Viewpoint: Finance Teaching After the GlobalFinancial Crisis by Jayanth R. VarmaINTRODUCTIONJayanth R. Varma holds a doctorate in management from the Indian Institute ofManagement, Ahmedabad, and is a professor of finance and accounting at the sameInstitute. During the last 25 years as an academic he has worked mainly in the field offinancial markets and their regulation. He has served on the board of the Securities andExchange Board of India, on several government committees concerned with riskmanagement and financial sector reforms, and also on the boards of a couple of Indian banks.

OVERVIEWI argue that wemust rethink the way financeis taught because the global financial crisishas revealed deep-seated problems witholder, oversimplified models that used to bepopular in the classroom. I believe thatnewer and more nuanced models becamewell established in finance theory in the lastcouple of decades, and the crisis has notdone anything to discredit these models.Finance teaching must therefore start shift-ing toward these more modern and sophis-ticatedmodels so that our students are betterable to cope with the post-crisis world.

RISK MEASURES MUST BEMULTIDIMENSIONAL ANDFORWARD LOOKINGThe capital asset pricing model (CAPM) wasdeveloped half a century ago, but it remainsthe workhorse model in the classroom eventoday. The CAPM is popular because it issimple and easy to use: there is only onesource of risk (market risk or beta), andthere is a practical way to measure this risk.Modern finance theory, on the other hand,has moved on to multifactor models wherethe measure of risk is multidimensional:† size: small-cap stocks are riskier thanlarge-cap stocks;

† value: value stocks differ systematicallyfrom growth stocks;

† momentum: prices trends cannot beignored;

† liquidity: illiquid assets are more risky.Today, although no serious finance journalwould publish a paper that relied exclu-sively on the CAPM to measure risk, manyfinance MBAs probably believe that theCAPM is the best way to measure risk.The CAPM makes the simplifying

assumption that all investors have identicalbeliefs about the probability distribution offuture stock prices—investors are assumedto agree on the means and the variances ofthe returns. While the modern models infinance theory assume that probabilities aresubjective and are estimated using optimalBayesian methods, classroom practice is

dominated by classical statistics. Studentstherefore easily fall into the trap of believingthat means, variances, and betas are objec-tive facts to be revealed by statisticalestimation from historical data instead ofbeing subjective judgments about the future.Finance professors like to joke that

accounting is about the past, while financeis about the future. However, when it comesto risk measurement, we have allowedstudents to uncritically imbibe a back-ward-looking methodology that failed sodisastrously in the crisis—VaR modelsbased purely on recent past data led tocatastrophic underestimates of the true risk.I think that finance teachers must now

bring modern risk models to the classroomin a much bigger way.

PRICES MAY NOT BE RIGHT, BUTTHERE IS STILL NO FREE LUNCHThe efficient markets hypothesis (EMH) hastwo important components, and the globalfinancial crisis has led to diametricallyopposite conclusions regarding these two:† There is no free lunch—or it is not possibleto beat the market in risk-adjusted terms.If something is too good to be true, itprobably is not true. The global financialcrisis has strengthened this claim. Allthose apparently low-risk, high-returninvestments turned out to be high risk.

† Prices are “right” in the sense that theyreflect fundamentals. The global financialcrisis has weakened this claim. Manyprices were clearly not right.

Limits to arbitrage imply that prices are notalways “right,” but limits to arbitrage alsotell us that the prices are wrong for a reason.The no free lunch argument remains true:there are anomalies, but no easily exploi-table anomalies.What appears like a free lunch is just the

reward for a hidden tail risk. The unhedge-ability of this risk (possibly a liquidity risk)means that the apparent free lunch can beexploited only by those who can back theirbets with a nearly infinite pool of liquidityand capital. Pre-crisis, the “too big to fail”

(TBTF) banks with implicit sovereign sup-port might have thought that they hadinfinitely deep pockets, but the crisis blewthe illusion away.Finance courses need to teach more

about the limits to arbitrage, with properattention paid to transaction costs, leverage,and collateral requirements. The importantstream of recent literature linking fundingliquidity and market liquidity needs to bepart of the core courses in financial markets.

MARKET MICROSTRUCTURE HASMACRO-CONSEQUENCESThe study of market microstructure hasbecome one of the most exciting fields infinance, and a vast literature of elegantmodels has emerged. In finance teaching,however, market microstructure is coveredonly in specialized courses, if at all. Thedominant thinking seems to be thatmicrostructure is important only to secu-rities brokers and dealers who are focusedon extremely short-term movements inprices. It was thought that the weirdphenomena that take place at the shorttime scales relevant to market microstruc-ture wash out over longer time periods andbecome irrelevant for mainstream finance.The global financial crisis and subsequent

events like the flash crash of May 2010 inthe United States have taught us that this isnot so. Quite often, market microstructurehas macro-consequences and, perhaps, afinancial crisis is simply market microstruc-ture writ large.Over the short time intervals of micro-

structure events (a few minutes), sharp andrapid price declines (market meltdowns) andthe converse (“meltups”) happen all the time.For example, any sell order large enough tosweep through the whole or a major fractionof the bid side of the order book would cause

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“The chief business of the American people is business.” Calvin Coolidge

a steep decline in prices within seconds (ifnot milliseconds). It might take severalminutes for enough latent orders to enterthe order book and reverse this meltdown.Conversely, a large buy order can send theprice shooting upwards in the space of a fewseconds or even milliseconds. These high-frequency price movements are several timesthe range that would be expected from aGaussian distribution.Although fat tails are very common in

high-frequency price data, microstructuretheorists do not regard these markets asdysfunctional or irrational. On the contrary,the self-correcting ability of the marketrestores equilibrium over the space of severalminutes or hours. Taking into account thevarious frictions (search and informationcosts, transaction costs, and leverage restric-tions), we should probably consider amarketwhich experiences (and then quicklyrecovers from) such microstructure melt-downs or meltups to be an efficient market.During the crisis, booms and busts

happened at a macro-scale (over time framesof several months instead of minutes), but itis possible that the phenomenon differedfrom microstructure events only in theirscale and duration. A financial crisis maysimply be amarket microstructure event thathas gone macro. Perhaps the complexities of“microstructure noise” persist at longer timescales as well, and the market is in aperpetual state of chaotic movement towardan ever-changing equilibrium instead ofbeing in a continuous state of equilibrium.The hypothesis that financial crisis is

simply market microstructure writ largeimplies that markets are messier and morecomplex than the ideal friction-free marketthat is typically taught in finance courses.On the flip side, it means that we have thetheoretical tools and techniques (of micro-structure theory) to study crises.

ECONOMETRICS MUST BEGROUNDED IN FINANCIALHISTORYThe global financial crisis and its aftermathevoked parallels with:† the Great Depression of the 1930s;† the panic of 1907;† the sovereign defaults of the 1890s and1930s;

† the financial (and sovereign debt) crisesof the 1830s and 1870s.

From a long historical perspective, thefinancial crisis does not appear to be anaberration at all. On the contrary, it is the so-called GreatModeration of the late 1990s andearly 2000s that appears to be an aberration.For example, Haldane (2009) provides thedata given in Table 1 for macroeconomicvolatility in the United Kingdom.

A key mistake prior to the crisis was theassumption that the Great Moderation wasa permanent structural change in the worldeconomy that implied a permanentlyreduced volatility. The crisis has taught usthat the statistical processes that we observeduring any particular period should beviewed as just one of several possibleregimes. There is always a nontrivialprobability of shifting to a different regime.The “new normal” in this sense is that thereis no unique and stable “normal.”I see financial history as providing power-

ful inputs into the econometric proceduresthat we use. Since high-quality data do notusually go back more than a few decades, wedo not have the option of fitting econometricmodels directly to centuries of data. Yet it isnot sensible to limit the estimation processto only the limited sample duration that isavailable. Students should be encouraged tofavor robust models that are qualitativelyconsistent with decades, if not centuries, ofhistorical experience.Students taking advanced courses should

be exposed to powerful econometric tech-niques like Markov switching models, butmuch simpler approaches may also besufficient. Haldane’s table reproducedabove involves only a simple tabulation ofmeans and standard deviations for differentsample periods, but it provides very valu-able information. This means that asignificant amount of financial historyshould be a part of the finance curriculum.

THE NORMAL DISTRIBUTION ISCOMMON INNATURE BUT RARE INFINANCEThe Gaussian (normal) distribution is foundeverywhere in nature, but nowhere infinance. Theoreticians and practitionersuse various tricks to correct for nonnorm-ality—for example, the smile in a Black–Scholes option pricing model accounts forthe fat tails of asset prices. Finance teachingtends to underemphasize this, and studentstend to think of the Gaussian distribution asthe default assumption in finance.I think that finance teaching should

include more discussion of fat-tailed distri-butions as well as copulas and other toolsfor dealing with non-Gaussian data. Simi-larly, courses on stochastic calculus shouldnot be focused only on the mathematicsof Wiener processes, but must also coverLevy processes, which have non-Gaussianincrements.

