The 10-year anniversary of Principles for Responsible Investment (PRI) coincides with the recent adoption of two major agreements by the global community, represented by the United Nations – the UN Resolution Transforming our world: the 2030 Agenda for Sustainable Development and the Paris Agreement on climate change. Looking back and looking forward, what is the relevance of PRI for achieving a more sustainable economy, and what is the relevance of these agreements for PRI? Kris Douma is director of investment practice and reporting at PRI
In late 2015 the United Nations adopted a resolution “Transforming our world: the 2030 Agenda for Sustainable Development”. The resolution commits UN member states, organisations and affiliated organisations to pursue 17 sustainable development goals. Parties to the UN recognise the need for partnerships. The recent “Paris Agreement” to combat climate change also mentions the importance of partnerships and the private sector.
Because of its affiliation to the UN, the PRI is almost directly addressed. As the leading global initiative to promote sustainable investment, the PRI is one of the UN’s main partners in achieving the sustainable development goals.
The preamble to the six principles for responsible investment states, “We also recognise that applying these Principles may better align investors with broader objectives of society”. This clearly indicates that the principles were developed with the expectation that responsible investment contributes to the “broader objectives of society”, recently redefined as sustainable development goals. Therefore, it should be asked what this means for the current process of evaluation of the principles and the PRI agenda for the next 10 years.
The conviction that the principles will contribute to these broader objectives is based on a number of assumptions. The assumption behind Principle 1, ESG integration in investment policy and decisions, is that it will ultimately affect the cost of capital, lowering the costs of capital for sustainable businesses and increasing the costs for non-sustainable businesses.
The lower costs of capital for sustainable businesses will lead to a competitive advantage. In the long run, sustainable businesses will therefore “crowd out” non-sustainable businesses. It seems logical to ask whether this is indeed the case. Longitudinal research by Robert Eccles, and metastudies by Deutsche Asset Management and others show that good corporate social responsibility performance by companies leads to lower costs of capital, but research is inconclusive as to whether responsible investment is one of the drivers of this phenomenon.
The assumption behind Principle 2, ESG integration in active ownership, is to improve the risk–return profile of the businesses in which institutions invest, through a process of engagement to highlight the materiality of ESG issues and convince businesses to adopt more sustainable products, services and processes.
Research about the effects of integration of ESG issues in shareholder engagement shows a positive but limited effect, partly diluted because an investor may voice different messages to investee companies through their ESG experts on the one hand and their mainstream portfolio managers on the other hand, thereby creating a lack of alignment between the execution of ownership and investment decisions. So there is definitely room for improvement.
The principles dovetail with fiduciary duty, which recognises that ESG issues can be material and should therefore be considered by investors if they are to fulfil their obligation towards their ultimate beneficiaries.
Though fiduciary duty has been used as a reason not to look at ESG factors, a recent PRI study and the US Department of Labor decision last year brought clarity to this issue. Not taking material ESG issues into account may even be a breach of fiduciary duty.
However, the underlying assumption still is that the ultimate beneficiaries define their interests as purely financial.
With growing concerns among global citizens about the negative externalities of financial markets, is it still correct to assume that the interests of beneficiaries are purely financial? Although research is scarce, there have been surveys showing that beneficiaries have a wider definition of their interests that includes sustainability, ethical considerations and future wellbeing.
There is one other assumption that has largely remained implicit. While other codes, like the UN Global Compact, OECD guidelines and IFC standards provide desired outcomes (no child labour, lower greenhouse gas emissions, waste reduction, freedom of association, etc.), the assumption of the PRI is that, for financial institutions to contribute to “broader objectives”, it is sufficient to agree on the principles and implement procedures and processes.
At PRI, while we would like to say that all of our nearly 1500 signatories are vigorously incorporating the six principles, we know this is not the case and that much more work is needed. But some signatories have, for example, already taken on a strategy of explicitly decreasing their carbon or even wider environmental footprint and structuring their portfolios to create a positive ESG impact.
With companies globally moving towards more sustainable business practices those investors are likely to be cutting edge and potentially stay ahead of the curve, which also makes perfect sense form a risk–return perspective.
After ten years of vibrant activity under the umbrella of the PRI, we should ask if the assumptions behind the principles still hold in today’s fast-changing world.
And if not (sufficiently), how can the PRI be adapted to the sustainability challenges put forward by the sustainable development goals? Addressing these questions is not an easy exercise and requires input from signatories, academics and stakeholders. Does this exercise lead to a change of the principles? It is too early to provide answers. But we are prepared to ask ourselves these challenging questions.
Kris Douma is director of investment practice and reporting at PRI