Getting it right first time around

The financial sector has a crucial role to play in promoting sustainable development in emerging markets – and is beginning to rise to the challenge. Roz Bulleid reports from São Paulo

For many environmentalists, the most profound challenges the planet faces are to be found in the developing world. As economies from Peru to China rapidly industrialise, they are making ever greater demands on natural resources and the ‘carrying capacity’ of both local and global ecosystems.

But development and environmental destruction do not have to advance hand-in-hand. If the South can learn from the lessons of the North’s industrialisation, it can meet the demands of the poor for higher standards of living without dangerously undermining the environment.

The Johannesburg stock exchange – leading the way in emerging market SRI

And one of the lessons that the industrialised world is beginning to learn is that financial institutions can wield considerable power in shaping environmental and social practices. If those in developing countries can learn the same lesson – at the same time – it could prevent untold problems in the future, many believe. And some are proving keen students.

“We want to do it right the first time,” says Maria Estela Ferraz de Campos, project finance manager at Brazil’s ItauBBA. In August, the bank became the second from a developing country to sign up to the Equator Principles, thus agreeing to apply the same social and environmental criteria as the International Finance Corporation (IFC) – the private sector arm of the World Bank – to all project finance deals worth more than $50 million. In doing so, it followed its compatriot, Unibanco, which signed up in June. Another Brazilian bank, Banco Bradesco, became the third emerging market signatory in September.

Sustainable finance may still be a minority activity in developing countries, but interest is growing. And when representatives from emerging markets around the world met up in São Paulo in November to share their experiences at a conference hosted by Brazilian business school FGV-EAESP, there were a number of causes for optimism.

Mario Monzoni, adjunct co-ordinator at the school’s centre for sustainability studies (CES), says that there are several reasons why financial institutions in emerging markets are beginning to take sustainability seriously. They include increasing privatisation and local financial sectors that are starting to overtake external sources of funding such as the World Bank and Inter-American Development Bank.

Also important is the increasing scarcity of natural resources, Monzoni says, and a growing awareness of social and environmental issues among populations at large. The latter has resulted in the rise of advocacy groups, spurred on by the opportunities that the internet provides for instant communication.

In many ways, it is misleading to group all “emerging market” countries into one bracket, and levels of environmental awareness are far higher in Latin America than in some of the other nations that could be placed in this category. Nonetheless, many of the arguments above in favour of taking a sustainable approach apply to banking in other regions too.

The most basic action financial institutions can take is reducing the social and environmental risks to which they are exposed in their lending business, through more rigorous due diligence screening. In South Africa, the ‘big four’ banks that dominate the market – ABSA, First National, Nedcor and Standard Bank – all consider environmental risk when granting credit, according to Sustainability Banking in Africa, a report published in September 2004 by the African Institute of Corporate Citizenship (AICC) and the UN Environment Programme Finance Initiative (UNEP FI).

Standard Bank, for example, has established an environmental steering committee and is testing a set of guidelines for environmental assessment in lending. And the report says that all four banks have debated whether to adopt the Equator Principles, although none has yet signed up. Nedcor claims, on its website, to comply “in substance with the Equator Principles through its compliance with South African legislation and World Bank standards, where appropriate”.

In Latin America, ABN Amro Real, a Brazilian subsidiary of Dutch bank ABN Amro, has been particularly active in this area, and has trained managers from 800 of its branches in environmental and social credit risk in association with Friends of the Earth.

External organisations are playing a strong supporting role in shaping these processes, with the IFC and UNEP FI, as well as a number of regional initiatives, providing training and support. In the IFC’s case, this includes working with the Union of Arab Banks to develop a set of social and environmental guidelines for financial institutions in the Middle East and North Africa, says Dan Siddy, head of its Sustainable Financial Markets Facility.

Nonetheless, social and environmental risk assessment is still far from routine in emerging economies. In Latin America, some financial institutions still fail to see a link between social and environmental performance, and economic performance, or consider environmental protection to be exclusively the role of regulators, says Edgar Rojas, a consultant for Central American business school INCAE’s Latin American Center for Competitiveness and Sustainable Development. The cost of implementing more sustainable business practices can also be a hurdle, he adds.

Indeed, a survey of 48 banks from Bolivia, Colombia, Peru and Venezuela, carried out in 2003 by INCAE and two other regional organisations, shows that only seven of the banks had an individual or department devoted to the environment, and only 15 had environmental procedures to follow when financing projects.

Even so, this defensive stance to sustainability, in which social and environmental issues are viewed purely in terms of risk, is only a first step. Drawing from earlier work by professional services firm Deloitte, Sustainability Banking in Africa sets out four stages in the path towards sustainable banking. Recognising the risk attached to sustainability is only the second level of awareness, just above “denial of sustainability issues”. The ultimate goal should be for a financial institution to integrate social and environmental issues into its core business strategy, using them to generate new products and services and increase competitiveness.

