KPMG released a publication in 2012 entitled Expect the Unexpected: Building business value in a changing world, which identifies ten sustainability “megaforces” that are projected to impact business across all industry sectors in the coming decades.  In today’s global economy, such megaforces as water scarcity, population growth, and urbanization will all shape the way business is conducted.  The report posits that the process of “decoupling human progress from resource use and environmental decline [will be] the central challenge of our age,” and businesses that emerge successfully through this transition will be more resilient and therefore protected against risks.  The concept of decoupling is an accepted way to reconcile the disparity between our planet’s apparent finite resources and thus far infinite (and virtually exponential) economic growth: economic growth can be possible without relying – at least as much – on natural resources or raw materials.  Waste elimination, recycling, and other methods of increasing operational efficiency will all provide ways for businesses to expand their output and economic growth while shrinking their ecological footprints.

The KPMG report goes on to discuss different industries by sector and explore which may be the most vulnerable to these sustainability megaforces.   As per the Industry Classification Benchmark (ICB) system, KMPG identifies the following 11 industry sectors:

• Airlines
• Automobiles
• Beverages
• Chemicals
• Electricity
• Food Producers
• Industrial Metals and Mining
• Mining
• Marine Transportation
• Oil and Gas
• Telecommunications and Internet

In order to effectively analyze and evaluate these sectors, KPMG used a data set created by the independent environmental research agency Trucost that translates environmental impacts into monetary values and is therefore a measure of an industry’s environmental sensitivity.  One important measure of environmental sensitivity is environmental intensity, which conveys the environmental cost of potential profits. Trucost’s data set indicates that environmental costs are rising very quickly, but since it puts a price tag on environmental externalities, those “off balance sheet” costs have not yet necessarily translated into financial impact.  KPMG points out that calculating these externalities is becoming more commonplace, as “businesses will be most motivated to act on sustainability when the costs of environmental and social impacts can be shown on financial statements.” (Expect the Unexpected)

This analysis reveals good news and bad news for different industries.  The Industrial Metals, Marine Transportation, and Mining sectors all showed a reduction in earnings exposure to environmental cost, or an improvement in environmental intensity, though this is largely the result of profits in those sectors growing more rapidly than their environmental impact, rather than a real reduction in these industries’ environmental impacts: in other words, this juxtaposition between economic growth and environmental cost likely cannot be contributed to decoupling.  Conversely, the Automobile, Chemicals, and Electricity sectors show signs of decoupling.  Their environmental costs are growing at a lower rate, or even shrinking altogether, while they are simultaneously improving their environmental intensity.

The Food Producer and Beverage industries, conversely, appear to be facing particularly devastating changes resulting from the sustainability megaforces.  Not only is their environmental intensity actually increasing, but the “environmental costs of the Food Producers sector could outweigh their entire earnings.” (Expect the Unexpected)  Beverages have significant exposure to these megaforces, with high exposure to water scarcity, food security, climate change, population growth, ecosystem decline, and with partial exposure to energy and fuel, deforestation, and urbanization.  Similarly, Food Producers will be highly exposed to climate change, water scarcity, ecosystem decline, population growth, wealth, energy and fuel; and potentially exposed to urbanization.

While decoupling is clearly a necessary process for all industry sectors to explore, it is worth further exploring just what this may mean.  Author Jackson of “Prosperity without Growth” stresses that there are actually two types of decoupling, relative and absolute.  Relative decoupling relies on increased efficiency to accomplish its goal: lowering the ecological intensity of industry activity relative to the GDP (Jackson).  With continuously growing GDP, however, ecological intensity may still ultimately rise even when employing relative decoupling.  Absolute decoupling means that the absolute ecological impact declines, regardless of what is happening with the economy.  Jackson proposes some potentially radical methods by which we may achieve absolute decoupling, including curbing economic growth.  While those ideas aren’t tenable in today’s economy, it is certain that now is the time to be making ecological investments in carbon reduction, infrastructure changes, and ecosystem protection among others (Jackson).  Furthermore, the KPMG report shows a stark future ahead for industry sectors that fail to reduce their environmental intensity in some form or fashion.  Creativity and innovation has always been vital for businesses, but will be increasingly so as they pivot to meet the coming sustainability challenges.

