mag.e.sine 2013

Inspiring reading on corporate engagement from GES®

2013

Building Brazilian business bonds Why financial analysts

should follow

ESG engagement Successful mission in Siberia

Key ESG trends in emerging markets Sustainability the new black in fashion – page 16

Trust a ticket to the top – page 36 MAG•E•SINE 2013 • 1

A majority of GES’ team from four offices gathered at annual conference in August 2012 in Ringsjöstrand, Sweden.

4

One of our GES Engagement Forum clients most wisely said: “If you look at the right things, the numbers will follow. If you follow the numbers, you might not look at the right things.” Working in the same spirit, GES’ engagement strives to help asset owners and asset managers look at the right things so that the right numbers can follow. Therefore, we are delighted that increasingly insightful investors are discovering the financial rationale of following engagement processes on environmental, social and governance (ESG) issues, please see article on page 34.

After having celebrated GES’ 20 years in business throughout 2012 and reflected upon our history and role (see previous anniversary magazine), we have also found some other numbers that add to the picture of who we are and what we do: • 50+ employees globally, of which • 40 are dedicated entirely to proprietary research and corporate change, spending • 80,000 hours per year on engagement with • 375 companies, through e.g.

• 160 travel days per year visiting companies, on behalf of • 100 asset owners and asset managers managing • 750 billion Euros under GES’ advice.

Such statistics underline our profile as a provider of Global Engagement Services. But since numbers never give the full picture, we also present this magazine as another way of describing what we do in words and photos. We hope it adds further to your picture of us!

10

Best regards, GES’ Team

30

contents

16 8

Successful mission in Siberia Corruption – not a dead end in Russian dialogue Dispersing the smoke screen around flaring Risk Transparency Engagement connecting companies to the investment analysis process “The capital market is ready for a higher level of transparency” Sustainability - the new black Tackling fashion’s labour problems at its roots CRBPs - an investor tool with specific child rights lens Key ESG trends in emerging markets Shareholder engagement gaining momentum in Germany Building Brazilian business bonds Why financial analysts should follow ESG engagement Trust - a ticket to the top Bridging the gap between asset owners and fund managers Cost-effective engagement overlay European angle meets American twist Looking ahead from five years of Burma engagement Time to raise investors’ voice in public policy

4 8 10 12 14 16 21 23 24 28 30 34 36 40 42 43 44 46

GES Kungsgatan 35, 111 56 Stockholm, Sweden Phone +46 8 787 99 10 GES Denmark Vestergade 27, 1456 Copenhagen K, Denmark Phone +45 30 86 03 70 GES Poland ul. Kupiecka 19/6, 65-426 Zielona Gora, Poland Phone +48 68 422 13 26 GES Switzerland Hohlstrasse 489, 8048 Zurich, Switzerland Phone +41 43 535 99 38

www.ges-invest.com

21

mag•e•sine is produced by GES in cooperation with Gylling Produktion AB. Publisher: Susanne Nyman. Art Director: Dan Larsson. Cover: Brazilian rainforest. Photo: Stina Nilsson. Print: Centraltryckeriet Linköping, certified according to the official Nordic Ecolabel. Paper: Tom&Otto Gloss 250 g and Tom&Otto Silk 130 g, both certified according to the Forest Stewardship Council (FSC) and climate compensated through Antalis.

MAG•E•SINE 2013 • 3

succesful missi on in Siberia If you go to an atlas or to a globe and look for Sayano-Shushenskaya, your map pin will land in what probably feels like terra incognita. That is a pity since South Siberia is beautiful, important to the world economy and much more developed than you may think – also with regard to environmental, social and governance issues, as GES discovered during a field trip.

By Flemming Hedén, Senior Engagement Manager, GES

Sayano-Shushenskaya is home to one of the world’s largest hydroelectric power plants run by Russia’s largest power-generating company, RusHydro. You get a distinct James Bond feeling as you approach the site. Silent guards armed with machine guns protect an enormous near-vertical concrete wall 245 meters high.