FINANCE MUST DRAW FROMOTHER DISCIPLINESInsights from psychology in the form ofbehavioral finance are now an integral partof the standard finance curriculum, but it isnecessary to seek inputs from other dis-ciplines as well. Neuroscience tells us a lotabout the cognitive capability of the humanmind as well as the nature of risk and timepreferences. The sociology of finance asksus to look at markets as complex socio-technical systems that overcome some ofthe limitations of bounded rationality. Net-work theory provides powerful theoreticaltools to understand highly interconnectedfinancial markets and institutions. Financestudents should be exposed to all theseimportant perspectives.Some of these ideas would surely lead to

changes in finance theory itself. But evenbefore this happens, finance teachers canprepare their students for a post-crisisworld by discussing the more robust modelsthat already exist in the literature.

Table 1. Volatility of UK macroeco-nomic variables during the GreatModeration compared with 150-yearaverageVariable Volatility,

1998–2007

Volatility,

1857–2007

GDP growth 0.6% 2.7%

Earnings growth 0.5% 6.4%

Inflation 0.9% 5.9%

Unemployment 0.6% 3.4%

Source: Adapted from Haldane (2009), Annex Table 1.

MORE INFOBooks:

Easley, David, and Jon Kleinberg. Networks, Crowds, and Markets: Reasoning About a HighlyConnected World. New York: Cambridge University Press, 2010.

Glimcher, Paul W. Foundations of Neuroeconomic Analysis. New York: Oxford UniversityPress, 2011.

Reinhart, Carmen M., and Kenneth S. Rogoff. This Time is Different: Eight Centuries of

Financial Folly. Princeton, NJ: Princeton University Press, 2009.

Articles:

Haldane , Andrew G. “Why banks failed the stress test.” Bank of England, February 13, 2009.Online at: tinyurl.com/aztdqc [PDF].

MacKenzie, Donald. “The credit crisis as a problem in the sociology of knowledge.” American

Journal of Sociology 116:6 (May 2011): 1778–1841. Online at: tinyurl.com/pfglcl2

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“Economics is as much a study in fantasy and aspiration as in hard numbers–maybe more so.” Theodore Roszak

Viewpoint: The Role of Insurance in BringingResilience to Societies Challenged by GlobalWarming by David BreschINTRODUCTIONDavid Bresch has headed the sustainability unit at Swiss Re since 2008. His previous rolesthere include head of university and risk research relations, head of atmospheric perilsgroup, and chief modeler for natural catastrophe risk assessment. He has been member ofthe deal teams for many innovative risk transfer transactions, like cat bonds and weatherindex solutions. He has been a member of the official Swiss delegation to the UNFCCCclimate negotiations in Copenhagen (2009), Cancun (2010), Durban (2011), and Doha(2012). He is amember of the adaptation board of the global network for climate solutions ofthe Earth Institute at Columbia University, a steering committee member of ProClim, and amember of the advisory board of the INSEAD energy club. He holds a PhD in physics from theSwiss Federal Institute of Technology (ETH) and lectures on the economics of climateadaptation there.

How does Swiss Re approachsustainability? Is it very different as aconcept for a reinsurer, given that bydefinition what you manufacture is atechnical insurance solution, not atangible widget that takes a set numberof carbon units to produce?The key point to grasp is that for everyreinsurer, the nature of the game has to belong-term. You have to take a long-termview of risk, since this is fundamental to theidea of insuring insurers and large corpo-rates against specific risks for moderatelylong periods. Much of what stood againstsustainability—and which the whole sus-tainability effort was partly aimed atredressing—was the myopic dash aftershort-term profits regardless, for example,of long-term environmental damage causedin the pursuit of those profits. Since SwissRe was founded 150 years ago, we’veworked together to find smarter ways tomanage risk sustainably, so that people allover the world can turn pioneering ideasinto reality or get back on track when thingsgo wrong.Risk for us comes in two flavors, both of

which have to do with “sustainability” inthat they are about sustainable growth overtime. First, there is the emergence of newtechnologies and the risks associated withmanaging new technologies, which for usmeans assessing how to provide coverfor these new technologies and theirinherent risks. The second is more directlyassociated with climate change and hasto do with development in hazard-proneareas, such as coastal plains. This is where alot of our focus is and our aim here is tomake societies and communities moreresilient by providing them with natural-catastrophe cover.

“Resilience” differs from“sustainability,” but they imply eachother. A “fragile” society will not bevery sustainable. However, in helpingsocieties to be more resilient you mustlook closely at their exposure toenvironmental risk. I imagine this alsomeans looking at what they must do tomitigate risk?Absolutely. We must have a sustainablebusiness, since we are engaged and com-mitted for the long term. So we have tomake sure that we do not engage intransactions that we would later regret.We use our in-depth knowledge of risk andour capacity to model a wide range ofenvironmental risks to evaluate specificopportunities to see if they fit withinacceptable parameters, or, if they don’t,what would be needed to bring the riskwithin acceptable parameters. It is often nothelpful simply to refuse a proposal. Thebetter approach is to engage in a conversa-tion with the client to see what we wouldrequire to be changed for the risk to beinsurable. Take a ouse that is on the edge ofa crumbling cliff, for example. That is not aninsurable proposition as it stands, but aserious consideration would want to look atwhether the cliff top could be stabilized, orthe cliff supported, perhaps for other reasonssuch as coastal defense that would justify thecost. To explore these kinds of issues weformed the Economics of Climate Adap-tation working group in 2008 with a view toforming partnering relationships with com-munities, cities, and regions There are largenumbers of cities or regions that would be ina better position if they could get some of therisk volatility out of their balance sheets,with much of that volatility coming from thestresses that follow “acts of God.”

The best example of this is the CaribbeanCatastrophe Risk Insurance Facility(CCRIF). The CCRIF is a risk-poolingfacility owned, operated, and registered inthe Caribbean for Caribbean governments.It is designed to limit the financial impact ofcatastrophic hurricanes and earthquakes toCaribbean governments by quickly provid-ing short-term liquidity when a policy istriggered. It is the world’s first and, to date,only regional fund utilizing parametricinsurance, thus giving Caribbean govern-ments the unique opportunity to purchaseearthquake and hurricane catastrophe cov-erage with lowest-possible pricing. TheCCRIF represents a paradigm shift in theway governments treat risk. The facility wasdeveloped through funding from the Japa-nese Government, and was capitalizedthrough contributions to a multi-donorTrust Fund by the Canadian Government,the European Union, the World Bank, thegovernments of the United Kingdom andFrance, the Caribbean Development Bank,and the governments of Ireland andBermuda, as well as through membershipfees paid by participating governments.Sixteen governments are currently mem-

bers of the CCRIF, namely: Anguilla,Antigua and Barbuda, Bahamas, Barbados,Belize, Bermuda, Cayman Islands, Domin-ica, Grenada, Haiti, Jamaica, St Kitts andNevis, St Lucia, St Vincent and theGrenadines, Trinidad and Tobago, and theTurks and Caicos Islands. In 2007, theCCRIF paid out almost US$1 million to theDominican and St Lucian governmentsafter the November 29 earthquake in theeastern Caribbean; in 2008, the CCRIF paid

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out US$6.3 million to the Turks and CaicosIslands after Hurricane Ike made a directhit on Grand Turk; and in 2010, the CCRIFmade a payment of US$7.75 million to thegovernment of Haiti after the January 12earthquake. Swiss Re provides the reinsur-ance for the fund and was instrumental inits establishment.We got together with the World Bank and

others to look at how we could combine tohelp Caribbean communities deal in a betterway with hurricanes and earthquakes in aforward-looking manner, instead of havingthe world community provide aid after theevent. The key here was to find ways ofstructuring the finances of these countries sothat they would be able to get fast access torelief money and to provide an insurancemechanism that would make funds availableto all the affected governments rapidly. Themechanism we came up with means that thescale of the payout is precisely calibrated tothe intensity of the disaster.What this shows is that even if the world

does move into a more unstable, morevolatile phase, if global warming takes hold itwill still e possible to model potential eventsand to plan for them in a coherent fashion.However, we have to engage and develop thedialogue with various regions, cities, andcommunities because if matters are left tolocal insurers, they very often simply do nothave the capacity to deal with the scale ofwhat is being envisaged. We also find thatthere are a great many public infrastructureexposures that are not being insured, andthese too represent opportunities.We have a similar example to the

Caribbean fund that we can point to,namely the Mexico catastrophe bond. Thishas a similar logic behind it, in that if thereis a large earthquake or hurricane, then thebond pays out. This is not reinsured by us,but it was brought to the capital marketsand was very well received by investors. Itmight seem odd that investors would wantto take on the risk of insuring againstcatastrophes, but you have to rememberthat the risk is well-rewarded and that it isnot correlated with any other risk in theinvestor’s portfolio, so it adds considerablyto their diversification.Another strong argument in favor of

investing in catastrophe bonds for manyinvestors is that this is an investment that isa good thing in and of itself. It does good inthe world by helping to make a particulararea or region more resilient and better ableto recover should disaster strike. Manyinvestors want to secure some ethicaldimension for at least a portion of theirinvestment and they can therefore justifythe investment on two grounds: on theprobable returns, and on the fact that this is

an investment that does good. This is wellbeyond aid, in that investors are not justgiving away money. They are entitled to ashare of the profits if things go well andthey have the satisfaction of knowing thatthe fund they are creating will do good ifthings go badly.