Sources

Jackson, Tim. Prosperity without Growth: Economics for a Finite Planet. London: Earthscan, 2009. Print.

KPMG. “Expect the Unexpected: Building Business Value in a Changing World.”Building Business Value in a Changing World. N.p., n.d. Web.

Raising C-suite awareness of sustainability benefits is a critical initial step before even creating a roadmap. Some progress can be reported on this issue, as more CEOs are aware of the benefits of implementing corporate sustainability. According to MIT Sloan’s 2012 Sustainability and Innovation Global Executive Study, 48% of CEOs responded that they had changed their business model to incorporate sustainability; of those, 46% reported that sustainability added to their bottom line. However, out of 600 companies surveyed last year by CERES for The Road to 2020 Report, more than half still fall into the Tier 4 “Starting Out” in their Roadmap for Sustainability. In Tier 4, CERES catalogs those companies who are beginning to understand sustainability and which need considerable work to integrate sustainability into overall corporate accountability systems.

Corporate sustainability demands a broad view of issues and impacts, as well as a working understanding of what the company does and how it does it. Embedding sustainability means joining the two together through a series of concrete steps.

1. Understand sustainability and recognize what it means to the company

As a first step, it is important to define what sustainability means for every area in the company and to identify its benefits. From investment decisions, developing new products or services to changing procurement practices, sustainability has an increasingly central role in these decisions. Coca-Cola is one of the companies centering its investment decisions on sustainability. When considering the development and location of new production plants, water sustainability has been now included as a key factor. Sanjay Guha, president of Coca-Cola Great Britain says “potential markets and ease of distribution were once the only key factors. Now it is the long-term supply of water.” In order to understand where sustainability efforts should be concentrated in a company, it is necessary to identify those issues that have the biggest impact and are most relevant to the business and to stakeholders.

 2. Engage with stakeholders

Depending on its line of business, a company’s impact can vary among stakeholders. Generally, companies engage with the most influential groups, keeping close ties and a constant dialogue. However, engagement can happen on different levels and should respond to expectations from both sides. Different levels and methods of engagement bring benefits to both companies and stakeholders and can be translated into more sustainable practices. Bonnie Nixon, Director of Environmental Sustainability at Hewlett Packard explains, “allowing stakeholders to honestly critique us pushes us to improve our programs and helps us develop our thought leadership platforms.” In the same way, Procter and Gamble has benefitted through the engagement with local communities around the world by finding alternative uses for its waste materials. Through employee engagement, Kraft Foods has developed a model where employees contribute with ideas and viable plans to reduce waste while helping to reach the company’s waste reduction targets.

 3. Set goals and commitments

Once key environmental, social and governance issues have been identified and engagement methods for each stakeholder group have been defined, efforts must focus on reducing risks and seizing opportunities around these issues centered on sustainable practices. Whether driven by cost reductions, innovation or improved financial performance, sustainability commitments and goals need to be established.

For Wal-Mart, most of it commitments and goals on sustainability are focused around the use of renewable energy and the adoption of energy efficiency. Initiatives in these areas have resulted in the recognition of Wal-Mart as the largest on-site green electricity generator in the U.S. and have led to cost savings of over $500m USD a year. Another example is United Airlines. The airline aims to reduce its environmental impact through the participation of all its suppliers in its Sustainable Supply Chain initiative.

While companies like Wal-Mart and United Airlines aim for a complete transformation of their businesses, small companies are setting goals and commitments according to their scope of action. Initiatives mainly focus on cost reductions from energy use, waste management and commuting practices, as well as social actions in the community like local development projects and volunteering campaigns.

 4. Establish systems and processes

Once the goals are established, specific systems and detailed processes need to guide the implementation of each initiative. Throughout the design, processes and policies in place must be taken into consideration and collaboration among areas encouraged. At this point, gaining executive commitment is crucial. The appointment of an internal sustainability champion as the main driver of sustainability and the development of a successful employee engagement model are also good practice. According to the 2012 Report of Sustainability Leaders by VOX Global and Net Impact Berkeley, 78% of respondents say top management was a key contributor to embracing sustainability. However, 81% identified their colleagues across the company as primary drivers of success.