An even bigger spillway next to the wall stands ready to contain a catastrophe in case a once-in-a-century snow melt in the mountain range separating Russia from Mongolia threatens to overfill the reservoir behind the dam wall. You feel even more dwarfed as you enter the turbine hall and get close up to the turbines and generators weighing hundreds of tonnes. These villasized units are designed for high-speed spins with millimetre precision in order to catch the energy from the Yenisei River. The electricity that is generated from the flow of water is then put on to the Russian power grid where it is consumed by residents as well as by industries including aluminium industries in the region and in Krasnoyarsk further away.

4 • MAG•E•SINE 2013

An unattended vibration in one of the turbines on the early hours of August 17, 2009, tragically demonstrated what devastating force can be released from a hydroelectric power plant. The entire turbine shot up like a rocket crashing through the turbine hall’s ceiling before it fell back again into the overflowing building. GES alerted clients about the incident immediately and contacted RusHydro as well as Russian authorities to assess the situation. Later it became clear that 75 people died in the accident.

A parliamentary report held the directors of the plant and RusHydro’s management responsible for the accident, due to the lack of permanent monitoring and control of the power plant safety.

From the start RusHydro was very responsive to GES’ inquiries regarding health and safety management changes and initiated a clearly serious investigation into what had gone wrong. You may think that this is something any listed company would do if such a

Before entering the Sayano-Shushenskaya hydropower plant, GES’ Senior Engagement Manager Flemming Hedén (left) and Research Analyst Paulina Kurkiewicz (middle) had a briefing and discussions with the plant’s head of PR Irina Zhuykova, RusHydro’s Director of Investor Relations Alexander Goldin and Alexei Kormilkin, first deputy CEO of the plant.

severe accident occurred but unfortunately this is not always the case. Perhaps it is human nature to go into denial and to try to find scapegoats when under pressure. Severe accidents like this occur almost on a weekly basis in the primary sector. Coalmines explode and collapse, gas pipes burst, refineries catch fire and even nuclear power plants explode. Companies neglect, without investors’ knowledge, well-known health and safety risks that should have been managed. And when investors want to know what has gone wrong and what has been done to correct this, the responses from companies can be less than enthusiastic or satisfactory to say the least.

To some extent it is true that emerging markets are more exposed to severe accidents but it is too simplistic to point to that single factor. Health and safety management is special in the sense that when it is really successful you do not even think about it. Therefore there is a constant risk of relaxing too much as a result of non-events. This can happen in a Texas refinery, in

the control room of a nuclear power plant in high-tech Japan, on one of the world’s most advanced oil rigs in the Gulf of Mexico and it can happen in a hydro power plant where most things have been working fine since its construction over 30 years ago, during Soviet times.

It is GES’ approach to undertake far-reaching efforts to achieve results. We combine information from several sources that may have varying opinions on what has happened in a controversial situation and from those differing versions we come to a conclusion on what companies should do to act responsibly. In this case GES had extensive information from Russian authorities on wrongdoings by the company. This together with further research enabled GES to conclude that the reported practices could be associated to a violation of the UN Global Compact Principle 1, addressing safe and healthy working conditions, and the corresponding Guideline V of the OECD Guidelines for Multinational Enterprises.

MAG•E•SINE 2013 • 5

Workers preparing the interior of pit that will hold a new turbine. The new, white turbine hall roof as it looks from the crest of the dam.

As the engagement with RusHydro continued over a three-year period, GES also received more and more detailed information showing how the company addressed the root causes of the accident and improved management of the safety risks. But GES needed verification from a third party that the relevant measures had been taken. As the Russian authorities reporting on the incident did not respond to our repeated requests, GES decided to undertake an on-site visit.

