Thought Leaders of the Emerging Regenerative Economy

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Capital Institute spoke  with Steve Waygood, Head of Sustainability Research at Aviva Investors, to learn more about the advocacy work the company— with $433 billion in assets under management—has undertaken to advance the cause of more transparent reporting and management of sustainability risk.  We also talked with Waygood about how Aviva Investors has embedded sustainability practices into its own operations, his broad concerns about the flawed methodologies that are currently used to value corporate assets and profitability, and the role both policymakers and the private sector need to play in addressing those flaws.

Advocating for Integrated Value Reporting

Last fall, in a speech before the European Commission’s Expert Group on Disclosure of Non-Financial Information by Companies,Waygood went far beyond calling for better voluntary ESG reporting requirements, instead making the case for integrated sustainability reporting to be required from all publicly listed or large companies on a comply or explain basis. He further called for the quality of that integrated reporting, or the explanation for its absence, to be put to a vote at annual general meetings.  “Integrated reporting involves considering the various forms of capital that the firm has at its disposal—financial, manufactured, human, intellectual, social and environmental—and integrating measures for the sustainability of their use into the report and accounts, wherever it makes sense to do so,” says Waygood. “This would include, for example, in strategy, in audit, in risk and—crucially—in remuneration.”

Voluntary ESG reporting has simply not worked, Waygood asserts, as evidenced by what Bloomberg analysts turned up as they combed through corporate reports to develop the firm’s electronic ESG database service. Bloomberg discovered that only about 24% of the 19,641 companies researched reported any ESG data at all and what data did exist were almost without exception of uniformly poor quality.

As part of its sustainability advocacy efforts Aviva Investors also commissioned a large-scale study by the Forum for the Future, Sustainable Economy in 2040, that looks at how the investment markets must be reshaped to take into account the social and natural capital constraints the global economy now ignores at its growing peril.  The study is developing a vision for what a sustainable economy would look like by 2040, focusing on the food, finance, mobility, health care and energy sectors.  “It looks at the various natural and social capital constraints on those businesses and how they need to transition,” Waygood explains.  “It is an open source document and we hope others will take it and build on it.”

Aviva Investors has also been leading the conversation on the role fiduciaries and trustees must play in advancing a sustainable economy.   In 2005 the Asset Management Working Group of the UNEP Finance Initiative published the seminal Freshfields Report, which concluded that trustees were not only permitted but also arguably legally required to embed ESG issues into investment decision-making.  Aviva Investors catalyzed a follow-up report published in 2009, “Fiduciary Responsibility,” that took the position that advisors to trustees also have a legal requirement to highlight ESG risks in their analytical work.  It further concluded if they fail to do so and their portfolios underperform they could be held legally liable.   “The report has been downloaded hundreds of thousands of times,” says Waygood. “I believe it has helped investment consultants make a case to support and create ESG teams that do meaningful work.”

Internal Practice

Aviva Investors has also stepped up to the plate by being a founding signatory to the UN PRI in 2006, committing itself to integrate material ESG issues into all its buy, sell and hold decisions. In 2010 Aviva plc was the first in the UK to put its own responsibility reporting to a separate shareholder vote. “The report received a vote in favor of over 99%,” Waygood reports, “but the main benefit was in hearing the supportive and constructive views of shareholders.”

Aviva Investors also actively exercises its shareholder voting rights to bring pressure to bear on companies to encourage higher standards of ESG risk management and disclosure. This has been its policy since 2001, when it was the first institutional investor in the world to formally embed the quality of a company’s sustainability performance and disclosure into its AGM voting. In 2010, for example, displeased with the mining company Vedanta Resources’ environmental and human rights track record at its mining operations in Orissa, India, Aviva Investors withheld its support for a number of resolutions advanced by management at the annual shareholder meeting.  It followed up by commissioning a report from the sustainability research group EIRIS, enumerating its concerns in detail, and laying out specific remedial actions it wanted the company to take.

Again, a year later, after commissioning a second follow-up study, Aviva Investors concluded that Vedanta had failed to make sufficient progress in addressing those concerns and again voted against 3 key resolutions at Vedanta’s annual shareholder meeting.

Whether it is good idea or not for an investor to routinely disclose its concerns publicly outside its client group is an ongoing subject for debate, according to Waygood.   Aviva Investors does not habitually disclose the rationale behind its voting record, although it does disclose its vote for each company in which it is invested.  Waygood reports that Aviva Investors took its case with Vedanta to the public only after exhausting other means of influencing the company’s behavior.

“While progress has been slower than I hoped, Vedanta has appointed senior people with a remit to deal with these issues,” Waygood explains, “and I have confidence that they will turn the business around.”

The Coming Resource Crunch

“As an asset manager working in the insurance industry we are particularly concerned that the future stability of the financial services system could be unsettled again not by a credit crunch but due to a natural resources crunch and a rapid reduction of the ability to access the natural resources currently assumed available for free in any discounted cash flow model,” says Waygood.

Waygood maintains that the valuation models and methodologies being used by policy makers to decide on how best to structure the market fail to address this growing resource scarcity risk.  From an investment perspective, he notes, discounting future cashflows is sensible as there is a time value of money and the future itself is uncertain.  However, this discounting of the future means thatvaluation models generally fail to factor in the very long-term impacts of climate change and resource scarcity.

This poses risks to long-term investors like Aviva Investors, Waygood reports.  For example, he notes, “it strikes me as a profoundly important observation that the market continues to value all current known fossil fuel reserves as though they are going to be brought to market, even though if that were to be we would get well north of the 350 parts per million of carbon in the atmosphere that represents the upper limit for runaway impacts.  At best, that says the market does not believe the policymakers have produced anything meaningful enough to make it likely that those assets will have to stay in the ground.  Analysts think that even if policymakers do get serious about putting a price on carbon they won’t over the next three years, which is about how far out the broker market goes before its forecast fades to mean growth rates,” says Waygood

“Discounting the future and assuming a company will be in existence in perpetuity are two assumptions that can be seriously challenged from a public policy perspective,” he notes. “We have seen them negated in the forestry and fishery industries.”

Compounding the lurking risks associated with carbon, Waygood points out, is that we have already gone over Hubbert’s peak for conventional oil, referencing the phenomena that global oil production has reached its peak and is declining as resources are depleted more rapidly than they are discovered. “That will be increasingly clear over time,” he reports. “But the oil in the ground will become more and more valuable over time due to supply and demand. There is likely to be a push to get it out and increase earnings in a race to realize the value that exists in the ground before policy stops it.”  The market is an engine that can create positive value but in motivating action that destroys the environment it can also turn into destructiveness for the economy and humanity, Waygood maintains.

The capital markets currently allocate capital to corporate activity in a way that undermines sustainable development, says Waygood. However, this need not be the case, he maintains, and, in fact, capital markets should be the primary facilitator of a global green and just economy. “However,” he explains, “before capital markets can be genuinely sustainable, we need capital market policy makers to have greater regard for future generations when setting policy. For the health of the economy, society and the environment, policy makers should integrate sustainable development issues into capital market policymaking. We need policy makers to internalise what are now corporate externalities onto company accounts via, for example, increased use of fiscal measures, standards and market mechanisms.”  We also need to ensure that the culture within the City and on Wall Street is not one where the many conflicts of interest are exploited, he reports. “This will require greater government intervention, particularly around the regulation of investor delivery of responsible ownership,” says Waygood. “In this way, capital markets will become the primary facilitator of a global green and just economy.”—Susan Arterian Chang is Director of Capital Institute’s Field Guide to Investing in a Regenerative Economy project.