Development Channel

This post features a conversation with Audrey Choi, chief executive officer of Morgan Stanley’s Institute for Sustainable Investing and managing director of its Global Sustainable Finance Group. Choi talks about the evolving $20 trillion sector, including important U.S. policy changes and her thoughts on where sustainable investing is headed. 1) What does sustainable investing mean, and how has it evolved in recent years? There has been an evolution in sustainable investing over the past five to ten years in both definition and practice. Investors have moved away from predominately avoiding—or divesting from—industries and companies considered harmful toward taking a more proactive approach as well. They are pursuing positive social and environmental impact while also expecting competitive financial returns. Traditionally, there was a tendency to divide investing and philanthropy, using the first to build wealth and the other to make a positive social difference. Sustainable investing, which includes values-based, environmental, social, and governance (ESG) integration, thematic investing, and impact investing approaches, allows investors to align their values or mission with their investment portfolio. Another shift has been the increase in research addressing the misconception that doing good requires a financial trade-off. Harvard University and Brookings compared a portfolio of companies that performed poorly on sustainability with a portfolio of companies that performed very well on the same issues. One dollar in the low performance portfolio grew to $14.46 between 1993 and 2014. The same dollar in the high performance portfolio rose to $28.36 over the same period. And at Morgan Stanley’s Institute for Sustainable Investing, we examined ten thousand mutual funds across seven years of performance, comparing sustainable to traditional investing strategies. We found that 64 percent of the time, sustainable strategies performed either the same, or slightly better, than traditional ones. Meanwhile, volatility for those strategies was the same, or slightly less, 64 percent of the time. Finally, the University of Oxford conducted a meta-analysis of over two hundred studies and found that incorporating ESG business practices resulted in better operational performance, lower cost of capital, and better stock price performance. We’re also seeing a shift in how sustainability factors into stock and company valuations. More and more investors and analysts are asking how to incorporate ESG into existing models of valuation. Whether a multinational company disposes of waste responsibly, monitors its water usage, and recycles increasingly matters. Sustainability efforts are more than corporate reports—they are considerations that can be materially relevant to core business practices and results. 2) How is “sustainability” measured, and what counts as sustainable investing? We take the broad view that sustainable investing encompasses both financial sustainability and environmental and social sustainability. As part of the sustainable investing evolution, there has been a great deal of work in the field to better understand the type of sustainability considerations that can have both real business and investment impact. The United Nations Principles for Responsible Investment (UNPRI) and the Sustainable Accounting Standards Board (SASB) are two important examples of increasingly-recognized bodies developing standards and frameworks for measuring and reporting on sustainability. UNPRI has not only established what responsible investment should entail, but as a membership organization, it is a platform for signatories (asset managers, owners, and service providers) to express their commitment to a more sustainable global financial system. And SASB has created standards for ESG considerations across eighty industries, helping public corporations disclose material issues to investors.  As part of its standard-setting work, SASB found that climate change alone affects seventy-two of seventy-nine industries—each in specific and different ways. That’s 93 percent of the capital markets, or $33.8 trillion dollars. 3) How does sustainable investing compare to philanthropy or development aid, through NGOs and others? Are there some areas that should be left to private donors rather than investors? Ultimately, driving large-scale positive social and environmental change requires government, philanthropy, and investment dollars to work in common cause. Tax dollars and philanthropy alone are not sufficient to fix the world’s problems. Private investment can play a crucial role in filling that gap. Still, sustainable investing should not be seen as a replacement to philanthropy. Indeed, there are critical situations when philanthropy and government aid should be the first resort, such as when an immediate response is required, as in humanitarian efforts and disaster relief. Aid is critical in these instances where financial returns, cannot, or should not, be expected. But governments and philanthropies also play critical roles as catalytic investors. They provide the visionary risk capital to enable discovery and innovation, setting the stage for future markets. For example, microfinance began as a donor-led space, eventually growing to a robust field where private sector investment has enabled scale and reach. 4) What are the U.S. rules and regulations that have helped, or hindered, sustainable investing? In the U.S. context, one of the most important recent changes was the revision to U.S. Department of Labor guidance around ESG investing for Employee Retirement Income Security Act (ERISA) plans, announced late last year by Secretary Thomas Perez. Employee retirement plans, such as pension funds or 401(k)s, are bound by the ERISA, which sets a fiduciary duty, or legal obligation, for managers to act in the interest of plan participants. In October 2015, Secretary Perez and the Department of Labor issued a clarification that “environmental, social, and governance factors may have a direct relationship to the economic and financial value of an investment.”  Rather than an external and separate consideration, ESG factors could now be considered relevant in evaluating an investment’s economic qualities. This clarification went a long way in addressing the perception that ESG consideration might be at odds with fulfilling fiduciary duty. Globally, another important development was the Paris Climate Conference (COP21) agreement that set binding targets to limit global emissions. It sent a clear signal of change that may open new conversations on ESG and sustainable investing, as well as the inclusion of climate change-related risk as a material financial consideration. 5) Looking ahead, what is the outlook for sustainable investing, in the short and long term? Within ten to fifteen years, we believe sustainable investing should be perceived as a redundant term. Sustainability considerations will be a part of a best-in-class investing thesis, rather than being a separate analysis. Just as political and cyber risk has become a core part of the risk and return analysis, so too do we believe that sustainability factors will become a core part of risk and return analysis. There has already been impressive growth in the field. In 2012, the U.S. Sustainable Investing Forum reported one out of every nine dollars invested in the United States had some type of sustainable mandate to it. From 2012 to 2014, that figure grew by 76 percent to one out of every six dollars. Though the starting point was small, we are seeing rapid growth, with more than $20 trillion dollars now invested in the sector globally. Another driver of change in sustainable investing is the influence of millennials. Compared to other generations, millennials are three times as likely to pick an employer based on their ESG performance. They are also twice as likely to check product packaging for sustainable sourcing information before they choose a product. And this philosophy carries over to their investing decisions. Millennials are twice as likely to check a mutual fund or equity investment and choose it because of sustainability, and twice as likely to divest—or walk away—because of objectionable corporate activity. As this generation is set to inherit more than $30 trillion in the United States over the next thirty to forty years, it will be significant how they integrate their sustainability priorities into their investment decisions going forward.  