In early June 2012, the engagement process reached its final stage when I travelled to the hydroelectric power plant in Siberia together with GES’ Russian-speaking Research Analyst Paulina Kurkiewicz. The field trip stretched over four days to get first hand information on how RusHydro managed its responsibilities at and around the Sayano-Shushenskaya plant. The field trip included interviews with more than 15 responsible managers, construction site inspections, medical emergency system demonstrations and visits to schools and health facilities in the local community.

6 • MAG•E•SINE 2013

GES was able to meet and ask follow-up questions to managers, employees as well as locals that were not associated with RusHydro.

By seeing with our own eyes what had happened on the site and in the surrounding area GES could confidently conclude that the incident had been resolved. After nearly three years of constructive engagement, the on-site visit by GES provided the final proof that the company not only had remediated and compensated the effects of the accident but also had addressed its root causes and improved management of the safety risks to resolve the case.

The feedback from RusHydro was also that the engagement process and the final acknowledgment from GES were important and appreciated. RusHydro’s deputy CEO George Rizhinashvili commented:

GES’ Senior Engagement Manager Flemming Hedén (third) and Research Analyst Paulina Kurkiewicz (right) received a thorough tour of the plant with its first deputy CEO Alexei Kormilkin (left) and RusHydro’s Director of Investor Relations Alexander Goldin (second).

Socially responsible investors are very important to us. Their presence in our shareholder base highlights the sustainability of the company’s core business - hydro generation. We appreciate the positive outcome of the dialogue with GES, as its report, which is based on solid methodology, is an important third-party acknowledgement of our progress with regard to environmental, social and governance issues.

In connection with GES’ engagement visit at RysHydro’s plant in Siberia, we also took the opportunity to meet in Moscow with some of Russia’s largest and most influential companies: Cherkizovo, Gazprom (left building), Lukoil, Norilsk, Novatek, Raspadskaya, Rosneft, Sberbank and X5.

MAG•E•SINE 2013 • 7

Corruption – not a

in Russian dialogue

8 • MAG•E•SINE 2013

By Flemming Hedén, Senior Engagement Manager, GES

When GES met with some of Russia’s largest companies in Moscow to discuss ESG issues, we received a surprisingly positive response, not least concerning corruption prevention.

The Moscow meetings were partly a follow-up to GES’ engagement tour to Russia the year before.

We raised many issues, e.g. health & safety, biodiversity protection and oil spill remediation, which proved very valuable both in terms of engagement progress and in terms of gaining a deeper understanding of some specifically Russian ESG challenges.

A major challenge is corruption, and how to implement best practices related to corruption prevention was extensively discussed. A recurring theme was that companies have had enough of the historically rough busiGES’ Senior Engagement ness climate and want to Manager Flemming Hedén in front of Saint Basil’s compete on fair terms with Cathedral, Moscow. quality products and quality management. The managers themselves try hard but are impatient and frustrated by the lack of accountability at high political positions as well as from an imperfect legal system.

The Putin era in Russia has brought stability where there previously was chaos. It has also brought substantially better incomes and living conditions for most of the population. A small fraction of the population, mostly concentrated in Moscow, has also become extraordinarily rich. Moscow’s streets are clogged with luxurious cars.

What the Putin era has not managed to do is to stop rampant corruption. GES’ Country Risk assesses risks related to peace and security, rights and democracy, corruption and environment in the countries where

the companies operate. Where corruption is concerned, GES’ Country Risk integrates data from Transparency International, a non-governmental organisation that monitors corporate and political corruption. In this ranking Russia comes out as number 133 among 176 ranked countries in terms of perceived corruption. That puts Russia behind countries such as Uganda, Nicaragua and Lebanon. By comparison India, not unknown for challenges related to corruption, is ranked as number 94.

Our own experience is that Russian companies in general are not mitigating material risks transparently.

Better corruption prevention management would reassure investors that the companies are operating in line with the OECD Guidelines for Multinational Enterprises and the Global Compact Principles. This is also supported by external studies in some instances.

