THE LIFEWORTH REVIEW OF 2008

Hungry bubbles

May 12, 2009 by  
Filed under Third Quarter

Dr Jem Bendell
Adjunct Associate Professor, Griffith Business School, Australia
Niaz Alam
Board Member, London Pensions Fund Authority/Senior Associate, Lifeworth
Barbara Wettstein
Research Officer, UNI Finance Global Union
Olivier de Schutter: speculation in commodity markets has contributed to hunger

Olivier de Schutter: speculation in commodity markets has contributed to hunger

Money, money, money. by mid-2008 money was certainly making the world go round, first in a spin, then a downward spiral. The financial system really unravelled in the third quarter of the year. Yet, before the credit crunch became a credit calamity, at the top of the world’s agenda was the huge inflation in the price of food, with some pointing an accusing finger at that soon-to-be-endangered species—the investment banker.

As the world saw a doubling in wheat prices and tripling in rice prices in a year, leading to food riots in over a dozen countries, Olivier De Schutter, the United Nations special rapporteur on the right to food, said that, although climate change played a part, ‘speculation in commodity markets, driven in part by investors seeking havens from slumping stocks has . . . contributed heavily to hunger by pushing food prices out of reach for tens of millions’.1 In the last few years, regulations and advice have been changed to enable large institutional investors to buy into commodities-tracking funds, thus allowing huge sums to pour into this sector and its derivatives, such as options and futures. ‘This has been a serious factor aggravating the crisis,’ Mr De Schutter said, with some retailers and global agribusiness firms benefiting disproportionately from the price hikes.

One implication of this situation for investor responsibility is that investors need to assess more carefully the societal and longer-term economic implications of any regulatory changes they seek. Investors have been incorporating the political affairs of the corporations they invest in as part of their environmental, social and governance (ESG) assessment, but what of the political involvement of the private financial institutions themselves? Might we expect their own political influence to be consistent with the longer-term interests of the people whose money they manage? It is an issue we return to below when considering the influence of financial institutions and their former staff on the regulators.

Although clearly a topic of increasing concern and research, the food crisis had not produced a concerted response by socially responsible investment (SRI) organisations. This disparity is reflected in the varied views collated in June 2008 in an Investment Week survey of UK ethical investment analysts by Sarah Griffiths.2 Gonzalo Baranda of JPMorgan Asset Management said the food crisis was in part driven by long-term trends of ‘an increasing world population and a change in consumption patterns in rapidly growing emerging markets with, for instance, an increase in the consumption of meat’, but that ‘growth in demand for heavily subsidised biofuels’ were an exacerbating factor.

Speaking to Jeffrey MacDonald of the Christian Science Monitor in August 2008,3 Lloyd Kurtz, principal at Nelson Capital Management, a private money-management firm in Palo Alto, California, said, ‘It’s hard to figure out who to blame for the food crisis. Social investment has been most influential when there was an actor that could be identified—e.g., the tobacco companies, the South African apartheid regime, etc. But the causes of the global food crisis are multifaceted . . . That’s probably why you haven’t seen a coherent response from the social-investment community.’

Joachim von Braun: capital for agricultural growth cannot come only from the public sector

Joachim von Braun: capital for agricultural growth cannot come only from the public sector

One response came in June 2008 when the Interfaith Center on Corporate Responsibility launched an initiative to tackle food-related issues and propose investing guidelines for its 275 institutional investor members with projects aiming to encourage sustainable agriculture worldwide. Joachim von Braun, director-general of the International Food Policy Research Institute, a food-security think-tank in Washington, DC, also looked at what investors might do to positively help the situation. He advised that ‘The mobilization of capital for agricultural growth, especially in the small-farm economy, definitely cannot come only from the public sector. So the private sector has a very important role to play in order to mitigate and overcome the current food crisis.’ He urged social investors to shun commodity futures trading and instead provide ‘what small-farm agriculture really needs, [which] is long-term investment’. Von Braun added that ‘Ethically motivated investors should stay away from grain and oilseed-based biofuels because these biofuels by now are the cause of about one-third of the overall increase in food prices.’ In select cases, he told the Christian Science Monitor, development of certain biofuels can be justified, but ‘the large-scale investment in Europe and North America has been extremely damaging to world food security’.

The price of many foodstuffs fell back somewhat in the third quarter, but the price inflation forewarned of likely future scenarios, as climate impacts increase, groundwater and soils are depleted, industrial agriculture becomes more expensive due to peaking oil production, and global finance herds from one asset class to another. Socially responsible investors need to consider these root causes. A key factor has been that investment seeks the greatest returns without pricing in externalities such as carbon, or the risk to future generations from a food supply dependent on oil. This gives rise to situations such as in the Philippines, which went from a net exporter to the largest importer of rice in a matter of decades, as investment poured into its business process outsourcing industry, and government and industry turned their backs on domestic agriculture. Supporting the resilience of communities and economies should be a key dimension to responsible investment, with encouragement given to the government facilitation of investment to build such resilience.

Another issue highlighted by food inflation is the bubbling nature of our financial system. Most countries use a debt-money system, where money is created by private banks in the form of loans. Consequently, as Chris Martenson explained on Corporate Watchdog Radio, there is not enough money in the world to pay back all the debt. It leads to a situation where the economy must continually grow at a continuing rate, because of compound interest. This, he argues, leads to inevitable economic bubbles.4 Any form of bubble can cause a problem for asset owners, who lose out far more when the bubble bursts, compared to the financial services professionals, who can make a personal fortune on commissions as the bubble inflates. A bubble affecting the price of goods that are needed by disadvantaged people (think rice rather than shares in ‘buy.com’) presents a double whammy, as many people are hurt as the bubble inflates. If a bubble becomes too large, due to an inability to create units of value out of thin air (think derivatives of mortgage-backed securities) bought by people with access to sufficient credit (think ‘sufficient’ to keep the process going until they get their bonus), then you have the mother of all bubbles, which leads to a financial crisis. As institutional investors such as pension funds invest in the whole economy, they are particularly vulnerable to boom-and-bust cycles, and yet we might expect them particularly able and willing to influence the economy, as part of their duty to their policy holders. Yet, as we will see, this has not happened, and people who have saved for their whole lives are as a consequence hurt by a lack of systemic fiduciary duty shown by those meant to safeguard their future.

