ESG

In this report, Aegon and Roche receive their comeuppance as responsible public companies.

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In this edition of our weekly video, 2N2, Rob Kellogg discusses two companies: Banco Santander, a Spanish banking company and BAE Systems, a U.K. based aerospace and defense company.

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Editor’s note: This article is the final installment in a four-part series on the rise of sovereign wealth funds and what they mean for U.S. investors.

The New Investor Class

A global trend in the investment world is underway. And this is one that Karl Marx might even approve of.

Some call it “socially responsible investing.” Others use terms like “sustainable development,” “social entrepreneurship” or the “triple bottom line.” Whatever you want to call it, there is growing recognition among a new class of progressive capitalists around the world that investment capital can and should be used to bring about social change. The motto of the growing movement is “doing good while doing well” and it is not just being adopted by bleeding-heart-social-do-gooders. More and more, professional money managers and pension funds in Europe, Asia and the U.S. are recognizing the link between investment return, profitability and corporate social performance.

Defining what is meant by the term “sustainable” or “responsible” investment is more art than science. Indeed, attempts to reconcile individual conceptions of what it means to invest money in a socially conscious manner is no easy task. Despite the variation in opinion out there as to what it means to invest responsibly (or less socially destructive as the cynic might put it), a common framework has emerged that encompasses four core analytical dimensions. The first dimension, of course, involves the traditional lens of looking at financial or economic performance. The second dimension involves evaluating governance factors which address the rights of shareholders in the context of corporate law. The third and fourth dimensions – social and environmental – are much newer in the lexicon of investment professionals and therefore are far less evolved within mainstream investment circles.

Sovereign wealth funds, like many other institutional investors, are just beginning to establish their investment philosophy as it relates to socially responsible investment criteria. The vast majority of the SWFs currently do not actively integrate SRI factors into their investment management processes (one notable exception is Norway’s Government Pension Fund). Nonetheless, despite the resistance thus far of SWFs to devote serious attention to the second, third and fourth dimensions of the investment equation outlined above (commonly referred by the acronym “ESG”), there is a rising expectation that these institutions can be used to support pan-regional public policy agendas to combat poverty, generate jobs and deliver health care to under-served communities in Asia, Africa, Latin America and the Middle East. The Gulf funds, for example, could play a powerful force in healing long standing religious-based conflicts throughout the Gulf region and beyond by investing in long-term projects focused on education and capacity building. Efforts in this direction would most certainly bolster the reputation and credibility of these institutions among skeptical policy makers in the West.

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Mainstream investors for the first time are beginning to assess labor and human rights factors as a way of increasing returns and lowering risk, according to a study released today by Harvard Law School’s Labor and Worklife Program (LWP). “Incorporating Human and Labor Rights Risk into Investment Decisions” says a growing number of institutional investors and global lenders are widening conventional investment decision-making to incorporate assessments of the long-term sustainability risks posed by corporate labor and human rights practices. Pioneers in the field include leading European and U.S. pension funds as well as financial firms such as Goldman Sachs and Mercer.

The editor of our companion blog, Governance Notes, has recently conducted an interview with Aaron Bernstein, the principal author of this study. You can listen to the interview here.

In addition, you can read or download a copy of the report here.

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In a press release issued by Marriott International this past week, the company announced its has again been included as a company member of the FTSE4Good Index, an index that measures the performance of companies that meet globally recognized corporate responsibility standards. The press release states that Marriott’s commitment to social responsibility and community engagement is focused on five signature issues: Shelter and food, environment, readiness for hotel careers, vitality of children, and embracing diversity and people with disabilities.

This is all nice but does this really define whether a company is socially responsible?

Should a company be recognized for its social responsibility by doing things external to its core business? Can a company such as Marriott do charitable things while opposing worker organizing efforts, doing business in troubled parts of the world and committing unethical acts in the course of its normal business activities and get the moniker of “socially responsible”?

I think you, the reader, know where I’m going with this. I would answer these questions with a resounding NO!

What is a Socially Responsible Company?

This raises another related question about how companies claim that they are socially responsible, adopting codes of conduct and the like while acting entirely differently.

These are questions that get to the fundamental issue of corporate social responsibility. It’s not just about what you say you do but how you actually act as a corporate citizen around the world that counts as far as I’m concerned. In my opinion, a company should be evaluated not only for its policies – however it chooses to label those – but also how it acts day to day in its normal business activities.

In drawing an informed opinion about a company, several broad areas of inquiry emerge. Does a company conduct itself reasonably with respect to:

• the workers it employs around the world
• its investors as manifested in its corporate governance practices
• the local communities in which it operates
• how it conducts itself ethically in its domicile country and in other countries around the world
• the environment

I propose that these actual behaviors determine the worth of a company and its responsibility to all of its stakeholders. As I am fond of saying, you can put lipstick on a pig but at the end of the day, it’s still a pig. This is true also of companies adopting environmental, social and governance (ESG) policies when corresponding practices aren’t actually adhered to on a consistent basis.

