Professor Mario Monzoni, FGV-EAESP, one of the creators of the ISE (Sustainability Index) in Brazil, takes us through its journey from conception to successful implementation. From an interview by Professor Adrian Zicari, ESSEC–CoBS.

The ISE Sustainability Index in Brazil: A story of sustainability, challenge, and success from an interview with Mario Monzoni, FGV-EAESP.

Sustainability indexes are promising tools. They give invaluable information to investors, as they present a selection of companies in a particular stock exchange with good sustainability results. Among the many sustainability indexes in the world, the one of the Sao Paulo Stock Exchange (ISE B3) has a particular place. Created in 2005, it was one of the first sustainability indexes in an emerging economy. We had the opportunity to interview Mario Monzoni, Professor at FGV, and one of the creators of this index.

First steps, first challenges

Adrian Zicari: How did the ISE begin?

Mario Monzoni: Legend has it that the ISE began on the insistence of Fabio Barbosa (at the time, head of Banco Real-ABN), who had just launched the Ethical fund, a family of ethical and SRI funds which were the first ones in Brazil, in 2001. They needed a benchmark to measure the fund’s performance and a more appropriate reference than comparing it to the traditional stock market index.

Raymundo Magliano, who was Bovespa’s president at that time (today it is B3), accepted the challenge and created a working group to think about the launch of an index. We were invited to this working group as FGV-EAESP as its Sustainability Studies Centre. In this working group, we realized it was necessary to look for funding to build the methodology of the index. We talked to the IFC – the International Finance Corporation (World Bank). We sent them a proposal to finance the first year of our research, which was to develop a questionnaire. They financed the studies throughout 2004 and 2005 to build the index. Then we launched the questionnaire, which also included a public consultation on the questions it included. It is important to talk about these because we were concerned that the questionnaire itself could have been a barrier to entry – it was very long and it covered several dimensions that concerned the responsible investing community itself and also the business world.

In 2005, the ISE was launched. That year, it had a large adhesion, while it decreased slightly over time. The Brazilian capital market is small compared to other capital markets, so it wasn’t possible to use a Best in Class model, for example, like the Dow Jones does. Companies competed among themselves to take part in the portfolio. A council was created within Bovespa, to which we, FGV, submitted our evaluations. So we designed the questionnaire, sent it back to the companies, they responded, we evaluated them and told the board: “In our evaluation, this group of companies is ahead of another group in terms of sustainability practices”.

The first stock portfolio was in 2005.  The ISE initially reached momentum in participation, followed by a drop, but we were then at another moment in the sustainability agenda. Personally, I think the ISE was very pioneering. To get investors, especially institutional investors, out of the traditional model and into sustainability investing.

Adrian Zicari: How did people react to the initiative?

Mario Monzoni: In the beginning, in 2005 and 2006, some banks even launched several products linked to the index, but institutional investors here in Brazil, especially pension funds, have a benchmark to follow, the Bovespa index. As such, it’s very difficult for them to leave an investment they know to migrate to others, even though the Investors’ Association and other associations linked to institutional investors had been discussing this issue since 2005. It was a different time than today with the explosion of ESG as an issue and interest in it reaching an all-time high.

From the second and third year on, the ISE became self-sustaining, with companies paying to participate in the index. However, it had a very marginal impact on the investment community, because at that time that agenda was still very in its beginnings. The capital market is small, so we had 50 companies participating to draw up a portfolio of 30, 35, 40 corporates to compose the index.

But we’re straying from the subject. The questionnaire and the approach we came up with involved several dimensions and three hundred questions and this posed a challenge to companies when deciding to join the ISE. Not least because they often had a single person dealing with the initiative, multiple internal stakeholders to discuss approval such as the operations and marketing departments to name only two. In short, the decision to move the whole company in such a way was a complex decision involving many issues and questions.

The ISE Sustainability Index: A purposeful and useful tool

Adrian Zicari: What impact did the ISE have in companies?