Since catastrophe bonds address thecapital markets, what role is there forSwiss Re in this side of thesustainability initiative?There are a lot of technical issues that haveto be overcome in the structuring of acatastrophe bond. Above all, you need it tobe supported by a really good modelingsystem. We do all our disaster modeling in-house and employ some 30 scientists forthis purpose. We are very transparent inhow we go about building these models andwe make them available for studies on theeconomics of climate change, so thatinstitutions, both academic and financial,can understand the economic risks associ-ated with global warming and the additionalrisks of further economic development.Obviously, catastrophe bonds are a very

good innovation in that they bring thecapital markets into play and they broadenthe capital base of the insurance industryvery substantially. However, structuring acatastrophe bond so that it is transparent toall the stakeholders, so that everyone knowswhat the bond’s purpose is when it istriggered, and what their liability is, iscritical. We see a very strong role for SwissRe in structuring these bonds properly, sothat they can be renewed and replenished.The deeper understanding of risk is at thecore of what we do.When you have models of the compre-

hensive risk landscape, you can start toassess the nature of the risk and how youcan reduce and manage it. From a commu-nity’s point of view, they can pinpointspecific actions, such as the impact ofbuilding a dam, or how zoning and buildingrestrictions on certain kinds of land mightreduce risk. Higher standards in building orflood-proofing could be called for. TheNetherlands is an extremely good exampleof how a whole country has dealt withnatural-disaster threats in a very resilient,long-term fashion.

Is your initiative in the directionof sustainability whollydependent on the realities ofclimate change?There is a tremendous body of evidencepointing to climate change being both a factand man-made, Even if all emissions couldbe stopped today, the climate will continueto alter in the coming decades. This means

we need to reduce emissions as quickly aspossible and deal with the impact of climatechange by making our societies moreresilient. We employ a scenario approachto imagine how various futures might look.When you look at the economics of climateadaptation, then you start figuring out whatwould constitute the basket of measuresthat societies need to undertake in order toincrease, strengthen, or at least maintaintheir resilience against possible futurechallenges. Above all, we need to transformour energy and transportation systems. Indoing this we encounter some of thosetechnological challenges I mentioned. Thereare risks, for example, in moving fromtraditional electric grids to smart grids. It isa huge step to take and one that comes witha lot of opportunities and some risks, andwe are willing to take on some of those risksin order to enable the change to happen.There are lots of opportunities, but youneed a deep understanding of the drivingforces and you have to dig through thecomplexity to provide viable solutions. Ourapproach is to collaborate very stronglywith the various stakeholders, since no oneorganization can provide a solution inisolation any more.The global society should do the utmost

to avoid the unmanageable—that is, globalgreenhouse gas emissions need to bedrastically reduced. Only if this is achieved,can the insurance sector help to manage theunavoidable—that is, the increase in riskassociated with a changing climate. Ifmatters are well organized, it is possible tomanage risk at a reasonable cost, with theaim to keep societies resilient and robust.The challenge for some of these societies,particularly low-lying islands, for example,is that if catastrophes happen too often, thepeople become desperate and lose trust ininstitutions and society. The social fabricstarts to unravel, so you need to addressthese matters with quite some urgency. As asingle actor we can by no means provideresilience single handedly; but we do play arole in helping communities to strengthentheir resilience.

MORE INFOSee Also:

Climate Change and Insurance(pp. 149–150)The Impact of Climate Change on Business(pp. 875–877)Viewpoint: Leveraging Influence to ImpactClimate-Change Policy (pp. 696–697)

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“Like other branches of the study of society, economics remains culturally parochial, and its underlying conceptsbased on a few centuries of Western experience.” John Gray

Viewpoint: A Single Currency for Asia?by Amitendu PalitINTRODUCTIONAmitendu Palit is an economist specializing in comparative studies of China and India,international trade and investment, political economy, and public policy. Currently he is asenior research fellow of the Institute of South Asian Studies at the National University ofSingapore. He has a decade’s experience handing macroeconomic policy issues at India’sMinistry of Finance. His latest book is China–India Economics: Challenges, Competition and

Collaboration (Routledge, 2012) and his forthcoming book is on theTrans-Pacific Partnership(TPP) and its implications for China and India. His work has been published in peer-reviewedacademic journals and he writes regularly for India’s Financial Express, China Daily, and TheBusiness Times.

BACKGROUNDAsia’s efforts to move toward a commonregional currency appear to have stalled.Although the Asian financial crisis of 1997created the tempo for greater monetarypolicy and exchange rate coordination inthe region, large heterogeneities in econ-omic structures, policies, and institutionsamong regional economies have preventeddecisive moves to a common currency. Asialacks appropriate institutions for adoptingcommonmonetary policies and moving to asingle currency. The problems faced by theeuro have further diminished the prospectsfor a single currency in the region.The key challenges facing implemen-

tation of a single currency for Asia are:† the Asian financial crisis of 1997, theneed for greater policy coordination, theChiang Mai Initiative, and the AsianCurrency Unit (ACU);

† ASEAN’s centrality in a common Asiancurrency and its lack of enablingconditions;

† the difference in exchange ratearrangements in the region;

† the question as to whether Asia couldeven contemplate a single currency,when the euro faces crisis despitecovering a more homogeneous economicregion.

One of the consequences of the prolongedeconomic contraction and financial down-turn in Europe is the skepticism it hasengendered about the prospects of a unifiedregional currency in Asia. There was a timewhen Asia was seriously considering theprospect of adopting a common currency.But the troubles of the euro have made theSouth East Asian economies wary ofcurrency unification. South East Asia, ormore specifically the ASEAN group ofeconomies, is central to moves toward asingle Asian currency. The lack of enthu-siasm of the ASEAN on a common legaltender for the region underscores the

erosion in credibility that the concept of asingle regional currency has suffered fol-lowing the European crisis.

THE 1997 ASIAN FINANCIAL CRISISAND THE BIRTH OF THE CHIANGMAI INITIATIVEThe beginnings of a common currency inAsia can be traced to the Asian financialcrisis of 1997. The crisis drove home theimportance of greater policy coordinationamong the regional economies, particularlythe large economies of North East, SouthEast and South Asia. These regions com-prise several large economies such asJapan, South Korea, China, Taiwan, HongKong, Singapore, Malaysia, Indonesia,Thailand, and India. Most of these countrieswere affected by the crisis of 1997, thoughnot in equal measure. Economies likeChina and India suffered relatively lessbecause of their limited integration with theglobal financial system. Nonetheless, theurgency of policy coordination was realizedby all the economies notwithstanding thedifference in the degree of the difficulty theyencountered.A major driver of greater policy and

institutional coordination among theregional economies was their disappoint-ment with the policy responses of the IMFduring the crisis. The crisis highlighted theimportance of the region being self-suffi-cient in warding off contagion-type situ-ations precipitated by speculative attacks onnational currencies. This realization gavebirth to the Chiang Mai Initiative (CMI).The CMI created a pool of reserve currencyand extended bilateral credit swaps toparticipating members. The reserve pooland the swaps are intended to help regionalcentral banks to maintain the stability oftheir currencies in the event of speculativeattacks. The CMI has 13 participatingeconomies, which include the 10 ASEANmembers (Brunei, Cambodia, Laos, Malay-

sia, Myanmar, Indonesia, the Philippines,Singapore, Thailand, and Vietnam), China(including the Hong Kong Monetary Auth-ority), Japan, and South Korea. It has beendecided that the current corpus of the CMIshould be doubled, from US$120 billion toUS$240 billion.The move on the CMI was accompanied

by the first steps for forming an Asiancurrency unit (ACU) in the middle of thelast decade. Following the interestexpressed by China, Japan, and SouthKorea in greater coordination of theircurrencies at the annual meeting of theAsian Development Bank in May 2006, theidea of an ACU was formally floated.The ACU is statistically conceptualized asa basket of currencies reflecting the move-ments of various national currencies againsta numeraire currency. This was expected tobe a precursor to an eventual commoncurrency in Asia. However, the move to acommon currency has been sluggish forseveral reasons. Many of these relate totypical features of the region and itseconomies.

