UNPRI: Are investors taking the initiative?

Written by Oliver Wagg and Nicholas Taylor

Since 2006 investors have flocked to sign the United Nations Principles for Responsible Investment (UNPRI) but now find themselves in the firing line for ‘greenwashing’, as many fail to fulfill their promise to fully integrate and report progress on environmental, social and governance factors. Most Australia-based UNPRI signatory super funds contacted by Ethical Investor admit there is still much work to be done to fully integrate ESG into its investment analysis and decision-making.

If the sheer number of parties to the initiative - 529 at the latest count, 79 of them from Australia - provided a gauge of its success, the principles would be very close to mainstreaming responsible investment. But it doesn’t take much digging beneath the surface to conclude that many of these signatories are, at best, giving ESG factors cursory attention.

As Donald MacDonald, chair of the UNPRI, said in a recent interview on evoTV’s Responsible TV channel, the credibility of the principles can be jeopardised by “gilding the lily”. “We have to recognise the fact that the UNPRI has become very rapidly a successful brand image [and so] we have to think about how we protect the integrity of that brand image. The assessment process becomes critical," Macdonald said.

Benjamin Richardson, a professor at Osgoode Hall Law School at York University in Toronto, goes further, saying some signatories lay themselves open to the charges of ‘greenwashing’ - the act misleading consumers regarding the environmental practices of a company or the environmental benefits of a product or service.

He acknowledges that the UNPRI represents an attempt to address the financial economy in a more systematic way, but “one problem is that financial institutions can sign up to the UNPRI without first having to demonstrate that they meet special performance thresholds”.

“The credibility of the principles would be greatly enhanced if it functioned closer to a certification scheme, where only the most socially responsible financiers could join the club,” Richardson says.

James Gifford, UNPRI executive director, admits there is still a long way to go before signatories fully integrate ESG analysis into investment decisions. “We’re still at a very early stage. I accept there is a lot to do and there’s a long way to go,” he says. But he says it is wrong to brand the principles as little more than ‘greenwash’.
“There is certainly some progress, compared to two to three years ago when we launched. [But] I’m absolutely convinced there have been significant advances,” he says.

“Are there signatories doing nothing?Yes there are,” Gifford says.

The UNPRI secretariat has just completed its third annual survey, to be published when signatories gather in Sydney in July for the annual PRI in Person event.

Because the UNPRI was set up as an investor-led initiative, the onus is on the signatories themselves to implement ESG into investment analysis and the decision-making process.

Tougher approach rejected
Mike Musuraca, a former UNPRI director and former trustee of US pension fund NYCERS, says the principles give investors a tool to push the ESG agenda, but it is critical that signatories figure out themselves how to integrate these issues.
“There is no doubt, in my mind at least, that there is the potential for PRI to become a fig leaf to hide behind. And, if such happens, it is because the investors either did not have the resolve to change the nature of institutional investing or found some other vehicle,” says Musuraca, who is now managing director of New York-based Blue Wolf Capital Management.

The UNPRI dismisses calls for a tougher regulatory framework.
“In terms of accountability, the PRI Initiative needs to strike a balance between accountability and engaging mainstream signatories to push the whole industry in the right direction,” says Gifford.

“If, as some suggest, the PRI were to become a prescriptive certification for only those niche investors seen as the most sustainable, it would make itself irrelevant to the vast majority of mainstream investors. The initiative needs to bring in a broad group of investors and then work with them to spread best practice from the leaders to the beginners.
”The UNPRI does carry out hour-long verification calls with around one third of signatories each year, with the goal of verifying all signatories at least once every three years.

Frank Jan de Graaf of the Hanze School of Business in the Netherlands sees a persistent, systemic problem for responsible investment. “It is under-defined, because the impact of companies and investors on societies is multidimensional and therefore unmeasurable. Making responsible investment more measurable is a trap that can only lead to ‘greenwashing’.

“However, the positive side to more comprehensive reporting standards is that it will help stakeholders to understand how a company takes up its social responsibility. A good reader can figure out the amount of ‘greenwashing’ and the seriousness of a company’s ESG intentions.”

Some critics go further.
“The only way to deal with ESG is through immediate, rigorous and disciplined amendment of the global accounting system,” says Robert A.G. Monks, shareholder activist and one the founders of the field of corporate governance.
“Essentially, external costs must be quantified and included within Generally Accepted Accounting Principles (GAP). This is the only way that corporate profit maximisation can be accommodated with public welfare. It is a hard job, at best.

“There is now general recognition of the really harmful nature of current accounting, so we have a bit of a tail wind. What is needed is commitment to an holistic accounting system,” Monks says.

ESG in Australia: A+ for box-ticking
Some prominent signatories, who have made significant advances along their sustainability journey, are openly critical of the laggards. “I am disappointed we haven’t got UNPRI signatories beyond the ‘box-ticking’ exercise,” says Bob Welsh, CEO of VicSuper. “I’m excited that a lot of funds have signed up to the UNPRI, but I think the level of integration of these issues is probably pretty superficial."

The 2008 Responsible Investment Benchmark Report for the Responsible Investment Association of Australasia found that while the number of Australian UNPRI signatories was substantial, there were only two boutiques that have “fully integrated” ESG factors into their mainstream investment process: Portfolio Partners and Five Oceans Asset Management.

These findings were backed up by Mercer Investment Consulting, which concludes that currently only about one in 10 Australian equity managers achieved an ESG rating of a “good standard”, while 56 per cent were ranked as“less than adequate.

This assessment of investment managers’ ability to integrate ESG factors into the investment process was based on a number of factors - the competencies and skills of team members, their access to and use of appropriate data for evaluation of ESG risks and opportunities, and the extent to which these metrics are embedded into the generation of the performance over and above a benchmark index.

