ICGN YEARBOOK 201310

Achim Steiner and David Pitt-Watson, United Nations Environment Programme

Corporate governance is about the proper use of entrusted power; how our global companies demonstrate legitimacy and accountability. It is therefore at the heart of some of the biggest issues that the world faces, including environmental degradation. Achim Steiner and David Pitt-Watson explain why well-governed companies that think clearly and practically about risk and return will profit from focusing on the environmental challenge.

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GLOBAL REFORMS

The challenge

The United Nations projects that the

world’s population will reach 9.6 billion

by 2050 – increasing by 1 billion over

the next 12 years alone. Those people

will rightly demand food, clothing,

housing and the other benefits that

those living in developed economies

enjoy. The social, economic and

environmental impacts of this increase

will be profound. By 2030, freshwater

demand is projected to exceed supply

by 40 per cent and global food prices

to rise by 70-90 per cent. These trends

are mutually reinforcing and greatly

exacerbated by climate change.

There are no silver bullets that we know

of for ensuring food, water and energy

security, as well as a green and inclusive

economy for the future of humanity.

The environment and the political and

economic forces that govern us form

complex systems, but our success in

resolving these issues will be impacted

as much by issues of corporate

governance as by issues of global

political governance.

Indeed, the United Nations

Environmental Programme Finance

Initiative (UNEP FI) believes that it is only

through the symbiosis of private and

public initiatives that solutions can be

found. In part, the issue is about raising

adequate funds to create a sustainable

environment. The scale of that challenge

is large but, if confronted in time, not

overwhelming. The financial sector has

the capacity to close the funding gap for

sustainable development and support

the transition to a green economy.

The EU’s climate and energy goals,

for instance, are estimated to require

investments of around 1.5 per cent of

GDP per year. The banking sector and

capital markets will have a crucial role

in providing a large share of the funds

for this and other sustainable

development projects.

The prize

Equally important, if not more, is the

finance industry’s role in governance.

Institutional investors such as pension

funds, insurers, sovereign wealth funds,

mutual funds and endowments held well

over US$85 trillion in assets across the

world in 2011. Global companies are,

for the most part, accountable to these

investors. Those companies, in turn,

have a huge impact on the environment.

If they ignore that responsibility it could,

quite literally, cost us the Earth.

This is not just a righteous call to

action, where companies ignore profit

in pursuit of a better society – far from

it. Those companies and those finance

institutions which respond to the

environmental challenge will surely be

the long-term winners.

Think of it this way. Human activities are

almost certainly affecting the climate.

The effects are difficult to predict,

potentially catastrophic, and could

wipe out the value of assets. Any board

serious about managing risk would

surely want to know explicitly how far

its organisation is exposed to such

events. Similarly, any asset manager

would wish to know the exposure of

their portfolio. Adaptation now is likely

to be much cheaper than paying for a

crisis response in the future. There is

also the very real issue of reputational

risk. As consumers and investors grow

more environmentally aware, they are

asking companies what they are doing

to safeguard the environment. Those

companies who cannot answer this

question face being left behind.

There is good news for those who can

address the challenges of sustainability.

Most studies suggest those boards

which do look carefully at environmental

practice discover a cornucopia of

opportunities for adaptation that

give private returns in excess of the

cost of capital. A recent UNEP study

suggests 25 per cent of the carbon

emissions used to build, heat, and

light buildings would be eliminated if

companies invested in projects which

would return above their cost of capital.

It is often lack of attention, not lack

of return which prevents adoption of

more environmentally friendly practices.

This is a huge financial opportunity

for companies and, since 40 per cent

of global carbon is generated from

buildings, this opportunity alone would

be material in promoting sustainability.

The role of institutional investors

and collaborative initiatives

How can institutional investors

mitigate the threat and benefit from

the opportunity? One way is for asset

owners and asset managers to use

their influence to direct capital and

send positive markets signals to those

companies that exhibit best practice.