If you are a major multinational corporation whose main business is in a sector that in general struggles with corruption, such as oil and gas exploration, and a substantial part of your business is located in an economy fraught with corruption, such as Russia, then the least an investor can expect to see is a company policy on corruption prevention. This is unfortunately not always the case.

This does not mean that individual company representatives are happy with corruption. Externally they must maintain the image that their company is completely on top of corruption since the last thing they want to do is to have to deal with the Russian anti-corruption authorities. But they do admit that on an overall business level corruption is a major problem that they would very much like to get rid of. Consequently, there is a real opportunity for investors to push for more transparency, systematic reporting, training etc.

Without confessing that there was a need for it, several companies showed a genuine interest when GES laid out which components a comprehensive corruption prevention program should consist of in order to be effective and in line with industry best practice. This will be very interesting to follow up on in our continuous engagement and next Russian tour.

MAG•E•SINE 2013 • 9

Dispersing the smokescreen around flaring

By Flemming Hedén, Senior Engagement Manager, GES

Another specifically Russian ESG challenge, although less well known than corruption, is flaring.

GES raised the issue and its financial impacts with the country’s largest oil and gas companies.

Graphic illustration of Russia’s high incidence of gas flaring, based on satellite recordings from the National Oceanic and Atmospheric Administration (NOAA).

10 • MAG•E•SINE 2013

There is surprisingly little controversy over the fact that Russia is the world leader in wasting valuable hydrocarbons through gas flaring. This practice of burning off flammable gas that bubbles up together with oil is an eyesore to many. Oil and gas producers see valuable raw materials go to waste when instead they could have been used for energy production, transportation fuels, chemical industry feedstock or as an oil recovery booster. Those that care about a healthy and prosperous planet see a giant man-made pollution source that jeopardises human health as well as the environment including the climate. Particularly disturbing is that this happens without giving us any of the benefits that we usually expect from burning hydrocarbons. In countries such as the US, Norway and even Kazakhstan the practice is illegal.

There are internal as well as external forces, the World Bank for example, that for a long time have pressed for better control of gas flaring in Russia. In response to this the presidential decree no.7 was passed on January 8, 2009. The decree demands that oil and gas producers’ overall associated petroleum gas (APG) utilisation rate has to be 95 per cent by 2012. This would align Russia with the world average but still lag well behind the 99-100 per cent APG utilisation rates typical of modern, well-run oil fields. In mid June 2012, when the average use rate was still falling short of the law, the newly appointed Russian resources minister, Sergei Donskoy, said that Russian oil companies were facing fines of hundreds of millions of dollars or more because of their inaction.

niably a lot of interdependence between companies.

A shared transportation infrastructure is used, transportation and storage capacity bottlenecks have to be sorted out, APG quality specifications need to be met, transfer fees must be agreed on etc. But in an industry known for excelling in creative and complex mega projects these challenges seem unconvincing.

Lack of government as well as investor pressure are more likely causes of the failure than technological and commercial obstacles. Government pressure is mostly but not entirely out of investors’ control. Oil and gas companies in their investment portfolios lobby the government for delays and exemptions in flaring fighting legislation. Investors can put a stop to this lobbying. Investors can also be much more demanding when it comes to requesting transparency from companies.

In order to reduce risk, investors would be well advised to demand full declaration from companies on what the financial impact will be as a consequence of the different proposed flaring fee levels.

During GES’ engagement tour in Russia in June 2012, we met with the largest oil and gas companies and naturally discussed the presidential decree no.7.

So far only two companies, Surgutneftegaz and Tatneft, have managed to reach the stipulated 95 per cent APG utilisation rate. The outlook for most other companies is not bright. In the past three years, the rate dropped from 84.1 per cent to 75.4 per cent. Russia continues to burn more and more APG in flares. This is due primarily to bringing new fields into development in areas with underdeveloped AGP processing and transportation infrastructures along with a simultaneous drop in production at old well-developed fields. The Vankorskoye field operated by Rosneft alone accounts for more than 25 per cent of all the APG burned off in Russia.