IS ASIA READY?On paper, a common currency has severalbenefits for Asia. These include moreseamless integration of trade and capitalflows within the region. This follows fromavoiding costs of invoicing products andservices in different currencies when theycross borders. Apart from cutting trans-action costs of paperwork and procedures, asingle currency also helps traders to avoidthe risks of exchange rate fluctuations.These risks often force traders to hedgeagainst fluctuations by entering into futurescontracts. More predictability and lessuncertainty are clear benefits of a commoncurrency. Given that the region has exten-sive intraregional trade, a common cur-rency should ideally be a welcome option.The early moves toward the ARU

involved China, Japan, South Korea, andthe 10 ASEAN economies. This is theASEAN þ 3 grouping that spans acrossSouth East Asia and North East Asia. Howfeasible is it for the group to work toward acommon currency?The ASEAN is the most cohesive regional

grouping in Asia. But it is different fromthe European Union in several respects.The most important difference, perhaps,is the lack of regional institutions with thecapacity to serve as overarching regulators.The ASEAN secretariat is hardly equivalent

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“In the end we beat them with Levi 501 jeans. Seventy-two years of Communist indoctrination and propaganda wasdrowned out by a three-ounce Sony Walkman.” P. J. O’Rourke

to the European Commission. More impor-tantly, ASEAN does not have the equivalentof a European Central Bank. IndividualASEAN members continue to retain sover-eignty over their monetary policies. Suchsovereigntymust be sacrificed if themove toa common currency is to be made.Progress on a common currency is

inseparable from progress on regionalintegration. The conditions for moving toa common currency must take shape withinthe ASEAN, which is the most visiblestructure of a regional bloc in Asia. IfASEAN cannot produce the enabling con-ditions for a common currency, it is difficultto perceive how the ASEAN þ 3 can do so.This appears all the more difficult given thatSouth Korea, Japan, and China are unlikelyto agree easily on various aspects ofconvergence of their monetary policies andexchange rate management.The EU experience shows that some

members can retain their individual cur-rencies. Those EU members outside theEurozone, such as the United Kingdom,Denmark, Switzerland, and Sweden, havedifferent currencies. Can Asia adopt such asystem? Reproducing the current EU struc-ture with similar features would requirecreating a “eurozone” within Asia. Morespecifically, in the context of theASEAN þ 3, either the ASEAN or a sub-group within ASEAN needs to replicate the“eurozone” by giving up sovereignties onmonetary and exchange rate policies andestablishing a supranational regulator tomanage the group collectively. Such ascenario appears distant within the ASEAN.Themilestones that have beenmentioned

to achieve the ASEAN Economic Commu-nity (AEC) by 2015 do not include steps formoving to a single currency. The planproposes the establishment of a regionaleconomic zone enabling free flows of goods,services, capital, investment, and labor. Butit refrains from proposing more ambitiousplans of monetary policy convergence orestablishing a regional regulator for mana-ging monetary policy and moving toward acommon currency. Indeed, it does not evenpropose the establishment of a parallelcurrency on the lines of the ACU. Similarly,the idea of a common currency does not findmention in other regional economic inte-gration initiatives, such as the one beingpursued by the East Asia Summit.It appears that ASEAN and the Asian

region are not yet ready to embrace the

notion of a common currency. One of themain reasons for the unwillingness isthe heterogeneity among the economies.There are considerable differences withinthe ASEAN economies in the degree ofeconomic development and in their econ-omic structures. The relative differencesincrease if the pool is enlarged to includeChina, Japan, South Korea, India, Australia,and New Zealand. Apart from the obviousdifferences in economic features and thenature of economic institutions, there arenoticeable differences in the economicpolicy management systems as well.One of the best examples of the hetero-

geneity in the region in the context ofa single currency is the difference betweenthe exchange rate systems of the variouseconomies. While most economies followthe floating exchange rate system, there arevariations in the nature of the float. Manyprefer the “managed” float where, despiteallowing the exchange rates of nationalcurrencies to bemarket-determined, centralbanks intervene at periodic intervals toinfluence the values of the currenciesthrough their sales and purchases. Theinterventions are usually influenced bythe desire to control large appreciationsof currencies, which can erode thecompetitiveness of a country’s goods andservices.Indonesia, Malaysia, Thailand, and India

are examples of managed floats, whileJapan and South Korea have more freefloats, in contrast to the “peg” arrangementsof China and Vietnam. In several countriesof South East Asia, such as Cambodia,Myanmar, Indonesia, and Vietnam, the USdollar is unquestionably accepted as thelegal tender. With such wide differences inexchange rate regimes and monetary policyframeworks, moving to a common currencythrough convergence of institutions andsystems is seemingly difficult.

THE EFFECTS OF THE EURO CRISISThe prospects for a common Asiancurrency have received a considerable set-back after the problems experienced by theeuro. The financial crisis in the Eurozone—particularly the difficulties suffered byrelatively smaller euro economies likeGreece, Portugal, and Ireland—has raisedserious doubts over the effectiveness ofcurrency integration in facilitating greaterintegration of trade and investment withina region. If the Eurozone and the euro,

with the Eurozone’s much greater insti-tutional, systemic, social, and politicalsimilarities than the ASEAN þ 3, could notavoid a financial catastrophe, then thepossibility of any such arrangement inAsia is far less likely.Indeed, common currencies can probably

work only if member countries have a lot incommon. There is no denying that non-commonalities among the ASEAN þ 3, andamong the even greater Asian region thatincludes India, Australia, and New Zealand,are too much to even contemplate formaland common exchange management struc-tures. Apart from economic dissimilarities,matters are further complicated by delicatepolitical and strategic dynamics. TheChina–Japan–South Korea grouping, forexample, harbors considerable politicalvolatility. The Eurozone was free fromsuch pressures. Even then, the members’economies are finding it difficult to stick tothe euro.The euro crisis also reveals the import-

ance of institutional support in times oftrouble. The European Central Bank hastried its best to support the affectedcountries. But probably that is not enough.It will be unwise of Asia to contemplate acommon currency unless the regionalinstitutions are strong enough to sustainmultiple bailouts. This will require thegrowth of contingency measures far largerthan the current Chiang Mai corpus.

FINAL THOUGHTSThe outbreak of the global financial crisisand the troubles faced by the euro initiallyraised hopes for the emergence of acommon currency in Asia and its gradualgrowth as a global reserve currency.However, Asia does not appear to beready for currency integration. Severallimitations are hampering a regional cur-rency union, including the large economic,social, and institutional heterogeneitiesin the region. Countries seem unpreparedto converge on common exchange ratemanagement systems and monetary policyframeworks. The region also lacks stronginstitutions for coordinating monetaryand exchange rate policies. The failure ofseveral Eurozone economies to managetheir monetary and fiscal health, despiteoperating in a far more homogeneousregion than Asia, has made the alreadyremote possibility of a single Asian currencyeven more distant.

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“What breaks capitalism, all that will ever break capitalism, is capitalists.” Raymond Williams

Viewpoint: Principles for Responsible Investment—Looking Beyond the Financial Metrics by James GiffordINTRODUCTIONJames Gifford is executive director of the PRI initiative and has been guiding the initiativesince its inception in 2003. He worked with UNEP FI and the UN Global Compact, leading thePRI drafting process, and after the launch of the PRI secretariat in 2006 became its firstexecutive director. He has a PhD from the Faculty of Economics and Business at theUniversity of Sydney on the effectiveness of shareholder engagement in improving corporateenvironmental, social, and corporate governance performance, and a background in IT andenvironmental protection. In 2010 Gifford was named by the World Economic Forum as oneof 200 Young Global Leaders.

What were the origins of the UnitedNations-backed Principles forResponsible Investment (PRI)initiative?The PRI initiative is a network of inter-national investors that work together to putthe six Principles for Responsible Invest-ment into practice. The PRI came out of twoUN agencies: the UN Environment Pro-gramme Finance Initiative (UNEP FI) andthe UN Global Compact (UNGC). UNEP FIworks with banks, insurance companies,and asset managers on environmental,social, and corporate governance (ESG)issues, while the Global Compactencourages organizations to sign up to aset of 10 principles. The Global Compact isthe United Nations’ key initiative oncorporate responsibility. In late 2003 westarted thinking about ways to enable theUN to work more closely with the invest-ment sector, and pension funds in particu-lar, to deliver a more sustainable economy.Our team at UNEP FI proposed thedevelopment of a set of principles focusedon what it would take to create a businesscase for mainstream pension funds andasset managers to engage with sustainabil-ity issues via ESG integration and activeownership.In 2005, the UN Secretary-General Kofi

Annan wrote to 20 of the world’s largestpension funds, inviting them to UN head-quarters in New York to commit todeveloping a set of responsible investmentprinciples. The drafting process took placeover 11 days of meetings with investors andexperts, and the initial six principles werelaunched with some fanfare at the New YorkStock Exchange in April 2006. Within ayear of the launch, about 50 investororganizations had signed up.Today there are more than 1,100 signa-

tories, representing about US$32 trillion ofassets under management, or about 15% oftotal global capital. Interest in becoming asignatory extends beyond the United States

and Europe. We have tremendous support,for example, in Brazil, where more than halfthe total funds under management in thatcountry have signed up. In Korea theNational Pension Service, the fourth largestpension fund in the world, is a signatory,and they are showing real leadership inAsia. Similarly, in South Africa, GEPF, thegovernment employees pension fund, hasbeen a champion in that market. Australiais also very strong, with our signatoriesmanaging half of the funds under manage-ment in that country, including the majorityof its superannuation funds. China, India,the Middle East, and Spanish-speakingLatin America, however, are in early stagesof awareness of these issues.