» From bail-outs to better capitalism

(The references are available in the pdf download and hard copy versions of this annual review, available from Lifeworth’s bookstore.)

This section can be referenced as:

Bendell, J., and N. Alam, S. Lin, C. Ng, L. Rimando, C. Veuthey, B. Wettstein (2009) The Eastern Turn in Responsible Enterprise: A Yearly Review of Corporate Responsibility from Lifeworth, Lifeworth: Manila, Philippines. (Page numbers for this section are available in the pdf download and hardcopy.)

Islamic finance

May 11, 2009 by  
Filed under Fourth Quarter

In November 2008, the US Treasury Department announced that it would convene an ‘Islamic Finance 101’ Forum to teach Islamic Finance to US banking regulatory agencies, Congress and other parts of the executive branch in Washington, DC.1 Collaborating with the Harvard University’s Islamic Finance Project, the purpose of this Forum is ‘to help inform the policy community about Islamic financial services which are an increasingly important part of the global financial industry’.2

Islamic finance is a banking system that is characterised by five principles of Shari’ah or Islamic Law. These include: prohibition of interest (riba), prohibition of uncertainty and excessive speculation (gharar), prohibition of certain economic activities (including the consumption of alcohol and tobacco, gambling and pornography), share of profits or losses (musharakah), and use of asset-based financing (murabaha).3 Islamic finance is concentrated in the Middle East and South-East Asia (predominately Indonesia and Malaysia) but is spreading into North Africa and Europe. It is regulated by the Islamic Financial Services Board (IFSB), an international standard-setting body which ‘promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry’.4 In 2008 the spread of Islamic finance in Western economies was highlighted when Dublin-based maritime communications group Blue Ocean Wireless secured access to debt funding of $25 million (417 million) from Bank of London and The Middle East plc (BLME), a Shari’ah-compliant wholesale bank based in the City of London representing what ‘is thought to be the first time that an Irish company has availed of Islamic finance’5

French Finance Minister Christine Lagarde: wooing Islamic banks

French Finance Minister Christine Lagarde: wooing Islamic banks

Islamic finance accounts for approximately US$700 billion of assets and is growing at 10–30% annually, according to Moody’s Investors Service. Wall Street now offers an Islamic mutual fund and an Islamic index. The importance of the Islamic finance principles has been accepted by the UK Financial Services Authority,6 the World Bank and the International Monetary Fund. In December 2008, the Associated Press reported that France became the latest country to woo Islamic banks.7 Finance minister Ms Christine Lagarde, who believes that Western financial institutions could learn a thing or two from Islamic finance, promised to make necessary adjustments to the French regulatory framework so that Paris could become a major marketplace in Islamic finance.

The turmoil in global financial markets since mid-2008 has raised serious questions about prudential lending and borrowing practices, risk management and corporate governance.8 Added to these are two behavioural problems: greed and fear.9 The Secretary General of the Franco-Arab Chamber of Commerce, Dr Saleh Al Tayar, claimed that the 44.9 billion loss suffered by Société Générale SA as a result of Jerome Kerviel’s unauthorised trading could not have happened in an Islamic financial institution.10 And Mohammed Awan maintains that the global financial crisis ‘would not have occurred if Islamic principles were applied in international financial markets’.11 This is because, under Shari’ah principles, one cannot ‘sell debt against debt’. In turn, greed leads to sale of dubiously rated collateralised debts. A further reason advanced is that Islamic finance principles require deals to be based on tangible assets that require tight controls over debt levels.

In relation to sukuk (bond) issues, Shari’ah rules require bondholders to be undivided partners in the underlying asset(s) that are being financed. Accordingly, the effect on Islamic financial institutions has been muted as sukuk instruments are generally held to maturity.12 Thus, narrow yield spreads provide less occasion for speculation in secondary markets. Some proponents argue there is minimal probability of default with sukuks since issuers are able to meet payment obligations.13

Moody’s in its November 2008 report shows that Islamic financial institutions have been quite resilient in the current global financial crisis. As an interesting aside, no Islamic bank has acknowledged investing in Bernard Madoff’s US$50 billion fraudulent Ponzi scheme.14 The resilience of Islamic finance is summarised by Zarina Anwar15 as follows:

The development of Islamic finance in general is also important from the perspective of financial stability . . . The Shariah-based approach contains in-built checks and balances through risk- and profit-sharing structures. More critically, it demands a high level of disclosure and transparency in the financial system which is consistent with the principles of sound securities regulation as well as in compliance with Shariah requirements. This is not to say that Islamic asset markets have not been affected by the current turmoil. Indeed it has, and the value of Shariah compliant equities has declined in tandem with that of global equities. But it has been shown that Islamic finance in various segments of the market has been able to weather the storm relatively better than its conventional counterpart.

