Jargon Buster
Explanations for financial terms and issues of specific relevance to green and ethical money.
Best in Sector (or Best in Class)
This relates to investment decisions which are made based on a company's record in relation to its peers. A fund might, for example, invest in the oil or gas sector, but only in those companies which are deemed to be the best in their class, with say, a better record on the environment and human rights than others in their sector.
Bond
A bond is what is known as a 'debt security'. The main difference between a stock and a bond is that stock-holders are the owners of the company (i.e., they have an equity stake), whereas bond-holders are lenders to the issuer. A bond is a loan: the issuer is the borrower, the bond holder is the lender, and a 'coupon' is the interest. Many funds are open to investment through bonds.
Building Society
Building Societies are 'mutual' companies which means they are owned by their members (savers and borrowers) instead of having external shareholders. These financial institutions tend to focus on mortgages lending, savings accounts and other personal banking services. Building societies generally focus on housing rather than business-orientated finance. However, it is important to note the many building societies de-mutualised in the 1980s and 1990s and therefore operate in much the same way as banks do and are listed on the stock exchange. Examples of building societies include Nationwide Building Society, Coventry Building Society and Leeds Building Society.
Climate Change (or Global Warming)
Climate change is an issue for financial institutions in three ways: who they lend money to, who they invest in and how they manage their own operations. Banks are in a unique position as they can refuse to lend money to businesses with heavy carbon footprints and thus facilitate a transition to a new lower carbon economy and reduce the risk of a global environmental crisis. Similarly pension and investment funds can divest companies with poor environment records or use their voting powers and/or engage with companies to help improve their performance. Big high street banks and insurance companies have thousands of branches and offices all over the world. It’s therefore important that they have plans in place to reduce their carbon footprint.
Community Development Finance Institutions (CDFIs)
CDFIs lend to or 'microfinance' small businesses, organisations and individuals within communities in an effort to help community development and sustainability. For more info visit the Community Development Finance Association site: www.cdfa.org.uk
Corporate Governance
A set of processes, customs, policies, laws and relationships (between shareholders, board, CEOs, employees) that govern how a company is run.
Corporate Responsibility (or Corporate Social Responsibility, CR/CSR)
This relates to how organisations consider the interests of society in how they run their business and how their operations might impact on customers, employees, communities and the environment.
Credit Unions
These are financial co-operatives, owned and controlled by their members, who put savings into a common fund. In turn the common fund is used to offer low-interest to members. Increasingly credit unions are offering members more bank-like facilities like the ability to pay bills for example. While Post Offices and bank branches across the UK are closing the number of credit unions is rising. To find the one nearest you check out www.abcul.org
Divestment
Green and ethical funds might divest or sell stocks when they feel that a company no longer meets their investment criteria. The funds may reinvest in that same company, if and when they feel that it is again suitable. Engagement is often a precursor to divestment in an attempt to encourage companies to improve their ESG performance.
Engagement
Engagement is the process by which investors/fund managers seek to maintain or improve the corporate social, environmental, ethical (SEE) or governance policy, management or performance of companies through dialogue and voting practices.
Investors can engage with companies to:
- To encourage more responsible business practices
- To encourage greater transparency and disclosure
- To improve investment returns by encouraging companies to manage SEE risks or to address new social or environmental business opportunities
Environment
Environmental issues impact financial institutions in three ways: who they lend money to, who they invest in and how they manage their own operations. Issues like air and water pollution, waste management and recycling, renewable energy and sustainable timber are issues for banks as much as any other business. Banks are in a unique position as they can refuse to lend money to or invest in businesses that might contribute to environmental problems. Within their own operations there are a number of measures that banks should introduce to reduce their carbon footprint and improve their general green performance including using only recycled paper and ensuring that all waste materials are recycled, powering their offices using renewable energy and avoiding any unnecessary business-related air travel are examples. Similarly pension and investment funds can divest companies with poor environment records or use their voting powers and/or engage with companies to help improve their performance.
Environment, Social and Governance Issues (ESG)
Environment, social and governance (ESG) issues often appear together as the key concerns which responsible investors need to take into account to reduce investment risks. There is a growing view among investment professionals that ESG issues can affect the performance of investment portfolios.