Unilever’s Sustainable Living Plan was launched in 2010. Under the leadership of its CEO Paul Polman, this ten-year sustainability plan has already accomplished considerable progress in its first two years. Under the umbrella of its comprehensive overall sustainability strategy, Unilever is utilizing its wide array of brands to target distinct social issues, invest in sustainable technologies and change consumer behavior. Unilever has also accomplished to fully embed sustainability across the company and to successfully engage external actors. Besides the appointment of a Chief Sustainability Officer in 2012, the company’s management structure includes a Sustainable Living Plan Steering Team, a group of external specialists in corporate responsibility and sustainability known as the Sustainable Development Group and the launch of the “Small Actions, Big Difference Budget” which finances employees ideas based on environmental benefit and financial return.

 5. Track progress, communicate actions and meet expectations

Lastly, it is important to set a system that measures the performance towards each goal. Defining key performance indicators to meet the identified goals will allow to detect areas for improvement and will gather relevant data to track progress. Metrics and indicators are also central for the reporting and communicating activities of the company. Internally, the availability of data contributes to the prioritization of issues and initiatives and to promote employee involvement around sustainability. Externally, collecting data is fundamental for an accountability strategy, to respond to stakeholders’ expectations and interests and to comply with reporting standards.

Companies reporting under the Global Reporting Initiative guidelines have already embraced the development of indicators. In addition to these guidelines, the Sustainability Accounting Standards Board is currently preparing frameworks that will standardize sustainability key indicators per sector. Alongside these efforts, companies are designing their own systems to measure performance, like Wal-Mart’s Sustainability Scorecards, which, among other criteria, ranks suppliers according to their environmental footprint and contributes to Wal-Mart’s performance measurement.

In the end, corporate sustainability needs to adapt to the maturity of the business and the company’s willingness to treat sustainability as a strategic opportunity. These steps are only the beginning of a process that can eventually transform a company’s entire business strategy into a sustainable business strategy.

Due to increases in energy prices, energy is being considered less a cost and more a strategic component of business. As part of sustainability efforts, the efficient use of natural resources, specifically of energy, is becoming a priority for businesses.

Although energy efficiency can be considered a low hanging fruit among sustainability practices, its adoption is not an easy task. Considerable investments are required to transform a company’s operations towards energy efficiency. In the 2011 Survey on Energy Efficiency prepared by the Economist Intelligence Unit, lack of funding was identified as a major obstacle in the implementation of energy efficiency. Most survey respondents believe energy efficiency will play a more important role in their business in the future; however, only large companies are taking aggressive steps to tackle energy use, as they are able to capitalize on economies of scale. In response to funding challenges, governments and other institutions such as energy service companies (ESCOs) are offering incentives and financing schemes to trigger public-private investments towards energy efficiency.

Besides funding, the survey reports proven return on investment as the most important obstacle for integrating energy efficiency initiatives into business strategies. While companies appear to embrace the benefits of energy efficiency, they are still struggling with how to implement energy saving measures. Skepticism and long payback periods – the period it takes for the project to recuperate the investment through savings – around these initiatives is keeping companies from going further than improving lightning or air-conditioning systems. Regarding payback, expectations tend to be for a 1 to 3 year payback timeframe. For energy efficiency projects, depending on the scale of investment, this may not be a feasible time frame.

Strategies on energy efficiency need to be tailored according to corporations’ energy demands. Companies in energy intensive industries such as steel, chemicals, refining or metals require the overall transformation of their processes and equipment. In the same way, corporations in manufacturing and retail incur in considerable investments to renovate supply and distribution chains. However, low energy intensive sectors and services can undertake gradual improvements without compromising a company’s financial situation. Changing habits and adjusting systems, supported by senior management and employee involvement, represent viable options that translate into significant savings.  Even turning off computers at night represent a 10% reduction in energy bills, according to the Carbon Trust.

Besides cost reduction, energy efficiency presents other tangible benefits related to brand value, performance and carbon emission controls. “Cutting carbon is a great environmental story, so customers will reward you for having proven low-carbon credentials”, says Harry Morrison, manager at Carbon Trust Standard Company. The carbon footprint also matters to investors in a company. The disclosure of information on carbon emissions and energy use is taking an increasingly central role in investment decisions by investors and shareholders.