This is being achieved mostly through

the integration of ‘financially material’

environmental, social and governance

(ESG) factors into the investment

process.

There has been considerable progress,

in large measure thanks to the work

of the UN-supported Principles for

Responsible Investment. Approximately

21.8 per cent of funds managed

professionally incorporate ESG into

investment selection and management.

But much, much more needs to be

done, both in the breadth and quality of

integration. It is time for those leaders in

this field to ask that the bar be raised.

Investors can also stimulate dialogue

and voting practices that are guided

by sustainability principles, driving

change by leveraging their influence

“The financial sector has the capacity to close the the capacity to close the funding gap for sustainable funding gap for sustainable development and support the transition to a green the transition to a green economy.”

ICGN YEARBOOK 201312

> on the corporate boards of investee

companies. For example, the North

American Ceres network has filed over

230 sustainability resolutions over the

past three years with a high level of

fulfilment and tangible environmental

effects.

Another way is through asset owners,

asset managers and companies

ensuring that relevant ESG risks and

opportunities are measured and

disclosed effectively. This will require

engagement and dialogue along the

investment value chain. Carbon risk,

for example, may have a huge impact

on company profitability and equity

valuations.

In July this year, UNEP FI ran an Investor

Briefing on ‘portfolio carbon’, which

argued that carbon footprinting is

one of several key tools that investors

should use to understand, assess and

mitigate portfolio carbon risk. Just

asking asset managers and companies

to report is a big step forward, because,

as the old adage goes, “you get what

you measure”. This is all the more

true for the investee company. The

disclosure of relevant ESG information

in corporate reports and transparency

over sustainability strategies, risks and

opportunities is crucial for companies

to manage environmental risks and for

investors to be able to assess these

factors.

We advocate that investors not only

encourage companies directly, but

that they also give vocal support to

the role of stock exchanges and their

consideration of ESG data. UNEP FI is

an active supporter and a secretariat

member of the Sustainable Stock

Exchanges Initiative (SSE), which

addresses the role of the exchanges

in stimulating listed companies to

consider and report on sustainability

performance.

Governance for sustainability

Part of UNEP FI’s vision is to push

the debate about governance for

sustainability, not least because it is one

of those rare situations where there is a

win-win solution. We have already noted

that good governance promotes greater

awareness of environmental issues. This

in turn leads to higher profitability as well

as contributing to a sustainable future

for us all. UNEP FI has contributed

seminal research in this area and

studies from some of the world’s leading

management consultancies support this

view. We see potential for significant

value in integrating sustainability into

corporate governance: a process that is

indispensable to the long-term transition

to a sustainable world economy.

There is one more argument which

should not be forgotten. As institutional

investors, most ICGN members

represent the savings of millions of

people. These citizen investors will

benefit little if, when they get their

savings back, we live in a world

characterised by environmental

degradation. The fiduciary duty of

investors representing such savers

clearly extends to considering the

environmental impact of the activities

that they support, particularly when it is

profitable to do so. This issue needs to

be on the governance agenda if we are

to demonstrate that entrusted power

and influence are properly used.

The transition to a sustainable world

economy is only possible if financial

institutions use their resources and

their influence to ensure we finance

change. The involvement of the entire

financial industry (investors, banks

and insurers) is needed to realise this

long-term vision. Good global corporate

governance therefore sits at the heart of

what we need to do.

UNEP FI’s role is to act as a global

convener, a catalyst, which can assist

the process of changing finance and

financing change. We hope that you will

join us in that mission.

ABOUT THE AUTHORS

Achim Steiner is

United Nations Under-

Secretary General and

Executive Director of the

United Nations

Environment Programme.

David Pitt-Watson, is

Co-Chair of the UNEP

Finance Initiative. For

more about UNEP FI,

visit www.unepfi.org.

Achim Steiner and David Pitt-Watson, United Nations Environment Programme