Equal Opportunities
This broadly applies to how a workplace recruits and treats its staff. Each workplace should have a policy that makes discrimination on the grounds of race, ethnicity, gender, disability or sexuality an actionable offence.
Ethical Investment
Also known as sustainable investment, responsible investment and socially responsible investment (SRI) among other things, ethical investment refers to any area of the financial sector where the environmental, social, governance and ethical principles of the investor (whether an individual or institution) influence which organisation or venture they choose to place their money with. It also encompasses how an investor might use their power as a shareholder to encourage better environmental and social behaviour from the companies they invest in.
Ethical Lending
An ethical lending policy is an explicit statement that governs who a bank will or will not do business with. Some banks have policies in relation to lending to individuals, companies, governments or countries that are involved in controversial activities such as arms manufacture or sales, environmental degradation or operating in countries with oppressive regimes.
Financial Exclusion
Financial products and services play an enormous role in most people's lives from how they get paid and access their money to how the pay for goods, services and utilities. However, an estimated two million people in Britain today do not have even the most basic bank account severely restricting their financial capabilities. The problem also extends into the areas of pensions, credit and debt. Financial exclusion also arises from inaccessibility of financial services - this usually affects the elderly, disabled, those living in remote areas and those for whom English is not their first language and is a growing problem in the UK as debt rises dramatically amongst those least able to manage their finances.
FSA Debt Test
Developed by the FSA, the BBC and Experian, the Debt Test tells users how they would appear to a credit rating agency. Results are an indicator rather than an exact prediction.
Based on the results of the test, users are told whether they should worry about how much they borrow, provides tips on how to avoid debt problems and how to tackle debts if they are in trouble. Take the Debt Test.
Human Rights and Oppressive Regimes
The Treasury maintains a list of individuals and organisations that UK financial institutions should not lend to. But aside from this, and, within the limits of the law, banks are free to decide for themselves who they will do business. The risks of non-repayment or adverse publicity often govern banking decisions, but over the years a number of financial institutions have been found to have directly or indirectly provided finance within countries with poor human rights records and oppressive regimes. It is therefore important to check what policy, if any, your bank has in terms of who it will lend to.
Institutional Shareholders
Institutional investors are organizations which pool large sums of money and invest those sums in companies. They include banks, insurance companies, retirement or pension funds, hedge funds and mutual funds.
Investment Policy (or Investment Approach)
An investment policy defines how a fund will invest money on behalf of its investors. Most investment policies describe how a fund aims to maximise returns or seek long-term growth of invested money. Ethical investment policies additionally outline the extent to which a fund has positive or negative criteria in place to screen out or screen in certain categories of company according to green and/or ethical criteria. A fund’s ethical investment policies also describe the extent to which it will exercise its voting rights at annual general or key shareholder meetings and whether or not it will engage with companies or divest those who fail to meet the requirements laid out in their policies.
Loan-to-income (LTI)
The ‘loan-to-income’ ratio relates to many times a borrowers income is loaned in a mortgage i.e. is an applicant’s gross income is £40,000 and the lender’s LTI ratio is set at 3.5 times gross income, the applicant can borrow up to £140,000.
Loan-to-value (LTV)
The ‘loan-to-value’ (LTV) ratio relates to the amount a mortgage customer wants to borrow as a percentage of the value of a property. So if a customer wants to borrow £130,000 to purchase a house worth £150,000, the LTV ratio or rate is 87%.
Microfinance
This refers to the provision of financial services to people in developing countries. We also use it in reference to 'microcredit' i.e. the provision of loans to microenterprises in developing countries. A type of banking service that is provided to unemployed or low-income individuals or groups who would otherwise have no other means of gaining financial services. Ultimately, the goal of microfinance is to give low income people an opportunity to become self-sufficient by providing a means of saving money, borrowing money and insurance. The interest charged on borrowing is usually at a lower rate than conventional banks.
Microinsurance
The provision of insurance to people in developing countries. See Microfinance.
Product Stewardship
Under the product stewardship model, environmental protection centres around the product itself, and everyone involved in the lifespan of the product (manufacturers, retailers, consumers and disposers) is called upon to take up responsibility to reduce its environmental impact.
