Emerging markets for SRI?

Socially responsible investors have, so far, paid little attention to emerging markets. But a new report commissioned by the International Finance Corporation argues that they should – both for their own sakes, and for the sake of sustainable development. Dan Siddy explains

In 2000, Vestel, a Turkish manufacturer of flat-panel TV screens for European and North American markets, emitted large volumes of pollution and suffered from a breakdown in employee relations. These problems made it the target of criticism from a range of non-governmental organisations (NGOs).They also made it the target of short selling – borrowing stock to sell in the expectation that the share price will fall, allowing it to be bought back at a lower price – from Green Cay, a Bahamas-based asset management firm.

Green Cay, which has operated a $30 million emerging markets hedge fund since 1997, uses the principles of socially responsible investing (SRI) to determine whether to buy and hold a company’s stock or sell it short. In this case, Vestel’s problematic record pointed to shorting its stock.

But Green Cay didn’t just sell short the stock, it also informed Vestel of its decision to do so.That produced a change – and by 2002 environmental organisations from around the world were praising Vestel for its new practices. “When that happened, we went long buying shares] in the company,” says Jane Siebels-Klines, Green Cay’s chairwoman and chief investment officer.

Brazil's Bovespa exchange - embracing sustainability

In other words, Green Cay, through its use of SRI screening, had both produced a profit and an environmental and social benefit – Vestel decided to change its practices because of Green Cay’s investment decision. “I think that because they basically told us so,” Siebels- Klines says.

As the private sector arm of the World Bank Group, the International Finance Corporation takes a similar approach to the environmental and social sustainability of its own investments in companies in developing countries. An independent report commissioned by the IFC from a Mexico-based consultancy, Enterprising Solutions, and released last month, analyses the case for other investors to follow suit. In essence, Towards Sustainable and Responsible Investment in Emerging Markets finds that “there is untapped potential for SRI entry into such markets, which could greatly increase the flow of private capital to socially and environmentally sustainable business activity in the developing world”.

Of course, SRI has been a part of the industrialised world’s financial sphere for more than 30 years and currently represents a $2.7 trillion worldwide industry, including 766 retail funds and even more institutional investors. Basically, these funds employ SRI as “an investment process that considers the social and environmental consequences of investments, both positive and negative, within the context of rigorous financial analysis,” according to a definition from the US Social Investment Forum (SIF). In other words, SRI provides the link between private investment and sustainability, or long-term business success that also contributes to economic and social development as well as a healthy environment and a stable society.

That is no small goal, and the SRI movement has not yet achieved it, particularly because SRI is almost exclusively an industrialised world phenomenon. Only 0.1% – or $2.7 billion – of global SRI assets are invested in emerging markets. Yet there are significant opportunities in emerging markets for SRI to work at its best, as well as signs of increasing investor appetite for such investment in these markets.

Currently, however, SRI investment within different emerging markets varies widely, with South Africa garnering the lion’s share of retail SRI fund investment, at $230 million or 70%. Most of the rest goes to Asia, with South Korea as the darling of the sector. In other words, Latin America and Africa (excluding South Africa) receive little SRI investment.

The primary reason for this, and for the lack of large-scale global SRI investment, is a lack of a supporting infrastructure. In the developed world, there are a wide variety of ways to access SRI information and check its validity. There are also a host of supporting organisations, such as the SIF and its counterparts in other developed countries. Only Asia has a similar, albeit fledgling, support network (see box). Nor is there access to high-quality SRI information on companies in emerging markets. While SRI research houses such as KLD and Innovest in the US, SAM in Switzerland and EIRIS in the UK have attempted some such research, there is no comprehensive and systematic database.

This lack of basic information is coupled with a host of biases. Emerging market investment is often associated with corruption, a lack of transparency, ineffective laws, illiquid stock markets and general political risk.As a result, it is difficult for retail funds in the industrialised world to develop viable products and investors in the developing world still find the concept of SRI (and stock market investment in general) foreign.

Nevertheless, a growing body of research shows that corporate social responsibility adds financial value to businesses in emerging markets. Developing Value, a report published last year by UK-based consultant SustainAbility, the IFC and Brazil’s Ethos Institute, surveyed 240 businesses in more than 60 countries and found companies that practised social responsibility gained cost savings, increased revenues, reduced business risk, enhanced market reputation, strengthened employee relations and improved access to capital, particularly foreign capital. Another report, Make Me Holy…But Not Yet, from Hong Kong-based brokerage and investment bank CLSA found the same to be true for stock markets as a whole: those with strong corporate governance regimes outperformed those with weaker rules.

In addition, as the Green Cay short-selling case illustrates, SRI can have profound positive impacts on the development of companies and markets in developing economies and societies. SRI has already had several successes with reforming multinational corporations and their operations in emerging markets. For example,Nike and Disney now closely monitor where and how their clothing and footwear is made after the exposure of controversial manufacturing practices in countries such as El Salvador and Vietnam.

In addition, timely SRI can help write the rules on financial regulation, particularly with regard to minority shareholder rights and information disclosure. For example, Brazil’s main stock exchange – the São Paulo Stock Exchange (Bovespa) – recently created a new market, Novo Mercado, specifically to address corporate governance issues, thanks to pressure from Brazilian pension funds and non- Brazilian shareholders.A company can only be listed on the new exchange when it agrees to provide statements in accordance with US and international accounting standards as well as detailed information about the activities of its major shareholders. The agreement also requires companies to treat controlling and minority shareholders in the same manner.

“A company’s decision to list on Novo Mercado is beneficial not only for investors, but for the company itself, and eventually strengthens the stock market as an alternative means of investment,” Bovespa argues. A whole slew of benefits follow, including greater accuracy in stock pricing, reduction in a company’s capital costs, increased liquidity in the market and stronger and more competitive firms, among other gains. Plans are now afoot for a sustainability index on the Bovespa, while FTSE4Good will also soon be launching a new index in South Africa in association with the Johannesburg Stock Exchange.

As a result of these findings, the report offers a series of recommendations, assuming that it is not likely that SRI will experience rapid, ‘organic’ growth but is instead likely to grow in the medium and long term.There is a pressing need to create national and regional networks to support better knowledge and information- sharing among the people, organisations and companies that will drive SRI in the future.

The IFC is helping to address this, for example by providing grant funding from its Sustainable Financial Markets Facility for the establishment of a Centre for Sustainability Investing under the auspices of the African Institute of Corporate Citizenship.The report also highlights the need to develop SRI research infrastructure in emerging markets to provide cost-effective data and analytical services to both local and international investors. Finally, the report recommends engaging institutional investors on the subject, and the creation of a high-profile, flagship emerging market SRI fund to help catalyse emerging market SRI.

The IFC believes that the developmental case for sustainable investment in emerging market equities is compelling, and the business case is increasingly promising. Developing countries face profound social and environmental challenges and, at the same time,will be fundamental to sustained global economic growth. If SRI is to be successful as an investment strategy, and in contributing towards sustainable development, it must look beyond its roots in the industrialised world.

Some important short-term barriers need to be overcome.The IFC’s executive vice president, Peter Woicke, announced in October that the IFC will hold a high-level roundtable in early 2004 to debate these issues, and identify opportunities for partnership and action.

Dan Siddy is head of the Sustainable Financial Markets Facility in the IFC’s environment and social development department in Washington, DC. E-mail: dsiddy@ifc.org