Investing with a conscience

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A combination of will and a code of practice are necessary for the success of ethical investing, writes PM Devaiah

The world today has scorned the idea of laissez-faire, the product of a so-called enlightened marketplace with freedom from government interference. Such a practice was in vogue at one time as a way to unleash human potential through a natural system, one that was unhindered by government restrictions.

PM DevaiahPartner and general counselEverstone Capital Advisors
PM Devaiah
Partner and general counsel
Everstone Capital Advisors

Nowadays, in a progressive and evolved market, general partners (GPs) and limited partners (LPs) in the dominion of private equity have given a clarion call to engage and adopt an investment strategy that considers financial return, responsible investing and social good to bring about positive and sustainable social change.

“Socially responsible investing” is one of several related concepts and approaches that is now embraced by portfolio managers as a way to deploy capital in the larger matrix of ethical investing.

What is ethical investing?

The meaning depends on one’s personal philosophies. Ethical investing is subjective because each individual investor has different ideas about what constitutes ethical behaviour. Broadly speaking, ethical investing is a way of earning returns in financial markets by supporting targets that are responsible, and that create positive change in the world, or, at least, that are not making the world worse.

In general, socially responsible investors, or investors with a responsible investing mandate, encourage corporate practices that promote environmental stewardship, consumer protection, human rights, transparency, clean money and diversity.

Others avoid businesses involved in alcohol, tobacco, gambling, pornography, weapons manufacturing, among many others. From a governance perspective, ESG (environment, social justice and governance) guidelines are necessarily mandated as a reference for portfolio managers to follow when deploying capital. Clean source, clean use and clean profits seem to be the immediate purposes and ultimate objectives.

At the core of the practice, there are know-your-customer mandates to assess the source of investor wealth as a standard operating practice, and to determine how ownership is held, and the ultimate beneficial owner.

LPs prescribe well-crafted integrity requirements for GPs to follow while investing, which include anti-money laundering checks and balances, and combating the financing of terrorism via audits that are obligatory when receiving capital for onward deployment.

GPs need to adopt a robust integrity management system comprising policies, procedures, systems and controls that adhere to relevant governance practices, and that require trained personnel to implement these integrity requirements at an operational level.

Tackling the twin maladies

The prevention of corrupt practices has taken centre stage in the world of institutional finance, requiring market intermediaries, such as private equity players, to have robust ESG systems to prevent the use of illegal means to obtain an undue advantage or avoid an obligation.

These obligations fall under the larger purview of the US Foreign Corrupt Practices Act and the UK’s Bribery Act, among other jurisdictional anti-corruption statutes. To meet the requirements of a robust anti-corruption regime, ESG codes have encapsulated preventive and corrective mechanisms for corrupt and fraudulent practices, among various other examples of questionable conduct.

While corrupt practices improperly influence the actions of another party, fraudulent practices are triggered when an act or omission misleads, or attempts to mislead, a party to obtain a financial or other benefit, or to avoid an obligation. Some LPs have taken upon themselves the duty of not profiteering from certain areas of business as part of their ESG discipline.

Few of the favourites excluded by international institutional LPs are activities deemed illegal under host country laws or regulations, or international conventions and agreements, or subject to international bans (such as unbounded asbestos fibres, products regulated under the convention on international trade in endangered species, trade in tobacco, or activities involving forced labour or child labour).

Whether it is avoidance of corrupt practices, planning an investment thesis on the bedrock of a preferred exclusion list, or avoiding funding businesses that have links to organized crime or terrorism, the success of a good ESG practice depends on the willingness of minds to put the capital into use, aided by strong ESG management systems.

Ultimately, compliance and good practice in the course of doing business depends on the strength of a compelling cultural value, rather than a mere mandate of a mundane written contract or statute book.

PM DEVAIAH is a partner and general counsel at Everstone Capital Advisors in Bengaluru. The views expressed are personal.