There are still considerable barriers that stand in the way of fully adopting energy efficiency measures, and there is a long way to go. Efforts in measuring and monitoring energy usage, promoting energy benchmarking and auditing as well as disclosure on savings will certainly incentivize the adoption of energy efficiency in business decisions.

What is materiality and why is it important?

The concept of materiality has its origins in the auditing and accounting processes of financial reporting. In financial terms, a concept is considered material to the company if its omission or misstatement influences the economic decision of users. In recent years, the concept of materiality has been adopted in sustainability and is increasingly influencing the design of sustainable strategies and reports.

Compared to financial statements, sustainability considers a broader scope of action and covers a multitude of issues- environmental, social, economic and more. This context requires a more comprehensive definition for materiality. The Global Reporting Initiative (GRI) defines as material those issues with “a direct or indirect impact on an organization’s ability to create, preserve or erode economic, environmental and social value for itself, its stakeholders and society at large”.

In simple terms, materiality aims to identify the societal and environmental issues that present risks or opportunities to a company while taking into consideration the issues of most concern to external stakeholders. The process of labeling material topics in a company requires a comprehensive framework that methodologically identifies and prioritizes issues, risks and opportunities, commonly known as materiality analysis.

Materiality analysis

Source: PGS Advisors

When to perform a materiality analysis?

A materiality analysis is a tool that takes into consideration the company’s financial concerns while foreseeing future risks and opportunities around ESG issues. A materiality analysis is especially useful for companies building a sustainability strategy, preparing a sustainability report or looking to explore new business opportunities.

As in traditional enterprise risk management, strategic planning for sustainability requires a deep understanding of the impacts of a company’s operations and a comprehensive stakeholder map. Materiality analysis helps a company tailor its sustainability strategy and stakeholder engagement activities around the issues that are most pressing to their business and sector. It not only identifies issues with significant social or environmental impact for the company but also takes into account the understanding of stakeholders. When preparing reports, the availability of this information guarantees addressing the issues that represent a major concern to stakeholders and consolidates a company’s accountability strategy.

In addition, materiality analysis can provide information to develop products and services with the greatest potential for sustainable business growth and can influence a company’s decision-making process by weighing risks.

How to identify materiality

Generally, materiality varies considerably from company to company. Material topics can be similar within an industry or a sector, but they also respond to particular characteristics of a company such as size, location, time of establishment, level of stakeholder engagement, financial performance, etc. As a result, the practical application of materiality is constantly evolving. Recently, organizations like the Sustainability Accounting Standards Board (SASB) and the GRI have developed tools to consolidate the process of identifying materiality.

The SASB is in the process of building materiality maps for each industry. It has determined materiality according to issues under five categories: Environmental Capital, Social Capital, Human Capital, Business Model & Innovation, and Leadership & Governance. Until now, materiality maps for the healthcare and financial sector have been published. Maps per industry will be available in the short to medium term.

At the same time, the GRI developed a materiality framework to guide sustainability reporting: the Reporting Guidance for Defining Content in the GRI Sustainability Reporting Guidelines. Companies reporting under these guidelines are taking advantage of the materiality analysis beyond reporting and are using the process to target their sustainability efforts.

Common elements in materiality analysis include:

1. Identification of a universe of relevant economic, social, environmental, and governance issues for consideration;
2. Evaluation and ranking of the level of stakeholder concern regarding each issue;
3. Evaluation and ranking of the potential impact on the company of each issue;
4. Presentation of issues prioritization, typically in a matrix format that is subsequently used to inform strategy and reporting.

In addition, the process usually takes into consideration surveys involving consumers and sustainability experts, feedback from stakeholder meetings, engagement events, media scans, internal business impact surveys, corporate risk maps, etc.

Materiality analysis is about setting priorities right. By complementing financial and non-financial performance, materiality helps align a business strategy with a company’s ESG risks and stakeholders’ interests while achieving larger impacts in sustainability. It is quickly becoming the dominant concept in sustainability reporting and it is just a matter of time before companies realize the potential and benefits of a materiality analysis for their overall performance and sustainability in particular.

