For several months now, Venezuela has been battling a wide variety of crises, from economic to humanitarian. Millions of children are going to bed hungry, there is a burgeoning prison population with an overcrowding rate of 250%, and widespread riots and protests. The Venezuelan economy, as the New York Times reported, has completely collapsed, in spite of having the world’s largest oil reserves. The International Monetary Fund predicts that inflation will cross 2,300% in the coming year. Its government is doing virtually nothing to prevent malnutrition and crime, rejecting all foreign aid for political reasons.
Tracing the stories of investments
On May 26, 2017, Harvard economist Ricardo Hausmann raised a question that many in finance stay firmly away from – moral dilemmas over investments. His blog on Venezuelan government bonds – the now infamous “hunger bonds” – calling out investors buying these and thus funding the government, went viral. It ultimately culminated in Goldman Sachs, which was a major initial investor in these bonds, making a public statement saying they regretted the deal. Hausmann had an immense impact on the fate of these bonds.
The Venezuelan government is, of course, not alone in funding its controversial policies at home. A 2017 Reuters report states that China accounts for over two-thirds of total emerging market green bonds issuance and a fifth of the global tally, even though it is classed as the world’s bigger polluter by carbon emissions. According to the Climate Bonds Initiative, it issued $23 billion worth of green bonds in 2016. Similarly, the second issue of Poland’s sovereign green bond was extremely controversial. It was not picked up by Lombard Odier Investment Management, which argued that Poland’s climate strategy belied its position on issues of environment and sustainability, with coal continuing to remain the foundation of the country’s energy policy.
There is of course a counter-narrative to this story. Haussman is also an advocate of foreign military intervention in Venezuela. The effect of US sanctions, active military training and intervention in encouraging regime change in the region can in fact escalate the crisis. However, Goldman Sachs is not the only investor looking to invest without any ethical considerations. In 2017, Warren Buffet helped raise almost $200 million dollars in Israeli bonds, which had a huge impact on the market for these bonds. By endorsing this investment, Buffet effectively ensured that the state in Israel continued to prosper, and continued its racist and colonialist policies against the Palestinians.
When it comes to Goldman Sachs and Buffet, there is little that can be done to create ethical spaces in investing apart from public campaigns that raise the reputational risk of unethical investments. However, for non-institutional investors, the issue of ethical lapses in investing frequently arises from moral oversight or neglect. In such cases, more contextual information about investments can be beneficial. Grounding these decisions into stories about the nature of different governments – and the impact of such investment on ordinary people there – can be a powerful tool of social transformation.
Increasing cost of capital
Mitu Gulati and Ugo Panizza argue that increasing the cost of capital for an arguably illegitimate government may have an effect akin to a financial sanction. A fundamental way of increasing the cost of capital is through increased public information and disclosures. The authors argue for the public listing of bonds, with information on legal and ethical issues attached to their funding for the benefit of investors. The argument here is based on the premise that the more information people have about their investments, especially those which go into funding despotic governments, the more careful they will be about funding such regimes.
Despotic regimes seldom honour their debts, since there is very little incentive to do so, and successor regimes are not traditionally under an obligation to make future payments on such loans. This is known as the principle of ‘odious debts’. The concept of ‘odious debt’, although not absolute, is based on the purported odiousness of the previous regime, and the notion that the debt it incurred did not benefit the people, or was used to repress them.
Tim Harford, in his book Adapt, argues that the international community can impose significant costs on regimes by issuing pre-emptive declarations of odious debt. It warns investors, and significantly reduces the credibility of the odious regime in power. However, it is important to be mindful that declarations of such kind by governments can also marked by their geo-political ambitions and gains. Powerful governments like the US, which use their own treasury bills to fund their own military and wars, can create diplomatic pressure to conveniently declare certain regimes as ‘odious’.
The International Capital Market Association, in its ‘Green Bond Principles’, recommends tht issuers of any project with environmental benefits clearly communicate to investors their overall environmental sustainability objectives and how they will identify and manage potential environmental and social risks associated with the selected projects. Controversial issues, such as fossil fuel, extractive or nuclear-based activities, may also require additional transparency from the issuer.
However, some of the most popular global indexes rely only on specific liquidity, and structural requirements, and fail to include any ethical consideration in their criteria for issuing countries. The JP Morgan Global Index for instance, simply relies on World Bank-defined per capita income brackets, and each country’s debt-restructuring history. Any mention of ethical screening for issuers have only been introduced in limited sectors of energy, such as the JP Morgan-Blackrock collaboration on the J.P. Morgan ESG Index.
The ‘Equator Principles’, which forms a risk management framework adopted by 94 financial institutions in 37 countries for determining, assessing and managing environmental and social risk in projects, has only one taker from India, IDFC Bank. This comes almost 11 years after the Reserve Bank of India first released a notification stating that “the urgency for banks to act as responsible corporate citizens in the society, especially in a developing country like ours, need be hardly overemphasised. Their activities should reflect their concern for human rights and environment.”
The National Voluntary Guidelines on the Social, Environmental and Economic Responsibilities of Business, which offer a principle-based approach for companies to create a positive impact on people and the planet, are currently under review by the government. However, in spite of being a positive step, they remain completely voluntary, and largely ignored by the corporate sector in India.
Virtue has financial value
The crux of the argument is simple, and two-fold. First, investors should, as a matter of legitimate right, know what their investments are funding. The principle of exercising their choice in the truest sense will only be possible in light of full disclosure and public information. It is their right to making an informed choice in an environment of good governance. Second, despotic governments are more prone to reneging on their promises; they have little incentive to be incorruptible and efficient; and successive democratic governments may not be legally bound to honour the previous government’s rogue attempts to finance their actions.
The larger question, of course, is whether virtue pays, and if there was any commercial gain to be had from doing well, rather than simply doing, and doing good. Milton Friedman wrote against it years ago, arguing that ‘firms’ should not be in the business of ethics, but others disagree. In 2015, accounting professor Tomo Suzuki at Oxford advocated a ‘One Additional Line’ financial reporting scheme for corporate social responsibility (CSR) in India. This simply meant that an additional line would appear on a company’s ‘Profit and Loss Account’ under expenses, as an independent item disclosing the amount of money being given to CSR. The disclosure has very little cost, and goes a long way in promoting a positive sense of competition between companies to do more around CSR. He argued that in time, shareholders come to attach more ‘value’ to companies that did more CSR than companies that did not, in addition to furthering massive improvements in healthcare, education and sanitation in some of the poorest areas in India. Virtue, in other words, has the potential to gain actual financial value.
There is evidence to suggest that motives which go beyond self-interest and are concerned with the idea of fairness allow people to internalise the effects of individual actions on others, and can contribute effectively towards better social outcomes. The global emphasis on climate change is one such example. It is also an imperative for financial regulations to evolve in a manner that is aligned to ensure that businesses and investors are attuned to ethical considerations while making investment decisions.
There is a lot to be said about the power of having more information in the hands of investors, the power of people, both individuals and local communities, to create institutions and environments of better governance. As of April this year, the Venezuelan government was reportedly inching towards a $50 billion dollar debt default on its publicly traded debt. This serves as a good example of how the legal and reputational risks associated with unaccountable governments and companies profiting out of investments is a far higher cost for investors to pay, compared to the cost of abandoning a few financial investments.
Shohini Sengupta is a Senior Resident Fellow at the Vidhi Centre for Legal Policy.