Specs in the City

It’s time to see to it that investors get the gen on sustainability when a company first floats on the stock exchange. Roger Cowe reveals where London’s listing regime is falling down.

Last April a company called Asia Energy joined the London stock market. In doing so it raised more than £10m from investors. This money is now being used to finance the first stage of an open-cast coal mining project in Bangladesh.

Yes, Bangladesh – much of which is less than 10 metres above sea level, and seriously threatened by climate change. So any company aiming to dig coal from the ground faces several risks – direct climate risks from flooding, perhaps, but also political and economic risks from potential government action to limit emissions of carbon dioxide (CO2). Curiously, however, investors in Asia Energy would find nothing about this, no matter how long they pored over the 84 pages of the company’s prospectus – the detailed description of its operations and prospects which is required for a stock market flotation.

It’s not that the prospectus doesn’t recognise environmental risks. An impact assessment is being carried out. But there is nothing about climate change. Despite the fact that the traditional complaint of financial short-termism does not apply here – the mining leases will last for 30 years.

And despite the irony that Asia Energy is part-owned by an Australian company called Deepgreen. But this is not because Asia Energy and its advisers are incompetent or worse. The prospectus complies with all the appropriate rules and regulations, and is in line with disclosures of similar fossil fuel companies.

It is simply because stock market rules have not caught up with the Kyoto era – they do not recognise the heightened importance of social and environmental issues, especially climate change, for business success. This is now an anomaly, because other parts of the financial world have woken up to this connection. Major companies have been publishing sustainability reports for some time.

For the last four years, pension fund trustees have been required to say something about their approach to social, environmental and ethical investment issues. The insurance and pension fund industry has asked the companies it invests in to address social and environmental risks. And, from April 1 this year, the new Operating and Financial Review (OFR) will place a formal requirement on all quoted companies to address these matters in their annual reports.

Classic but outdated

Shareholders, in other words, are judged to have a legitimate need for this kind of information once they have invested in a company. But for some reason prospective investors aren’t judged to need it, when they are thinking of buying the shares in a new company, based on the prospectus information. It’s not just an oversight. A review of the UK listing rules has specifically ruled out requiring companies to address social and environmental factors. So does a European Union Prospectus Directive, which will come into force in July and effectively lays down what must go in a prospectus anywhere in the EU.

Its requirements, which will be incorporated in the new UK listing rules currently being finalised by the Financial Services Authority (FSA), say very little about sustainability. Well, nothing, actually – except an obscure requirement to disclose environmental issues which might affect “the utilisation of property, plant and equipment”. This could be interpreted, of course, as requiring a mining company to comment on the risks of climate change.

Mark Mansley, a sustainability investment expert who now works for the investment management firm Rathbones, believes the FSA does still have some discretion here. “There is still a degree of flexibility and interpretation,” he says. Unfortunately, Mike Duignan disagrees. And Duignan is the man in charge of listing policy for the FSA. “The Prospectus Directive is a maximum harmonisation directive,” he says.

This horrendous piece of EU jargon means, he explains, that “the FSA has no flexibility in extending the content requirements for prospectuses”. Not quite the same as saying there is no room for interpretation. But the FSA essentially relies on the classic, if rather outdated, financial defence.

If something is important enough for investors, this argument goes, then it is already covered by the general requirements for directors to report all significant constraints and risks. As Duignan puts it: “The FSA’s Listing Rules require that issuers producing prospectuses include the information investors need to make an informed decision about the financial position and prospects of the issuer.”

Switching on to sustainability

Logical, at least. If an environmental risk is significant, then it must be included in the risks section of a prospectus. If it is not significant, then investors don’t need to know about it. However – and this is the crux of the matter – few companies are yet sufficiently switched on to sustainability.

That’s why they are not properly assessing these risks. They are outside their conventional field of vision or experience. Experience tells us this is true. A recent Unep/SustainAbility analysis of corporate reports confirmed that it is.

The Asia Energy example is a further illustration of it. Which is precisely why these factors have been specifically included in the OFR and other disclosure requirements. As for requiring companies to address them from the outset, however, by building this into the listings regime as Mansley suggests [see box right], Duignan takes the line that the regulator wants to avoid over-prescriptive requirements.

That would be worse than useless if it just forced companies to make meaningless disclosures. The two clear objectives of the review of the FSA’s listing rules were “to simplify and modernise the listing regime, while implementing the Prospectus Directive”. Duignan’s yardstick is whether they now provide “an appropriate level of regulation” and, at the same time, ensure “the flexibility and transparency required by those wishing to raise capital in the London markets”.

On that score, he clearly reckons they’ve got it right. But Emma Hunt at Forum for the Future’s Centre for Sustainable Investment (CSI) thinks there’s an opportunity to be more forward-looking. “London’s robust governance and reporting requirements are major factors,” she says, “in its enviable reputation as a well-respected exchange for companies seeking to list.

By keeping abreast with the latest research on what drives value creation, London could stay ahead of the curve. It is no longer a point for debate whether sustainability issues may lead to value creation or destruction. So the next piece in the jigsaw is creating the mechanisms to enable companies to report on these potentially material issues, in a way that is meaningful for investors.

Two good places to start are the annual report, and the documentation released as part of the listing process. The FSA has a role in ensuring the rigour of this process. Bringing it into line with other moves in this area would be a small step within the whole listing process, but would provide a large piece of the jigsaw puzzle.” Duignan’s position is less ambitious. FSA staff do review documents before they are published, but they cannot be expected to make judgments about individual companies, or be experts on their industry.

“The FSA is concerned solely with how companies meet the requirements of the Listing Rules and relevant legislation,” he says. “Disclosure of environmental and social issues in prospectuses is judged against those requirements. The regime is designed to accommodate companies from all sectors and we do not make a qualitative assessment of how issuers operate.” In this respect the FSA relies on others to alert it to problems.

It is talking about roping in the Environment Agency to provide some advice on specific environmental problems which companies may not be disclosing in their routine public statements. But by definition, this would only apply once companies are listed. By which time, of course, it could be too late.

When coal mining company Xstrata came to the stock market in March 2002, its prospectus – just like Asia Energy’s – did nothing to draw investors’ attention to climate change risks. Six months later, Xstrata’s shares dropped by 12% over two days, following reports that Japan was to introduce a tax on coal imports, as a contribution to meeting its CO2 targets under the Kyoto agreement.

Next time a fossil fuel company floats on the stock exchange, should the prospectus automatically be marked caveat emptor – or can we hope for something more substantive about its sustainability? After all, one of the FSA’s four principal objectives is securing the appropriate degree of protection of consumers of financial services. It could help to make sure fund managers are fully equipped to make sound decisions about where they put their clients’ money. LISTING RULES WITH SUSTAINABLE TEETH?

26 January 2005

Roger Cowe