Nevertheless, the impact of an economic downturn and evaporating asset values was having an effect on Islamic financial institutions, and led to a number of events at the end of 2008 to discuss measures to mitigate those impacts. For example, on 25 October 2008, the Islamic Development Bank convened an urgent meeting to discuss the impact of the global financial crisis on the Islamic banking industry and agreed on policy initiatives to tackle the challenges and opportunities for the industry. In November 2008 in Kuala Lumpur, the IFSB and the Institute of International Finance (IIF) jointly organised a conference, entitled Enhancing the Resilience and Stability of the Islamic Financial System, to examine whether the Islamic financial system is strong enough to weather the crisis. The connectedness of global finance and the global economy means that, although principles may protect Islamic financial institutions from the extreme impacts of the financial crisis, they cannot be insulated entirely. This raises a question that has hitherto been avoided by the Islamic finance community: should they engage more assertively in international policy processes to promote their principles to non-Islamic governments and financial institutions, for mutual benefit? An affirmative would imply a reversal of a dominant assumption of recent centuries: that the ‘West’ has a version of economics that is suitable for the rest of the world, while non-Western approaches are seen as exotic, at best filling a niche, at worst being mere artefacts from pre-modern societies. That is an assumption that some non-Western communities have been complicit in maintaining, by assuming their own ways of organising are specific to their society, rather than relevant for all societies.

The rest of the world could benefit from the Islamic financial community assuming a greater role in international initiatives to achieve financial stability. That is not only because of the problems described above, but because Islamic finance recognises the deep problems associated with interest. As money enters economies as debt, being lent by banks, so interest is attached, thereby requiring organisations and people to pay back more than they originally borrow. This creates a growth imperative, as the economy must keep expanding in order that the interest is paid. That poses a problem for a world of finite resources. Interest also promotes a competitive approach to society, as people need to acquire more money than they began with, because of the interest payments. In his description of money systems, one of the originators of the euro, Bernard Lietaer, explains how interest-money therefore necessitates increasing economic inequality.16 Although many financial institutions would be wary of Islamic finance principles being seen as a blueprint for a new global financial system, as it would curtail many of their lucrative but risky activities, leaders of the ‘real economy’ could support such a view, as they would benefit from a more stable financial system. That is not to say that Islamic finance does not present areas for substantial refinement. First, the emphasis on debtors having tangible assets could restrict loans to the economically disadvantaged, such as those currently being helped through microfinance. In addition, the processes for discriminating against certain economic activities or systems of financing on the grounds of their being considered morally inappropriate would need to be refined. For instance, the sukuk market declined at one point in 2008 as a ‘Bahrain-based group of Islamic scholars decreed . . . that most bonds ran afoul of religious rules . . . Only one that complies with the edict has been issued, pushing up borrowing costs on projects including $200 billion of real-estate developments in the United Arab Emirates capital’.17 The growth of Islamic finance therefore raises challenging questions about the accountability of those who have greater power in interpreting religious texts and their contemporary spiritual implications. This highlights how an ‘Eastern turn’ in economic power is likely to present a range of novel questions for corporate responsibility.

» Sovereign wealth fund responsibility

(The references are available in the pdf download and hard copy versions of this annual review, available from Lifeworth’s bookstore.)

This section can be referenced as:

Bendell, J., and N. Alam, S. Lin, C. Ng, L. Rimando, C. Veuthey, B. Wettstein (2009) The Eastern Turn in Responsible Enterprise: A Yearly Review of Corporate Responsibility from Lifeworth, Lifeworth: Manila, Philippines. (Page numbers for this section are available in the pdf download and hardcopy.)

From bail-outs to better capitalism

May 11, 2009 by  
Filed under Third Quarter

People began to realise just how bad the situation with the financial industry was when governments began bailing out major banks and insurers. They started in the US, in March 2008, with investment bank Bear Stearns. Then, in the space of ten days in September 2008, the two mortgage giants Fannie Mae and Freddie Mac were taken over by the federal government as was one of the world’s biggest insurers, American International Group (AIG). During the same period the four remaining large independent banks disappeared. Lehman Brothers was allowed to fail, Bank of America acquired Merrill Lynch at a discounted price while Goldman Sachs and Morgan Stanley turned themselves into regulated banks.

The Federal Reserve System (Fed)’s lax monetary policy, leading to abundant liquidity in the system, and loosening lending practices combined to cause a crisis in sub-prime mortgages in the US. What transformed this into a global financial crisis was the complex and opaque securitisation process and the shadow banking system made of off-balance-sheet vehicles, special-purpose vehicles and the like. Yet, as the crisis developed, it became clear that the whole system of highly leveraged banking had become unstable and unsustainable.

In a first plan to rescue the financial system, the US Treasury Secretary Hank Paulson and the Chairman of the Board of Governors of the Fed, Ben Bernanke, had Congress pass a vast bail-out of US financial institutions whereby the Treasury Department can buy up to $700 billion in toxic mortgage-backed securities or recapitalise the banks.5 This dramatic turn of events raised many questions and was widely commented upon. Were these bail-outs necessary? Should taxpayers’ money be used to bail out private companies that failed because of their excessive risk taking? What should regulators and government demand in return? In other words, who should pay the price for yesterday’s recklessness?

Robert Borosage: it would be obscene to help the predators and not those that they preyed on

Robert Borosage: it would be obscene to help the predators and not those that they preyed on

That bankers were going to be bailed out, while homeowners still struggled, was galling to many. Robert Borosage, president of the Institute for America’s Future, said, ‘many homeowners were misled by predatory lenders to taking mortgages that they didn’t understand and couldn’t afford. It would be simply obscene to help the predators and not those that they preyed on.’6 Some also questioned the revolving door between bankers and regulators, and whether people such as Paulson, who became super-rich from working in one of the firms whose practices had helped create the crisis, should be deciding how to hand out billions to the same sector.7 They could point to investment firms scrambling for the oversight of all the assets that the Treasury planned to buy, so they could receive hundreds of millions of dollars in fees.8 News that the bankruptcy courts had released $2.5 billion to secure Lehman Brothers bonus payments, at a time when savers were still losing out, was just one example of a situation that seemed to many like a systemic abuse of power by a professional elite of regulators, judiciary and bankers.9

