Responsible Investment in Europe
Executive Summary
Interest in responsible investment is booming in Europe as financial markets start to acknowledge the benefits of the “triple bottom line”, which takes into account added economic, environmental and social value. Most of the growth has occurred during the last two years. The trend is likely to continue as an increasing number of countries are introducing new legislation that requires pension funds to disclose the social, environmental and ethical aspects of their investment policy. In the UK such legislation has been in force since July 2000. Since then, Belgium, Sweden and Germany have followed suit, and France is likely to do so in the near future. As a result of emerging needs for information, indicators and benchmarks, there is a multiplication of initiatives to develop harmonised and comparable corporate reporting systems, standardise research methods and establish new indices. This is happening very quickly, and a clear mapping of the field is needed.
The Observatoire de la Finance has developed a wealth of expertise on financial and ethical issues. Building on this expertise, it has now conducted a survey on responsible investment in Europe that focuses on the products, the major actors, the methods and how screening criteria are applied.
Trends
Triggered originally by Church treasury managers interested in investing in accordance with their values, responsible investment started in the 1970s in both Europe and North America. Since then, it has evolved broadly in three successive stages.
First generation funds (ethical funds) exclude whole industry sectors - such as tobacco, alcohol, nuclear power, defence, gambling and pornography - from their investment portfolios. However, no screening is applied to companies belonging to the “accepted” sectors.
Second generation funds appeared in the mid-1980s. They are based on a more positive approach, which screens companies according to the positive contribution they are making in various areas. During this period, green funds focusing on pollution control technologies emerged as a result of a wave of environmental problems in Europe (forest dieback, acid rain, eutrophication, etc.).
Third generation funds, which emerged in the second half of the 1990s, aim at achieving both financial performance and sustainability, i.e. good environmental, economic and social performance. Because of the eruption of public concern in the late 1990s in areas covering genetic engineering, animal exploitation, labour, human rights issues and climate change, we are at present moving towards a fourth generation of funds that screen stocks using a complex set of social, environmental, ethical and human rights indicators, frequently combined with wide-ranging exclusionary criteria.
The main drivers for the rapidly growing interest in responsible investment are both an enhanced awareness of the public and pressure groups, who are improving their financial understanding and are increasingly prepared to challenge institutions holding investments in companies they consider undesirable, and increasing evidence that responsible investment does not mean lower financial performance.
The terms “ethical”, “socially responsible” (SRI) or “sustainable” investment are generally used interchangeably and as a function of cultural preferences (for instance, while ethical is commonly used in the UK, it is not liked either in the Netherlands or in Sweden). While ethical can have a more restrictive meaning when it applies to investment that excludes certain sectors (based on negative screening criteria), all terms now tend to refer to investments that take into account ethical, social, environmental and human rights concerns. We prefer to use the generic term of responsible investment for the sake of simplicity.
Responsible investment in european countries is shaped by Cultural references
Our survey shows that there is now close to €12 billion under management in more than 300 responsible funds in Europe. If one includes responsible institutional investment, the figure reaches close to €95 billion.
Belgium
Of the 25 responsible funds in Belgium, 20 were created since 1998. An Alternative Finance Network (Réseau Financement Alternatif) provides regularly updated information on these funds, as well as on ethical savings and social and co-operative finance institutions. Most of the funds combine negative and positive screening and scan a broad spectrum of issues (ethics, social, environmental, sustainable development, democracy). Since 1992, an independent agency - Ethibel - screens third generation funds and grants a quality label to those that meet their criteria. Since January 2001, pension funds are required by law to disclose their ethical, social and environmental investment policy.
France
Ethical funds have appeared in France in the 1980s to respond to the demand from religious communities. There are presently 35 responsible funds in France, representing 5.7 billion Francs (€800m) in assets. The majority of these funds (24) have been created since 1999 and close to 80% rely on the research of AReSE (member of SIRIGroup, cf. p3). This agency rates CAC40 companies and other companies in the Euro zone using a set of five stakeholder-based criteria that assess corporate performance in their relations with the environment, employees, customers and suppliers, shareholders and civil society.
Germany
Most of the German funds (approx. 15) are green funds that invest in environmentally friendly technologies, pollution reduction, renewable energies and organic food. They manage DM3 billion (€1.5b) today, compared to DM500m in 1998. Alternative or co-operative banks, such as GLS-Gemeinschaftsbank, Oekobank and Umweltbank, also place the main emphasis on lending and investment in environmental projects. The social dimension is only starting to emerge and the main rating agency (Oekom Research) has recently developed a Corporate Sustainable Assessment that includes both social and cultural criteria. Pension funds will be required as of January 2002 to disclose the ethical, social and environmental components of their investment strategy. A green index - the Natur-Aktien-Index NAX – was launched in 1997 by two German-speaking ecological press agencies: the Munich-based Natur and the Vienna based Öko-Invest.