Emerging market financial institutions that are close to reaching this goal may be rare, but some are beginning to appreciate the opportunities that sustainable products might offer, and several countries are seeing nascent socially responsible investment (SRI) industries developing. South Africa is, again, reasonably advanced in this area with around R9.3 billion ($1.6 billion) of assets under management in 21 SRI funds, according to the AICC report. And in May 2004, the JSE Securities Exchange in Johannesburg launched a socially responsible investment index, with 51 components.

Brazil’s São Paulo stock exchange, BOVESPA, is planning a similar index, which it hopes to launch in mid-2005. The country has three SRI equity funds, with more than R$85 million ($31.5 million) of assets under management. As yet, no other Latin American countries have SRI funds, but ABN Amro Asset Management, whose Brazilian SRI fund, launched in 2001, was the region’s first, is considering launching a Latin American fund. The fund, which would invest in companies across the region, would be sold in Europe and North America, as well as to domestic investors.

Meanwhile, in November, the Brazilian Pension Fund Association (ABRAPP) launched a set of guidelines on SRI. Drawn up with the Instituto Ethos, which promotes corporate social responsibility in Brazil, these are intended to prompt pension funds in the country to consider sustainability when making investments. They cover 11 different issues including care for the environment, corporate governance, labour standards and transparency.

Despite such positive examples, there is a concern among some of those involved in sustainable finance that their message is not getting through to a wide enough audience. “We need more players,” says Luiz Maia, chief executive of ABN Amro Real Asset Management, adding that an isolated movement will not attract followers.

Siddy at the IFC plans to address this concern by turning the emerging markets conference mentioned earlier, which the IFC helped to sponsor, into an annual event. He hopes to gather participants from across the developing world, bringing proponents of sustainable finance from different regions together to share their experiences.

But while sustainable investment pioneers in developing countries may be able to draw on the experiences of their industrialised world peers, there are limits to the degree to which ideas can be transferred wholesale, warns Tessa Tennant, executive chair of the Association for Sustainable & Responsible Investment in Asia. The practices of financial institutions in industrialised countries cannot be transposed directly onto less developed regions, she argues. Instead, those in emerging market countries have to adapt the concept of sustainability to suit their own needs and cultural values. EF

BOX – From the outside looking in

While some SRI funds in industrialised countries may invest in emerging markets, the sums involved are small, says Mark Campanale, UK-based head of SRI business development at Henderson Global Investors. He points out that, 150 years ago, 30% of UK pension fund assets were invested in developing countries such as Chile, South Africa and Brazil. The figure is now only 2%. “How do we get all the capital that’s flying round the North down to the South and invested in sustainability?” he asks.

India – boasts “strong and sustainable” GDP growth

He suggests that SRI funds could consider investing their portfolios along the lines of the Commonwealth Business Council’s Global Index, which is based on GDP, calculated in terms of ‘purchasing power parity’. Compared to a distribution of investments based on stock market capitalisation in the MSCI ACWIF (All Country World Index Free), this would increase investment in emerging markets in Asia and in Latin America almost ten-fold, while reducing US investments by more than half.

Campanale argues that GDP growth in countries like India is “strong and sustainable”, and says that, “if you want to make money, investing in emerging markets is the place to be”. He also thinks that investing in emerging markets clearly coincides with the interests of Henderson’s SRI clients – a survey of which shows that, for more than half, the opportunity to invest in companies promoting sustainable solutions was a major factor in their decision to use Henderson.

A number of issues are holding back potential northern hemisphere SRI investors, says David Morrow, social marketing manager at US-based fund manager Calvert, which runs a $313 million World Values Fund, of which around 10% is invested in emerging markets.

They include a lack of data available on emerging market companies, and inertia among institutional investors, particularly given the limited interest they show in SRI in their own countries – let alone emerging ones. More education and publicity is also needed, especially as many investors believe that they are already sufficiently exposed to emerging markets through their holdings in multinational corporations, says Morrow.

Nonetheless, there are some useful initiatives for promoting emerging markets, he says, and the number of SRI research organisations located in the developing world is increasing.

This is an area in which the International Finance Corporation hopes to play a role, and a system of grants to help establish research organisations is on the cards, says Dan Siddy, from its Sustainable Financial Markets Facility.

Campanale, meanwhile, offers a note of caution about equity markets, warning that emerging market companies are often directly linked to the natural resources sector. “I’m not sure that equity markets are the right place for companies that operate in primary markets,” he says. He points to the mid-1990s when a rush of forestry companies listing on stock markets led to rapid deforestation as they hurried to maximise shareholder returns, and he thinks that another approach, perhaps using long-term debt finance, might be more appropriate.