Sustainability has a range of meanings.How should investors relate to the PRIinitiative?Responsible investment today is very differ-ent from the earlier movement of ethicalinvesting and it is not focused on restrictingthe range of potential investments based onabsolute criteria. The PRI started from thepremise of engaging mainstream investorsand investment processes. Telling investorsthey should restrict themselves to anapproved list was never going to resonatewith fund managers whose priorities are toachieve their benchmark returns. If wewanted to engage mainstream investors onESG issues, it had to be entirely aligned withtheir fiduciary duties and, therefore, had tofocus on the business case.The PRI initiative takes a twofold

approach. First, we encourage investors tolook at ESG issues from a risk andopportunity perspective. The world ischanging very fast. There are hugelyimportant megatrends going on aroundenvironmental shifts, societal develop-ments, and changes in regulatory frame-works and governance; all of these presentchallenges for investors and fund managers.Traditional fund managers have measured

success in terms of a very narrow andshort-term set of metrics, and it is clear thatthere are real risks with that approach.Mainstream investment is increasinglyembracing the view that you need a muchbroader understanding of future valuedrivers and that traditional narrow financialmetrics simply represent the tip of theiceberg, and a deeper analysis of ESG issuescan help to work out what might be underthe water.Investors should therefore look at a broad

range of ESG issues when evaluating andvaluing companies. This does not mean thatyou need some kind of exclusion filter, butrather that you should look at issues such asa company’s environmental performanceand its relationship with its community,and how these may affect its futurebusiness. To understand the potentialimpact of ESG issues on shareholder valueyou only have to look at examples likeLonmin in South Africa, with its laborissues, which have led to a dramaticdestruction of shareholder value. Similarly,it was relatively well known in the industrythat BP’s US division was not managingsafety issues as well as its peers prior toMacondo. Massey Energy in the UnitedStates also had a poor safety record that ledto a dramatic loss of shareholder value.It is a relatively straightforward argument

to make to investors that the companiesthat are going to prosper over the long termare those that manage ESG issues betterthan their peers. We encourage our signa-tories to consider these issues deeplywhen they make investment decisions. Forexample, when you assess two miningcompanies with similar fundamentals, areview of their respective ESG performancecan help to reveal which one may offer thebetter long-term prospect and lower risk.

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“I don’t invest in anything I don’t understand—it makes more sense to buy TV stations than oil wells.” Oprah Winfrey

What is becoming clearer to investors is thatESG issues can have very material con-sequences, and investors have not tradition-ally paid attention to these issues, whichcould drive, or destroy, value for share-holders in the future.

Where does shareholder and investorstewardship fit into this?The Principles themselves (see panel) wereoriginally designed to provide a frameworkaround which to build an active communityof investors sharing best practices and,ultimately, pooling resources and influenceto seek improvements in the ESG perform-ance of investee companies. It was felt thatthis community would only develop, andthe initiative would only fulfill its potential,if the Principles were backed by a dedicatedsecretariat tasked to promote them, buildthe community, and coordinate investorcollaboration. As soon as the Principleswere launched, a secretariat was establishedand got to work, with the strong support ofthe UN partner agencies.Stewardship is the second pillar of main-

stream responsible investment, and activeownership is reflected in Principle 2.The PRI urge investors to take theirstewardship responsibilities seriously.They are part owners, after all, and thatcomes with responsibilities. If not, who willhold management to account? If capitalismis to function and flourish, it needsresponsibility and accountability acrossthe whole agency chain, from companyemployees right through to the owners ofcompanies and their customers and bene-ficiaries. It requires monitoring and thenecessary information flows to make stew-ardship possible. When responsible inves-tors look carefully at the behavior of thecompanies they are holding in their portfo-lios, they will press companies that arenot managing their ESG risks appropriatelyto do so. Investors need to engage thecompanies they hold in dialog, and theyneed to vote at annual general meetings inan informed way. They also need to voteagainst management when they feel thatthe company is on the wrong track, and theyneed to encourage management generallyto be more long-term in its thinking. We doa lot of work with our signatories toencourage the companies in their portfoliosto be world-class in their approach toESG issues.Transparency is another principle

enshrined in the PRI. It goes hand-in-hand with stewardship, and investorsshould ensure that they are getting suffi-cient information from management tohave a clear and appropriate view of thebusiness.

How does the PRI initiativeensure that its signatories areaccountable?The PRI has an annual reporting andassessment process that is mandatoryfor all investor signatories to complete. Wehave compiled good statistics on what oursignatories are doing with respect toimplementing responsible investment, andit is fair to say that there has been increasedactivity with respect to responsibleinvestment.The PRI clearinghouse remains one of the

most important strategic priorities for theinitiative. Its role is to stimulate collabor-ation among large investors with companieson their ESG performance. Using a privateonline forum, investors post proposals forcollaboration with peers to seek changes incompany behavior, public policies, orsystemic conditions, or they simply discussissues of concern. The clearinghouse lowersthe barriers of entry to active ownership andoffers leverage to single institutions thatmay have a “good point” that others maynot have identified. The tool, starting as asimple online bulletin board, has become anactive hub of investor collaboration hostedon a searchable IT platform and supportedby a number of dedicated staff. The PRIsecretariat also works with signatories tocome up with new ideas for collaborationand ensures that they are framed in waysthat are likely to gain as much support aspossible from peers.The clearinghouse is one of the most

active areas of signatory participation, andmore than 350 signatories have joined incollaborations.

How well do companies respond toshareholder concerns?There are generally a number of dialogstaking place, and sometimes the companiesrespond well to shareholder concerns andsometimes they don’t. In the United Statesit is common practice for investors to fileshareholder resolutions when they feelthey are not getting the response theyneed from companies or the attention oftheir boards. In other countries shareholderresolutions tend to be seen as veryconfrontational.Disclosure on ESG issues, which is at the

heart of Principle 3, is key to much of whatwe do, so naturally there is an emphasis onencouraging companies (via their owners)to improve ESG disclosure. Principle 6focuses on disclosure from the investor side,and encourages signatories to communicatewith clients, customers, and beneficiariesabout ESG issues and their approaches toPRI implementation. This includes deter-mining the impact the PRI make on their

investment processes and, ultimately,investee companies.A lot of the work done in the clearing-

house revolves around finding ways toencourage companies to produce systematicdisclosures about their business operationsthat are compliant with recognized frame-works, such as the Global ReportingInitiative or the Global Compact’s Com-munication on Progress.One of the successes of the PRI is that

we have been able to bring investorstogether globally to address collectiveaction issues. Before the PRI, there wasno global forum capable of bringinginvestors together to address these pro-blems across a full range of ESG issues. Aswell as engaging with corporations andindustry sectors, our signatories engagewith governments on specific issues. Inves-tors can encourage and lobby for appro-priate policies, and they can drive voluntaryinitiatives within the corporate and invest-ment sectors.The Extractive Industries Transparency

Initiative, for example, is an initiative thathas been driven both by the UK and othergovernments, investors, and TransparencyInternational, the world’s leading nongo-vernmental anticorruption agency. Thisleverages the power of investors to pushgovernments to sign up to the UN GlobalCompact and to implement reportingrequirements that encourage greater trans-parency on issues such as facilitationpayments and royalty payments.What our reporting and analysis shows

beyond doubt is that the companies thatcreate the most value are those that deliveron these wider objectives. There is a verystrong connection between creating finan-cial value for shareholders and creatingproducts and services that people want,make their lives better, and are alignedwith what society wants. That alignmentbetween financial prosperity and the inter-ests of society as a whole converges overthe longer term. If you take a pension orsuperannuation fund, its obligations to itsmembers extend over a two- to four-decadetime frame, so it has a natural interest inwanting to be part of a long-term productiveenterprise that is delivering value tosociety. This is at the heart of the culturethat the PRI initiative is trying to generate:encouraging investors to invest in pro-ductive enterprises that deliver real valueto society is the classic win–win over thelong term.

Appendix: the UN Principles forResponsible Investment (PRI)As institutional investors, we have a duty toact in the best long-term interests of our

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“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”Warren Buffett

beneficiaries. In this fiduciary role, webelieve that environmental, social, andcorporate governance (ESG) issues canaffect the performance of investment port-folios (to varying degrees across companies,sectors, regions, asset classes and throughtime). We also recognize that applying thesePrinciples may better align investors withbroader objectives of society. Therefore,where consistent with our fiduciary respon-sibilities, we commit to the following:

Principle 1. We will incorporate ESG issuesinto investment analysis and decision-making processes.Possible actions:† Address ESG issues in investment policystatements.

† Support development of ESG-relatedtools, metrics, and analyses.

† Assess the capabilities of internalinvestment managers to incorporate ESGissues.

† Assess the capabilities of externalinvestment managers to incorporate ESGissues.

† Ask investment service providers (suchas financial analysts, consultants,brokers, research firms, or ratingcompanies) to integrate ESG factors intoevolving research and analysis.

† Encourage academic and other researchon this theme.

