Advancing Responsible Business

Many businesses are continuing to fail to pay attention to what is often regarded as ‘non-core’ parts of business: ethical conduct, corporate governance, social and environmental factors, says Simon O’Connor, the CEO of the Responsible Investment Association of Australasia.

The world of business continues to highlight just how relevant and important the role of responsible investment is. The News Ltd phone hacking revelation typifies how poor internal management of ethical and governance practices ultimately resulted in dire consequences for News, costing investors dearly and causing an incalculable impact to people, media regulation, politics and beyond.

If it was an isolated example, it would be of sufficient concern, but other recent examples highlight systemic failure in non-financial risk management. The finance sector, still recovering from the fall-out of the global financial crisis, was in 2012 slapped with over $US13 billion in fines from a multitude of legal breaches: colluding to rig interest rates through the LIBOR scandal; breaching sanctions with Iran; misleading investors; and being complicit in money laundering.

The list goes on, but the consistent thread shows that many businesses are continuing to fail to pay attention to what is often regarded as ‘non-core’ parts of business: ethical conduct, corporate governance, social and environmental factors.

The fallout shows clearly that non-core issues very rapidly become core when they’re ignored. Many of these issues don’t turn up on corporate balance sheets, being considered intangible, and by the time they are noticed the damage has often been done and value destroyed.

A United Nations Environment Program sponsored report of the world’s top 3000 listed companies highlighted how out of balance the balance sheet gets when environmental costs are factored in. It concluded that these 3000 companies are creating environmental damage of $US 2.2 trillion, annually. If these companies were taken to account for these costs, this has the potential to wipe out, on average, a third of each company’s profits.

The reality of this situation is that while the individual company may avoid paying these costs, other parts of the economy are lumped with them instead. As they are shifted around the economy, the tab ultimately has to be picked up by other sectors, governments (and hence tax payers) or by future generations.

For investors, this matters. For responsible investors, it’s our bread and butter. Long-term investors, many holding investments across the entire ASX and beyond, are referred to as ‘universal owners’ who incur these shifted costs in other parts of their portfolios. Therefore when companies are eroding the world’s natural capital (e.g. depleting water, eroding soils, damaging our atmosphere) or social capital (e.g. failing to invest in training their workforces) the individual company many benefit in the short term, while putting at risk the future returns of investors.

In Australia, where 75 per cent of the total pool of investments is retirement savings, that’s our nest eggs at risk. From this perspective, there is a uniquely important role for the investment community to play in ensuring we’re not all profiting now at the expense of our future.

Indeed, a precondition for sustainable, long term financial performance is the improvement in environmental, social, governance and ethical performance of the corporate sector. This value is embedded in the constitution of the Responsible Investment Association (RIAA) and is what underpins our activities and aligns our membership.

With this in mind, the role for us is clear: there is no choice but to pay attention to our government’s policies and company actions, because if we don’t, all of us will ultimately carry the cost.

This raises a long list of questions such as:

• Are we as a nation investing in a well educated population?
• Are we encouraging R&D and innovation to ensure we have an economy well prepared for the post-mining boom period?
• Are we looking after our ‘natural capital’, such as the river systems that maintain a strong agricultural sector, and the water supplies for running an economy on the world’s driest continent?
• And if we are not stronger in our response as shareholders when companies are continuing to make governance and ethical breaches that are costing us, then are we failing in our roles as fiduciaries?

But there is a good news story here.

Responsible investment is increasingly a mainstream consideration of the investment industry, now making up 18 per cent of total funds under management in Australia and representing around $180 billion. Pleasingly, this doesn’t come at a cost to investors. Our recent industry benchmark report found that these funds have been outperforming the market over 1, 3, 5, and 10 years. Indeed, the top performing fund in Australia last year was a responsible investment fund.

Although there is a range of investment practices that makes up responsible investment—from ethical screening through to integrating environmental social and governance risks—the common theme amongst all of them is that at a minimum, they look at more than just traditional financial factors.

However you argue this, fundamentally our members do more research and more analysis and therefore provide a more comprehensive investment.

RIAA’s role is more than just advancing responsible investment; it’s about advancing responsible business practice and ensuring the public knows that there are more responsible practices out there.

RIAA as an organisation needs to be driving these discussions where they are not already occurring, acting as an influential voice for the sector, and educating both the finance sector and the general public to ensure we do achieve a more prosperous and sustainable future.

It’s in all of our interests to do it—we’re literally invested in it.

This article was originally published in Living Ethics, the quarterly newsletter of St James Ethics Centre -www.ethics.org.au/content/living-ethics