Nobel Peace Prize winner Kofi Annan died one year ago leaving a legacy of impressive achievements in areas such as HIV control, world peace, human rights and social justice. For the corporate world, arguably his greatest legacy was paving the way for adoption of corporate social responsibility around the globe.
The launch of the Global Compact campaign in 1999 will be remembered as one of Annan’s greatest achievements in kickstarting a transformation of the investment community and their attitudes to investing responsibly. Some years later in 2005, as Secretary General of the United Nations, Annan invited a group of the world’s largest institutional investors to co-create the Principles of Responsible Investment (PRI) – a set of six guiding principles that would become a globally accepted framework for investors to consider ESG issues using a menu of possible actions.
At the time of the launch there were just 63 institutional investors who agreed to sign a commitment to incorporate ESG issues into their investment decision making. Our own investor, Australian Ethical, was one of only six superannuation funds that signed in 2006. Fast forward 14 years and there are now 2450 signatories who are actively considering ESG when making investment decisions about the collective $US82 trillion under management.
And Australian superannuation funds are amongst the trailblazers. At the recent UN PRI Conference in France, six Australian funds were amongst 47 asset owners who were elevated to the PRI Leaders Group for their superior work in selecting, appointing and monitoring investment managers. Australia was third, trailing only the UK and France who had nine and seven companies respectively. The Australian funds included Local Government Super, First State Super, Cbus Super Fund, VicSuper and Vision Super.
This raises the question: how do these institutional investors ensure that the fund managers they work with and their underlying assets meet their expectations around ESG issues?
With an increasing amount of investment directed to venture capital (VC), satisfying the expectations of institutional investors has been well thought out and anticipated. ESG screening is not a one-off box ticking exercise for VCs and the start-ups they fund. It is a process of ongoing monitoring, evaluation and engagement with the rapidly changing, high growth companies that VCs invest in.
To do this thoroughly, some VCs have an ESG policy. This will detail the negative screens such as tobacco and firearms, an ESG screen to identify and manage ESG risks such as the supply chain and social licenses to operate, and finally, a screen to recognise and give greater weight to positive contributions. These positive screens will reflect an alignment with sustainable development goals (SDGs), another UN brainchild that clarifies 17 goals considered an urgent call to action to address the world’s greatest challenges.
To get just a foot in the door with some VCs, a start-up will be screened for negative ethical factors and blackmarks against the founder, such as ASIC breaches. As due diligence continues, the VC will interrogate factors such as the supply chain, governance and alignment with SDGs. If a founder passes the stringent process of investment committee approval, the screws will tighten as the VCs work with the founder to proactively manage ESG risks, improve team and governance processes, reduce risk in the supply chain and monitor the social license to operate.
VCs operating in the broad area of technology will generally align their investment themes with appropriate SDGs. For example, this might positively screen start-ups in the Internet of Things area who are meeting the goal of “building resilient infrastructure, promoting inclusive and sustainable industrialisation and fostering innovation” – one of the 17 urgent calls to action.
Monitoring and working with founders to maintain high ESG standards is a constant exercise for VC firms. The role of the VC is to ask founders the question, ‘can you achieve the same outcome with a more responsible allocation of capital?’ As these companies grow, a VC investor will help guide the founder to achieve this. This guidance will take a number of forms:
- Board prominence – routine inclusion of ESG as an agenda item in board meetings ensures these issues remain in the foreground as decisions are made around factors such as changing supply chains.
- Accountability – individual accountability within the start-up to give ownership of ESG is essential.
- Auditing – internal and external auditing to uncover any blind spots that may not have been given due consideration
- Reporting – establishing reporting and metrics to formalise ESG measurement as start-ups rapidly evolve.
For start-ups, keeping their VC investors and the VC’s own limited partners happy is not the only reason for allocating capital responsibly. Often a founder will be on board with ESG from the outset as they know their ability to secure contracts with corporate giants depends on their ESG report card – which they will again need to demonstrate their worthiness to get through the door.
VC’s are in a privileged position to shape new businesses by helping them incorporate ESG from inception. It is easier and cheaper to apply ESG filters from their conception rather than reengineer their business model to meet the demands of investors and customers. For founders this is often simply a process of education – and as Kofi Annan himself said, “education is the premise of progress.