Corporations must be prepared for the introduction of tax and other policy tools and should be aware of the benefits and implications they represent. This post highlights three challenges corporations face regarding the implementation of green policies: 1) identifying relevant policies, 2) understanding their scope and 3) integrating them into the company’s operations.

Identifying relevant policies

The first challenge companies face is identifying and understanding the tools in place and their relevance for their operations. In most cases, companies are aware of relevant penalties but lack information on other instruments’ potential usefulness. Given that the green policies are increasingly focusing on incentives and other tools such as low-interest loans and grants, companies should take advantage of these incentives by reviewing strategies and operations, and evaluating the incorporation of incentives into new or existing projects.

Understanding policies’ scope

Companies often misinterpret the scope of green policy tools. In some cases, corporations believe these instruments are only relevant to companies offering green products or services or to companies who have a long-term sustainability strategy. Fortunately, green policies are addressing multiple topics and can result in the transformation of core strategies, the modification of everyday operations and the increase of the feasibility of projects in the pipeline. For example, the Japanese government is providing subsidies to acquire eco-friendly vehicles and fleets, which will reduce a company’s transportation costs considerably; Australian farmers are selling carbon credits to companies looking to offset emissions and are contributing to more sustainable farming practices in the country; and energy-efficient buildings deductions in the U.S. are representing millions of dollars in potential savings to corporations.

Integrating policies into everyday operations

The adoption of new policies into everyday operations can represent challenges that require leadership and collaboration. In this process, company leaders have to make sure that policies are considered an opportunity and not a threat. As reported in E&Y’s Six Growing Trends in Corporate Sustainability, setting the tone from the top is key to ensure the adoption of sustainable practices. The same approach should be adopted when aiming for the adaptation of green policies by companies.

At the same time, the introduction of new policies will require alignment across areas in both strategy and processes. In order to successfully adopt these, collaboration among areas is essential: the translation of sustainability issues into costs and benefits by financial teams, into project planning tasks by operations departments and so forth. Lastly, the communication of potential benefits and clarity in goals will be key to engage all areas of a company into making the necessary changes to adopt new policies.

Governments have taken steps – however timid – towards addressing environmental challenges. Corporations contribute to these challenges and should play a central role in addressing them too. As companies  incorporate green policy tools and become examples of successful adaption, the private sector’s perspective and experience will be an invaluable source of information for the future design and evaluation of green tax systems. It could be win – win for everybody…

In order to address the challenges of environmental changes, governments are designing and implementing green policy tools ranging from tax incentives to specific subsidies and grants. KPMG International’s Green Tax Index Report analyzes green tax systems from 21 countries. The Index provides information on “which countries are most active in using green tax incentives and penalties to drive sustainability”. It identifies over 200 individual tax incentives and penalties to achieve green policy objectives and categorizes countries into four quartiles according to the degree of tax use (see table below). The ranking of China in the first quartile and Finland and Germany in the third are certainly surprises.

Source: KPMG Green Tax Index Report 2013

The United States tops the ranking with a strong bias towards tax incentives due to its extensive program of federal taxes promoting energy efficiency, renewable energy and green building. Japan comes in second place, ranking higher on green tax penalties than the U.S, with a specific focus on the use and adoption of green vehicles. In third place, the United Kingdom leads on carbon and climate change and presents a more balanced approach between incentives and penalties.

Australia, Germany and Finland, associated with strong environmental policies, are surprisingly constituents of the third quartile. However, this is mainly explained by the wide range of green policies they have implemented, few of which are of the tax variety. Australia (18^th) has focused on non-tax tools such as grants, loans and direct investment to promote green innovation and energy efficiency. Similarly, Germany (17^th) favors low-interest loans and capital subsidies, and Finland (21^st) focuses on grant funding for green innovation.

The emerging economies Brazil, Mexico, Russia and Argentina are located in the fourth quartile. Policy tools in these countries are mainly applied as incentives: Russia leading in promoting energy efficiency and Brazil in green innovation.  However, overall, there are few instruments in place in these countries regarding the achievement of green goals.

Since January 2011, more than 30 green taxes have been introduced around the globe. This trend will continue to drive consumer and business behavior towards more sustainable practices. These policies will certainly contribute to already changing customers’ perceptions on greener businesses and products. Corporations must be prepared to benefit from these policies and to adopt them into their everyday operations. In another post we will discuss some of the implications these policies represent for corporations and their sustainability goals.