Mario Monzoni: I think it had a great impact on the corporate sector. The ISE questionnaire, although its function was to build a portfolio, ended up serving as a management tool for sustainability. Very importantly, at that time we had the Ethos indicators and Ibase model, giving us a mix of guidelines for reporting and questionnaires for indexes. These included the Dow Jones itself and the FTSE which ended up being imported into the sustainability management systems of companies. Because the questionnaire, in a way, reflected what was expected of a company in terms of sustainability practices, there were questions for companies to address which went from action plans and strategy to very basics.

It was a diagnostic tool to see gaps in terms of management and, on top of that, action plans to address these gaps, from a strategic point of view. I think that it wasn’t the ISE but the ISE questionnaire itself that had a role as an instrument, and a very important tool for corporate management towards sustainability. There, yes, in the business world – I believe it had an impact. We were also responsible for the Exame Award – a prestigious award for companies in Brazil – and this award also used the ISE questionnaire. Only that in the Exame Award, as closed-capital companies were also offered the opportunity, we took all multinationals. This is because, in general, multinationals in Brazil are through subsidiaries – closed-capital companies – and they do not necessarily participate in the capital markets.

In the Exame Award there were up to 250 companies participating. For 10 years, we took charge of, in parallel, the methodology, the questionnaire and the evaluation among other things. I believe that this has given impetus to or contributed to driving the corporate responsibility agenda in Brazil, together with other players that were also active such as the Ethos Institute and the branch of the World Business Council here in Brazil. The CDP then played an important role in the climate dimension. Today, the CDP questionnaire constitutes the climate change questionnaire of the ISE itself.

Moreover, I think that, yes, there was a lot of criticism because the questionnaire was so long, because academia was developing it and we were faced with the old stereotype from professionals that “academics don’t know life as it is”. We suffered a lot in this process, but while the “dogs were barking”, as we say in Brazil, “the carriage was passing”. I believe it had a great impact on the business community, it is still a reference. Being part of the ISE is important. Any corporate and institutional PowerPoint having the ISE on it means a plus for the company. And losing its place in the ISE is very bad for a company. And actually, at that time we didn’t even use the word “leave”. We used to talk about “not entering again” because the portfolio was renewed every year, so it was possible that a company would not enter the next portfolio. To be in one year and not be in the next was very badly seen. For companies, if they want to participate and enter, then they can’t leave, because leaving is worse, the loss being greater than the benefit of entering, perhaps. I believe that in this sense, the impact of the ISE was higher among companies than among investors themselves.

Pressure for profit: Overcoming the short-term view

Adrian Zicari: What impact does the index have on investment decisions?

Mario Monzoni: Investment, I think, follows business as usual. Maybe now the picture is a little different, as the financial community in Brazil is quite innovative in terms of practices and even the Central Bank is regulating on sustainability issues. If we were to do qualitative research on what led these things to happen, maybe the ISE has a little place in the equation. I don’t know how relevant the coefficient is in the equation, but in the business world it certainly has a greater impact than on the investment side.

Adrian Zicari: What have you learnt from all this?

Mario Monzoni: Oh, everything. It was a very important experience for us. Today, the ISE has undoubtedly contributed to what we are as a sustainability centre. However, sustainability is still marginal on the corporate agenda. Certainly, it’s the short term that drives actions and business practices, especially for publicly listed companies, which have to demonstrate their results to shareholders quarterly. In Brazil, with high interest rates, with part of the benefits of sustainability connected more to the medium and long term, when you add interest rates and time to the denominator, it’s cruel.

So when it comes to decision making, without a doubt, short-term issues prevail. We had to go on building, creating awareness. I believe that today this ESG world tells me that companies have realized that looking into this is important. Not that they are already doing things, but they have realized that not looking into sustainability issues, especially climate change, for example, can bring risks to the company and affect returns. They have a greater and better understanding of what that means.

