Steve Waygood holds what at first glance seems like a contradictory view. Markets, he says, are failing to address environmental, social and governance (ESG) issues. But—and it’s a big but—he emphatically stresses that things look more likely to come good than they have ever done before.
And so begins a conversation about how markets have got it wrong, are still getting in wrong, in fact, but how things are beginning to go right.
According to Waygood, chief responsible investment officer at Aviva, the investment industry’s focus on ESG is “massively increased”. He says campaigners used to “dream” of the day when ESG issues would become mainstream in investment decision-making and some elements, he says, are now there.
“The day job can be a bit of nightmare,” he says. “It’s so overwhelming to have so much interest from fund managers and analysts, as well as the institutional types.”
And Waygood should know. He heads Aviva’s campaign to reform the investment industry so that ESG issues stop becoming a niche interest and simply become the norm. He was part of the expert group that wrote the United Nation’s Principles for Responsible Investment; serves as an ambassador for the International Integrated Reporting Council; and has been chairman of the UK Sustainable Investment and Finance Association.
He authored Aviva’s whitepaper, A Roadmap for Sustainable Capital Markets, and toured the document and its message through the annual conferences of all the major UK political parties, at the OECD in Paris, to policymakers in Brussels, and has even spoken before the UN General Assembly.
The latest chapter in the ESG campaign sees Aviva’s chief executive Mark Wilson take a lead role in launching a new benchmark, ranking companies on their human rights performance. If anyone has a view worth listening to about ESG and investors, it is Steve Waygood.
In what has become a necessary rite of passage for anyone with a decent idea worth sharing, Waygood has given a TED Talk. In Glasgow 2015, he told an audience of business people that markets were failing in three significant ways: they fail to integrate the personal ethics of investors; they fail to encourage long-term investment by the companies in which they invest; and they fail to recognise that we only have finite resources on Earth—what Waygood calls the “one-planet boundary”.
When Waygood tells Board Agenda that conditions now are better than they have ever been for ESG, it is against the background of that talk where he, a senior investment figure, critiqued the short-sightedness of his own industry, and the markets in general.
However, he is feeling very different about the potential of the message he’s been trying to sell. People are asking about ESG issues which are now being debated at the “top tables” of the G20, the United Nations and at the European Commission.
“So, I am more optimistic than ever,” says Waygood. “But the challenges have never been greater.”
And here’s his technical point—one for company directors to note. “It’s one thing to integrate environmental, social and governance issues into your investment process, and quite another for that to lead to a sustainable outcome for society, the planet and the individual.”
He adds: “In the presence of market failure, where doing wrong pays the company, even over the long term … you continue to have allocations of capital that don’t properly reflect sustainability issues.” And we continue to have companies that are not rewarded with lower capital costs, even though they may be sustainable.
“That matters,” says Waygood, “because you really need the market doing well; it should reward companies that integrate those long-term issues properly into their strategy and their execution of that strategy. They should be rewarded with a lower cost of capital, which would help them grow more quickly.”
Investment chain relationships
So, work still to do. And for Waygood this has much of its cause in the relationships of the investment chain. Asset owners aren’t asked about their ethics when they are given advice. Advisers are under no obligation to ask if individuals want their money in tobacco or munitions, for example.
“The failures of finance continue, and it really fails the individual,” he says, “because it doesn’t ask them if they have any personal ethics they wish to be considered in the advisory process.”
But investment advisers are not entirely to blame. A degree of education is required too, according to Waygood, who laments the dearth of knowledge among the general population about how the finance system works—a situation he describes as “weird”. This is an issue for national curriculums to resolve, according to Waygood.
“Frankly, it’s extremely odd that the citizens of the world aren’t encouraged to understand how the world is shaped by their own money. They are disenfranchised, as a consequence, of helping to ensure that the companies they own are held to account. They simply don’t know that the potential even exists.”
There are those who argue that the investment chain is over-complicated and in need of simplification. Waygood observes that the system hasn’t been designed step by step, but has evolved to serve clear needs.
He places more stress on the problem of fees along the chain, whether they are transparent, and how they incentivise various players. He says transparency is in the process of being addressed.
“It’s particularly important now,” he says, and adds that the “end investor” needs to be educated. The incentives question, however, prompts Waygood to talk about the way the investment chain is riddled with short-term incentives, not least stock exchanges that have gone from being market supervisors to for-profit companies listed on their own exchanges.
“We’ve taken what was a regulator and turned it into a machine for short-termism,” he says. He points out that short-term incentives require their own detailed debate, just as executive pay is currently being debated in many major markets.
