ESG: the next evolution of investment

Following is a speech by Green Building Council of Australia chief executive Romilly Madew on environmental, social and corporate governance, which was presented to the August IPD breakfast series in Sydney on Thursday. Other panel guest included Rowan Griffin, head of sustainability – investment management at Lend Lease; Paolo Bevilacqua, national sustainability manager at Australand; Mark Rogers, infrastructure investment at Colonial First State GAM; and Michael Salvatico, vice president ESG at MSCI.

Thank you for the opportunity to be here today to share with you my thoughts on ESG and sustainability.

E-S-G.

Three letters that have become a “catch all” term for the criteria used to identify socially responsible investing.

While environmental, social and corporate governance has risen up the boardroom agenda in recent years, it’s not actually a new concept.

Throughout history, investors have made decisions about where they’d place their cash.

Financial return has usually been the most prominent, although political and ethical considerations have often come into play. Think the 18th and 19th century abolitionists who refused to invest in businesses that profited from slavery or the selective disinvestment in South African companies during the apartheid regime.

In 1962, free-market philosopher Milton Friedman argued that corporate social responsibility was “fundamentally subversive” as it is the pursuit of individual interest in an unrestrained market.

His belief that a company or asset’s value should be determined solely by the bottom line found favour.

Enter the era in which Gordon Gecko’s “greed is good” mantra echoed down the corridors of power.

Business decided that it operated in a separate sphere – in a place where bosses told people to “just do it”.

But the high-tech world has made our lives “hyper-connected and hyper-transparent”, as Thomas Friedman of The World is Flat fame says. We can easily peer into each other’s businesses and lives and share what we see with the world.

In this hyper-connected and hyper-transparent world, how does business maintain a separate sphere?

What happens when a business decision down your supply chain – one which results in children being paid 10 cents an hour, or women burned to death in a factory blaze for instance – lands you on the front page of the newspapers?

Companies don’t operate in a vacuum, and increasingly we’re seeing community values disrupt not only an individual company but entire industries – the suspension of live cattle exports to Indonesia after community outrage at a Four Corners program is a case in point.

As Ray Anderson, founder of Interface, once declared: “In the future, people like me will go to jail.”

At the same time, in the era of instant information, shareholders, who once waited by the letterbox to get the latest update on their investments, now know – in a matter of seconds via Twitter – about the mine explosion in Turkey, the political corruption scandal in Sydney or the oil spill in the Gulf of Mexico.

These non-financial issues can rapidly turn into financial risks for a company and for an investor.

In this brave new world, investors are increasingly expecting accurate, timely and comparable data so that they can understand where their money is going.

This isn’t just about “warm and fuzzy” socially responsible investment – it’s about understanding and managing risks.

As new Grocon CEO Carolyn Viney said at a recent GBCA breakfast (and reported in The Fifth Estate), “If something is cheap, who’s paying for the cheap? Is it cheap labour or is it the environment?”

RICS has found that non-sustainable buildings are becoming increasingly risky. At the same time, investors are beginning to see that sustainability delivers dividends.

AMP Capital’s analysis of its proprietary ESG Index is a great example. Since 2007, the AMP Capital ESG Index has outperformed the ASX200 on a rolling three year average by typically 0.5 per cent. AMP says the reason for this is that “sustainability is shaping the markets in which companies operate”.

On an individual level, people want their personal values to align with their professional values – and to contribute to organisations that are ‘doing well by doing good”.

This goes for everyone – from employees to customers.

According to a survey commissioned by the Global Reporting Initiative (GRI), around 40 per cent of jobseekers now read a company’s sustainability report.

Bain and Co’s 2013 survey of employees in industries across the developed world found two-thirds of respondents care more about sustainability now than they did three years ago – and the same percentage of respondents said that sustainable business was extremely important to them.

Consumers are also rewarding sustainability with their wallets. Last year’s global Regeneration Consumer Study, for instance, found that two-thirds of those surveyed felt “a sense of responsibility to purchase products that are good for the environment and society.”

The Globe-scan Aspirational Index finds that more than one-third of consumers globally – 2.5 billion people – identify as “aspirational”.

This means they love shopping, but are committed to responsible consumption.

Consumers are increasingly demanding products and services that Trendwatching has dubbed “eco-superior”.

This is not just about being green – it’s about being superior.

Think superior functionality, superior design and superior savings.

It should come as no surprise, then, that the world’s largest companies have all invested in corporate social responsibility programs.

A study last year by Boston College’s Center for Corporate Citizenship found that 97 per cent of surveyed companies allocated a discreet operating budget for corporate citizenship, compared with 81 per cent just three years earlier.

