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Implementing ESG in Emerging Markets

Hermes' Gary Greenberg says engagement can make a real difference in improving governance in emerging markets firms

Hermes 12 December, 2017 | 3:07PM

Brazil flag

Companies do not exist in isolation: they use resources, employ labour and attract customers, and are required to operate under the laws of the land.

They influence the lives of far more people than shareholders alone, but unfortunately plenty of businesses act to the detriment of many – including, in the long run, themselves and their investors.

To help ensure companies exert a positive impact on the world, including the bottom line, we believe investors need to do more than assess environmental, social and governance (ESG) risks. They must engage. Engagement can be effective in emerging markets, provided a tailored approach is taken by investors. 

Positive Change in Mexican Banking

We opposed the re-election of Banorte Chairman, Carlos Hank González, at the Mexican bank’s 2016 AGM. Our reason was the potential conflict of interest arising from his family’s major shareholding in Grupo Financiero Interacciones, a competing bank run by Gonzalez’s father.

Banorte was unable to convince us and other shareholders that the safeguards it had put in place mitigated the risk of it acquiring Interacciones at a valuation harmful to the interests of minority shareholders.

Gonzalez was still re-elected as Chairman in 2016, but perhaps felt the embarrassment of receiving 75% of votes in favour compared to the approval given to other board nominees, who garnered more than 95%. However, Banorte did take on board the concern that we and other investors voiced.

The company embedded risk controls designed to prevent acquisitions of significant assets that were seen by shareholders to be against their interest. Indeed, the lender called an extraordinary general meeting to propose that any acquisition amounting to more than 5% of its assets be referred to a shareholder meeting. The previous level of 20% meant acquisitions of $14 billion could proceed without approval.

Until the recent 10% slide in the share price of Interacciones in October 2017, the new level put any purchase of the bank without shareholder consent out of reach, thus preventing the Chairman from selling his stake in Interacciones to Banorte. Although we did not suggest this specific solution, we judged it to be an effective risk control measure that was aligned with the aim of our engagement, and voted in favour of it.

Russia's Largest Bank Makes Progress

Our engagement with Sberbank (SBER), Russia’s largest, began in 2016. We have applauded the many positive steps it is taking to deliver on its recently published anti-corruption policy, though we also have identified room for improvement.

Sberbank has carried out money laundering checks for some time, but lacked a centralised approach, which we encouraged it to implement in order to limit human error and ensure consistency across all branches. We also had concerns about its internal whistleblower line and about the credit underwriting process it employed to mitigate environmental and social risks.

We met with Sberbank’s senior independent director, who confirmed that although the bank’s loan officers were instructed to consider the environment when assessing a business loan application, there was no company-wide policy, set of detailed guidelines or reporting methodology for modelling environmental and social risk.

This area is now the focus of our engagement and progress is being made. We have not yet seen a draft policy, but are encouraged by several positive developments. Our overall view is Sberbank’s steps to prevent money laundering and, in time, reduce environmental and social risk in the projects that it finances, are taking the bank in the right direction.

A New Stewardship Code in Brazil

Many ESG concerns are not company specific so need to be addressed through engagement with policymakers and industry bodies. This is particularly true in emerging markets, where corporate disclosure, pollution, worker safety and other standards are often behind those in the west. Our role as active owners is to help close this gap.

In 2016, the Brazilian stewardship code was created by a working group of members of the Association of Capital Market Investors, of which Hermes was the only non-Brazilian member. The process included the benchmarking of stewardship codes, interviews with the International Corporate Governance Network, the Financial Reporting Council, local and international asset managers and owners, as well as a public consultation.

We expect the new code will be instrumental in developing a stewardship culture in Brazil, especially as a number of major local asset managers attended the launch. The aim is to help investors better accomplish their fiduciary duty. This includes implementing and disclosing stewardship programmes, managing conflicts of interest, integrating ESG into investment processes, monitoring companies, exercising voting rights diligently and establishing collective engagements.

 

The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring on our website, please email submissions to UKEditorial@morningstar.com

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Sberbank of Russia PJSC240.17 RUB0.00

About Author

Hermes  Hermes is a multi-asset fund manager offering global institutional and pension fund clients access to a broad range of specialist, high conviction investment teams.

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