When this issue was raised by GES, the responses were less than satisfactory. Instead of detailing company plans on how to comply with the law, companies repeatedly blamed their competitors. There is unde-

Gas flaring torches in Russia.

MAG•E•SINE 2013 • 11

RISK Transparency

Engagement

connecting companies to the investment analysis process

GES takes engagement to a new level by adding a company forum to its investor-subscribed Engagement Forum, where companies can access and interact on their analysis. Already tested on the Warsaw Stock Exchange, this Risk Transparency Engagement has proven to increase reporting on environmental, social and governance (ESG) issues and to build a better decision basis for responsible investment. Therefore, it will now be successively implemented on an international level.

By Magnus Furugård, President and Managing Director, GES

When we set up GES Engagement Forum in 2005, it was an unprecedented investor client interface for active ownership. Eight years later, we are extending it during 2013 with a forum for companies to login to, thereby enhancing its position as the leading engagement platform. The new section has been developed in response to both investors’ and companies’ needs.

12 • MAG•E•SINE 2013

Companies often ask us about our analysis of them, how they compare to others, what they should do to improve, and how the analysis models work. These are natural and relevant questions. Sometimes it takes very little encouragement to convince a company to improve their management of ESG issues and to be more transparent about how they do so. At the same time

many investors ask about the evaluation of companies, and how individual companies are compared to their peer group. On behalf of investors, we engage extensively with a number of selected companies in order to improve their management of ESG issues. But what about all the other thousands of companies in the investment universe - would it be possible to have a basic dialogue with each one of them to spur them in the same direction?

We have found a very efficient way to do this: Risk Transparency Engagement. As always, Internet is part of the solution, which makes it especially well suited to smaller companies and to companies in less CSR (corporate social responsibility) developed regions, as proven in our Polish pilot project - please see article on next page.

The solution is two-fold. Firstly, GES has created a company forum where each company can access GES’ evaluation system and see its own risk analysis, rating

and benchmark towards its peer group average. At the same time, it can put questions to GES, comment on its own rating and provide GES’ analysts with new and up-dated information. They can also access valuable information e.g. international conventions and other international ESG guidelines.

Secondly, investors will have access to the results of the Risk Transparency Engagement when they login to GES Engagement Forum, and be able to take part in the development of all their portfolio companies’ management of ESG issues.

During 2013, GES will step by step encourage companies all over the world to report on their management of ESG issues and thereby diminish their risks.

Investors will get access to more frequently updated information about these risks. And other stakeholders will also benefit from the increased transparency.

Everybody wins.

MAG•E•SINE 2013 • 13

”The capital market is ready for a higher level of transparency” In 2012, GES started a pilot project on Risk Transparency Engagement together with the Polish Association of Listed Companies and the advisory company Accreo Taxand. The project covers 831 Polish listed companies on the Warsaw Stock Exchange, including the alternative share market New Connect, and is the first project in Poland where non-financial information is collected and analysed for such a large number of companies.

By Martin Pitura, Managing Director, GES Poland, Chief Financial Officer, GES, and Maja Kostrzewa, Senior Research Analyst, GES.

Although Poland is one of the largest countries in Europe and the largest financial centre of the CentralEastern European region, it is still in its initial phase of responsible investment and reporting on social and environmental issues is on a relatively low level. For example, less than forty companies listed on the Warsaw Stock Exchange published CSR (corporate social responsibility) reports in the years 2010-2011.

Mirosław Kachniewski, President of the Polish Association of Listed Companies

14 • MAG•E•SINE 2013

The Risk Transparency Engagement project was set up to promote this development by educating Polish companies and the Polish financial market. The project began with GES’ desktop analysis of the companies’ preparedness and performance on environmental, social and governance (ESG) issues according to GES Risk Rating, where all criteria are derived from international norms or best practice. GES Risk Rating is used to evaluate risks and opportunities with regard to ESG issues.

The analysis is based on publicly available information.

To facilitate communication and increase transparency of ESG issues, an interactive platform was created.

