SUSTAINABLE STOCK EXCHANGES 2012 GLOBAL DIALOGUE 18 JUNE 2012, RIO DE JANEIRO MARIA HELENA SANTANA KEYNOTE ADDRESS I WANT TO THANK THE SSE INITIATIVE S SPONSORS FOR THE INVITATION TO BE HERE TODAY. IT IS AN HONOR FOR ME TO GIVE THIS KEYNOTE, OPENING SUCH A RELEVANT PROGRAM IN OUR LOVELY RIO. IT IS TELLING THAT THIS INITIATIVE WAS PUT IN PLACE AFTER THE 2008 (FIRST ROUND OF THE) FINANCIAL CRISIS. NOTHING SPEAKS MORE ELOQUENTLY OF THE LACK OF SUSTAINABILITY OF BUSINESSES THAN THE AMOUNT AND THE QUALITY OF RISKS THAT FINANCIAL INSTITUTIONS WERE RUNNING WITHOUT THEIR LEADERSHIP BEING AWARE OF THEM. MANAGEMENTS HAD EXPORTED THEIR DUTY TO MANAGE RISKS TO CREDIT RATING AGENCIES OR TO INDICATORS SUCH AS THE CREDIT DEFAULT SWAPS MARKETS, FOR EXAMPLE, AND THE BOARDS WERE NOT SUFFICIENTLY INVOLVED TO UNDERSTAND THE EXTREMELY RISKY BUSINESS MODELS ADOPTED BY MOST FINANCIAL INSTITUTIONS. MORE THAN THAT, BOARDS WERE GENERALLY NOT ABLE TO UNDERSTAND THE RELATIONSHIP BETWEEN INCENTIVES OR REMUNERATION DRIVERS AND THE BUSINESS MODELS AND RISK APPETITE OF THE COMPANIES THEY WERE SUPPOSED TO STEER. WHAT CAN BE LESS SUSTAINABLE THAN THAT? IT IS VERY EASY TO SEE THE ROLE OF CORPORATE GOVERNANCE ACTORS, SYSTEMS AND MECHANISMS IN THIS PICTURE AND THE IMPORTANCE OF THE SEVERAL WORKSTREAMS, AT THE INTERNATIONAL AND AT THE LOCAL LEVEL, TO IMPROVE CORPORATE GOVERNANCE IN THE CONTEXT OF EFFORTS TO AVOID THE REOCCURRENCE OF SUCH TRAGEDY, ONE THAT IS COSTING AND WILL STILL COST THE SOCIETY SO MUCH. BUT THERE IS ALSO BROAD RECOGNITION OF THE EXTREMELY RELEVANT ROLE PLAYED BY REPORTING IN THE PREVENTION OF SUCH SYSTEMIC FAILURES. AND REPORTING IS ALSO, AS OF NOW, CENTRAL AMONG THE INITIATIVES TO FOSTER SUSTAINABLE STRATEGIES AND BUSINESS PRACTICES BY THE COMPANIES. REPORTING IS SAID TO INFLUENCE BEHAVIOR AND I STRONGLY AGREE WITH THAT. SO, IT IS NOT BY CHANCE THAT, AMONG THE VARIOUS 1
INITIATIVES BY LEGISLATORS, REGULATORS AND EXCHANGES TARGETED AT PROMOTING SUSTAINABILITY, THE REQUIREMENTS TO REPORT ARE THE MOST PRESENT ONES. STOCK EXCHANGES, DESPITE OF ALL THE INSTITUTIONAL CHANGES THEY HAVE GONE THROUGH IN RECENT DECADES, ARE STILL SEEN AS POLICY MAKERS AND ARE EXPECTED TO ACT AS SUCH. THAT IS ONLY NATURAL, DUE TO THE CENTRAL PLACE THAT THEY OCCUPY IN THE CAPITAL FORMATION PROCESS OF BUSINESSES. THE BRAZILIAN EXPERIENCE, AS MOST OF YOU KNOW, IS A TESTIMONY TO THE POWER THAT LIES IN THE HANDS OF AN EXCHANGE THAT DECIDES TO ACT STRATEGICALLY. THE