The bail-outs were defended by the fact that these financial institutions were ‘too big’ or ‘too interconnected’ to fail and that failure would have caused a systemic risk. If governments and regulators have let financial institutions become so big that they cannot be allowed to collapse, shouldn’t they be encouraging more competition and more diversity? This is at least the view of trade unions. UNI Finance Global Union, the global trade union for finance workers, has repeatedly called for a diverse finance market that includes not only private banks and insurance companies but also public banks, savings banks and insurances, cooperative banks, mutual insurance companies and foundations.10 However, this does not seem to be the view of governments and regulators who were pushing failing institutions into the arms of healthier ones (for example, the acquisition of Merrill Lynch by Bank of America in the United States or the takeover of HBOS by Lloyds TSB in the United Kingdom). As Lina Saigol, a Financial Times columnist, argued, this ‘new generation of gargantuan institutions [will have] the power to dictate the next financial boom and bust’.11 With the new injection of funds from governments, many banks turned their attention to attempts at buying each other out, and thus compounding the problems associated with market domination by too few players, rather than getting back to the business of lending money to people in the business of making things for others.

Another issue raised by the bail-outs was that of moral hazard. Many commentators, including Financial Times columnist John Gapper, argued that the rescue of AIG ‘encourages the idea that institutions can run amok in markets and will be bailed out. Indeed, the bigger they are and the worse they have behaved, the more likely it is to happen.’12 Other critics called these events ‘a perfect demonstration of Wall Street socialism’13 and the ‘socialisation of finance’.14 It is true that the financial industry seems to have understood better than any other how to privatise gains but socialise losses. After all, in 2007, Daniel Mudd, the CEO of Fannie Mae, reaped a 7% pay increase to $13.4 million while his company was losing $2.1 billion and its shares fell 33%.15

In many cases the bail-outs became part-nationalisations of the banks involved. This gave governments some additional influence over their practices, yet most politicians were cautious about what influence they would exert, and merely spoke about future executive pay. This timidity is an issue we return to in the following section, when discussing the broader implications of the financial crisis.

The irony of increasing government ownership of the banks is that taxpayers may face a double whammy of their own. Not only have they bought up bad debts, but they have bought into potentially massive legal liabilities. In a comment in The Guardian, Nick Leeson, the trader who brought down Barings Bank in 1995, said, ‘For my role in the collapse of Barings I was pursued around the world, and ended up being sentenced to six and half years in a Singaporean jail. Who is going to go after the reckless individuals responsible for the financial catastrophe? Apparently no one.’16 However, as time passed there appeared to be growing pressure to hold companies as well as individuals responsible for the global financial crisis. On 24 September 2008, regulators announced the broadening of the investigations into the collapse of the sub-prime mortgage market to include Fannie Mae, Freddie Mac, Lehman Brothers and AIG.17 In addition, many observers expected a sharp rise in shareholder lawsuits against investment banks and other financial institutions following the millions of dollars of losses they made by gambling money in asset-backed securities and the like.18 Lawsuits were emerging from Hong Kong to Paris to Reykjavik.

These actions slam the legal door after the capital horse has bolted. Rather than punishing the individuals who profited from using other people’s money to buy derivatives they did not fully understand, but knew could turn a profit in time for their next bonus, this legal action will cost the companies’ new owners, including the taxpayer. First the bankers, then the lawyers, will have bled the collective purse. As this situation becomes visible to the general public, calls for the people who made millions from speculating with their money to replenish their depleted pension funds may grow. There could be investigation into whether there was abuse of fiduciary duty by those who received large bonuses through creating, investing, rating or trading in mortgage-backed securities or credit-default swaps since the deregulation of those markets in 1999. Given the mobility of capital, such processes would require international cooperation, to freeze assets of those being investigated. If this happened, it would remind us of the words of Interface CEO Ray Anderson, who said that people like him would in future be regarded as criminals for doing things that at the time they considered normal business. Letting bankers live as millionaires, some as billionaires, from creating a crisis that has emptied the pensions funds and now the coffers of government, would sadly stand as a testament to systemic injustices of contemporary societies. However, it is unlikely that governments will want to see such a wave of litigation. As such, there may be growing calls for some form of ‘financial truth and reconciliation’ commission, to explore how this crisis developed, where fault lies, and how to repatriate some savings.

» The end of financial triumphalism

(The references are available in the pdf download and hard copy versions of this annual review, available from Lifeworth’s bookstore.)

This section can be referenced as:

Bendell, J., and N. Alam, S. Lin, C. Ng, L. Rimando, C. Veuthey, B. Wettstein (2009) The Eastern Turn in Responsible Enterprise: A Yearly Review of Corporate Responsibility from Lifeworth, Lifeworth: Manila, Philippines. (Page numbers for this section are available in the pdf download and hardcopy.)

Sovereign wealth fund responsibility

May 10, 2009 by  
Filed under Fourth Quarter

As the banking crisis deepened, media attention increased on the role and size of sovereign wealth funds (SWFs), which played a major role in the multi-billion-dollar bailouts of Western banks such as Citigroup and UBS. Rising energy prices and trade surpluses by exporting nations enabled SWFs to grow to control assets worth an estimated $3 trillion, a figure that the Organisation for Economic Cooperation and Development (OECD) estimated could increase to around $10–12 trillion by 2012. The rise of these government-owned foreign investment funds is, the BBC notes, ‘one sign of the shift in the balance of power in the world economy from Western industrialised countries to new emerging market giants like China and the oil-rich Middle East’.18

How does the emergence of SWFs relate to corporate responsibility? In at least two ways. First, as investors and owners of companies, they become relevant for assessment by firms with policies on whom they do business with. Second, as asset owners they have responsibilities to their ultimate beneficiaries, which are their national governments, and to others they affect through their investment decisions: sovereign wealth fund CSR.