Italy
There are €3.8 million under responsible management today in Italy (0.8% of total investments), for a total of 15 funds, the majority of which are invested in bonds. A third of these are only “ethical” in the sense that part of the revenues is used as grants to charities. Another group is based essentially on exclusion criteria and the third group is largely focused on the environment. Since February 1999, Banca Etica - a virtual bank with 14'000 shareholders and a social capital of €7.5m - has been investing exclusively in social and environmental projects. In January 2001, a Finance Monitoring Organisation (Osservatorio FINETICA) was created by two academic institutions. The rating agency Avanzi is a member of the SIRIGroup.
Spain
There are 5 responsible funds on the Spanish market, most of them with an environmental focus. With Triodos Bank, the independent financial advisor Proyecto TRUST aims to promote sustainable investment in Spain. Last year, a network of alternative and ecological organisations (Red de Utiles de Financiacion Alternativa y Solidaria, RUFAS) and a bank established the first responsible savings account in Spain.
Netherlands
There are 25 green (groen) and sustainable (duurzaam) funds in the Netherlands (one of which will be launched in July 2001), where four banks control the totality of the sustainable investment market. The largest is Triodos Bank, which also operates in Belgium and the UK. Triodos Research, a member of the SIRIGroup, conducts ratings of stocks. As a result of fiscal incentives provided by the Dutch government, green investment has increased 125% in 2000 to reach fl2.25billion (approx €1b, 1.2% of total investment).
Sweden
The building blocks of responsible investment in Sweden are cooperative banks (e.g. JAK since1968 and Nordiska Sparlan since 1992), green banks (Ecobanken) and 40 funds that focus on the environment, health and human rights. Amongst these, 80-85% exclude tobacco, weapons and alcohol industries from their investments. According to CaringCompany, a Swedish rating agency, responsible investment now represents kr27 billion (approx. €3b, 3.3% of total investment). Environmental criteria can be defined with a certain degree of flexibility, which led the Swedish media last year to claim that most Swedish environmental funds were a misnomer.
Switzerland
Swiss responsible funds in general combine a focus on innovation in the environmental or sustainability fields, best-of-sector criteria and strict exclusionary screens. Responsible investment volumes tripled between 1999 and 2000 and now represent SFr5.5 billion (€3.6b, 0.1% of total investment). Some pension funds, either directly or through the Ethos Foundation, include human rights, labour standards and environmental criteria in their investment policy. Switzerland hosts three rating agencies - the Fribourg-based Centre Info (member of the SIRIGroup), SAM Sustainable Asset Management and Eco-Rating International, both based in Zürich.
United Kingdom
The first ethical trust in the UK was launched in 1984 and there has been a continued growth in socially responsible investment (SRI) during the 1990s. Recent data shows that there is now £3.3 billion (€5.3b, 5% of total investment in 2000 according to CSR Europe) under management in ethical or SRI funds, compared to £912 million in 1995 and £280m in 1990. During the period, the number of funds has risen from 18 to 90. According to the Prince of Wales Business Leaders Forum (PWBLF), responsible institutional investment in Britain amounts to £50 billion (€81b). A number of rating agencies, independent financial advisors and asset management firms specialise in SRI. As a result of the legislation introduced in July 2000 for pension funds, prospects for a yet larger increase in responsible investment are favourable. Indeed, last February, Norwich Union launched six « Sustainable Future Funds » based on triple bottom-line criteria and targeted at renewable energies, public transport and clean technologies. In addition, a new set of indices based on screening research performed by EIRIS (Ethical Investment Research Service) - FTSE4Good - will be launched this Summer.
Criteria for portfolio screening
Ethical funds are generally administered in accordance with a range of negative criteria (see box) to avoid investment in companies associated with certain sectors. Many responsible funds combine negative screening with a range of positive criteria, which scan a wide range of issues (cf. next page).
Sustainable performance ratings are based on the evaluation of the quality of the company’s management and control systems, its exposure to risks, the extent to which the company’s products and services contribute to sustainable development and the company’s relations with stakeholders. Performance based approaches tend to be research intensive. The resources and rigour needed for the research process are important, which is why relatively few asset management firms have their own research teams. Some examples include Henderson Global Investors (formerly NPI), Friends Ivory&Sime and Jupiter Asset Management in the UK, Storebrand in Norway, Sustainable Asset Management, UBS and Bank Sarasin in Switzerland. Assessments are generally conducted via questionnaires, study of corporate reports, research of academic literature and NGO analyses, direct interviews or site visits and media surveys.
