The Ethical Index Performance Challenge

The Ethical Index Performance Challenge

The FTSE4Good index for socially responsible companies has revealed future plans for tightening up corporate ethical related criteria, raising questions about the links between policy and business performance. By Poulomi Mrinal Saha

At a London meeting on June 7, 2005, the FTSE4Good index series launched its 2004-05 annual report. In this new publication, FTSE4Good aims to assess the index's performance to date in driving the corporate responsibility agenda forward. FTSE4Good also announced criteria for future development, in particular with regard to the inclusion of nuclear power companies in the index.

The FTSE4Good index, launched in July 2001, aims to help socially responsible investors make an informed decision towards ethical allocation of their assets. The index ranks global companies based on how well they are deemed to be performing on social and environmental policy development. The examinations are done by the Ethical Investment Research Service, an independent research company.

When the index announces criteria for inclusion -- and companies have no choice about being assessed on these -- companies interested in remaining included are given a specific timescale in which they are expected to meet the new criteria. Non-compliance results in publicly announced deletion from the index.

FTSE4Good has deleted more than 100 companies, including big names such as Goldman Sachs, Carlsberg, Rank Group, Anheuser-Busch, Nortel, Skandia, Hutchison Whampoa and News Corporation, from the index since 2001, due to their inability to satisfy either environmental or human rights related requirements.

Of the FTSE4Good corporate deletions over the last four years, 85 have been regarding environmental criteria alone. Those removed were companies that either refused to engage in any initial dialogue with EIRIS or simply failed to meet the specified environmental criteria within the deadline.

Indices relating to sustainability and corporate ethical issues, in particular the Dow Jones Sustainability Index, are said by some critics to give companies too easy a ride in terms of what they ask from them in order to be listed.

One consultant has even told Ethical Corporation that he has designed a strategy to get virtually any big company listed in the DJSI Index if they follow his relatively simple plan.

Other critics, such as NGO Friends of the Earth, have been more strident. They say that such indices measure process, policies and management systems, rather than impacts, outcomes and performance. While accepting that they do demonstrate an interest among financial institutions for information about corporate social and environmental performance, many would prefer to see more compulsory disclosure on these issues mandated by governments.

Who, us?

While almost 200 of the original 450 companies affected by FTSE4Good's environmental criteria have met them, 117 continue to be on tenterhooks. Most of these are U.S.-based domestic companies that FTSE4Good perceives to be less willing to implement global environmental standards across their business than their multinational peers.

Non-disclosure is another barrier to implementation of environmental criteria which is recognized by the ethical index. "In a litigious culture like that of the U.S., too much information in the public domain is a perceived risk," explains Will Oulton, strategic advisor to FTSE4Good.

Oulton says that some domestic U.S. companies tend to see indirect environmental impacts, such as those through project finance or lending of financial firms, as irrelevant to their business.

In order to try and change this outlook and enhance compliance with the FTSE4Good criteria, the index series has extended the deadline for domestic U.S. companies over a phased process that lasts until September 2007.

Performance on meeting FTSE4Good's human rights criteria has been comparatively better. Only 18 companies have so far been deleted from the index in this respect.

FTSE4Good also launched its supply chain labor standards criteria in November last year in collaboration with the International Labor Organization. Of the 62 companies found to be affected by the criteria initially, seven have satisfied the conditions while the rest of the original respondents are currently engaged in outlining their approach to the criteria.

Culture Counts

However, with respect to these supply chain labor standards criteria, FTSE4Good has encountered a new problem in their implementation: regional differences.

Overall acceptance of ILO standards, such as freedom of association and collective bargaining for employees, is proving difficult in countries like the U.S. and Japan, as FTSE4Good has discovered.

It is currently in dialogue with all companies affected by these new criteria in order to help them understand the index's requirements better. This, said FTSE4Good, also helps the index appreciate local practices and, where appropriate, incorporate them into its criteria. But companies unwillingly to either meet the criteria or participate in any dialogue with the index risk deletion, warned FTSE4Good.

However, in something of a u-turn, the index abolished its policy of excluding companies engaged in the production of breast milk substitutes from the index and developed new criteria for them in March last year. Eight listed companies, including Nestlé, Novartis and Danone, have been recognized as affected by this criteria.

