Stock Exchanges Should Push For Socially Responsible Investing

The stock market is not synonymous to sustainable development. In the past, sustainability could very well be the last thing on the list of institutional investors when it comes to investment decision making, often receiving a fair dose of scepticism around the value of doing so. Sceptics claim that a lot of ‘greenwashing’ is involved when it comes to sustainability reporting by companies, that is to say that many companies are accused of inflating their sustainability practices simply to ward off the pressure from non-government organisations (NGOs) when in actual fact they might be doing very little for the environment and community.

This mind set, however, is starting to change. Recently, the term socially responsible investing (SRI) is becoming more commonplace, often making headlines in mainstream media as well as major accounting and finance conferences. SRI is often used to encourage investors to integrate sustainability or more specifically environmental, social and governance (ESG) issues when deciding which assets to invest in. Assets here could refer to either equities or real estates. The logic is straightforward. If investors have an option to choose where to invest in, they would select companies that perform better in ESG as this is symbolic of the quality of the management team.

ESG encompasses a wide scope of issues. Some of these issues could include environmental compliance, water management strategies, supply chain management and labour practices among many others which may represent either risks or opportunities to businesses. For example, a company violating environmental laws and regulations or produces unsafe products might face future litigation risks. The additional cost burden on the company may appear in the form of monetary fines not currently captured in current company accounts. In some instances, this cost incurred might have a significant impact on a company’s bottom line.

While such issues were largely ignored by financial analysts in the past, this is no longer the case. Fund managers and pension funds are now starting to take ESG seriously as they acknowledge that these issues have an underpinning on the future prosperity of companies. There is no doubt that SRI is gaining traction worldwide given that information providers such as Bloomberg and Thomson Reuters are also now providing ESG data in addition to financials.

In view of this changing landscape, institutional investors are now demanding for more transparency and accountability on ESG issues. In a recent study, however, researchers at the University of New South Wales (UNSW), found that there is still much room for improvement. Large inconsistencies are found in ESG disclosures - companies reporting based on different indicators and time periods, use of materially distorted graphs to put companies in a better light and lack of benchmarking across industry sectors which hampers comparability. ESG reporting, in short, is still unsatisfactory where ‘style tends to dominate substance’.

This is where stock exchanges have an important function. First, stock exchanges are seen to play a key intermediary role in the dissemination of quality ESG information. The formation of the Sustainable Stock Exchange (SSE); a joint initiative between various parties- Principles of Responsible Investment (PRI), United Nations Global Compact (UNGC), United Nations Environmental Program (UNEP) Finance Initiative, United Nations Conference on Trade and Development is indeed fantastic news. Stock exchanges that commit to the SSE are encouraged to participate in dialogue sessions with investors, companies and regulators on ways to promote long-term sustainable investment and improved ESG disclosures among listed companies on the exchange. This platform also facilitates greater learning, networking and co-operation between different stock exchanges. Best practices can be adapted and implemented by participating SSE members.

Second, the development of sustainability indexes such as the FTSE4Good Index Series and Dow Jones Sustainability Index (DJSI) across stock exchanges is also expected to drive more quality ESG disclosures. In order to be included as part of these indexes, listed companies are required to be more transparent about their ESG disclosures and performance. The introduction of such indexes could also act as an incentive for companies to benchmark ESG indicators across their respective industry sectors to ensure that ‘apples to apples’ comparison can take place.

Third, stock exchanges are involved in the development of guidelines on ESG disclosures and competency-building in SRI by providing relevant training to listed companies. At the moment, a majority of existing ESG disclosure guidelines appear non – standardised, that is each stock exchange has developed its own set of guidelines and frameworks based on perceived market needs.

In the context of India, it is worth mentioning here that the Securities and Exchange Board of India (SEBI) mandated that from 31 March 2012 the top 100 listed companies must submit Business Responsibility Reports (BRRs) as part of their annual reports, providing information about their sustainability performance.  Another crucial development in India is the 2012 Companies Bill which was passed by the Parliament in December 2012.  This Bill contains the first ever legislation which has direct implications for companies regarding their approaches and policies for CSR. It mandates companies to design and implement CSR policies and to spend 2 percent of previous year’s average net profit on CSR projects and activities. Moving forward, SEBI could definitely look into the possibility of going beyond the top 100 and making it compulsory for all listed Indian companies to submit BRRs. It should also consider being a Partner Stock Exchange within the SSE Initiative. By being a partner, SEBI will be declaring its voluntary public commitment to promote improved ESG disclosure and performance among Indian listed companies. This move, in my opinion, definitely puts the right emphasis in helping to advance the SRI agenda in India.

The question remains though whether Indian publicly-listed companies are ready to embrace this challenge and work on improving their sustainability disclosures. Their ability to do so will surely put them at the forefront of their competitors.

 Dr Renard Siew is a researcher based at the Centre for Energy and Environmental Markets (CEEM). His research interest lies in sustainability, integrated reporting, ESG research, socially responsible investment (across different asset classes: equities, infrastructure and property, real estate), climate change, sustainability strategy and green construction for the building/infrastructure sector. Renard did his PhD at UNSW with the support of the Australian Postgraduate Award (APA) Scholarship. He has published in international refereed journals on various sustainability issues in Asia.