“We need the same level of sophistication when it comes to how investment banks are rewarded, how fund managers are rewarded and how long-term issues of corporate governance and corporate responsibility are embedded in their incentive structures.”
He asks, rhetorically: “To what extent, for example are fund managers rewarded for being good owners? Or, should it be a question of being routine and standard and we should be sanctioned if we are not?”
The stewardship problem
As you might expect, stewardship is a major issue for Waygood. He describes an industry that devotes huge energy to measuring the performance of fund managers and whether they achieve enhanced returns, but spends little time on “the job of ownership”, because of the “lack of good standards and effective oversight of fund managers, bluntly, by investment consultants”.
Some do, and Waygood reserves praise for Mercer in this regard. He also worries that even the Kay Review said fund managers should be putting their shoulders to stewardship, but failed to look at the demand from end investors.
“Until you have sophisticated demand for this, for supply of good stewardship, it will take significant time for the level of good stewardship and ownership to actually be supplied,” he says. “I think we’re some way from that right now.”
There are efforts to aid investors keeping tabs on the ESG performance of companies. March saw the launch of the first ever ranking of companies based on their human rights performance. The Corporate Human Rights Benchmark comes after two years of consultation with more than 400 companies, and responds directly to the UN’s Sustainable Development Goals (SDGs) and the argument for more benchmarking.
Aviva has supported the goals and is a lead organisation behind the development of the human rights rankings. Waygood says the benchmarking—applied to apparel, agricultural and extractive industries—will give the first reliable view of how companies perform against the UN guiding principles on business and human rights.
The results reveal that even those that score well against the benchmark do so perhaps only modestly. Waygood says that means “current best practice and what ideal practice should look like remain too far apart, and the worst practice is far too common.”
Perhaps more important, however, is the argument behind the benchmarking, whether it is humans rights or the SDGs in general. Benchmarking is a way to generate “a race to the top” among companies which, seeing themselves ranked, feel a competitive need to improve their position. Reporting standards have been useful, but they address only the individual company, while a benchmark can address an entire sector.
Waygood says: “…what matters is comparative competitive performance.” He adds: “Once there are credible independent transparent and understood measures of performance, you turn the transparency that exists…into a focused competitive environment that generates direction…”
And for all the reporting systems that exist, and all the talk of changing values and ethics, it’s the harsh spotlight of public rankings that may just bring about the next step in corporate ESG performance.
“Over the last two decades, there’s been a quiet revolution in the number of companies disclosing their performance,” explains Waygood. “What we now need is a similar revolution in the analysis of that performance and the comparison, sector by sector. I think we are at the cusp of that.”
How capital can do more
“Public policy makers have traditionally tended to focus on the flow of aid when considering traditional sustainable development issues. However, we believe that considering how the tens of trillions of private capital are allocated matters far more than how the tens of billions of dollars of official assistance get dispensed.
“We see the primary failure of the capital markets in relation to sustainable development as one of misallocation of capital. This, in turn, is a result of global governments’ failure to properly internalise environmental and social costs into companies’ profit and loss statements. As a consequence, the capital markets do not incorporate companies’ full social and environmental costs. Indeed, until these market failures are corrected through government intervention of some kind, it would be irrational for investors to incorporate such costs since they do not affect financial figures and appear on the balance sheet or – therefore – affect companies’ profitability.
“This means that corporate cost of capital does not reflect the sustainability of the firm. The consequences of this are that unsustainable companies have a lower cost of capital than they should and so are more likely to be financed than sustainable companies.”
Source: Excerpt from Aviva’s white paper, “A Roadmap for Sustainable Capital Markets”
Aviva endorses three main routes for finance to support the pursuit of UN Sustainable Development Goals:
1. Free league tables benchmarking corporate performance on the SDGs
This would move us one step closer to our above vision, where individuals would be aware of what corporate activity they are funding, and how these companies are performing on sustainability issues.
2. Standards for sustainable investment
This moves us a second step towards our vision, as the standard can assure individuals that their influence over the companies they own has been used positively.
3. Sustainable finance literacy in national curricula around the world
A third large incremental step, which would help individuals understand how to hold their fund managers to account and ensure they are aware of how sustainably and responsibly the fund manager is managing their money.
Source: “Money Talks: How Finance Can Further the Sustainable Development Goals”, Aviva Investment
This article is supported by Mazars Business. For Good—interviews on thinking and acting long term to enhance business performance.