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ESG in question as investors fail the Russia test: experts

Institutional funds haven't done enough to ensure they are not supporting hostile and repressive regimes with their investors' capital, according to ESG industry leaders.
ESG in question as investors fail the Russia test: experts

In the midst of the ongoing invasion of Ukraine by Russia, questions are being asked of the investment and business community. Have they enabled Russia by not holding it to the standards of governance and human rights they purport to uphold by their ESG statements?

Panellists at this week's conference held by the Responsible Investment Association of Australia (RIAA) were unequivocal. Asset owners and their fund managers need to do more to address the moral issues involved in investing in hostile countries.

“The question for asset owners is, did you sufficiently understand the risk Russia was posing?” said Alexis Cheang, sustainable business leader at Mercer.

ESG pioneer and CEO of the Blended Capital Group, Paul Clements-Hunt, was in no doubt that they did not. And he suggested that ESG itself should be called into question, in failing to halt the flow of investment to the Russian regime.

“Sure, investors have made money, but look where we’ve landed 30 years since the Soviet Union collapsed," said Clements-Hunt.

“I’m not defending ESG. I am shining a light on the failure of investment with respect to never truly calling Russia out. This is not with the benefit of hindsight. The full evidence of the corruption has been there; the criminality, the dilution of the rule of law and the hollowing out of institutions — combined with extra-judicial killings.

"At every stage, at every level — as Russia retreated under Putin into a full nationalist autocracy — all the evidence was before us, but investors chose to ignore it, as the money-making opportunities were too great.”

Recent studies have suggested that super funds now have just 0.1% of their assets in Russia, noted Cheang. "Some might think that’s still too much. However, diversification would say that’s pretty reasonable and some return was generated for a unit of risk of that magnitude."

Where investors could have done better, she said, is in understanding the systemic risk they were exposed to. 

"If we want ESG risk analysis to succeed, we need to be asking these questions about risk and what they mean for long term returns on a more consistent basis. Yes, many asset owners are doing it when it comes to climate change, because the TCFD recommendations require it, but how many are actually testing their portfolios for exposure to acute governance risk? Which country will we be talking about in the future?"

Ross Piper, CEO of the US$8 billion Christian Super fund, agreed that "Brand ESG is at risk here," and said that ESG at its heart is really about understanding how risk impacts portfolios in order to minimise that for the benefit of members.

"But it’s interesting when you begin to consider risk and what is morally or ethically right," he said.

"In our fund, we have members who have made an active choice, in terms of how their capital is managed or stewarded. Because of their expectations, we have more licence to consider very meaningfully sovereign risk and a whole range of other factors over and above investment risk.

"But once you overlay the marketing question of ESG — and the idea of sprinkling ESG fairy dust across the whole range of products — you end up with further confusion and arguably a credibility issue, in terms of where investors' capital is being placed."

CLEAR GOVERNANCE

All the more reason, agreed the panellists, why asset owners should have really robust governance frameworks to navigate these increasingly complex systemic risks.

Cheang asked fund trustees to consider what their investment beliefs are; where they will and won’t invest, and how that is reflected in their risk appetite statement.

"Are you thinking about the risk you are willing to accept to generate those returns, and have you set clear parameters around exclusion or divestment, and equally around impact and thematic investments? Because the flipside of action to divest from Russia is action to support refugees or to be part of a humanitarian response to the refugee crisis," she said.

"Many of the asset owners I come across, their investment beliefs are silent on these things. They don’t have any framework for saying should we divest or not. I challenge asset owners to reevaluate your investment beliefs and ask if you have the decision making systems in place to address those questions, so they are available to you to make wise decisions during a crisis."

From the asset owner's perspective, it starts from the fund's underlying philosophy about long term value creation, according to Piper.

"China’s another fascinating question as well, in terms of sovereign risk. Everyone will have a different moral position about whether there are certain countries they should be in. If you don’t have clarity around these investment beliefs, you’ll find yourself in a reactive place, with the risk of stranded assets."

DIVESTMENT AND SANCTIONS

Australia’s Future Fund is winding down a $200 million exposure to Russia and superannuation funds, with clear guidance from the federal government, have also removed Russian assets from their respective portfolios. Clements-Hunt also mentioned New Zealand Super as having "played it in a very interesting and robust way in terms of how they responded to the Ukraine situation."

NZ Super has excluded Russian Federation sovereign debt and the securities of majority Russian state-owned enterprises from its funds, and will sell their directly held assets as market conditions permit.

"These actions have been taken in accordance with their respective responsible investment and ethical policies," said the fund's official statement.

"The policies provide for sovereign bond exclusions when there is widespread condemnation or sanctions by the international community, and New Zealand has imposed meaningful diplomatic, economic or military sanctions aimed at that government."

The question then is, should investors be going beyond the legal requirements of the sanctions regime? The Australian government, with the apparent backing of the prudential regulator, APRA, has encouraged such action.

"It’s a complex question, when the government encourages this and then APRA comes in and says that trustees will not be held to account for actions they take to divest. The net effect is frankly a degree of confusion," said Piper.

"As regulated entities, trustees are accountable to make decisions in the best interests of their members. I think it comes down to a fund by fund decision. Then the key question is, what governance do you have internally, to be able to determine how far you go in moving beyond the framework of legal sanctions?"

Encouragingly, Cheang said this latest global situation highlights how corporate and investor attitudes have changed for the better.

"What has changed is that we’ve seen businesses make moral decisions, to stand with Ukraine. I don’t think we have seen that in previous crises. They see it as part of their social licence to operate."

¬ Haymarket Media Limited. All rights reserved.
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