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The contribution of the FTSE4Good Index to socially responsible investment

In a fast moving world, individuals and organisations need to make quick decisions based on sound judgement supported by accurate data. As a result, one of the most important products in the modern world is reliable, up-to-date information. Governments, businesses and individuals all depend on it.

This is particularly true for companies working in the financial markets. The markets provide a range of investment opportunities offering varying returns. Individual investors and financial institutions need to compare alternative opportunities in order to make the ‘best possible decisions about purchasing and holding financial securities. They also need to know that the financial securities they hold meet their individual investment criteria e.g. for high growth rates, low risk, or only in reputable, socially responsible companies.

This case study examines the work of FTSE Group, one of the world’s best-known data providers. FTSE manages over 20,000 financial indices including its best-known product: the FTSE 100.

This case study focuses on one of FTSE’s key index series, the FTSE4Good Index Series. Through the setting of criteria for companies to gain entry to these indices, FTSE has played a significant role in the debate over corporate responsibility and encouraged companies to consider their obligation to adopt socially responsible practices.

Index values are used to show how a particular average figure changes over time. For example, the FTSE 100 Index sets out the average figure for the value of a basket of the shares of the top 100 UK companies quoted on the London Stock Exchange (LSE). This index serves as a useful indicator of how the UK economy is performing. A rising index signals investors’ increasing confidence in the outlook for business.

Another important indicator for the UK economy is the FTSE All-Share Index. This covers around 90of the UK market. The average of share prices in these companies is compared against a base year that was given a figure of 1,000. If today the figure is 3,000 this shows that, on average, share prices in these companies are three times higher than in the base year. Investors can examine the index daily to see if it is rising or falling. A rising index is a good indicator of increasing confidence in the companies that the index covers.

Investors will want to compare the performance of one index with that of another. For example, a comparison to see if the FTSE 100 Index is performing better than an:

  • index of shares in American companies
  • index of shares just in a particular market sector (e.g. oil or telecommunications).

In addition, investors will want to compare the performance of shares of a particular company in an index against the overall index e.g. how are the shares of Marks and Spencer (a company in the FTSE 100) faring compared with the FTSE 100 whole?

Being sufficiently large or important to be included in an index is a key status symbol for a company. It also provides increased investment in the shares of a company due to index following by investors. Senior managers will seek to maintain the performance level required for continued inclusion because of these reasons. Rising companies can enter the index and others leave it in the course of time as witnessed by the rise and fall of a number of prominent dotcom companies during the boom and subsequent ‘bust’ of some of these companies at the turn of the millennium.

FTSE produces many different global indices of company shares e.g. by region or by the industrial sector. Companies included in these indices are public companies – their shares can be traded on a stock exchange. The origins of the public company may have been as a sole trader. As they grow, sole traders may incorporate to become private limited companies.

Incorporation gives owners limited liability. If the company cannot pay its debts from its own funds, creditors cannot force the owners to repay the money from their personal funds. Owners of private companies may eventually decide to ‘go public’ and arrange a public issue of shares in order to raise large-scale funds for the company to continue its growth. Once issued, these shares can be traded on a stock exchange.

In these public companies, shareholders’ liability is also limited; they stand to lose only the sum they have invested in shares. Shareholders can monitor the performance of their investment against benchmarks like the FTSE 100.

The process of business growth is essential to a dynamic modern economy. Small businesses are the most numerous within the UK economy, but it is the large public companies (owned by shareholders) that employ the highest percentage of employees in the UK and who make, by far, the largest contribution to national output. By offering shares to the general public, these companies can fund their growth.

FTSE Group is a world leader in the creation and management of equity indices and associated data services. It manages and develops globally recognised indices ranging from the FTSE All-World Index to the recently launched FTSE4Good Index Series. FTSE is owned by The Financial Times and the London Stock Exchange. FTSE became a limited company in 1995, although it has calculated indices since the 1930s. FTSE rose to global prominence in 1985 when it created the FTSE All-World Index to provide an index of prominent shares from across the globe.

