Corporate social responsibility (CSR) can be defined as the voluntary integration of environmental, social and human rights considerations into business operations, above and beyond legal requirements and contractual obligations. In a recent speech Malcolm Wicks, the UK's energy minister and minister with responsibility for CSR, said, "Successful companies will be the ones that continually seek to raise their game and take a responsible approach to all their activities ... these activities contribute to a kind of triple bottom line: ecological, financial and social.

Business case for CSR

Over the last decade, the importance of CSR grew steadily. On the one hand, it was driven by the increasingly evident business case for CSR: a good CSR record and listing on sustainability indices can give a competitive edge vis-a-vis other market players; give access to finance; open up new markets (such as the fairtrade, organic, certificated timber markets); bring reputational advantages; and facilitate greater employee satisfaction and therefore retention.

On the other hand, the roots of this growth can also be found in the increasing realisation that companies can, and do, have a major impact on the environment and society. As the pressures on global water, land, biodiversity and other natural resources grow due to rising population figures and growing development, and as climate change becomes a more immediate threat, the role of corporate entities in addressing and tackling such pressures becomes increasingly important, and their scrutiny by non-governmental organisations and other stakeholders more likely. Similarly, companies' approaches to human rights and poverty issues can no longer fall outside the scope of public scrutiny as such issues gain increasingly frequent publicity and media exposure.

There are three key areas in which CSR will be of relevance to corporate entities: corporate governance, social and environmental impact and socially responsible investing. The major initiatives in each area are summarised below.

Corporate governance: In a number of jurisdictions, legislation or government guidance regulates the appointment and composition of the board, audit and remuneration committees (eg Sarbanes-Oxley in the US; and the Combined Code on Corporate Governance in the UK);

Social and environmental impact: A number of CSR initiatives have been formulated by governmental and non-governmental organisations at national, regional and international levels. In the UK, for example, the reintroduction of the Operating Financial Review into the Draft Companies Reform Bill may mean that listed companies will soon be legally required to prepare an analysis of their key objectives, strategies, resources, risks and uncertainties, including their impact on the environment, information about the employees and social and community issues, using key performance indicators. At the EU level, the most recent CSR development has been a communication by the EU Commission (dated 22 March 2006), in which it announced the launch of the European Alliance for Corporate Responsibility, aimed at coordinating and further developing EU-wide CSR strategies. Internationally, the popularity of the UN-led Global Compact and the growing importance of codes of practice such as the OECD Guidelines for Multinational Enterprises signify a movement towards more concerted CSR efforts.

CSR and investment: With assets worth over $42trn being managed by institutional shareholders, the way in which they invest and exercise their shareholder rights inevitably has a major impact on the society at large. It is therefore essential to consider what strategies are available, as well as to explore the extent to which investment takes into account issues such as environmental, social and governance (ESG) impacts and whether this is consistent with the legal parameters which set the limits of investors' behaviour.

CSR-consistent investment

A 2005 survey of 195 fund managers by Mercer Investment Consulting revealed that 70% of respondents believe integration of environmental, social and ethical factors into investment analysis will become a mainstream part of investment management within three to ten years. Moreover, 50% believe active ownership will be commonplace within the next two years, while 60% believe screening for environmental, social and ethical factors will be mainstream within the next three to ten years.

The key strategies available to institutional shareholders wishing to improve their CSR performance include screening of investments and shareholder engagement.

Screening of investments: Passive screening involves making investment decisions by following indices with ESG benchmarks, such as the Dow Jones Sustainability Index or FTSE4 Good. Positive screening, on the other hand, sets inclusive criteria that must be met before an investment is included within a portfolio (eg strong employee relations, good corporate governance, an excellent charity donation record or superior environmental performance). Positive screening can take a variety of forms, including best-in-class (selecting the companies that are "best" in their industry regarding ESG considerations) and thematic investment (selecting companies that have made a commitment to responsible products or services, such as investing in renewable energy technologies). Negative screening applies criteria to exclude companies on the basis of ESG performance. Such screening may be applied to exclude, for example, organisations that manufacture alcohol, weapons or nuclear energy; have poor labour standards; or are guilty of breaching human rights.

Shareholder engagement: This requires that an institutional investor understand and attempt to influence the ESG performance of an organisation through engagement with management (eg by means of dialogue, pressure and support for responsible management) and through the exercise of voting rights. Some investors adopt an "integrated analysis" approach, whereby screening and shareholder engagement are combined for maximum impact on the ESG performance of selected companies.

While the strategies for incorporating ESG into investment decisions are clearly available, investors would justifiably not wish to exceed the parameters of legality in exercising their mandate.

In October 2005, Freshfields Bruckhaus Deringer was commissioned by the United Nations Finance Initiative (UNEP FI) to produce a report titled "A legal framework for the integration of environmental, social and governance issues into institutional investment", ( ) which examines the issue of whether, and to what extent, ESG issues can be integrated into investment decision-making. In relation to all of the jurisdictions examined, the report concluded that a particular ESG consideration must be taken into account when it either affects financial performance or is the subject of a clear consensus amongst the beneficiaries. It was also suggested that in cases where a decision-maker has exhausted the analysis of financial criteria, and is still left with two or more equally attractive investments, a particular ESG consideration may be taken into account by the decision-maker without breaching his or her fiduciary duties or civil law obligations.

CSR and climate change

One area in which investment decision-making and CSR have become closely intertwined, is climate change. Several major insurance industry participants have recently announced that they are aware of their vulnerability to the most adverse consequences of climate change, including real estate and casualty risks associated with flooding, hurricanes and similar natural disasters. For example, in October 2003, Swiss Re announced it was aware of the fact that UNEP FI had estimated the cost of climate change to stand at approximately $150bn in the next ten years, and that this will inevitably impact on various insurance lines. Munich Re, alongside other insurers, has helped initiate research regarding the greenhouse gas emission market.

Likewise, the Financial Services Authority's "Financial Risk Outlook 2006" has recognised, for the first time, that "the insurance industry has faced a testing operating environment in recent years. The underwriting cycle, the impact of climate change, exposure to terrorism ... continue to pose challenges to general insurance firms". Clearly, then, the insurance industry will - and already does - set increasingly stringent standards for the corporate bodies they insure, or in which they invest their insurance reserves.

In a keynote speech at last year's Association of British Insurers conference on insurance and international climate change policy, the Rt Hon Margaret Beckett put the position succinctly. "The financial costs of climate change are not the only reason for concern," she said. "A growing number of institutional investors are increasingly aware of other important risks stemming from climate change. Alongside the physical risks from direct impacts in exposed sectors (like property, life insurance, water, tourism), climate change may bring additional market risks, regulatory risks, operational risks and reputational risks."

It seems only a matter of time before managers of corporate institutions will be asked to minimise their impact on climate change, or face the stark reality of growing insurance premiums (or even absence of insurance cover) and/or reduced access to institutional shareholders.

The importance of CSR will continue to grow, stemming from the increasingly evident business case for CSR and the mounting pressures on global natural and population resources. While the areas in which CSR and investment overlap are numerous, the approach the insurance industry has taken to climate change issues serves as an excellent example of the fact that companies' CSR record is becoming an increasingly important consideration in investors' decision-making.

- Paul Watchman is a partner and Giedre Kaminskaite-Salters is an associate in the dispute resolution practice at Freshfields Bruckhaus Deringer.