Nasty surprises on the rise for investors, says ESG expert

Corporate disasters such as the BP Gulf of Mexico oil spill and the Fukushima nuclear disaster will be more prevalent and pose a greater risk to investors unless they act to comprehensively change the way they invest, a sustainability expert has warned.

After more than a decade advising the investment industry on Environmental, Social and Governance (ESG) issues, Raj Thamotheram has launched an independent project that aims to tackle the systematic risks that lie behind some of the world’s biggest corporate catastrophes.

Whether it is the origins of the financial crisis or an environmental disaster like the BP oil spill, Thamotheram says that there are six major factors that in varying degrees cause what he describes as these “preventable surprises.”

Thamotheram has recently quit as senior adviser for responsible investment at AXA Investment Management to write a book that looks at the BP oil spill and other corporate failings and what can be learnt to prevent similar events.

He was previously a senior adviser for responsible investment at Universities Superannuation Scheme and has worked as a consultant to the British Government and the United Nations Secretary Generals Office.

Thamotheram says that investors have been particularly influential as “enablers” of what he describes as “dysfunctional shareholder value maximisation dogma”. This approach focuses on short-term performance while ignoring long-term sustainability risks that could destroy value.

He identifies six key factors behind these so-called “preventable surprises”:

  • Narrow conception of risk, where organisations that increasingly engage in complex and dangerous activities ignore or underestimate significant risk factors.
  • Weak concern for negative externalities: Organisations ignore potential negative impacts with the unspoken belief that they will be socialised, typically through the taxpayer picking up the bill.
  • Regulatory capture: Corporations are better informed and better resourced and intensively lobby to minimise the influence and scope of regulation.
  • Leadership failures:  Weak boards, over-dominant chief executives and a failure to have adequate checks and balances.
  • Organisational learning disabilities: Repeated minor failures, such as safety breaches that are ignored and lead to a catastrophic failure.
  • Shareholder value fundamentalism: A focus on cost cutting, dangerous outsourcing of core operations such as risk management and dominance of short-term performance over building long-term value.

Thamotheram says that investors have previously considered themselves either simply observers or victims of the kinds of value destruction caused by these behaviours.

“These six factors are what we think underpin in different mixes a lot of the corporate preventable surprises we are seeing and will continue to see increasingly because corporations are getting more powerful,” Thamotheram says.

“The likelihood and severity of preventable surprises is not going to go away and we want to move from retrospective analysis to using this framework to see what are the future preventable surprises we can prevent.”

Thamotheram identifies ongoing systematic risk in the financial system and political and social fallout from a lack of food security as two areas likely to see “preventable surprises” in the future.

Investors as a group still had far less lobbying power than the corporations that they invest in, despite being a key source of capital for governments in the future, Thamotheram says.

Issues such as climate change would need innovative public/private partnerships to be addressed.

Thamotheram sees investors taking an increasingly active role in this space as both ensuring true inter-generational sustainability for their portfolios as well as better risk-adjusted returns.

“We need to change, not because we want to be all green and fuzzy but because we want to create better risk-adjusted returns not only for this generation but the next generation of investors,” he says.

“If we fail on that inter-generational equity issue then the pension promise fails and people will go elsewhere.”

Thamotheram says he is encouraged by the increased interest in ESG and its integration into the mainstream of the investment industry, siting increased transparency and accountability in the investment process as key developments.

However, he notes funds have done little to look at where there are internal structures block ESG principals from being seriously and deeply integrated into the everyday activities.

“The constraints to it (integrating ESG practices) such as the processes around performance measurement, incentive structures, recruitment, risk and promotion these haven’t adapted,” he says.

“We have been doing a lot of work on pushing ESG principles into organisations but there are constraints to it being desired and we haven’t done much on the constraints.”

In concert with his work on preventable surprises, Thamotheram is also launching a project to encourage people within organisations to come forward to provide information that can lead to positive change.

He is launching what he called a “Positive Deviants Club” an invitation only confidential organisation where members of companies or organisations can pass on information or ideas that can lead to a change in behaviours.

Focusing initially on the oil and gas industry, where there are widespread concerns about the safety culture at both oil companies and regulators.

Thamotheram says he hopes the idea will be project-based and look at practical measures to affect change in the oil and gas industry.

“There are people within regulators and companies who know what the kinds of regulatory system should be implemented and that is not the regulatory system that we have in place today,” he says.

“Individually they feel less able to talk about it, there is career risk, there is embarrassment, they don’t fully know if they have the right idea. But by allowing these people to come together in private, confidential settings they can support each other to do what they want to do, which is the right thing.”