Panama Papers Expose Weak Regulations The “Panama Papers” are an unprecedented leak of 11.5 million files revealing a complex global network of hidden wealth. For four decades, Panamanian law firm Mossack Fonseca helped to set up over 200,000 shell companies—a favored tool for laundering money, stashing ill-gotten resources, and evading taxes—for tens of thousands of clients in over fifty countries, with current and former heads of state among the 143 politicians and cronies named. So far the revelations have forced Iceland’s prime minister and the president of Transparency International’s Chile branch to resign, and upped support for a Brexit given British Prime Minister David Cameron’s involvement. The Panama Papers further expose weaknesses in global financial regulation. More than half of the leaked shell companies are based in UK  territories—100,000 in the British Virgin Islands alone—where Cameron has tried to end such anonymity by legally mandating a public registry of companies’ owners. European banks HSBC, Credit Suisse, and UBS are among the ten institutions that worked most frequently with the Panamanian firm to create offshore accounts for clients. Since the leak, countries including the United States and Germany have proposed new legislation to increase transparency around offshore companies. Curbing Tax Evasion: OECD and the United States Diverge The hundreds of thousands of accounts revealed in the Panama Papers provide a glimpse into the vast efforts made to avoid taxes globally, and call into question the efficacy of current rules and regulations. The best seem to be standards set by the Organisation for Economic Co-operation and Development (OECD), in which 132 countries allow participants to check on their citizens’ assets abroad. Next year this process will become more automated, as ninety-six of these countries will routinely share the financial data they collect on non-residents with foreign tax authorities, making it harder to avoid taxes. The United States has not signed on, preferring instead to share information bilaterally under the Foreign Account Tax Compliance Act (FATCA), its own anti-tax evasion program. Under FATCA the United States can refuse to share information on foreign nationals, enhancing its own status as a tax safe haven. United States Cuts Aid to Tanzania Over Election In a show of U.S. support for democracy, the Millennium Challenge Corporation (MCC) suspended $470 million in aid to Tanzania. The move came after the government nullified election results in semi-autonomous Zanzibar and cracked down on free speech using a draconian cybercrime law. MCC says these actions violate its strict eligibility criteria, requiring that countries score highly on political rights, civil liberties, control of corruption, and other indicators in order to qualify for aid dollars. While the decision will not affect $600 million in additional healthcare, education, and assistance the United States provides as Tanzania’s largest bilateral donor, it sends a clear message that MCC’s good governance standards are non-negotiable.  