Project Finance
Project finance, is a form of financing for companies and governments where lenders are repaid only through the revenues generated by the project itself e.g. the tolls collected from a toll road, the electricity generated by a power plant. Lenders do not have ‘recourse’ to the borrower's own assets if a project fails to generate the revenue projected. Project finance is most commonly directed at large infrastructure projects.
Responsible Investment
Responsible Lending
As consumer debt continues to rise sharply, it is increasingly important that banks provide credit only after proper background checks are conducted to ensure that repayments can be met. Professional judgement should be carefully applied to all lending decisions. Similarly the way in which loans or related products are marketed should clearly spell out all terms and conditions to potential borrowers. Also institutions should flag up warnings about the consequences of defaulting on payments for mortgages, personal loans, credit cards and other forms of credit. An important aspect of lending responsibly is offering debt advice and helping customers who fall into financial difficulty by offering payment restructuring or payment holidays.
Risk
Risk management is about assessing, mitigating and monitoring risks. In terms of ethical finance, environmental, social, governance and ethical (ESG & E) risks are of key importance. If companies fail to take ESG & E factors into consideration, they may be exposed to risk such as damaging their reputation, losing investors, not being fully prepared for shifts in market trends or new regulation on key issues like climate change.
Screening
Companies can either be ‘screened in’ (positive screening) or ‘screened out’ (negative screening) of funds based on whether or not they meet or breach certain criteria. On the positive side, a fund may seek to invest in listed companies making a positive contribution to society, say in the form of renewable energy or waste management.
On the negative side, a fund might avoid investing in certain areas deemed controversial like the tobacco, arms or fossil fuel industries, companies with poor human rights records, heavy polluters or those that test on animals for cosmetic purposes. Other funds might avoid investment in financial institutions while some, known as ‘fund of funds’ might invest only in other ethical funds.
Shareholder
A shareholder or stockholder is an individual or company (including a corporation) that legally owns one or more shares of stock in a company.
Social, Environmental and Ethical Factors (SEE)
This is a common grouping of issues often used in discussions on risk. 'Social' factors refer to how a company performs within communities and whether it provides needed services or charitable donations as well as whether it minimises its impact on the areas in which it operates. 'Environment' factors to whether a company has a policy on the environment or an environment management system to set targets for the continued improvement of its performance in areas like energy efficiency and waste management. 'Ethical' factors covers a broad range of other areas including involvement in animal testing, alcohol, tobacco, gambling, genetic engineering, arms or the military and human rights.
Socially Responsible Investment (SRI)
Statement of Investment Principles (SIP)
In July 2000, the UK government enacted a law that requires occupational pension funds to disclose in their Statement of Investment Principles (SIP) whether or not they incorporate any social, environmental or ethical assessments into their funds’ investment strategies. In other words, occupational pension funds are legally bound to state their ESG (environmental, social and governance) practices and policies. Funds are not obliged to incorporate these elements however, just to state whether they do or they don’t.
Sustainable Investment
Sustainable investing tends to focus on green investment themes such as clean energy, water management, green transport, waste management, sustainable living and environmental services.
Sustainability
Sustainable development can be described as development which meets the needs of the present without compromising the ability of future generations to meet their own needs. It is a about balancing three goals or ‘pillars’ environment, society, and economy to enable throughout the world to satisfy their basic needs and enjoy a better quality of life, without compromising the quality of life of future generations.
Turner Review
The chairman of the FSA, Lord Turner was commissioned by the Chancellor of the Exchequer to review the events that led to the financial crisis and to recommend reforms.
Within the Review, Lord Turner suggests that the loan-to-value (LTV) rates offered to mortgage customers should not exceed 90%, i.e. that the borrower has at least 10% of the value or the property to use as a deposit. With regard to loan-to-income (LTI) rates, the Review suggests that lenders give no more than 3.5 times gross annual income to single mortgage applicants. For more information see: http://www.fsa.gov.uk/pubs/other/turner_review.pdf
Voting
Shareholders in companies are entitled to vote on big issues like bonuses and policy change at annual general or other key meetings. They can vote for or against or abstain from voting on the issues presented at these meetings and in this way have their say/influence company policy on key issues like climate change.
