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Using Better Governance To Help Sustain Economic Recovery

Calling on global stock exchanges to improve information flow to investors.

Paul Abberley The crisis that engulfed financial markets and the real economy is showing signs of easing. Official figures suggest that the U.S., Germany and France have all come out of recession in the last few months. We have arrived at a promontory from which to survey the events leading up to the crisis and see how the financial system can be made more robust and capable of sustaining growth and returns on a long-term basis.

One of the underlying causes of the financial crisis was that too many market participants focused on short term profits and incentives. They looked only as far as the next quarterly earnings instead of paying attention to the longer-term fault lines that were emerging.

A key reason for this was that much of the information available to investors – on executive pay, the environmental and social impact of a company, financial structuring and business practices – was inadequate and focused on short-term outlooks. It was challenging for investors to assess with any accuracy which companies were suitable candidates for their investment, and which ones would provide them with the best long-term returns. Eventually, this lack of information impacted the whole market.

More efforts are needed to encourage global stock exchanges and the companies listed on them to adopt sustainable, long-term business practices and to provide this information to investors.

Recently, there have been promising initiatives taken to improve information flow to investors and call on companies to enhance their transparency. For example, UN Global Compact membership has grown from an initial base of 47 companies a decade ago to 6,000 member companies in 135 countries today. A Global Compact membership demonstrates to investors that a company complies with best practices around human rights, the environment, labor relations and anti-corruption.

The aim of the UN conference on “Sustainable Stock Exchanges,”where I spoke in November, was to establish how the world’s exchanges could work together with investors, regulators and companies to increase corporate transparency and encourage responsible long-term investing.

The conference’s key recommendation was for stock exchanges to require companies, as part of the listings process, to assess the wider environmental, social and governance (ESG) risks and opportunities associated with their business practices, and to disclose this to investors.

At the conference, the Egyptian Stock Exchange offered a case in point. In the past, Egypt pulled 750 companies from its exchange because they failed to meet good-governance requirements. The 350 that were left were better-run companies, and it was argued, better equipped to survive both the 2006 Gulf market collapse and the recent global crisis. As evidence, we heard that the volatility of the Gulf market was reduced and the combined market capital had actually increased.

In its analysis of the relationship between how companies address ESG issues and the returns they generate, Goldman Sachs Global Investment Research contends that in a number of sectors there is a direct correlation between sustainable business practices and the longer-term financial success of that company.

So what can practically be achieved? It is imaginable that stock exchange regulators could make it a market requirement that companies adequately disclose relevant ESG information. However, at this time, it is more prudent and practical to support a comply-or-explain model. This framework will allow individual boards to consider which ESG information is relevant for the market and disclose it in a consistent and transparent fashion, or else clearly explain why they will not. In fact, all companies should compile a forward-looking sustainability strategy and put this – or the explanation - to shareholders to vote on at their next annual general meeting.

Stock exchanges and their listing authorities can also assist in promoting a recovery for the long-term by developing specific ESG indices that highlight companies’ meeting standards of sustainability, such as those recently set up in Turkey, South Africa and Indonesia. Not only do these indices feature firms with better long-term business practices, they provide a way of tracking the performance of this sector versus the wider market and measuring how sustainability works in practice.

At this time, a unique opportunity exists for not only improving the long term profitability of corporations (and the returns for their investors), but also the transparency of the markets that they are listed on and the lives of those impacted by them. Motivating companies to look at how sustainable their business models are and encouraging investors to take this information into account will promote longer-term investment decision making and help to ensure that the events of the last two years are not repeated.

Paul Abberley is CEO of Aviva Investors London. He is responsible for all Aviva Investors’ high alpha business and for developing and delivering Aviva Investors’ fixed income investment philosophy in the UK.

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