BM&FBOVESPA WAS RESPONSIBLE FOR UNLEASHING A REAL REVOLUTION IN BRAZIL IN WHAT RELATES TO CORPORATE GOVERNANCE AND INVESTOR PROTECTION. IN FACE OF THE ENORMOUS DIFFICULTIES TO CHANGE THE CORPORATE LAW AT THAT TIME, TO ADDRESS THE MANY PROBLEMS PERCEIVED BY INVESTORS, IT DECIDED TO ADOPT A PRIVATE SECTOR / MARKET DRIVEN INITIATIVE AND ESTABLISH THE PREMIUM CORPORATE GOVERNANCE LISTING SEGMENT NOVO MERCADO, IN THE YEAR 2000. THE RESULTS ARE WIDELY KNOWN AND RECOGNIZED. THE SAME EXCHANGE WAS THE FIRST TO COMMIT TO THE U. N. GLOBAL COMPACT, HAS SPONSORED THE CREATION OF A CORPORATE SUSTAINABILITY INDEX IN 2005 AND HAS SINCE DEEPENED ITS COMMITMENT TO THE SUSTAINABILITY AGENDA. RECENTLY IT BEGAN RECOMMENDING REPORT OR EXPLAIN ON ESG BY LISTED COMPANIES. EXCHANGES CERTAINLY HAVE A CENTRAL ROLE TO PLAY IN PROMOTING SUSTAINABLE DEVELOPMENT. THEY WOULD, AS WELL, ALMOST CERTAINLY BE ABLE TO PROFIT FROM BEING ACTIVE IN PROMOTING GOOD GOVERNANCE AND SUSTAINABILITY THROUGH THEIR VARIOUS INITIATIVES. BUT I THINK IT S FAIR TO RECOGNIZE THAT NOT ALL EXCHANGES WOULD BE IN SUCH A POSITION. LOOKING AT THE REPORT ON PROGRESS PROVIDED AS A BACKGROUND TO TODAY S DISCUSSIONS, ONE COULD SEE THAT THE MAJORITY OF THOSE THAT ARE SEEN AS THE MOST ACTIVE EXCHANGES IN THE FIELD OF SUSTAINABILITY ARE ESTABLISHED IN DEVELOPING MARKETS. AND, I BELIEVE NOT BY CHANCE, THEY ENJOY MONOPOLY OR QUASI MONOPOLY STATUS IN THEIR MARKETS. THE REALITY IN THE MOST DEVELOPED MARKETS MAKES THIS TYPE OF POLICY MAKING BY EXCHANGES EVER MORE UNLIKELY, IN MY OPINION. THE COMPETITIVE THREATS REPRESENTED BY OTHER MARKET OPERATORS THAT ARE ALLOWED TO OFFER TRADING ON EXCHANGE LISTED INSTRUMENTS IN THE U.S. AND IN EUROPE ARE HUGE. THESE 2
COMPETITORS TEND TO ACCOUNT FOR MORE TRADING VOLUME THAN WHAT IS TRADED ON THE EXCHANGES WHERE THE COMPANIES ARE LISTED. IF THE BULK OF THE VOLUME IS NOT THERE, THE LEVERAGE IN THE HANDS OF INCUMBENT EXCHANGES TENDS TO BE SMALLER. IS IT REALISTIC TO EXPECT THEM TO IMPOSE NEW LISTING RULES ON ISSUERS, NO MATTER HOW IMPORTANT? THE REPORT VOICES SOME CONCERNS WITH THE FACT THAT AN INCREASING PROPORTION OF EXCHANGES REVENUES DERIVE FROM TRADING FEES, A TREND THAT SHOWS THE IMPORTANCE THAT ALGO AND HIGH FREQUENCY TRADERS HAVE GAINED AT THE CORE OF THE BUSINESS MODEL OF MOST EXCHANGES. SUCH A SHIFT REDUCES THE RELEVANCE OF LONG TERM INVESTORS AS EXCHANGES STAKEHOLDERS, POSSIBLY IMPLYING THAT MARKET OPERATORS ARE MORE RELUCTANT TO PERFORM ANY POLICY