† Advocate ESG training for investmentprofessionals.

Principle 2. We will be active owners andincorporate ESG issues into our ownershippolicies and practices.Possible actions:† Develop and disclose an active ownershippolicy consistent with the Principles.

† Exercise voting rights or monitorcompliance with voting policy (ifoutsourced).

† Develop an engagement capability(either directly or through outsourcing).

† Participate in the development of policy,regulation, and standard-setting (such aspromoting and protecting shareholderrights).

† File shareholder resolutions consistentwith long-term ESG considerations.

† Engage with companies on ESG issues.† Participate in collaborative engagementinitiatives.

† Ask investment managers to undertakeand report on ESG-related engagement.

Principle 3. We will seek appropriatedisclosure on ESG issues by the entities inwhich we invest.Possible actions:† Ask for standardized reporting on ESGissues (using tools such as the GlobalReporting Initiative).

† Ask for ESG issues to be integratedwithin annual financial reports.

† Ask for information from companiesregarding adoption of/adherence torelevant norms, standards, codes ofconduct, or international initiatives (suchas the UN Global Compact).

† Support shareholder initiatives andresolutions promoting ESG disclosure.

Principle 4. We will promote acceptanceand implementation of the Principleswithin the investment industry.Possible actions:† Include Principles-related requirementsin requests for proposals (RFPs).

† Align investment mandates, monitoringprocedures, performance indicators, andincentive structures accordingly (forexample, ensure that investmentmanagement processes reflect long-termtime horizons when appropriate).

† Communicate ESG expectations toinvestment service providers.

† Revisit relationships with serviceproviders that fail to meet ESGexpectations.

† Support the development of tools forbenchmarking ESG integration.

† Support regulatory or policydevelopments that enableimplementation of the Principles.

Principle 5. We will work together toenhance our effectiveness in implementingthe Principles.Possible actions:† Support/participate in networks andinformation platforms to share tools,pool resources, and make use of investorreporting as a source of learning.

† Collectively address relevant emergingissues.

† Develop or support appropriatecollaborative initiatives.

Principle 6. We will each report on ouractivities and progress toward implement-ing the Principles.Possible actions:† Disclose how ESG issues are integratedwithin investment practices.

† Disclose active ownership activities(voting, engagement, and/or policydialog).

† Disclose what is required fromservice providers in relation to thePrinciples.

† Communicate with beneficiaries aboutESG issues and the Principles.

† Report on progress and/or achievementsrelating to the Principles using a “complyor explain” approach.

† Seek to determine the impact of thePrinciples.

† Make use of reporting to raiseawareness among a broader group ofstakeholders.

MORE INFOWebsites:

Extractive Industries Transparency Initiative (EITI): eiti.orgPrinciples for Responsible Investment (PRI): www.unpri.orgTransparency International: www.transparency.orgUnited Nations Environment Programme Finance Initiative (UNEP FI): www.unepfi.orgUnited Nations Global Compact (UNGC): www.unglobalcompact.orgUnited NationsGlobal Compact “Progress &Disclosure” section—includes page on the annualCommunication on Progress (COP) reporting: www.unglobalcompact.org/COP/

See Also:

Ethical Funds and Socially Responsible Investment: An Overview (pp. 481–483)Viewpoint: Green Investing—Looking beyond the Financial Metrics (pp. 492–493)Viewpoint: Outperformance through Ethical Lending (pp. 546–548)

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“Those who invest only to get rich will fail. Those who invest to help others will probably succeed.” Art Fry

Viewpoint: The Companies Bill, 2012, and its Impacton the Future of Corporate Social Responsibility inIndia by Sudhir Singh DungarpurINTRODUCTIONSudhir Singh Dungarpur is partner and head of the development sector practice at KPMG inIndia. He has over 18 years’ global experience working in both start-ups and largemultinational corporations in the areas of technology, education, and consulting. Sudhir’sstrength lies in developing new businesses and he has successfully built new divisions andbusinesses in highly competitive environments. Building strong relationships and networks,a clear control onmarket dynamics, and creating the best teams has ensured that Sudhir hasdelivered consistent results in growth, revenue, operational performance, and profitability.

BACKGROUND TO THE INDIACOMPANIES BILL, 2012The peril of socio-economic inequality hasbecome an urgent priority in India,especially over the last decade. Inequalitiesvary from region to region, between ruraland urban populations, between social andethnic groups, and most obviously betweenthe rich and the poor. It is in recognition ofthese challenges that the Indian governmenthas repeatedly articulated its commitmenttowards “inclusive growth.” There has alsobeen a widespread recognition that criticalto the push towards “inclusive growth” is theparticipation of a wide range of stakeholdersin designing, financing, implementing, andevaluating development interventions.With the Companies Bill, 2012, passed in

the Lok Sabha in December 2012, discus-sions on its impact on corporate India havebeen gathering steam. The Companies Billstates that companies with a specified networth, or turnover, or net profit during anyfinancial year shall constitute a CorporateSocial Responsibility Committee of theboard of the company, and, accordinglydecide the strategy and spend on corporatesocial responsibility (CSR) activities.In this article, I outline the opportunities

for CSR in India and the priorities on whichcompanies should focus in the new regulat-ory regime. Companies should view this asan opportunity to expand their scope andreach towards society at large, by trans-forming themselves into model corporatecitizens. This may very well be achievedthrough a strategic approach towards CSRand by incorporating rigorous standards ofeffectiveness in the projects funded as partof its CSR interventions.

CORPORATES AND INCLUSIVEGROWTHIndia ranked a lowly 134 out of 187countries in the UN Human DevelopmentIndex 2011, with 30% of its population

estimated to be living below the povertyline. Over the last decade therefore addres-sing socio-economic inequality has becomean urgent priority in India. In its endeavorto counter this inequality among citizens ofthe country, the Indian government hasinitiated various social-sector schemes ineducation, public health, food security, andlivelihood support in order to reach out tothe poorest of the poor and facilitate theirsocio-economic development. At the sametime, there has been a widespread recog-nition that critical to the push towards“inclusive growth” is the participation of awide range of stakeholders in designing,financing, implementing, and evaluatingdevelopment interventions.The society looks at the corporation as a

social organ for wealth creation. Peter F.Drucker had in the 1950s eloquently saidthat “even the most private of businessenterprise is an organ of society and serves asocial function . . . the very nature of themodern business enterprise imposesresponsibilities on the manager . . . it canno longer be based on the assumptions thatthe self-interest of the owner of propertywill lead to public good, or that the self-interest and public good can be kept apartand be considered to have nothing to dowith the other.”There is a growing consensus that

companies are expected to contribute tothe welfare of the society in which theyoperate and wherefrom they draw theirresources to generate profits. To meet itsgoal of inclusive growth, the Indian govern-ment has mandated CSR for all companies,including the private sector, through astatutory provision in the Companies Bill,2012. This is a significant step by thegovernment, given that in most developedeconomies there are hardly any jurisdic-tions mandating an allocation towards CSR.By and large, it is a voluntary initiative bythe corporate sector. And while in countries

like Denmark, Sweden, and France report-ing on CSR practices is mandatory, invest-ing in CSR is not.

INDIA’S COMPANIES BILL, 2012AND THE EMPHASIS ON CSRSection 135 of the Companies Bill, 2012mandates that companies having net worthof INR 500 crore (circa US$100million) ormore, or turnover of INR 1000 crore (circaUS$200million) or more, or a net profit ofINR 5 crore (circa US$1million) or moreduring any financial year shall constitute aCorporate Social Responsibility Committeeof the board constituted of three or moredirectors, out of which at least one directorshall be an independent director. Thissection also directs the committee to:† formulate a CSR policy;† allocate funds;† monitor the progress of the CSRactivities.

The Companies Bill, 2012, further directscompanies to ensure the expenditure of atleast 2% of the average net profit madeduring the three financial years immediatelypreceding the current year, or to specify thereasons for not spending the amount as partof the board’s report to the financialstatement.The Bill therefore attempts to make CSR

a sustained and systematic activity by:† mandating the presence of anindependent director, therebyencouraging companies to bring inpeople with specific social-sectorexpertise and an objective outlook;

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“Leaders are almost likemidwives of ideas. They really understandwhat is going on. You knowwhen you come to themwith an idea, they aren’t going to just say, ‘Well, that’s nice, and maybe we can use that.’”Warren Bennis

† formulating a comprehensive CSR policyas a strategic engagement, and not anepisodic charitable activity;

† encouraging companies not only toallocate funds for CSR, but also tomonitor (and evaluate) progress andoutcomes.