The first area was highlighted when The Co-operative Bank in the UK publicly stated a policy on SWFs, based on its policies excluding business with companies connected with countries with poor human rights records. One league table (see Figure 8, available in pdf download or hardcopy), of the world’s 12 largest SWFs, shows that only four are from countries with democratically elected governments, although neither Russia nor Singapore was rated as fully free by Freedom House. Barry Clavin, The Co-operative Bank’s ethical policies manager, explained, ‘our policy precludes us from investing in an oppressive regime or in businesses and investments owned by an oppressive regime. Any business more than 20 per cent-owned by a blacklisted sovereign wealth fund will be turned down for business.’19 Given the growth of SWF investing in Western companies, that stance may become difficult to maintain, as well as raising questions about its efficacy in either promoting social change or more effectively managing financially relevant human rights risks.

Hugo Chavez: a political leader who ‘mixes investments with politics’

Hugo Chavez: a political leader who ‘mixes investments with politics’

The second area of relevance for corporate citizenship is that of the SWFs’ own responsibilities as private institutions—both to their beneficiaries and wider stakeholders. As the SWF assets are state-owned, we might expect them to be managed as those states see fit. The investments of SWFs have therefore raised concerns in the West that (Western) strategic assets such as banks and energy firms may end up in the hands of (unstable or unfriendly) foreign governments.20 Concerns of stakeholders in countries receiving inward investment from SWFs therefore became more widely discussed during 2008. A McKinsey report on the topic even cited Venezuela’s President Hugo Chavez as an example ‘of a political leader who mixed investments with politics’21 as an illustration of the growing calls for new rules for SWF investments.

Traditionally, however, despite periodic press coverage about human rights abuses by some SWF regimes, both investor and investee country governments have taken a laissez-faire approach to the role of SWFs, with investee nations tending to welcome investments and SWFs tending to shy away from controversy and any appearance of interference in other states’ affairs. For instance, China, Singapore and Saudi Arabia have historically downplayed the extent of their governments’ potential influence on investments in the West.22 On the other side of the SWF coin, as Western economies tend to be the major recipients of their investment funds, the OECD has argued the world economy benefits from the growth of sovereign wealth funds, ‘which recycle the trade surpluses earned by oil producers and manufacturing exporters like China back into the world economy’ and point out that OECD countries should be as open to investment as they have called on other countries to be.23 The occasional high-profile protectionist stances by US lawmakers to foreign investment (for example, objecting to Dubai Ports’ takeover of UK company P&O because of its US port interests on ‘security grounds’) have been atypical or driven by short-term political concerns. More frequently, the default position has been for governments to avoid public interference as far as possible.

This debate led to some increased transparency: for instance, by the Government of Singapore Investment Corp. (GIC), which publicly released its annual report for the first time in 2008 ‘to help allay Western fears that their investments are politically motivated’,24 following GIC’s $18 billion investments in the struggling UBS and Citigroup.

Given the continuing concerns from recipient countries, and the potential backlash against SWF investments, an IMF-hosted working group involving 23 investing and recipient countries agreed a voluntary code to increase transparency by SWFs in order to ‘promote a clearer understanding of the institutional framework, governance, and investment operations of SWF, thereby fostering trust and confidence in the international financial system’.25 It was a challenging task, given the SWFs all have different sources of capital, different legal statuses, different mandates and different investment policies. In October 2008 the working group released the Santiago Principles—also known as the Generally Accepted Principles and Practices (GAPP). The principles cover areas such as SWFs’ meeting of local recipient regulatory requirements, making public disclosures in a variety of areas, and investing on the basis of economic and risk-and-return considerations. The principles were founded on the notion of keeping politics out of the way of SWF investment, whether the politics of the recipient or investor country.

Although some questioned whether the code would really restrict political involvement in the management of the funds and thus the companies they invest in, what matters more for corporate responsibility and responsible investment is the way the code reasserts the primacy of financial value over other values, and limits fiduciary duty to solely financial considerations. Thus, SWF managers may become more accountable through procedures associated with the measurement of the financial performance of their funds, yet less accountable to the people whose savings created the funds in the first place, because their interests are assumed to be purely financial. If, as a result, managers of large companies worldwide can access funds that are purely interested in financial returns, this may not help achieve greater corporate accountability, and could undermine the move towards more active and responsible ownership typified by the development of the UN Principles for Responsible Investment (UNPRI).

Norway’s Finance Minister Kristin Halvorsen: excluding Rio Tinto on ethical grounds

Norway’s Finance Minister Kristin Halvorsen: excluding Rio Tinto on ethical grounds

In 2008 one SWF was a member of the UNPRI. The Norwegian Government Pension Fund–Global, with an estimated US$390 billion-worth of assets, is the world’s second largest SWF after the Abu Dhabi Investment Authority. It highlighted its uniquely active ethical policy by selling its US$500 million stake in Rio Tinto, a leading UK-based mining company for potentially subjecting it to ‘grossly unethical conduct’. Norway’s finance minister, Kristin Halvorsen, said its concerns related to Rio Tinto’s joint venture with US-based Freeport McMoRan, a company excluded by the fund in 2006, for a mining operation in the Indonesian province of West Papua. In a statement on the ministry’s website, she said,

Exclusion of a company from the fund reflects our unwillingness to run an unacceptable risk of contributing to grossly unethical conduct. The council on ethics has concluded that Rio Tinto is directly involved, through its participation in the Grasberg mine in Indonesia, in the severe environmental damage caused by that mining operation.26

The Grasberg complex is the biggest gold mine and third largest copper mine in the world. Environmental groups and local people are concerned with the environmental damage caused by dumping millions of tonnes of ore waste into the local river. In 2007, a study published by the campaigning charity War on Want claimed that local people had suffered serious human rights and environmental abuses. Rio Tinto spokesman Nick Cobban expressed surprise to the Guardian at the Norwegian move, saying, ‘Our immediate response is one of surprise and disappointment. We have an exemplary record in environmental matters—world leading, in fact—and they are given the very highest priority in everything we do.’27 The Guardian also quoted Ruth Tanner, campaigns and policy director at War on Want, welcoming the decision to exclude Rio Tinto and challenging other funds to follow its lead: ‘The Norwegian government has again put its money where its mouth is to ensure a real ethical investment policy. Now other pension funds should follow Norway’s example.’28

The unprecedented level of investment transparency practised by Norway’s SWF potentially makes it easy for other investors to follow suit and to leverage its global influence. Norway’s SWF invests profits from oil and gas in a portfolio of around 7,000 companies around the world. The fund’s ethical policy is based on applying to its investments the spirit of international agreements and ethical norms (such as ILO [International Labour Organisation] conventions) signed by the Norwegian government.