Many rating agencies conduct sector-specific evaluations to allow judgement on company performance within its own industry sector. Rating systems are proprietary, and numerical rankings are not standardised. A network of European and North-American rating agencies, the SIRIGroup, was created in August 2000 with the aim of harmonising research methods to build company profiles. It has to be recognised, also, that much of the interpretation and application of the criteria is subjective and depends both on the characteristics of the rating system and on the fund manager’s specific policy. The latter is not bound by the ratings and may choose to include non-screened stocks in so-called “ethical” or SRI portfolios. In addition, while green funds are expected to invest in companies whose processes, products and services contribute to a cleaner and healthier environment, some asset managers choose to include heavy polluters in their investment portfolio, based on the claim that these are the industries where the potential for improvement is greatest. This illustrates the difficulty of interpreting notions such “environmentally responsible” in the absence of commonly agreed standards. Finally, many investment institutions remain unfamiliar with the sustainable development concept and the application of human rights principles to business is still in infancy.
Negative criteria:
Armaments and nuclear weapons
Animal exploitation (e.g. fur industry, factory farming)
Animal testing (e.g. pharmaceutical and cosmetic industry)
Alcohol manufacture and promotion
Activities, processes or products that have a major impact on climate change (e.g. automobile, oil and gas industry, road building, etc.)
Genetic engineering
Manufacture and promotion of hazardous substances such as pesticides, chlorine-containing chemicals (e.g. PVC)
Manufacture and promotion of ozone-depleting substances
Tobacco manufacture and promotion
Environmentally damaging practices
Nuclear energy
Oppressive regimes
Poor employment practices
Gambling
Pornography
Positive Criteria:
Corporate governance: Transparency, communication policy, environmental and social reporting, relations with shareholders, CEO salary and benefits, position of the officer responsible for environmental and social affairs, codes of conduct, charters, internal audits...
Human rights: Operations in countries with oppressive regimes or with a record of human rights violations, rights of indigenous peoples, labour standards (child labour, safety, forced labour...)
Social policy: Personnel rotation, education and training, income levels and distribution, gender representation in top decision-making positions, employees benefits, safety and hygiene, conflict resolution, rights of association...
Relations with external stakeholders: Relations with NGOs, involvement in the local community, support of local socio-economic development...
Supply-chain management and business ethics: Relations with customers and suppliers, procurement policy, fair competition, publicity policy, corruption.
Environment: Emissions, pollution, waste, resource use (energy, water, raw materials), transport policy, eco-efficiency, hazardous substances, industrial accidents, risk and liabilities, non compliance with legislation, infrastructure and equipments, environmental objectives, environmental accounting.
Environmental Management Systems (EMS): Audits, reporting, initiatives, monitoring systems, objectives and verification.
Products and services: Direct Impacts, impacts of use or consumption, recyclability, packaging, labelling, eco-design, innovative products or services promoting health, public transportation, renewable energies, training, sustainable development.
Synthesis
Many people today are investors through savings, pension schemes, life insurance and lump sum investments. They are increasingly expressing concern over the activities of the companies in which their money is invested, either directly or through financial institutions such as banks and insurance companies. It is hoped that companies will eventually be forced to become better corporate citizens if enough individuals and institutions choose to invest in a responsible way. However, although responsible investment has increased dramatically over the last two years, it represents a tiny fraction of overall investment and almost totally ignores opportunities in developing countries. Even within this tiny fraction, the ethical or responsible quality of the funds is not always clear cut in the absence of appropriate standards. Yet, it is becoming clear that, with legislative pressure placed on institutional investors to adopt an enlightened attitude to their investment responsibilities, companies that have responsible policies and practices in place will prove to be the ones which have better survival prospects in the long term.
The financial community itself has a role to play in influencing good ethical, social and environmental practice through credit approval processes and investment policies. Its attitude today towards these issues is still mostly reactive, as the major concern is risk and liabilities. Nevertheless, an increasing number of asset managers and banks are starting to adopt branded approaches that apply to all their investment decisions (such as Friends Ivory&Sime’s Responsible Engagement Overlay (REO®)). In the environment field, recent initiatives both in Switzerland (EPI-Finance) and in the UK (“First Environmental Management Guidelines for the Financial Service Sector”, launched by Minister of Trade Patricia Hewitt in November 2000) aim at improving the environmental management of financial institutions, both internally and with regard to their operations.
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