MAKING ROLE. THEREFORE, I THINK THAT THE CHANGE IN BUSINESS MODEL TOGETHER WITH THE CHANGE IN MARKET STRUCTURE MUST BE TAKEN INTO ACCOUNT WHEN LOOKING FOR A STRATEGY TO FOSTER SUSTAINABILITY BASED ON THE ROLE OF STOCK EXCHANGES AND, IN MY VIEW, EXPECTATIONS MUST BE CALIBRATED ACCORDINGLY. THE CHANGES IN EXCHANGES BEHAVIOR DUE TO SHIFTS IN MARKET STRUCTURE MUST BE CONSIDERED ONE MORE UNWANTED SIDE EFFECT OF REGULATORY CHOICES THAT WERE MADE FOR VERY GOOD REASONS TO PROVIDE INVESTORS WITH THE ABILITY TO CHOOSE AMONG TRADING VENUES, ALLOWING COMPETITION TO INCREASE THE EFFICIENCY OF THE MARKETS. WHEN DESIGNING A STRATEGY TO FOSTER SUSTAINABILITY, THOUGH, WE MUST TAKE THESE CHANGES AS GIVEN AND DEPART FROM THERE TO LOOK FOR POLICY ALTERNATIVES, ASSUMING THAT EXCHANGES WILL, IN MANY CASES, NOT BE ABLE OR WILLING TO PLAY AN ACTIVE ROLE. I AM A BIG FAN OF USING MARKET MECHANISMS IN POLICY MAKING, DUE TO THEIR NATURAL ACCEPTANCE AND ADOPTION, AND DUE TO A CERTAIN LEGITIMACY THAT THEY CARRY WITH THEM. BUT I BELIEVE IT S NECESSARY TO RECOGNIZE THE LIMITS OF SUCH AN APPROACH IN TODAY S MARKETS, AT LEAST IN THE MOST DEVELOPED ONES. THAT TAKES US TO THE NEED TO WEIGHT THE POSSIBLE ROLE OF LEGISLATION AND REGULATION IN INDUCING SUSTAINABLE DEVELOPMENT THROUGH CAPITAL MARKETS. AND THE FIRST CANDIDATES THAT COME TO OUR MINDS ARE THE MARKET REGULATORS. I CAN TESTIFY TO THAT, HAVING BEEN APPROACHED BY MANY DIFFERENT PLAYERS DEMANDING REGULATORY ACTION TO IMPROVE ESG REPORTING. AND IT IS ALSO POSSIBLE 3
TO SEE THE SAME SENTIMENT ON PART OF SOME EXCHANGES INTERVIEWED FOR THE REPORT, THAT DESCRIBED WHAT THEY SAW AS A LACK OF REGULATORY SUPPORT FOR THEIR INITIATIVES. IN MY VIEW, SECURITIES MARKETS REGULATORS ARE NOT WELL POSITIONED TO ADOPT REGULATION REQUIRING ESG REPORTING ON THEIR OWN. AND THAT IS BECAUSE THE VAST MAJORITY OF THE INVESTORS WE ARE MANDATED TO PROTECT AND THE MARKETS WE ARE MANDATED TO KEEP INFORMED BASICALLY DO NOT CONSIDER THIS INFORMATION AS RELEVANT FOR THEIR DECISION MAKING. WHAT I MEAN IS THAT, IN BROAD TERMS, EVEN LONG TERM INVESTORS WITH A MANDATE TO PURSUE SUSTAINABLE INVESTMENT STRATEGIES AND THEY ARE NOT YET A BIG GROUP - HAVE DIFFICULTIES IN EXPLAINING HOW THEY USE ESG CRITERIA IN THEIR STRATEGIES AND WHICH INFORMATION WOULD BE REALLY MATERIAL FOR THAT MATTER. ANOTHER EVIDENCE OF INVESTORS APATHY IS THE LIMITED SUCCESS ACHIEVED UNTIL NOW IN PROMOTING PRODUCTS BASED ON THE EXISTING SUSTAINABILITY INDEXES, AS THE