The bulk of the fund’s ethical activity is in common with a growing number of public pension funds, largely based on engagement with companies in which it is invested. What sets it apart is the combination of the sheer size of its holdings and the ability and willingness of its Ethics Council (governed separately by the Ministry of Finance) to recommend shares for disinvestment. Of the 27 companies disinvested by Norway’s investment programme on ethical grounds since 2005, the majority relate to governmental objections to certain types of military and nuclear weapons hardware. Boeing, Raytheon, Northrop Grumman and Lockheed are among the leading US arms companies excluded along with Britain’s leading arms manufacturer BAE Systems, Thales of France and UK support services group Serco, which was removed in 2007 because of its involvement in the UK Atomic Weapons Establishment at Aldermaston.29 The Norwegian Ethics Council has also disinvested from major companies for ‘serious, systematic or gross violations of ethical norms’, notably Wal-Mart for alleged complicity in breaches of international labour standards (including child labour, gender discrimination and the blocking of unionisation attempts). As the fund itself acknowledges, while disinvestment may continue to be applied in some high-profile cases, its preferred strategy remains engagement on a broad range of ethical issues.

As you may have noticed, this actively responsible approach from Norway’s SWF is a form of politics: it derives from the interests of the Norwegian government in certain social and environmental principles. Therefore, its engagement in the development of the SWF code led to an interesting compromise, illustrated by the paradoxical Principle 19. It reads that ‘The SWF’s investment decisions should aim to maximize risk-adjusted financial returns in a manner consistent with its investment policy, and based on economic and financial grounds’, but then continues in a subprinciple that ‘If investment decisions are subject to other than economic and financial considerations, these should be clearly set out in the investment policy and be publicly disclosed’, further qualifying that ‘The management of an SWF’s assets should be consistent with what is generally accepted as sound asset management principles.’ Principle 21 goes further in describing the nature of the shareholder activism and engagement that will be acceptable, saying, ‘if an SWF chooses to exercise its ownership rights, it should do so in a manner that is consistent with its investment policy and protects the financial value of its investments’. These principles limit the exercise of social responsibility from SWFs, including Norway, to approaches that have demonstrable financial benefits. As previous Annual Reviews from Lifeworth have outlined, the ‘enhanced risk management’ approach to responsible investment is only one approach, with some recognising how individual savers, as human beings, have interests that extend beyond the financial, whatever time-frame is applied.

The code is what one would expect from a group convened by the IMF, given its ideological bias towards traditional financial disciplines, and the fact that this code was developed to defend SWFs from Western scepticism. A much-needed dialogue would focus on what active responsible ownership can look like when being pursued by SWFs from the Gulf or Asia, rather than Scandinavia. Just because the latter have been historically more active on their concerns for people in other countries, and come from a cultural and political tradition less complicated for the West than those from the Middle or Far East, does not mean that only their form of shareholder activism should be welcomed. Without such dialogue on what are universally acceptable ways of governments, or any organisation, pursuing their full range of interests through their commercial activities, this code will soon lose legitimacy among SWF nations, and, as world power shifts, may be increasingly ignored.

For now, the code means the SWFs are tethered to the shareholder-value paradigm and thus environmental, social and governance (ESG) concerns can be forwarded only in terms of enhanced risk management. Therefore, the opportunity lies in corporate responsibility advocates seizing on Principle 22’s statement that ‘The SWF should have a framework that identifies, assesses, and manages the risks of its operations’ and promoting a fuller understanding of ESG-related risk management.

» From CSR in Asia to Asian CSR

(The references are available in the pdf download and hard copy versions of this annual review, available from Lifeworth’s bookstore.)

This section can be referenced as:

Bendell, J., and N. Alam, S. Lin, C. Ng, L. Rimando, C. Veuthey, B. Wettstein (2009) The Eastern Turn in Responsible Enterprise: A Yearly Review of Corporate Responsibility from Lifeworth, Lifeworth: Manila, Philippines. (Page numbers for this section are available in the pdf download and hardcopy.)

The end of financial triumphalism

May 10, 2009 by  
Filed under Third Quarter

Bill Gross: we are all to blame

Bill Gross: we are all to blame

Time will tell what the lessons of the financial crisis really are. One way of exploring the lessons is to look at how people were apportioning the blame at the time. From lenders to investors to regulators, it seemed everyone had blood on their hands. As Bill Gross, chief investment officer at Pimco, the world’s biggest bond fund, put it, ‘we are all to blame. For the most part, you can throw in central bankers, Wall Street, investment bankers and you can throw investors into the pot as well as mortgage bankers and regulators who looked the other way.’19

Joseph Stiglitz: the idea that banks should self-regulate is absurd

Joseph Stiglitz: the idea that banks should self-regulate is absurd

Joseph Stiglitz, winner of the 2001 Nobel Prize for Economics, summarised the main debate around the financial industry and its social responsibility: ‘In both the UK and the US, about 40 per cent of corporate profits go to the finance industry. What is the social function of the industry that justifies that generous money? The industry exists for managing risk and allocating capital. Well, it clearly didn’t do either very well [. . .] The idea that banks should self-regulate, relying on their own risk management systems and rating agencies, is absurd. We lost sight of why regulation is needed. The trouble is that regulators are too close to the people they are regulating. There was a party going on and nobody wanted to be a party pooper.’20

