Impact Investment: Sovereign Wealth Funds, Corporate Governance and Stock Markets

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday June 21, 2013 at 9:04 am
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Editor’s Note: The following post comes to us from Dimitrij Euler, a Visiting Scholar at the Lauterpacht Centre for International Law at the University of Cambridge.

In the light of the ever-dwindling resources that will be addressed by our future generation, impact investors invest in accordance with ethical and environmental principles, going beyond financial performance. In particular, Sovereign Wealth Funds invest in assets worldwide in accordance with ethical and environmental principles and significantly influence the investment sphere and how enterprises are managed. In the last decades, corporate governance and stock market rules require information beyond financial performance and have changed the information requirement of how listed enterprises have to inform. Although this had an impact towards a more transparent market, the law has to establish obligations broadly reflecting the needs of impact investors and thereby taking the chance of contributing more significantly to development. The SSRN Working Paper “Impact Investment: Sovereign Wealth Funds, Corporate Governance and Stock Markets” recalls that some soft law standards of the OECD favour disclosure and some Stock Market rules require disclosure of information that help an impact investor to justify the investment.

Sovereign Wealth Funds are major global impact investors. The top three managed a combined total of USD 1,910 billion of assets, with the Government Pension Fund of Norway alone managing USD 715.9 billion. The OECD mentioned the power of Sovereign Wealth Funds, which contribute significantly during crises when capital is difficult to find. However, these vehicles have transparency requirements and need to be accountable. These funds need to comply with high standards of Corporate Governance, not just because Sovereign Wealth Funds invest public capital but because some of the funds invest in accordance with societal and environmental principles. Thus, the investment operator needs to provide information that justifies the investment policy. Due to the market power of such funds, the world of Corporate Governance changed.

The Government Pension Fund of Norway addresses environmental, social and economic policies in their investment strategies. Their strategy implements the principle of global citizenship as opposed to shareholder value or stakeholder value. The concept of the global citizen overcomes the narrow functionalist vision of business and sets the enterprise as a citizen in the global society. Human rights or environmental standards are addressed when governments fail to comply with them.

This approach requires that multinational and transnational corporations address at least the same goals as Sovereign Wealth Funds. The investor checks the investment using the disclosed information. Thus, transparency is essential to achieving the goals. The OECD 2004 Principles of Corporate Governance promote transparency and efficient markets. The commentary hereto states that transparency is a central feature in monitoring a corporation. These principles require compliance with the law and public interest and the underlying principles relate to stakeholder value. The OECD Guidelines for Multinational Enterprises go further and besides a stakeholder value, also foster economic, environmental and social progress. Additionally, these guidelines require timely disclosure of financial and non-financial information. Moreover, the Council for Human Rights endorsed the Guiding Principles on Business and Human Rights: Implementing the United Nations Protect, Respect and Remedy Framework as proposed by Special Representative, Professor Ruggie. Here, transparency is, besides being a human right and having an environmental impact on due diligence, a core principle.

Publicly listed corporations face continuing disclosure obligations depending on stock market rules. Generally, in most countries, these rules require informing the public about facts, risks and other issues that would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments, if publicly known. The EU proposed, in regulation 2004/124/EC, the disclosure of such information and the European Security and Market Authority, formerly the Committee of European Securities Regulator, clarified that such information encompasses any information that “if it indicates a set of circumstances which exists or may reasonably be expected to come into existence or an event which has occurred or may reasonably be expected to do so and if it is specific enough to enable a conclusion to be drawn as to the possible effect of that set of circumstances or event on the prices of financial instruments or related derivative financial instruments” (precise nature test). In Germany, the Wertpapierhandelsgesetz, (Statute for Securities Exchange) and in England, the rules of the London Stock Exchange, as well as the Financial Services Authorities Disclosure Rule, recall these principles. The difference between the countries lies firstly in the interest in managing these corporations. The underlying interest of corporations in England lies in shareholder value plus elements of stakeholder value, whereas in Germany, it is stakeholder value. Secondly, information may be withheld in Germany if the information owner guarantees non-disclosure. Corporate Governance may, however, override the general interest and declare an immediate disclosure obligation on the corporation.

The US rules incorporate similar disclosure obligations for publicly listed corporations. The Securities Exchange Act provides “[e]very issuer of a security registered [under the law of this title] shall file with the Commission, in accordance with such rules and regulations as the Commission may prescribe as necessary or appropriate for the proper protection of investors and to insure fair dealing in the security” and addresses information about financial and non-financial status and impact. The information needs to have a material effect on the corporation’s value (materiality test) and has to be disclosed as early as possible. Similar to the position in the EU, the corporate law forms part of each state’s law. The general interest of the corporation lies in increasing shareholder value. The US law is far-reaching with regard to the information but the purpose of the corporation is very narrowly defined. The disclosure obligations need to be seen in the light of this purpose. As well as in the EU, there is an argument that Corporate Governance may diverse the purpose.

The Swiss Stock Exchange establishes a potential duty to disclose price-sensitive information. No guidance is given with regard to information addressing non-financial interest. The duty needs to be read in the light of the self-regulatory organisation of the Swiss Stock Market. In other words, in Switzerland, no legal continuing disclosure obligation exists in stock market law. This is not an unusual fact in a country proud of being famous for trading cheese and jewels around the world. The purpose of a corporation lies between shareholder value and stakeholder value, based on the competence of its directors in achieving these objectives.

The Framework of Corporate Governance is fast developing soft law standards with an ever-increasing shift towards hard law. Except for some smaller countries, the world is heading in the right direction to set up a business environment, allowing for diversified investment in the rest of this century.

The full paper is available here.

  1. The Paper will be presented at CONFERENCE IN ROME, OCTOBER 17-18, 2013 concerning “Financial Distress: Corporate Governance and Financial Reporting Issues”.

    Comment by Dimitrij Euler — June 21, 2013 @ 11:42 am

 

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