The GRI, which is widely considered to be the closest thing to a standardized reporting framework in the sustainability world, has conducted a study of existing integrated reports: reports that have been issued by organizations and self-identified as integrated.  These findings are shared in its recently published “The sustainability content of integrated reports – a survey of pioneers” report.  The report categorizes existing integrated reports into three categories:

1. Sustainability structure – The report focuses on sustainability while neglecting financial metrics, and is thus integrated in name only.
2. Cover structure – Sustainability and financial performance are discussed separately and published in the same document.
3. Embedded structure – The report contains “clear evidence of inter-linkage between reporting on financial and sustainability performance.”

In its report, the GRI is careful to describe these three reporting styles in neutral terms, but it is clear that an embedded structure is a more genuine integration of sustainability and financial reporting, and that this kind of structure is the direction in which they assume <IR> will evolve.  Feedback from companies currently practicing integrated reporting (of the embedded structure variety) confirms that they view the practice as “the natural logical expression of their intrinsic business model” and that to report in any other fashion would actually be “counter-intuitive.”

The companies that report such sentiments are most likely in the minority, and in fact, most companies probably have some work to do before integration becomes so comfortable, but the International Integrated Reporting Council is seeking to facilitate the transition to <IR> by developing a reporting framework that companies can use.  As a starting point, the IIRC released a Consultation Draft  of the International <IR> Framework earlier this spring, and they are currently soliciting feedback with an open comment period that started on April 16 and runs until July 15.

The main themes of the Framework are value creation over different time frames (short, medium, and long term); and accounting for the different kinds of capital, both internal and external, that an organization utilizes and creates.  Organizations are invited to decide upon and justify their individual short, medium, and long term time frames.  In its Framework, the IIRC categorizes capital as financial, natural, manufactured, intellectual, social and relationship, and human, and posits that each kind, whether owned or not, plays a role in creating or diminishing company value.  The IIRC also suggests that determining materiality – the factors that significantly affect value creation over time –  will be fundamental to an organization’s business model, its growth strategy, and its ability to participate successfully in the <IR> process.

During this open comment period, the IIRC encourages stakeholders to read and evaluate the draft Framework, and in addition to providing general commentary, to answer a specific set of Consultation Questions regarding the Framework’s content.  These questions generally pertain to definitions and the scope of the report, as well as how such a report might be verified.  The responses to these questions will be taken into account when updating the Framework, and the IIRC intends to publish the first – of probably many, in this iterative process – official version of the Framework in December 2013.  We look forward to the continued evolution of sustainability reporting, and of <IR> in particular.

Every two years, Aon asks risk leaders across industries to identify the main risks their companies are facing in their operations. More than 1,400 practitioners responded to the 2013 survey. The 2013 survey ranked the top 50 risks companies face, focusing on the top 10 risks in 2013 and how they may change in 2016, displayed in the table below. Overall, the survey found that most respondents found their organizations less risk-ready than in the previous survey in 2011, which might in part be attributed to the prolonged economic recession, which has strained many organizations resources.

Source: Aon Risk Solutions – Global Risk Management Survey 2013

We have three main observations about this ranking:

1. It is certainly interesting to see that damage to reputation/brand is perceived to be diminishing in risk, according to the survey. From our perspective, this seems to be an optimistic scenario. With social media – both a valuable marketing and communication tool as well as potent potential reputation killer –– being only ranked as risk factor number 40, it certainly appears as if companies seem to underestimate reputational and social media risks.
2. Political risks and uncertainties are ranked 10th and are expected to be more relevant going forward. Weather/natural disasters, while not far off the radar at the current ranking of number 16, are also projected to jump into the top 10 risk list at number nine. Both rankings make sense. Somehow though, the connection is not made between environmental risk, climate change and severe and erratic emerging weather patterns. Environmental risk is ranked only 28th and climate change 38th. This seems to be an underestimation of these factors – especially moving forward – and in particular in the light of recent weather events in the United States.  These numbers also imply that companies that take the development of sustainable strategies serious should be able to gain an edge over companies that do not.
3. What’s more, and we will be focusing on this issue in a subsequent blog post, these are all external risks. One might argue that the most relevant risks a company faces are internal, of the organizational nature, ranging from inadequate board oversight to lack of monitoring capabilities to insufficient risk strategies. It can be argued that it is quite essential to get these issues right before one sets out to worry about global external risks.