The Social Responsibility Conundrum

This raises a number of questions of course. Fundamentally, how do we differentiate between companies that are bad actors and those that have passing problems with their ESG practices? I don’t think there is any clear-cut answer to this question. At least not yet. The problem is exacerbated by the fact that, in the investment world, clear cut answers to these sorts of questions are the norm and fuzzy answers to this question don’t fit well into their analysis. This forces analysts to look at assessment factors that can be quantified such as codes of conduct. Unfortunately, this doesn’t get us the best results or the right answers.

The challenge then is to develop a quantitative approach for what is basically a qualitative problem. This evaluation problem, which in my view is very subjective, must ultimately be forced into an objective matrix that can then be duplicated on a consistent basis.

Now that I have thrown down the gauntlet on this topic, I would like to hear from you, the reader, about how you would tackle this problem of assessment.

Any takers?

For my part, I will post several follow up articles in which I will try to tackle these questions. I look forward to hearing from you.

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Société Générale focuses on three activities: global investment management; retail banking and specialized financial services, including finance, leasing, and insurance; and corporate and investment banking, focusing on European capital markets, derivatives and structured finance. In the US, the company controls asset manager The TCW Group. Société Générale has nearly 2,900 branches in France and more than 1,700 locations worldwide. The Company, which has retail banking operations in more than 25 countries, is looking to boost its international franchise, both through organic growth and through acquisition. Key markets include Central and Eastern Europe, the Mediterranean, and Asia.

Recent Events

On January 24, 2008 the bank uncovered a fraud by one of its traders in what may be the world’s largest trading fraud to date. According to the AFP, Jerome Kerviel, a 31-year-old trader has been charged with breach of trust, fabricating documents and illegally accessing computers. Although he was initially allowed out on bail, a Paris appeals court upheld a plea from the state prosecutor that Kerviel be held in custody “to avoid any consultation with possible accomplices or conspirators.”  The French government has blamed Société Générale’s risk control mechanisms for failing to detect Kerviel’s activities. Prosecutors have said Kerviel sought huge profits to get a better bonus and to improve his own reputation in the hard-driving culture. Société Générale began raising funds to help cover the estimated $7.1 billion cost of the fraud. Additionally, chairman and co-CEO Daniel Bouton and co-CEO Philippe Citerne each gave up nearly six months’ salary to take responsibility for the company’s losses. The event has sparked talk that Société Générale will be taken over by another banking institution.

In February 2008 Agence France Presse reported that the embattled bank is facing other woes for alleged involvement in a vast money laundering scam between France and Israel. The trial is expected to last until July.   

According to the Financial TImes, Frédéric Oudéa, Société Générale’s chief executive, said France’s second-biggest bank would become stronger than before the rogue trading scandal that cost it €4.9bn ($7.6bn) of losses.

Presenting second-quarter results that were better than expected, Mr Oudéa said the results showed “the impact of the Kerviel case is largely behind us”.

SocGen was fined €4m last month by the Banking Commission after the French regulator identified “serious shortcomings” in internal controls that had paved the way for Mr Kerviel to accumulate €50bn of allegedly unauthorised bets on futures markets under the noses of his managers.

“We will be stronger after Kerviel,” said Mr Oudéa, adding that the bank’s franchise had not been affected.

French private customers opened 23,100 current accounts in the three months to the end of June, but this was almost half the 45,400 opened in the same quarter last year.

Global Risk Factors

The company operates in China, Kazakhstan, Vietnam and The United Arab Emirates. These countries are either lacking labor legislation that recognizes fundamental worker rights or they have labor legislation, but it is not enforced.

Labor Relations

Société Générale workers in France are represented by Syndicat national des banques (SNB), Confédération Française des Travailleurs Chrétiens (CFTC) and Confédération générale du travail-Force ouvrière (CGT-FO). No labor issues have been noted.

Risk Assessment

Due to what recent events that may represent the world’s largest trading fraud to date, its status as a responsible comnpany is of concern. On a positive note, the company has robust unionization and its recent adoption of the Equator Principles bolsters its corporate responsibility practices. How the events related to the trading fraud play out at the company will ultimately determine whether the company remains a responsible company from a social responsibility perspective.

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Toyota Motor Corporation is a leading auto maker. However, as a corporate citizen, the company poor and, in our opinion, poses serious human rights risk to investors.

It is Japan’s #1 carmaker. The company makes a hybrid-powered (gas and electric) sedan — the Prius — that is popular in US and European markets. Its gas-powered cars, pickups, minivans, and SUVs include such models as Camry, Corolla, 4Runner, Land Cruiser, Sienna, the luxury Lexus line, the Scion brand, and a full-sized pickup truck, the V-8 Tundra. Toyota also makes forklifts and manufactured housing, and offers consumer financial services. Toyota has already passed Chrysler and Ford and is closing in on General Motors. [click to continue...]

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