FTSE4Good insists that removal of the sector-exclusion policy in this instance will not undermine the credibility of the index in any way.

"This new approach can hardly be accused of going soft. None of the companies covered by the breast-milk substitutes criteria have been able to meet them. They are very demanding," says Craig MacKenzie, head of investor responsibility at Insight Investment, who is deputy chair of the FTSE4Good policy committee.

The Nuclear Hot Potato

Following on these lines, this year new criteria will be developed for companies involved in uranium mining. And, at the London meeting, another previously excluded sector was announced as now open to criteria development: nuclear power.

"This is in line with a higher level public debate about whether nuclear power, as a low carbon dioxide emitting energy source, can play a role in mitigating climate change," said FTSE4Good.

The decision to bring nuclear power back into the running, it said, was based on the opinions of 270 participants from 21 countries in a public consultation process last year.

These members of the corporate, investment, NGO and academic communities were, however, unanimous in showing a thumbs-down to the tobacco and weapon systems industries.

As finalised by the consultation exercise, after the development of bribery and corruption criteria later this year, climate change, board-level governance of corporate responsibility and corporate responsibility towards customers and employees, in that order, are up for future criteria development in the three-year period leading up to 2008.

Craig MacKenzie said that, as in the case of previous sector exclusions that have now been given a chance to demonstrate responsible behaviour, FTSE4Good is keen to encourage good corporate behaviour rather than discriminate at the outset.

"FTSE4Good isn't an index of best practice companies or 'pure' companies -- those that haven't got into trouble on ethical grounds. It is, instead, seeking to benchmark companies that have established good practice in management of corporate responsibility," he explained.

Policy vs. Performance

Corporate responsibility experts acknowledge the good work FTSE4Good has done in encouraging responsible corporate policies. Some, however, are skeptical about the impact the ethical index has on the ground with regard to actual performance.

"FTSE4Good has a process- and policy-driven approach. It needs a more performance-based approach," said Sean Gilbert, associate director for technical development at reporting standards framework Global Reporting Initiative.

The FTSE4Good approach, argue some campaigners, gives companies the opportunity of getting away with just talking the talk and not actually walking it.

Deborah Doane, chair of the CORE coalition, complained that ethical indices like FTSE4Good undermine the role of the government by suggesting that market mechanisms can affect change on their own.

"It [FTSE4Good] is crowding out relevant discussion on policy. The only type of change it brings about is in company policies and their reporting, which is superficial," she said.

With respect to reporting, Adam Faruk, assistant director at the Ashridge Centre for Business and Society, suggests the problem can be solved if indices aim at standardization of criteria. Some performance indicators, perhaps based on a small number identified from the GRI standards, he says, can be agreed upon as appropriate to be reported by all companies of a certain size.

Faruk says this procedure would supplant the need to rely on companies developing policies using their own house-styles, which leave room for maneuvering by the companies and, at times, misinterpretation by index researchers.

"This would also provide a degree of comparability, and build consistency and credibility in CR performance analysis that is all too often lacking," he says.

Analysts, ratings organizations and index providers could then build on this commonly reported information to introduce their own emphasis to distinguish their product from others, and index users could easily compare results across indices.

Faruk also adds that FTSE4Good should now aspire towards more performance-driven, rather than policy-driven assessments.

While this might push companies to raise policy implementation levels, many ethical indices continue with an inclusive approach that seeks to ensure large numbers of firms are involved before the bar is raised, bit by bit. Moving too quickly to a tougher standard might scare off companies from the voluntary process, say supporters of the 'softly softly' approach.

But the European Commission has said that if progress does not come fast enough for regulators they retain the right to mandate more disclosures.

Companies may disagree over how they might use standards like the GRI, but almost all would agree that they do not want mandatory rules put in place as an EU directive.

But as the Commission's Dominique Bé noted at Ethical Corporation's recent annual conference, the European regulator's patience for companies to catch up with their expectations is not inexhaustible.

Compared to this so-called "threat' that the business lobby regularly opposes, reacting meaningfully to the tightening up of the rules for inclusion in ethical indices like FTSE4Good may suddenly sound a lot more attractive to many senior managers.

This article has been reprinted courtesy of Ethical Corporation. It was first published on June 21, 2005.