It is true that clues of the crisis to come were abundantly available to regulators. As early as 1993, the Interfaith Center on Corporate Responsibility (ICCR), a faith-based investors’ association, warned of the risks to households, communities and investors associated with sub-prime lending.21 In 2000, a House of Representatives hearing addressed many of the issues that were blamed for the sub-prime market woes, in particular abuses by mortgage lenders.22 In December 2006, a report by the Center for Responsible Lending, a not-for-profit organisation based in North Carolina (USA), published a report showing that, despite low interest rates and a favourable economic environment, foreclosure rates in the sub-prime market were very high (almost 20%). The report held predatory lending practices such as adjustable rate mortgages, no- or low-doc loans and pre-payment penalties as culpable.23

There is also evidence that regulators knew about the loosening of lending standards. The Fed’s survey on bank lending practices revealed a deep fall in standards beginning in 2004 until the end of the housing boom in 2006.24 In addition, global institutions, such as the Bank of International Settlements, issued warnings of the risks associated to parts of the US housing market in 2004.25

Kenneth Rogoff: governments and central bankers fell prey to ‘financial triumphalism’

Kenneth Rogoff: governments and central bankers fell prey to ‘financial triumphalism’

If the evidence was so clear, how could the regulators let the party go on? According to former International Monetary Fund (IMF) Chief Economist Kenneth Rogoff, governments and central bankers fell prey to ‘financial triumphalism’,26 the idea that light regulation and a self-correcting financial market are not only enough to maintain discipline but can help economies to grow faster. That the IMF did little to curb this process, and a lot to increase it through influencing financial liberalisation, raises a serious question mark over its legitimacy and proficiency in helping solve the problems now. It was the International Labour Organisation of the UN that has been warning in recent years of the excessive financialisation of the economy.27

Financial derivatives had became so complex that people trading in them did not really know how they worked, just that they were offered from reputable institutions and were receiving good credit ratings. The more complicated a product, the more ingenious, and the more profitable, or so it seemed. Some call this approach the greater fool theory, or pyramid selling: so long as someone else is willing to buy, then the prices can keep going up. Some talk about a collapse of trust, but that is misrepresenting what was involved in the market and emptying the term ‘trust’ of any meaning. Trust involves people. Most trades are done through a computer, often automatically. Finance professionals did not so much as trust, but they assumed—that complexity, ingenuity, a famous institution, and large market power, were all signifiers of financial value. With the onset of the credit crunch they now assume almost the opposite—hence inter-bank lending grinding to a halt.

Credit ratings agencies took some heat for an apparent lack of rigour in their valuation of complex derivatives. Developments in accounting, with the introduction of mark-to-market or ‘fair value’ approaches, facilitated a global-market group-think of ‘it is valuable because many of us think that many other people think it is valuable’. The credit ratings agencies are involved in a process that sociologists call ‘social construction’, i.e. where assumptions, beliefs and norms are constructed by people and organisations in society. The larger and more famous the ratings agencies, the more authoritative their ratings are and the greater impact on perceptions and thus of the market price of what they value. Thus within the current system there is an implicit value in play—that might is right. The socially constructed nature of financial markets was discussed at length by financier George Soros. Yet he did not articulate a value basis from which such processes could be more accurate and beneficial. Sociologists and stakeholder dialogue experts have different views on how a socially constructed concept of something’s nature or worth can be made legitimate and effective, with some advocating forms of ‘communicative action’ in the process as a way to achieve a participatory and intelligent view of phenomena. There is no such ‘communicative action’ in the valuing of assets in the financial markets.

Niall Ferguson: a lack of political-historical understanding contributes to the problem

Niall Ferguson: a lack of political-historical understanding contributes to the problem

Perhaps the underlying reason for this situation is a lack of sociological and political-historical understanding within the financial services sector and its regulators. Finance services professionals, like most people, are naturally competent in objectivist or positivist approaches to understanding reality, and so, when they work in fields that are relativist in their nature, they are not at ease with exploring how we might wish to shape the ways in which we decide what the value of something is, and so just fall back on mob rule—where something is valued according to the sum of the views of the most powerful. If we are explicit about values, then we might seek a credit ratings system that allows new entrants, balances views, moderates the influence of strategic commercial self-interest and seeks to arrive at socially beneficial forms of valuation, such as using a five-capitals model of valuation.28 In this way the financial system might be able to learn something from the corporate responsibility community. A lack of political-historical understanding also contributed to the problem, according to Harvard historian Niall Ferguson. He said that most people in the industry and its regulators do not have memories stretching back before the 1980s, so they do not understand how financial systems have evolved over time and how they can collapse.29

This philosophical turn may seem to some readers to be miles away from matters of corporate citizenship. What are the implications of this financial crisis for corporate responsibility and responsible finance? A few immediately appear. First is the issue some dub ‘the political bottom line’.30 Intense lobbying by the financial industry helps explain how the financial crisis took shape. According to the non-profit advocacy organisation Common Cause, the mortgage lending industry spent nearly US$210 million between 1999 and 2006 in lobbying activities as well as political campaigns contributions to both Democratic and Republican politicians that helped persuade the US Congress to refrain from passing regulation that would restrict predatory lending practices.31 In addition, economist Robert Kuttner blamed the repealing of key protections put in place by the New Deal for contributing to the crisis.32 An example of this is the Gramm–Leach–Bliley Act (1999), which eliminated restrictions on affiliations between commercial banks and investment banks. Senator Phil Gramm, who led the charge to pass this bill, has close ties with the financial industry: he is a vice chairman at UBS Investment Bank and was paid by the Swiss bank to lobby Congress on mortgage-related legislation.33 The political affairs of corporations are a key element of social responsibility, implying transparency and consultation on the societal impact of the forms of regulatory change sought by investors.

