI suggests that simple exclusions are often
regarded both by their practitioners as well as by market observers as a part of risk management
rather than as an SRI practice.
In the context of the ongoing SRI debate, this approach
results in a conservative view of the market and is thus less subject to contention. Using the core
market approach, the United Kingdom is the most developed institutional SRI market in Europe.
Afterwards, Germany, France, the Netherlands and Switzerland are of similar sizes. Finally,
Austria, Italy and Spain close the ranks as less developed markets.
It is interesting to note
that in the more restrictive view of the SRI market, the domination of the UK is not the
consequence of pension fund involvement, but rather of its charities practicing elaborate negative
screens, which alone account for 82 percent of the UK market.
Vision 2: SRI is
becoming mainstream
In this enlarged view of institutional SRI, Eurosif calculates
that SRI among European investors is €336 billion. The figures suggest that SRI has already entered
the mainstream financial markets in countries such as the UK and the Netherlands. This approach
posits that engagement practices and simple exclusions are increasingly being accepted and adopted
by the greater financial community.
Comparing Assets under Management (AUMs) subject to
engagement for pension funds in the UK to the total UK share ownership of their pension funds
produces an SRI ratio of 24 percent. Similarly in the Netherlands, almost all of the pension funds
surveyed for a study by Eurosif said they applied at least simple negative screens in their fund
selection, either as a form of risk management or an ethical statement (i.e. the Doctor's Pension
Fund screens out Tobacco).
These facts may be viewed as a good sign for the future of SRI,
since the high penetration rate of these practices point to investors and asset managers viewing
them as causing little or no financial risk and possibly help in building company value.
Trends
Pension Funds Driving SRI Market Growth
Although charities have played an important role in driving the institutional SRI market in the
UK, growing evidence indicates that pension funds and similar retirement systems have taken a
leading role in developing the European SRI market, whether engagement and simple exclusions are
taken into account or not. And everything points to this influence increasing in the future. As the
pension fund market continues its growth in Continental Europe, trade unions are taking an
increasingly active role in institutional SRI. In many countries, unions have an important say in
how pension money is managed, and their interest in this area is continuing to develop.
Another
relevant element is the fact that pension funds have a long-term view in the way they want their
money managed. This fits the argument that SRI concerns along with sound corporate governance would
enhance long-term company performance. Finally, it is fairly well known that SRI has been led not
by debt instruments, but through the equities markets. It is significant that the weight of
equities in overall pension investment still differs greatly from country to country. Nevertheless,
pension systems across Europe are gradually moving away from debt and increasing their share of
equity holdings. As this shift continues, SRI as a percentage will increase in pension fund
holdings.
SRI Strategies Evolving, but not Always in the Same Direction
Positive screening will increase in some countries more than others. It already plays a
significant role in markets such as France and Italy. Eurosif expects its growth to continue in
continental Europe. It is appealing because its approach fits into the global financial culture and
encourages "sustainable" competition between corporations aiming to be among the best-in-class and
thus attract investment. Many rating agencies and sustainability indexes see their future in the
development of this practice. Cynics, however, tend to believe that positive screening is
inefficient since it is for now only applied in small amounts in comparison to the overall
institutional market or even to the pension funds market (i.e. less than 1 percent of pension fund
equity holdings in France, 0.3 percent in the UK, 0.17 percent in the Netherlands) and the original
investment universe is restricted.
Since they are not subject to these restrictions, critics of
positive screening find more potential in engagement practices. At the current time, a key question
on the engagement approach is whether it can be translated from its national base in the UK
successfully into other European nations. Within Continental Europe, the Netherlands has been
showing signs of using this approach successfully in some of its fund management, but the practice
remains limited. Most likely, an engagement approach will be hindered in the near term by its lack
of visibility and measurable results.
Finally, the debate around simple exclusions as a
strategy exemplifies the debate on SRI. Many SRI practitioners discount it as "real" SRI and say
that it is just the basic entry point. This may ignore the fact that simple screening is also
arguably an effective entry point into the financial mainstream as it is easily defined and largely
defendable. At a minimum, it is a simple tool for risk management for a broad range of
institutional investors. It may also serve as a means for SRI and financial communities to create
an improved understanding of each other's perspectives.
Conclusions
Today, the potential for market development is enormous. At the moment, core SRI is only 2.1
percent of total European pension fund equity holdings.
The main element shaping the
future of institutional SRI is how sustainability issues can successfully be integrated into
long-term financial management of public funds. The strength of debates on corporate governance,
transparency and disclosure suggests that to a large extent, SEE might become a mainstream analysis
factor for the financial markets. The development of engagement practices beyond the scope of SRI
mandates on the UK market is certainly a positive sign.
Additionally, anecdotal evidence
such as the fact that asset management providers are now including SEE data in their international
electronic financial analysis platforms also witnesses the power of this trend. Thus, recent events
support that institutional SRI is growing in Europe. How long it will take to fully bloom across
the continent is a matter of years, taking into account the future growth of public awareness, the
strength of the regulatory context, and the central issue of profitability.
Article
written by Matt Christensen, executive director of Eurosif - http://www.eurosif.org
with
assistance from Helen Wildsmith, executive director of the UK Social Investment Forum -
http://www.uksif.org
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