IMPLICATIONS FOR COMPANIESThe new CSR model has moved away fromsimple social concerns to a model in whichgenerating value for both the society and forthe companies go hand in hand. Currently,barring a few notable exceptions, CSRlargely comprises voluntary initiatives bycompanies. One has to recognize thatcompanies have to worry about theirbottom line and, therefore, they may notsee this as an obligation. The CompaniesBill provides an opportunity for companiesto develop social businesses and to integrateresponsible business activities by makinguse of 2% of their profits. However, inestablishing a sustainable CSR architecture,there are many issues that need to beconsidered. Three critical ones are set outbelow.† Identifying Opportunities forInvesting in Strategic CSR: In theemerging regulatory regime, companiesmust make the transition from voluntary,sporadic, CSR activities to a strategicCSR roadmap. The Companies Billidentifies a number of areas (mostly onthe lines of the Millennium DevelopmentGoals (MDGs) and supporting localprojects and contributions to relieffunds) from which companies canchoose. At the same time, companiesmust ensure that CSR is strategic—thatthe CSR activities selected are alignedwith the corporation’s core competenciesand businesses. This will requireprofessionals, internal and external, whocan design programs that have a long-term vision, are mutually beneficial forthe company and the local community inwhich it operates, and are in tune withthe country’s priority for inclusivegrowth.

† Delivery Mechanisms for CSR:Broadly, companies can be guided bythe provisions in the bill, which allowCSR spending as per the priorities thatare in line with the MDGs. At the sametime, companies also need to determinehow CSR is best done. Is CSR to beundertaken through activities manageddirectly by the company (employeeengagement or a corporate foundation),or through supporting non-governmentorganizations (NGOs), and promisingdevelopment interventions? TheCompanies Bill propels macro-level CSR

to become a core business function thatis central to the corporation’s overallstrategy and success. At the micro level,companies will need to formulate arobust governance structure for theirCSR programs.

† Making Visible Impact by Doing“Good”: It is clear that companies thattake up CSR activities will do so with adual objective—that of doing good to thesociety at large, while at the same timegaining visibility for the impact itachieves. Critical to this is the ability tomonitor and measure outputs andoutcomes of development projects. As forany business investment, monitoring theaccountability and performance of CSRactivities is the key. For example whenbuilding a classroom in a village school,one should assess whether theinvestment has translated into anincrease in enrolment and animprovement in learning. Also, without arobust monitoring system it will bedifficult to ascertain where furtherinvestments are needed, whether there isvalue for money, and value-creation forthe communities supported, and, mostimportantly whether the 2% hard-earnedcontribution is leading to the largerinclusive development agenda of thenation.

IMPACT MEASUREMENT: NEWPARADIGMSToday, those investing in India’s develop-ment sector are under increasing pressureto demonstrate the social impact createdthrough their activities, in a language easilyunderstood by different groups of stake-holders. This applies to companies as theyseek to create value through their CSRactivities, while seeking to report the impactthey create accurately. All around us, we areconstantly seeing traditional social-impactmethodologies being challenged, as greateremphasis is placed by decision-makers onshowing value-for-money and understand-ing "return on spend" in monetary terms.For companies, this implies measuring

and reporting “return on investment,” anidiom that appeals to the judgment ofcorporate boardrooms. In this context, theimpact-measurement tools used must beinnovative, combining rigor with smartreporting. I believe that the importantcharacteristics of an impact-measurementtool should be the following:† a tool that monetizes social,environmental, and financial outcomesof a development-sector project orprogram, organization, or even apolicy, through a combination of Returnon Investment (ROI), Cost-Benefit

Analysis (CBA), Opportunity CostAnalysis, and so on;

† a participatory tool, and it uses financialproxies to uncover the value of alloutcomes, including those that do nothave direct market values, and which areoften left out of traditional impactassessments;

† a tool that goes beyond a quantitativeindicator and gives a narrative—of how aproject, program, organization, or policycreates and destroys values in the courseof implementing a development project.Further, it must explore the processesand mechanisms by which it attempts tocreate an impact, thereby yieldinglessons for both internal and externalstakeholders.

Using impact-measurement tools that bringtogether the characteristics outlined aboverequires commitment towards measure-ment and reporting. Companies mustrecognize the benefits that accrue from theuse of a robust and comprehensivemeasurement framework. Some of theseare as follows:† Gaining a clear understanding of thewider impact: Impact measurementcan help understand and account forthe wider impact of the work being doneas a result of the CSR spend by thecompany. It further fine-tunesunderstanding of the potential and actualimpacts.

† Clear communication of impact: Impactmeasurement can help to communicateto the stakeholders the value created bytime and money invested in thedevelopment of interventions in aconsistent, robust, and rigorous way(this may be to board members,shareholders, funders, or beneficiaries).It will show others how valuable theinterventions are.

† Refinements and improvements: Impactmeasurement can reveal potentialrefinements and improvements to enablethe company to take informed decisionsand support better design, planning, andimplementation.

† Informed decision-making: An impactmeasurement analysis can provide astrong basis for internal and externalstakeholders to make decisions regardingfunding, thus assisting them to recognizeimpact in a language that theyunderstand.

† Stronger partnerships with stakeholders:Impact measurement can help to developa strong ongoing relationship anddialogue with stakeholders, particularlybeneficiaries. Using impact measurementshows beneficiaries that their needs andconcerns are being addressed.

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† Profile raising: Using impactmeasurement can provide adifferentiator for an organization tryingto raise itself above its competitors.

† Risk management: All of the abovefactors ultimately support good risk-management practices.

CONCLUSIONIt is advisable that companies view this newregulatory regime not as a constraint, but asan opportunity to expand their scope andreach by transforming themselves intomodel corporate citizens. This can beachieved through a strategic approachtowards CSR and by incorporating rigorousstandards of effectiveness in the projectsfunded as part of its CSR interventions.Evaluating CSR programs using rigorousimpact-measurement tools can bring a lotof value to companies. It provides a solidfoundation with which to communicatesimply and effectively CSR results to theboard and to other stakeholders. Ulti-mately, to be ahead in the game, companiesmust not only engage in strategic CSR, butthey must also demonstrate how theirinvestments are creating sustainable valuefor the society at large.

MORE INFOBook:

Drucker, Peter F. The Practice of Management. New York: Harper, 1954.

Websites:

India Companies Bill, 2012: www.mca.gov.in/Ministry/pdf/The_Companies_Bill_2012.pdfUN Human Development Index: hdr.undp.org/en/statistics/hdi/UN Millennium Development Goals: www.un.org/millenniumgoals/

See Also:

CSR: More than PR, Pursuing Competitive Advantage in the Long Run (pp. 664–666)Viewpoint: The CFO and the Sustainable Corporation (pp. 719–720)Viewpoint: Embedding CSR and Sustainability in Corporate Culture: The Boots Experience(pp. 671–672)Viewpoint: The Growth of Sustainability Reporting (pp. 680–681)India (pp. 1505–1507)

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“Capitalism is at its liberating best in a noncapitalist environment. The crypto-businessman is the true revolutionary ina Communist country.” Eric Hoffer

Viewpoint: Leveraging Influence to ImpactClimate-Change Policy by Mark KenberINTRODUCTIONMark Kenber is CEO of international NGO The Climate Group. He has worked on climatechange for fifteen years and is an expert on international climate policy. Before becomingCEO, he was The Climate Group’s deputy CEO (2010) and international policy director(2004–10). Mark advised former UK Prime Minister Tony Blair in the joint policy initiativeBreaking the Climate Deadlock. He is also a carbon markets expert and cofounded theVoluntary Carbon Standard (VCS), now the most popular kitemark for the US$400 millionvoluntary market. He continues to be involved as deputy chair of the VCS Association. Priorto joining The Climate Group, Mark worked forWWFand Fundacion Natura, Ecuador’s largestenvironmental organization. Mark currently sits on the Climate Change Advisory Council atZurich Insurance (since 2009), BP’s targetneutral Assurance and Advisory Panel (since2007), the Climate Policy Editorial Advisory Board (since 2005), and the InstitutionalInvestors Group on Climate Change Steering Committee (since 2005). Mark has a degree ineconomics and an MPhil in development studies.

The Climate Group’s mission is to useits ability to influence positive actionon climate change wherever it sees theopportunity. How did this initiativebegin?In mid-2003 Michael Northrop, ProgramDirector at Rockefeller Brothers Fund, wasconcerned that the United States had pulledout of Kyoto. He wanted to ensure that noteveryone in the United States got tarred withthe same brush, and to show that there wasreal concern in the United States about thepotential adverse impacts of climate change.However, he also saw clearly that for UScompanies toparticipatepositively in actionsto alleviate climate change, the fundamentalthrust had to switch from one that viewedclimate-change initiatives as a cost burdenon companies to one that saw it as anopportunity. As a result, The Climate Groupwas launched in April 2004 with the simplemission to change the perception of climatechange from burden-sharing to opportunity.The key to doing this was—and continues tobe—our ability to demonstrate in projectafter project that specific climate-changeinitiatives bring real benefits to the partici-pating parties. One of our earliest initiativeswas the C40 Network, a network of 40 of theworld’s most populous cities, all committedto pushing through initiatives to lower theircarbon footprint as cities and to look at waysof making their cities runmore efficiently byutilizing and disseminating best practicebetween themselves.The C40 Network became independent

and now runs its own affairs, but it all beganwhen Ken Livingston was the Mayor ofLondon, about the time of the G8meeting in2005. We worked with the office of theMayor of London to produce an initial C20groupof global cities, but it grewvery rapidly

from there. Now, despite the name, whichhas stuck, the C40 Network has around 60city members that exchange best practiceand support each other. That is a pretty fairindication of the kind of project that TheClimateGrouphas beenactive in promoting.Our aim is always to find interaction pointswhere a combination of our own network ofmembers and interested parties, and ourcombined skills can have the biggest impactin promoting action on climate change.

