The current financial crisis has exposed a number of structural and functional weaknesses in the global financial system. Some consensus has been reached on the main contributing factors to the crisis, many of which have long been the focus of a subset of the investment community known as socially responsible investors. The Socially Responsible Investment (SRI) community has actively campaigned and engaged with public companies on issues such as executive compensation, transparency and predatory lending for more than two decades.
This report examines the root causes of the financial crisis from the environmental, social and governance (ESG) perspective employed by the SRI community. The report describes the progression of the crisis, places it in the Canadian context and analyzes the factors that are most relevant to socially responsible investors; namely governance and executive compensation, subprime and predatory lending, transparency and disclosure, securitization and systemic risk. It also comments on the role of regulatory gaps throughout the system.
The report also highlights similarities between the financial crisis and the issue of climate change, and describes how lessons learned from the financial crisis can be applied to the climate change crisis. Finally, it provides a synopsis and assessment of the actions of the SRI community leading up to and during the crisis and makes recommendations for long?term investors and policy?makers.
In our analysis of the SRI community, we found that it was ahead of the mainstream financial community on issues like corporate governance, executive compensation, predatory lending and transparency – all significant contributors to the crisis. However, with few exceptions, the SRI community did not foresee the crisis any better than did the mainstream financial community.
Nonetheless, the crisis does reinforce the critical importance of two tenets of SRI, specifically, the value of long?term investing and the necessity to identify and measure hidden risks. In fact, the SRI community can take credit for laying the groundwork for the recent broader acceptance of concepts such as shareholder oversight of executive compensation and enhanced reporting.
While socially responsible investors clearly care about ESG issues from a values perspective, they also typically link ESG performance with long?term financial performance. However, in many instances this link needs to be better established and the financial consequences of ESG issues better defined.
The financial crisis has drawn attention to issues of concern to the SRI community and, despite its negative consequences, represents an opportunity to further the objectives of the community. With respect to climate change, another key focus of the SRI community, in addition to the devastating environmental and social problems that will result if the process continues unabated, we identify some potential problems on the political and financial fronts that could serve to exacerbate this already grave situation.
First, governments are displaying an admirable single?mindedness in addressing the financial crisis, but there are concerns that this is diverting attention and resources from addressing the unprecedented risks posed by climate change. Second, the developing market for carbon has the potential to resemble the subprime lending market if regulators and investors do not proceed with care and caution. Finally, while investment in renewable and cleaner forms of energy production and distribution are critical elements of any genuine effort to mitigate the effects of climate change, the growing level of support for and popularity of alternative energy technologies could be providing fuel for the next speculative bubble.
Contents
Executive Summary
Introduction
Background
- The Canadian Context
Contributing Factors: An ESG Perspective
- Governance and Executive Compensation
Subprime and Predatory Lending
Transparency and Disclosure
Securitization and Systemic Risk
Climate Change: lessons from the financial crisis
Assessment of Actions and Responses
Recommendations
- For long?term investors
For policy?makers
References
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