Mercer not only looks for evidence of voting and engagement policies and activities, but also considers how these are implemented, on what issues, and the transparency in reporting and sharing outcomes with others. The consultancy is currently completing an ESG survey of Australian equities investment managers.
The government agrees that Australia is trailing the rest of the world.

The federal minister for supernannuation and corporate law, Senator Nick Sherry, says investors are not doing well at identifying ESG issues and taking them into account for long-term investment decisions.

“There’s some good practice but it’s still reasonably limited in Australia,’’ Sherry says.

Green shoots of reporting
A major step toward ESG implementation would be better reporting. Just 46 of the 79 Australian signatories have completed their annual assessment as part of a UNPRI annual report to be published in July. Very few will make their assessment report public.

The UNPRI Secretariat does not name names: the UNPRI’s Gifiord tells Ethical Investor that those that do not fulfill their reporting obligations are “quietly dropped off the list”.

Most Australia-based UNPRI signatory super funds contacted by Ethical Investor admit there is still much work to be done to fully integrate ESG into its investment analysis and decision-making.

Data presented by former Russell Investments’ director of fiduciary research, Scott Donald, at the early May Australian Institute of Superannuation Trustees governance conference confirms integration is a big issue for super funds.
According to Donald’s assessment in late 2008, from a sample of 20 industry funds only two can be found to have implemented what they committed to members through their policies and online communications on ESG issues. The implications under fiduciary law are huge, he says.

“As a fiduciary, it is imperative you deliver on what you say to members – whether that means you take into account ESG factors or not. Because whilst the UNPRI has no legal bearing, its incorporation into an investment policy or an official communication to members, does,” Donald says.

Australian Super deputy CEO and chief investment officer Mark Delaney says ESG is a critical part of its investment process. “Our fund managers need to integrate ESG principles into their investment decisions. Significant progress in this area has been made in the last 12 months.”

On its website the super fund says it already complies with a number of UNPRI and has developed an “action list” that will be worked through “gradually over time”. Australian Super is the nation’s largest super fund, with 1.4 million members and $28 billion in funds under management.

Not-for-profit First State Super, which signed the UNPRI in October last year, launched an SRI Option on 1 May, because of demand from its members.

“Certainly, adopting the principles involves more than offering an SRI option,” CEO Mark Dwyer says.
“Both offering an SRI option and becoming a signatory to the UNPRI are important steps towards First State Super incorporating ESG issues into our investment analysis and decision-making process,” he said.

First State Super does not publicly report against the six UNPRI. Dwyer says it is engaging with the industry to find the best practice method for future reporting and is conducting work around how to make reporting relevant to its members.

The UNPRI’s Gifford says he is seeing clear progress among signatories that goes well beyond ‘box-ticking’. Many signatories have hired new staff, are buying in more ESG research and investing more in shareholder engagement activities, he notes.

The 2008 annual PRI reporting and assessment process, which is mandatory, has shown clear progress in signatories’ responsible investment activities, Gifford says.
Robert Fowler, investments and governance manager at HESTA, says there is certainly room for improvement, but that the UNPRI are a starting point.

“One way of thinking about the UNPRI is that it provides a common language and a shared conceptual base. However, that is – or should be – only the first step. It is in how the UNPRI is implemented that is perhaps the most interesting part of this story,” Fowler says.

“Fund managers will develop different models of integration, different ways of seeing and understanding ESG/UNPRI. Thus, from a collaborative enterprise which is the UNPRI, the next step is competitive advantage in implementation and product development.

”HESTA and VicSuper this year launched ESG Research Australia (ESG RA) to increase the amount and quality of ESG-inclusive research by Australian brokers.

“The point here is that there is room for other initiatives besides the UNPRI. In fact, it is in the interests of the UNPRI itself that other projects that seek to further ESG are developed and come into being. The UNPRI is not – nor do I think they would think of themselves as – a monolith.”

Selling ESG
Martin Fahy, CEO of financial services industry body Finsia, observes varying levels of ESG integration across the industry and is calling for greater engagement from financial planners, wealth managers and advisers.
“The understanding and awareness of ESG across sectors of the financial services sector industry is quite different. For instance, financial planners and advisers are the least prepared.”

There is also a general need for awareness-raising or educational initiatives aimed at the consumers of financial products.“The sense is that as we bring forward new products, the level of awareness will increase and … the mainstream media and organisations like yourselves will help,” Fahy says.

A fully functioning emissions trading scheme is likely to make a difference. “We’re going to see consumers moving from awareness to understanding to engagement. The impending [CarbonPollution Reduction Scheme] is likely to see consumers impacted by energy prices and there will, of course, be signals sent back from the market,” Fahy says.

Missing a trick
ESG proponents emphasise that trustees who ignore the power that ESG research and analysis gives them are missing a huge opportunity.

Nathan Fabian, CEO of the Investor Group on Climate Change and formerly manager of ESG research at Regnan, wrote in a recent research paper that by understanding environmental and social risks, investors can improve their assessment of enterprise wealth and investment value.

“External forces such as community expectations, constraints in environmental resources and regulation can all affect investment risk and return,” says Fabian’s paper, prepared for In the long grass – leadership in adversity, a research project by Finsia in conjunction with Griffith University Business School.

“By assessing governance practices, especially board skills, financial oversight, incentive structures, policies and ethical practices, investors can learn what to expect in terms of future risk-taking behaviour, effective execution of strategy over the long-term and guardianship of enterprise wealth,” Fabian writes.

Oliver Wagg is managing editor of Ethical Investor; Nicholas Taylor is principal of ESE consultancy Outcrop