The Dow Jones Sustainability Index has become a hotly-contested annual prize. While the Global Real Estate Sustainability Benchmark, which now reports on 49,000 assets in 46 countries worth AUD$1.73 trillion dollars in value, finds that more than half of those companies surveyed include certified green buildings in their portfolios.

Harvard has identified sustainability as a “megatrend” along the lines of the industrial and IT revolutions – arguing that it will dramatically refashion the way we do business.

The bottom line is this, in our current challenging economic climate, which many pundits are claiming is the “new normal”, people are expecting more, not less, accountability.

And one of the best ways to demonstrate accountability is through transparency.

Increased transparency – being demanded by governments, consumers, employees and shareholders – will drive more companies to seek Green Star ratings as they seek to demonstrate their commitment to green, not greenwash.

Green Star has now been around for over a decade, and has certified more than seven million square metres of green building space.

Green Star certification is increasingly seen as not only a measure of a building’s sustainability, but as a measure of quality assurance.

As ISPT chief executive Daryl Browning said: “Those investing in or occupying properties need benchmarks they can rely on. Green Star certification is one of the quality assurance measures everyone can rely on with confidence.”

The success of ISPT’s 4 Star Green Star-rated 100 St Georges Terrace in Perth is instructive – because it’s not the most spectacularly high-tech Green Star building, nor the largest, nor the most iconic.

Achieving its certified rating in 2008, 100 St Georges Terrace was only the third building to achieve Green Star certification in Western Australia.

This speculative development was fully leased by practical completion and is now home to high-profile corporate tenants including NAB and Microsoft, as well as resources companies Apache Energy and INPEX. Each of the building’s corporate tenants entered into green leases.

ISPT says that the primary focus – particularly for the resources companies – was to promote environmentally and socially responsible brands. So, occupying a Green Star-certified building was a good start.

Colliers International’s Latest Office Tenant Survey found that a massive 95 per cent of tenants wanted to occupy a green building, up from 75 per cent in 2010.

Colliers’ managing director of office leasing, Simon Hunt, has said that “Green is now the norm – where it used to be a bonus in a building, it is now expected.”

When all the big banks – including NAB, Commonwealth, ANZ and Westpac – and law firms including Clayton, Corrs and Freehills are embracing sustainability, you know it’s because it’s a smart business move.

Likewise, when $300 million of Green Star apartments at Barangaroo sell out in a matter of hours, you know sustainability is a smart investment.

These examples underscore why AMP Capital has said that investment in sustainable property is now “so much more than an optional extra”.

Being green, AMP Capital argues, “is a vital element to delivering superior investment performance well into the future”.

Investa Office 2012/13 Sustainability Report states “our sustainability strategy provides a framework for focusing on and enhancing good business practices in a responsible manner”. Investa has $4.6 billion in funds under management. The funds performed to global standards in 2012, ranking in the top five property funds in the world by GRESB.

How successful has Investa been?

Investa’s office portfolio has an average 4.32 NABERS Energy rating, with the portfolio consistently performing better with lower vacancy rates compared to the PCA average office market vacancy rate.

The industry’s agenda has expanded from its early emphasis on environmental sustainability to encompass economic sustainability.

If you look at the industry’s earliest communication about our achievements, it was all about how many kilowatts of photovoltaics were integrated into a building’s roof, or how many litres of water were saved by the water tanks in the basement.

This then evolved to how many thousands of dollars were being saved in energy consumption.

Today, we are increasingly talking the language of social sustainability – about how our buildings benefit people.

And our next great challenge will be to put a value on the social capital to be gained from green building.

The World Green Building Council is currently working on two projects that exemplify this shift.

A new socio-economic category for rating tools will guide the design and delivery of buildings that empower local communities, create jobs and upskill disadvantaged groups for example.

And a study into the health and wellbeing benefits of green buildings will provide best practice guidance on the type of green building features that enhance productivity and performance.

We know that up to 70 per cent of a building’s whole-of-life value comes from improved productivity and health benefits – so we need to find ways to monetise this so the case for green building is irrefutable.

The world is interconnected, and we have a shared fate and a shared responsibility – to our communities, to our society and to our environment.

The next step on the journey is ESG reporting.

For most companies in our industry, this is a new way of thinking – but one which we must all embrace not because it’s the moral thing to do, not because it will help build brand equity, attract Generation Y employees or provide competitive differentiation.

Not even because it will secure shareholders.

ESG reporting will be embraced because it’s the next evolution of investment.

Romilly Madew is the chief executive of the Green Building Council of Australia