I’m not saying that this ESG tsunami has made us enter the enchanted world of sustainability or corporate practices, because you only have to look out the window and see social and environmental indicators, and there is a lot of work to be done. That’s it. Realising the obvious – that sustainability fights with the interest rate and the discount rate – it fights with time. Here, we joke that there are three Cs: which is conviction, convenience and catastrophe.

We realize that some companies are convinced that they have no other way to go, and that to question the environment will mean questioning their operations, their way of life, their entire production and consumption model – because their inputs and outputs are related to the planet. So, they are convinced that there is no other way. Even if, in the short term, there is a trade-off, they know that up ahead this will be very important and will guarantee or increase the probability of the business’ sustainability. Others, the vast majority, I think, are in the world of convenience.

Maybe they are tired of fighting against it and they understand that: “Gee, if I don’t do this, my European customer will buy from the competitor” So, I have to at least say that I’m doing something. It’s the class of convenience. “Not that I believe in it very much. In fact, I don’t even like this issue, but for my business it is convenient to say that I believe, because otherwise I can lose market access, or I can have some reputational problems. Everybody is doing it and why not me?” It is the convenient group, which I think is the vast majority. Then there is the C of the catastrophe, usually for those in denial, who tend to say “what’s the point of that? Another tax to be paid.” Sometimes a catastrophe happens, linked precisely to governance issues. Here, in Brazil that could be linked to corruption, which is very strong. Or water crisis. If we talk about ecosystem services, water supply, water regulation, nobody understands. But when people see a water crisis, they say “Ah, now I understand.”

When there’s a water crisis, a company has to pay for water trucks to keep operations going and the usual reaction is “Oh, but I had them for free, now I have to pay?” Perhaps here too, in a catastrophe scenario, companies will understand the ESG issue at stake. Maybe one thing I’ve learned is that you can divide the world into three: conviction, convenience and catastrophe.

The ISE Sustainability Index: Lessons learnt and future evolution

Adrian Zicari: If you had the opportunity to do it again, what would you do differently?

Mario Monzoni: Ever since I received your question, I’ve been thinking about this. I don’t know. Actually, I was the technical advisor for Bovespa, so it was them who decided, not us, but I think that if everything were to start from the beginning again, I’d create two leagues, two clubs. Maybe a questionnaire, the way it is, for the champions. And then a league to give visibility to those companies that are making an effort, that are starting out – as if it were an access league – where obviously you wouldn’t be able to compare with the class that is up there doing a lot of things, but it would give visibility to the market that they have already started. It would have a standard, minimum standards in there, including reporting among other things.

Or perhaps an expanded index, which would give even greater investment possibilities, because one of the criticisms is that it was too small a portfolio: “I need more, with more sectors, to diversify my risk.” In addition, I would maybe add a little more inclusiveness there, even if there is a trade-off. Because by the time you include more firms, I think you would have to really differentiate as well. Those who are there are going to say: “Gee, I want to stay in the club, in the A league, I don’t want to be in the B league.” I pushed that idea for a while, but I don’t think the board understood that nobody would want to stay in a B league. That’s fine, they call the shots.

A further idea is maybe a more simplified questionnaire, maybe a more customized questionnaire by sector, which would be a lot more work – because as I said, we don’t have Best in Class. Sometimes, the best in a sector is the worst in the sector, because it is the only one. There are not 2,500 companies like the Dow Jones to be able to choose from and divide into sectors. For the ISE, 40 companies answered the questionnaires. It was a limitation given a priori, and it was a fact of the problem. I don’t know, maybe if FGV had gone out earlier, looked for more partners, it would have been possible to leave earlier. We were there for 15 years. Maybe it was time to realize that we had done our part, now the other one can do better than us, maybe.

Useful links:

• Link up with Profs Mario Monzoni and Adrian Zicari on LinkedIn
• Read a related article: Can financial markets push for CSR?
• Discover FGV-EAESP and the GVces Center for Sustainability Studies
• Study in Brazil at FGV-EAESP: Undergraduate and graduate programmes.

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