A second implication for corporate responsibility, and responsible finance, is that much of the work being done in our area is fiddling around the edges, and not addressing fundamental economic issues. This has been discussed in these Lifeworth Annual Reviews since 2001, when the Enron collapse led Business Ethics editor Marjorie Kelly to question whether work on corporate responsibility risked being beside the point, and called for more focus on the fundamentals of corporate law and financing.34 In a new book by one of these authors, The Corporate Responsibility Movement,35 it is argued that corporate responsibility is evolving in a way that can address these deeper challenges. ‘The corporate responsibility movement is a loosely organised but sustained effort by individuals both inside and outside the private sector, who seek to use or change specific corporate practices, whole corporations, or entire systems of corporate activity, in accordance with their personal commitment to public goals and the expectations of wider society.’ The analysis suggests an interlocking framework is slowly emerging, which seeks to integrate economic and social principles, dubbed ‘capital democracy’ by the author. ‘Capital democracy describes an economic system that moves towards the creation, allocation and management of capital according to the interests of everyone directly affected by that process, in order to support the self-actualisation of all’.

Might the financial crisis spur professionals in the corporate responsibility and responsible finance fields to take up this deeper agenda? One process holding back an embrace of that agenda is the way that work in this field has been defined as a particular set of professional practices rather than an evolving field of societal expectation on business and finance. This delineation of a field of practice meant that, in August 2008, the United Nations Principles on Responsible Investment (UNPRI) could put out a press release reporting ‘Rapid growth in Responsible Investment despite credit crisis’.36 They were referring to new signatories, yet many of those same signatories were being lambasted at the same time for irresponsibly investing in ill-understood derivative markets. Until now the field of investor responsibility has been defined by the investors themselves. Therefore the focus has been on the social, environmental and governance (ESG) performance of the firms they invest in. But, with the financial crisis, they are beginning to have to look in the ESG mirror, as the public and civil society increasingly question the financial institutions themselves.

Nicolas Sarkozy: the idea that markets were always right was mad

Nicolas Sarkozy: the idea that markets were always right was mad

Perhaps the lasting impact on the corporate responsibility field will be that the more critical perspectives, such as those often reported in these pages, will receive greater attention from the shapers of the mainstream agenda on corporate responsibility. They will be able to quote people in high places. In Europe, for instance, some political leaders have called for an end to laissez-faire capitalism. In a political rally in French city Toulon, French President Nicolas Sarkozy said that ‘the idea of the all-powerful market that must not be constrained by any rules, by any political intervention, was mad. The idea that markets were always right was mad.’37

Trade unions have also reiterated their calls for more regulation. The Trade Union Advisory Committee (TUAC) to the Organisation for Economic Cooperation and Development (OECD) issued a statement in September 2008 spelling out what governments should demand in return for taxpayers’ money. According to TUAC, ‘international cooperation should go far beyond what is currently under consideration—i.e. reviewing prudential rules for banks and “encouraging” more transparency on the market place. It is the national and global regulatory architecture that needs to be restored so that financial markets return to their primary function: to ensure stable and cost-effective financing of the real economy.’38

UNI Finance Global Union also called for a fundamental overhaul of the financial industry based on tougher regulation, more transparency, long-term investment and sustainable growth.39 In June 2008, it released a statement with 13 key demands on the regulation of finance markets. These asked regulators to act on issues such as pay systems for executives, consumer protection, sales targets, and tax breaks for private equity.40

Given the caution with which governments were saying they would seek to influence banks and change the banking system, the unions have some work ahead. This is not surprising given how in recent decades monetary policy has been turned into a technical not political issue—symbolised by the establishment of independence for national banks. Yet the recent financial crisis has made publics around the world more aware of the political nature of their monetary systems. Most governments oversee a system whereby private banks print money, and loan it out as debt, thereby benefiting from the system of money creation in a way no one else in the economy does. In return for that privilege, we could expect that governments might influence the way they then loan out that money. But they don’t. Why is this monetary process beyond the political process? Why can’t the contracts governing how the private banks issue money incorporate restrictions on the way that money is used, to promote the objectives set through government? For instance, guidance could be given on the employment or carbon created by the activities funded by the loans. Perhaps corporate responsibility could be embedded in the money system?41 Rising awareness due to the financial crisis might lead to more discussion of policy innovations in monetary systems, yet governments do not seem ready to lead that process in 2008.

At a time of crisis it is natural to look for a quick fix. Yet, once the gold dust settles, it is clear that deeper questions must be asked, and discussed by a broader range of people than international financial institutions and the finance ministers of powerful nations. Any economic historian will tell you that ‘moral sentiments’ precede ‘the wealth of nations’. We should be considering what values we want to further through the design of financial systems. Being clearer about the values embedded within and furthered by the current financial system, and whether that’s suitable for this century, would be a good start. Steve Waddell, of the Global Finance Initiative (GFI), said, ‘although stability is clearly the major concern, there are also significant concerns about the social and environmental impacts of finance. Indeed, increasingly there are suggestions that stability cannot be realized without more categorically considering these broader impacts. There is no formal, open and inclusive public space to develop a global strategy to address these concerns.’42 Along with the Network for Sustainable Financial Markets,43 the GFI is one of a number of initiatives of progressive professionals thinking big on the future of finance.

» Beyond the Western financial crisis

(The references are available in the pdf download and hard copy versions of this annual review, available from Lifeworth’s bookstore.)

This section can be referenced as:

Bendell, J., and N. Alam, S. Lin, C. Ng, L. Rimando, C. Veuthey, B. Wettstein (2009) The Eastern Turn in Responsible Enterprise: A Yearly Review of Corporate Responsibility from Lifeworth, Lifeworth: Manila, Philippines. (Page numbers for this section are available in the pdf download and hardcopy.)