This brief defines the responsible investment approach and differentiates it from standard investing practices. It also discusses the key debate whether it is profitable in the long or short term to align societal and investment values.

Highlights the motive for investors to engage in public policy debates since it decisively influences their long-term financial interests.

Discusses imminent shifts in the interpretation of fiduciary duties imposed on trustees and other fiduciaries away from being solely focused on maximizing return on investment in the short term.

Elaborates on the rationale for being an active owner and debates the effectiveness of active ownership.

The last brief focuses on the critical question whether ESG issues are relevant for investors, i.e. whether they are financially significant.

Emerging markets have been lagging in the development of ESG investment and investment products though. However, it seems that the time has come for the systematic incorporation of ESG risk assessments into emerging market investment decisions.  Three major trends are responsible for bringing emerging markets and ESG investing together, until recently separate investment specialty areas, although two of the fastest growing:

1. Emerging markets growth is diversifying and is not predominantly based on infrastructure investments anymore. In addition, a rising middle class represents a new class of consumers increasingly paying attention to sustainability concerns. Both developments lead to an increasing role for sustainability considerations in emerging markets.

2. Many emerging market companies are entering their mature growth phase, consolidating and affording the ability to focus more on management quality and corporate responsibility. These companies also are also facing increasing challenges such as resource constraints, demand for more corporate accountability and compliance with global best practices such as labor standards and reporting guidelines. Companies that embrace the challenge can truly differentiate themselves from companies that do not and offer attractive investment opportunities.

3. Information on ESG practices of emerging markets companies was very difficult to obtain only a few years back. This has changed significantly in a short time span. An increasing number of emerging market companies today publish sustainability reports, a growing number of them in compliance with the guidelines of the Global Reporting Initiative. In addition, for investors willing to purchase rating reports, GMIRatings has increased its ESG rating service for emerging market companies from 688 in June 2012 to 998 as of April 2013.

Indeed, underlining these developments, two commercial emerging market ESG indices have been launched in the past two months.

In February, RobecoSAM, a sustainable investment specialist and S&P Dow Jones Indices launched the Dow Jones Sustainability Emerging Markets Index with 69 companies. The companies are selected based on RobecoSAM’s annual corporate sustainability assessment, which evaluates companies’ sustainability performance based on economic, environmental and social criteria.

In March, asset manager Northern Trust announced the first emerging markets custom index based on MSCI ESG Research and Institutional Shareholder Services’ (ISS) governance screens. The design of the fund applies three screens to the MSCI Emerging Market (EM) Index universe, followed by a sequence of checks on governance and executive independence. The first screen eliminates constituent companies of the MSCI EM Index that have been found to be in breach of the UN Global Compact’s ten principles. The second screen removes manufacturers of controversial weapons ant he third tobacco manufacturers. Following these exclusions a filter is applied targeting companies lacking sufficient independence across ownership, board representation, key corporate committees and audit and remuneration committees.

In addition to these indices representing select companies from a variety of emerging markets, stock exchanges in a number of emerging markets had already launched ESG indices over the past decade. Prominent examples are the Johannesburg Stock Exchange Socially Responsible Investment Index and Sao Paulo’s BM&FBOVESPA’s Corporate Sustainability Index, launched in 2004 and 2005 respectively.

While these are encouraging signs, much work still needs to be done. Two reports published late last year, EIRIS’ “Evolving markets: what’s driving ESG in emerging economies?”, and the Forum for Sustainable and Responsible Investment “Lessons Learned: The Emerging Markets Disclosure Project, 2008 – 2012” found that poor corporate environmental and social governance disclosure remains the number one challenge to investing in emerging markets. The reports also highlighted that knowledge of sustainability reporting practices and international norms varied widely between markets.

As investors are integrating ESG risk factors into their investment decisions in emerging markets, it is clearly time for emerging market companies to take the sustainability challenge serious.