BACKGROUND PAPER ALSO REPORTS. SOME EXCHANGES HAVE MENTIONED THEIR DIFFICULTY IN ADOPTING CORPORATE SOCIAL RESPONSIBILITY REPORTING REQUIREMENTS, BECAUSE MOST INVESTORS DO NOT DISCRIMINATE SUSTAINABLE FROM NON-SUSTAINABLE COMPANIES. THAT IS A FACT, UNFORTUNATELY, AND HAPPENS NOT ONLY REGARDING SUSTAINABILITY BUT ALSO CORPORATE GOVERNANCE PRACTICES. SINCE BESIDES THE ALGO AND HIGH FREQUENCY TRADERS, WHICH OF COURSE COULDN T CARE LESS ABOUT FUNDAMENTALS, THERE IS A BIG PART OF THE MARKET COMPOSED OF PASSIVE INVESTORS THOSE THAT SIMPLY TRACK INDEXES OR BASKETS THROUGH FUNDS OR E.T.F.S. AND EVEN THOSE THAT ARE DEEMED ACTIVE MANAGERS WITH A LONG TERM INVESTMENT HORIZON, TEND TO BE IN FACT ALIENATED FROM INVESTMENT DECISIONS, DUE TO THE MANY LAYERS OF INTERMEDIARIES THAT THERE ARE TODAY BETWEEN, SAY, THE PENSION FUND MANAGER AND THE ACTUAL MANAGER OF THE PORTFOLIO. ADDING TO THAT IS THE FACT THAT THE REQUIREMENT TO DISCLOSE MATERIAL INFORMATION IS ALREADY PRESENT IN EVERY MARKET LEGISLATION, SO THAT IF ANY ISSUE RELATED WITH SUSTAINABILITY BECOMES RELEVANT, THE COMPANY IS ALREADY REQUIRED TO REPORT ON IT. ALL THIS POINTS TO A LIMITED SENSE OF URGENCY FOR ESG REPORTING IN THE CONTEXT OF SECURITIES REGULATORS STRICT MANDATES. WHICH DOES NOT MEAN, OF COURSE, THAT THE SAME LACK OF URGENCY EXISTS AT A HIGHER LEVEL OF POLICY MAKING. 4
I BELIEVE THAT FOSTERING CORPORATE ESG RESPONSIBILITY MUST BE AT THE FIRST LEVEL OF STATE POLICIES, DUE TO THE RELEVANCE AND URGENCY OF THE ISSUE TO OUR SOCIETIES. AND THIS GUIDANCE MUST COME FROM THE POLITICAL LEADERSHIP. IN OTHER WORDS, THE DECISION TO PROMOTE SUSTAINABLE POLICIES BY CORPORATES IS TO BE TAKEN BY THE SOCIETY, BY APPROVING THE NECESSARY LEGISLATION. BASED ON A CLEAR LEGAL MANDATE, EVERYTHING RELATED TO ESG REPORTING AND MANAGEMENT ACCOUNTABILITY, CAN AND SHOULD BE REGULATED AND ENFORCED BY SECURITIES MARKETS REGULATORS. IN MY VIEW, THE APPROACH PROPOSED BY THE CORPORATE SUSTAINABILITY REPORTING COALITION, OF CALLING ON GOVERNMENTS HERE IN RIO TO ADOPT A RESOLUTION MANDATING, ON A COMPLY OR EXPLAIN BASIS, THE INTEGRATION OF MATERIAL SUSTAINABILITY ISSUES IN THE ANNUAL REPORTS OF COMPANIES, IS REALISTIC AND IS THE ONE THAT CAN YIELD MORE. IF WE WERE TO CONTINUE PLACING OUR MAIN HOPES AND PUTTING PRESSURE ON STOCK EXCHANGES AND SECURITIES REGULATORS, I BELIEVE THE RESULTS WOULD TAKE A LOT MORE TIME TO COME, AND TIME IS REALLY PRECIOUS IF WE ARE TO REVERSE UNSUSTAINABLE BUSINESS PRACTICES. 5