This is a guest blog post by Dr. Richard Messick, an anticorruption specialist. It is based on a CFR roundtable discussion on March 24 hosted by Matthew M. Taylor, adjunct senior fellow for Latin America Studies. One of the most promising developments in U.S. foreign relations is the all-out war on corruption being waged across Latin America. From “Operation Car Wash” in Brazil to investigations of presidential wrongdoing in Bolivia, El Salvador, Honduras, Guatemala, and Panama, across the region independent, tenacious prosecutors and investigators are out to end the massive theft of state resources that for so long has hobbled political development and throttled economic growth. The United States should be cheering for these corruption warriors, for we have much to gain if they succeed. Less corruption translates into more stable, reliable political allies; it means faster, more equitable growth and that means shared prosperity and less northward migration. Finally, less corruption in government will offer U.S. firms new opportunities. Think what the end of corruption in Brazilian public works would mean for U.S. engineering and construction companies. But given the stakes in Latin America’s corruption war, the United States should be doing more than cheering from the sidelines. It should be doing everything it can—without infringing the sovereignty or sensibilities of Latin American neighbors—to see its corruption warriors succeed. Here are five things to start with: Fund the U.S. Department of Justice’s Office of International Affairs (OIA) budget request. If a Latin American investigator learns an official he or she is investigating has a bank account in the United States, the investigator can ask the OIA to obtain the account’s records to see if corrupt money is being parked there. But the office had at latest count more than 11,000 requests pending and was receiving 3,000 plus new ones each year. Unless the investigator gets lucky and the request finds its way to the top of the pile, he or she will be long retired, and the suspect long dead, before the OIA responds. For years the U.S. Department of Justice (DOJ) has asked Congress, without success, for funds to hire more staff to speed requests. This year it requested $10 million to add 97 positions, 54 attorneys, and 43 paralegals and support staff. Isn’t it time Congress said yes to this modest request? Name a single focal point to help Latin American law enforcement agencies. When looking to the United States for assistance, Latin Americans face a bewildering number of agencies, bureaus, and offices: the Federal Bureau of Investigation (FBI), the Drug Enforcement Agency (DEA), U.S. Immigration and Customs Enforcement (ICE), the U.S. Secret Service, the Financial Crimes Enforcement Network (FinCEN), the 92 U.S. Attorney’s offices, and these are just at the federal level. There are hundreds, if not thousands, at the state and local level. It takes experienced U.S. law enforcement officers years to figure out where to go for information. Why not make it easy for Latin Americans who don’t have years to decipher the complex and bewildering U.S. system? Create one office, staffed with personnel fluent in Spanish and Portuguese from across the federal and state governments who can serve as a “one-stop shop” for Latin American police, prosecutors, and judges needing information from their U.S. counterparts. Create an interagency task force to work with Latin American counterparts to target corrupt Latin American officials. Whenever a corrupt Latin American official uses the proceeds of a bribe to buy an apartment in Miami or open a bank account in Houston or Los Angeles, he or she has violated U.S. antimoney laundering laws. Depending upon whether they traveled in the United States, used U.S. mail services, or U.S. email servers, they may have also committed wire fraud or violated the laws forbidding travel across state lines in furtherance of fraud or corruption. A task force of U.S. personnel drawn from ICE’s Foreign Corruption Investigations Group, DOJ’s Foreign Corrupt Practices Act (FCPA) unit, the U.S. Attorney’s offices in Miami, the FBI’s international corruption squads, DOJ’s kleptocracy unit, and other relevant agencies should be available to work with Latin American counterparts on possible violations of U.S. law committed by corrupt Latin American officials. Greater intelligence sharing and joint investigations in association with Latin American anticorruption agencies and prosecutors would enhance both regional and domestic efforts against corruption and ill-gotten gains. Enact the Incorporation Transparency and Law Enforcement Assistance Act. Introduced by Congresswoman Carolyn Maloney and colleagues in the House of Representatives and Senator Sheldon Whitehouse and colleagues in the Senate, this would end the ability of corrupt officials, as well as drug traffickers and other unsavory individuals, to keep investigators from learning how much money they have and where it came from. Under current law, a corrupt Latin American official can open a bank account in the United States in the name of a Delaware limited liability company. He or she can own the company anonymously, that is, without anyone, in Delaware or elsewhere, knowing his or her identity. If Global Witness’s exposé of U.S. lawyers counseling an investigator posing as the agent of a corrupt minister weren’t enough to persuade lawmakers of the need for the legislation, the April 3 revelations of massive abuses in the use of anonymous shell companies by the International Center for Investigative Journalism (ICIJ) should lay to rest any lingering doubts about how critical this legislation is to the fight against not only corruption but terrorism and organized crime as well. End secrecy in the U.S. real estate market. Thanks to gaps in U.S. antimoney laundering regulations, corrupt officials in Latin America (and elsewhere) can use the proceeds of corruption to secretly buy property in the United States. Requiring real estate agents, title insurance companies, and others involved in the purchase and sale of condominiums, houses, and other U.S. real estate to comply with the antimoney laundering rules will expose attempts by corrupt officials to create a “safe haven” for when they leave office. The U.S. Department of the Treasury took a small, first step in this direction in January when it issued an emergency order (in response to a New York Times’ exposé) requiring title insurance companies in Manhattan and Miami-Dade Country to apply antimoney laundering rules to all real estate purchases over $1 million in cash for the next six months. The rule should be made permanent and extended to all regions. Since 2002 the Treasury Department has given real estate brokers a “temporary” exemption from the antimoney laundering rules while it studies their situation. The time for study is over. The Treasury Department should follow the European Union’s lead and require brokers to comply with the antimoney laundering rules. The burden of ridding Latin America of the corruption that infests so many of its governments remains first and foremost the responsibility of its governments. But the United States has much to gain if they succeed, and there is much it can do to help them. The steps above are a modest beginning; it should move on them expeditiously. This piece also appeared on the Global Anticorruption Blog.