The C40 Network was a veryimpressive initiative. What werethe others?We created the Verified Carbon Standard(VCS). This too, is now a fully independentorganization on whose board I sit. VCS wasfounded to provide a robust quality-assur-ance standard that various projects coulduse to quantify greenhouse gas (GHG)emissions. The program is still evolving tomeet the needs of themarket, but itsmissionis to provide a trusted, robust, and user-friendly way of bringing quality assurance tovoluntary carbonmarkets. It aims to pioneerinnovative rules and tools that open up newavenues for carbon crediting and that willallow businesses, not-for-profit organiz-ations, and government entities to engagein very specific, measurable climate action.The aim too, is to share knowledge and to

encourage the uptake of best practice incarbon markets, so that markets developalong coherent and compatible lines, even astop-down regulations are being developed.Another major project of ours, one that is

still very much in play, is the light-emittingdiodes (LED) street-lighting scheme. TheLED street-lighting campaign started whenwe realized that while consumers were takingup LED lighting and enjoying very substantial

savings, as well as lowering the overall carbonfootprint of their homes, this was simply notthe case in many public spaces. Streetlighting, which can be very successfullyaddressed with LED lighting, was simplybeing ignored and the opportunity was notbeing adopted. So we formed a working partyto look at the barriers to take-up and to lookat how we could overcome such barriers asthere were out there. The opportunities werehuge, and ranged from Sydney, to CentralPark in New York, to Calcutta. We looked tosee if we could come up with a model thatwould enable 15 pilot projects in 12 majorcities to be scaled up their take-up.The first problem any city fathers face is

that initially it costs more, since the upfrontcosts for LED lighting are higher than for asodium bulb, for example. But what wesought to impress upon city authorities wasthat you get the costs back over two to threeyears, and youmake very substantial savingson your power usage, and you enjoy asignificant lowering of your carbon foot-print. Another problem that we faced,straight away, was that the quality of a lightbulb has for decades now been measured bythe amount of electricity it consumes. So weexpect a 40Wbulb to be dimmer (that is, of alower quality) than a 100W bulb. Moreover,if you measure yellow light instead of whitelight, more often than not the instrumentsthat youareusingarenot suited to givingyouan accurate view of the quality of the lightoutput of the yellow LED. The way in whichwe addressed this issue in Calcutta, forexample, was first to have a pilot scheme of150 LED street lights and then to do surveysof the views of women and children whowere using an LED-lit park. What emergedwas that they felt significantly safer with theLED lighting. That was very interesting.

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“Conservation is business too.” Gaston Vizcarra

Calcutta is now negotiating a loan to scale-up its project from 150 LED bulbs to 15,000bulbs, and Sydney has committed itself tofull LED street lighting. To summarize thisproject, our undertaking of pilot studiesallowed city authorities to see in a tangibleway the realities and the benefits of LEDlighting. This now has some momentum ofits own, so we are not planning and do notintend to do anymore pilot studies.Whatwedo now is to help a few states to prepare theirtenders for LED street lighting, but we feelquite confident that we have done our bit interms of demonstrating and catalyzing thepotential out there.

One still meets global-warmingskeptics out there, including somescientists. They are headed in adiametrically opposed direction to yourinitiatives. What do you say to them?We are aware that a “rubbishing-climate-change” lobby exists. I have been in debateswith exponents of this view over the years, butin reality theirs is not a serious voice. Theoverwhelming scientific and anecdotal evi-dence points to the fact that climate change ishappening and happening because of ourindustrialization. What we try to emphasize,however, is that irrespectiveofwhether youarea believer or a skeptic on climate change, theopportunities that come from shifting to amore carbon-conscious framework have apositive internal rate of return,with orwithoutclimate change. A lot of the things that havebeen done, such as the LED-lighting initiativeare good in and of themselves. The LED bulbssimply produce a better quality of light and aremore power-efficient. A shopkeeper in Cal-cutta, for example, told us that switching fromthe old sodium lights to LEDs made hisproducts look fresher to potential purchasers,sohesoldmore!The fact is that there isawholerangeof things that it isabsolutely important todo, including transitioning from an oil-basedeconomy, even if the whole climate-changeissuewasproved tohavebeenmisconceived.Alot of what we do concerning low-carbonsolutions have very positive immediatereturns, create profits by doing things moreefficiently, and lead toabetter life.Theclimate-change argument is not necessary tomake thisworthwhile. There are other projects, ofcourse—such as carbon capture and storage—that cost a huge amount of money toimplement and you need to have a broadconsensus on the importance of introducingfairly dramatic measures to combat climatechange if you are going to get these projects tohappen.Our role, however, is not to arguewiththe skeptics. We focus on categorizing themany opportunities that do exist.What we have seen, without a shadow of

doubt, is that if you look at climate-related

insurance claims in the 1980s and comparethem to recent levels of claims, it is clearthat climate-related claims have gone upsix-fold in three decades. Then there is thedrought effect in many countries that hasbeen predicted as one of the consequencesof global warming. Drought cost 1% of USGDP through 2012, and those sorts ofthings are pretty consistent with what thetheory of global warming says we shouldexpect. The overall pattern is very con-formant with what the IntergovernmentalPanel on Climate Change’s (IPCC) climate-change model says should happen.However, if you just take it down to

common sense and look at it from thepositive side, every additional dollarinvested in clean energy can generate threedollars in future fuel savings by 2050, sothere are a lot of areas where carbonreduction makes real economic sense,whatever your views on climate change. Ahouseholder with a well-insulated house, forexample, has a more comfortable house andone that costs less to heat, and in a worldwhere energy bills are going up year on year,that matters. There are numerous examplesof this at city and at state level. If you live inBeijing, for example, and have to put upwithparticulate matter that is 40 times higherthan the World Health Organization rec-ommends it is palpably clear that therewould be strong collateral benefits toreducing the city’s level of carbon pollution.

Howdoyougo about giving structure toyour work when it is so project-based?We split our work into two parts. The firstpart involves the strategic communicationsdimension. This looks at the way you canchange themindset of political and businessdecision-makers on issues such as givingleadership on low-carbon initiatives, onrenewables, and on investment programs.Already it is clear that companies that take aleadership position on green strategies aremore successful than their peers. A study bythe Harvard Business Review showed thisquite clearly. We now have just over 40corporate members of The Climate Groupand 60 state and regional members. We alsowork with a number of cities and we haveother institutional partners, ranging fromThe World Bank to the European ClimateCommunity. There is a whole range oforganizations that we work with to identifyblockages and barriers to low-carbon initiat-ives and to see where there are significantlow-carbon opportunities that are not beingtaken up. Then, the second part of our workkicks in and we form a project that helps toovercome those barriers and blockages.For example, it is clear that there are

significant barriers still in the way of a wider

take-up of electric vehicles. So we are lookinginto the feasibility of fleet-goods ownersforming a procurement alliance to bringdown the cost of electric vehicles to theirmembers. Another factor here is looking atpredictable short routes, so there is no anxietyabout power running down and no rangeanxiety. The fleet charges up at the depot, sothere are no refueling issues associated withthe absence of recharging stations for electricvehicles. The aim is to choose the battles thatwe fight fairly carefully and to bring ournetwork of partners together to help identifyopportunities and problems. It is a verypragmatic approach and has real successes topoint show.

What else are you working on now thatholds out significant promise?Weare currently looking at the policy barriersto using IT to accelerate and scale-up energyefficiency and clean energy. We are looking,for example, at the way cities and corporatesprocure their energy solutions and at the waythey use IT to run sustainable-energypartnerships. Right now we are pretty well-known in the climate-change space and in thesubset of the corporate community that isalready well-engaged with sustainabilityissues. However, the challenge is to buildrecognition beyond this space. That is truenot just for us, but for many climate-changeorganizations who are looking at how toresonate outside their established niche. Oursolution is to seek continuously to partnerwith organizations that are not yet part of theclimate-change space. There actually is atremendous willingness by people who arenot committed climate-change activists to getinvolved. The Climate Group hosts ClimateWeek NYC every year, which is a series ofevents, and in 2012 it was astonishing to seehow many sectors and communities—fromfarmers’ organizations to veterans’ groups, tobankers and electricity companies—wereinvolved. They were motivated by a verywide spectrum of reasons, and it is veryencouraging to see just howmuch energy andwillingness there is out there, waiting to betapped.

MORE INFOWebsites:

TheClimateGroup:www.theclimategroup.orgVerified Carbon Standard (VCS):www.v-c-s.org

See Also:

Climate Change and Insurance(pp. 149–150)The Impact of Climate Change on Business(pp. 875–877)

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