By providing independent indices for clients in nearly 80 countries, FTSE offers the means by which pension providers, investment banks, brokers, stock exchanges and fund managers can monitor financial products relative to particular indices. This enables customers to measure the performance of their investments against an independently measured index. For example, individuals who contribute to a pension plan which is invested in a portfolio of shares in the FTSE 100 Index can keep a regular eye on how their future pension is performing by examining the FTSE 100 Index in their daily newspapers, TV or the Internet.

FTSE benefits from its trademark; the FTSE name is recognised throughout the world. FTSE has copyright over the company information it collates into an index. FTSE gains its revenue from selling licences to companies that wish to use selected indices to inform their own investment decisions and enhance their own management performance.

FTSE also gains revenue from licensing indices to companies who want to sell investment products that feature FTSE index names. For example, investment ‘tracker funds’ are designed to track a particular FTSE index – they are tied to the average performance of the market sector to which they relate. In addition, the company licenses the use of its indices to the media e.g. websites that want to quote FTSE indices as part of the data they provide.

In February 2001, FTSE launched a new family of indices named FTSE4Good. These are designed to help create a global standard enabling investors to identify and measure the performance of companies who practice a recognised, acceptable standard and social behaviour. Investment in ethical and socially responsible funds had grown rapidly. FTSE responded to this investor interest by creating the FTSE4Good Index. Additionally, in July 2000 the UK government set out a new requirement that occupational pension funds must state in their investment policies the extent to which they take account of ethical, social and environmental issues in investment.

Today, it is particularly important that companies operate in a socially responsible way. Investors and other key stakeholders in companies are increasingly concerned that the companies in which they are involved behave in an ethical way. To be included in the FTSE4Good Index a company must meet a number of important criteria. Research indicates that over 50of companies in the four regions (UK, Europe, US and Global) to which an FTSE4Good Index applies do not today meet the criteria. The creation of the new indices indirectly puts pressure on companies excluded from the index to change their ways and so become eligible for consideration for inclusion in the index.

The FTSE4Good indices have been developed in conjunction with the Ethical Investment Research Service (EIRIS). EIRIS is the UK’s leading independent provider of research into the social, environmental and ethical performance of companies and has partnerships with similar organisations all over the world.

For inclusion in FTSE4Good, companies need to satisfy standards in three types of criteria:

  • Environmental criteria
  • Social and stakeholder criteria
  • Human rights criteria.

These criteria address three key questions:

  • What is the company doing to protect the environment?
  • How well is the company safeguarding the interests of the society in which it operates and the interests of its stakeholders e.g. employees, suppliers and customers?
  • How far does the company comply with the requirements of human rights legislation?

The criteria for inclusion in FTSE4Good is detailed, but important features are that:

  • They are more demanding in sectors that are likely to have a higher impact e.g. agriculture and chemicals have a higher impact on the environment than most media and entertainment companies
  • They relate to company policy, management and reporting arrangements
  • They are challenging but achievable standards and will continue to get tougher for companies to meet.

The process through which companies qualify for inclusion in the FTSE4Good indices

The requirements are tough. To meet the environmental criteria, for example, a high-impact company (e.g. a paper mill or fast food chain) must have:

  • a detailed environmental policy covering all parts of the company
  • an effective system for managing the environment
  • reporting procedures that provide data on environmental indicators.

A further key benefit of the FTSE4Good Index is that all licensing revenues are being given to UNICEF. FTSE has supported UNICEF for a number of years and is now working closely with this global children’s charity. In the first year following the launch of FTSE4Good, licensing revenues raised US$1 million for UNICEF. For FTSE, further benefits of the new indices have been increased involvement with the companies included in the index and increased awareness of ethical issues. FTSE’s staff have benefited from the opportunity to work with UNICEF, creating a greater sense of achievement and motivation for all involved. FTSE has also benefited from positive coverage in the media and has been able to engage with governments through this project.

The modern global economy relies on information systems that enable appropriate decision-making. FTSE provides innovative indices and data services to assist global investors to develop successful investment strategies. In a world in which social responsibility is essential to all our futures, the FTSE4Good indices of socially responsible companies are more important than ever.