Once a rating was finished it was made available there and communicated to the company. Each company was invited to review its own individual ESG rating and had the opportunity to verify the detailed results; comment, ask questions and provide additional feedback to GES about their rating evaluation via the platform. All new information was in turn revised by GES’ analysts and, if verified positively, led to an improved company rating.

“The dialogue mainly focused on verification of additional information or sources; the former enabled us to enter into a real dialogue with a company and serve as a source of knowledge, whereas the latter very often served as example to explain what kind of sources can be used by the analysts. Through this, we wanted not only to assess the score properly but also to inform the company about what is needed to improve its level of transparency and thereby to improve the rating,” says Maja Kostrzewa, Senior Research Analyst at GES and responsible for the company dialogue in the project.

The feedback with recommendations for future improvement is an important element of this dialogue and can be used by the companies as an input in building sustainable business strategies, policies, practices and reporting systems. The platform also allows each company to compare its rating against global benchmarks, based on the results of international companies being part of e.g. the following indexes: MSCI World, MSCI Emerging Markets, FTSE All World or Vinx Nordic. And since this is intended to be a long-term project, companies will eventually be able to monitor their results over time and raise the standards of ESG data disclosure in Poland.

we decided to participate in this project as it brings these ideas closer to the companies listed on the stock exchange.

The companies’ interest and positive comments convince us that the capital market is ready for a higher level of transparency.”

Business consultancy Accreo Taxand conducted qualitative research among companies that could help identify barriers, meet expectations and provide effective support for Polish companies within the context of ESG. “During the project we met with representatives from the companies’ investor relations (IR). In most of the cases we observed that IR communicates internally with a limited number of departments. This results in information gaps in such areas as employment and employee training, purchasing policy, supply chain, social risks as well as impact on the natural environment. We also identified that a reason for not paying attention to communicating ESG data to a large extent to investors is because of lack of investor interest. However, some respondents declare readiness to report non-financial indicators if they would observe more activity among investors in this area,” concludes Robert Sroka, Head of CSR Projects at Accreo Taxand.

The Polish Association of Listed Companies undertakes efforts conducive to the development of capital market through education, promotion, and lobbying activities. For this project it created a special section on its webpage where the idea and background of the project were displayed and explained to Polish companies. It also promoted the project among listed member companies and organised a conference where the results of the project were presented.

Mirosław Kachniewski, President of the Polish Association of Listed Companies explains their motives: “Bearing in mind how important the themes of reporting ESG data and responsible investment are becoming,

Robert Sroka, Head of CSR Projects at Accreo Taxand

MAG•E•SINE 2013 • 15

Fashion NBC/Getty Images

Sustain Eco fashionista Livia Firth and her husband and actor Colin Firth in sustainable fashion made by Giorgio Armani for the Green Carpet Challenge 2012. This is an annual event by journalists Livia Firth and Lucy Siegle, who engage top designers to create sustainable fashion and show it at the world’s biggest red carpet events. The tuxedo was made in organic wool and the gown from recycled plastic bottles; both were worn at the Golden Globe Awards 2012.

16 • MAG•E•SINE 2013

A

sustainable race has taken off on the world’s catwalks led by a diverse

starting field of brands like Gucci, H&M, Patagonia and Walmart.

Their goal is to wash off the label of being one of the world’s most

nability

polluting industries. Testing new materials, new production methods and

even new business models, no hindrance seems to remain except one: making consumers desire sustainable fashion as much as they do. And if they succeed, many other industries are expected to follow suit.

– the new black

By Susanne Nyman, Founder and Strategic Communications Advisor, GES

GES was the only spectator from the investment community when the starting signal was given last year at the world’s biggest conference on sustainability and fashion, the biennial Copenhagen Fashion Summit.

Over a thousand key industry stakeholders welcomed the launch of a Code of Conduct for the Fashion Industry, the first sectorial initiative within the UN Global Compact, developed by the conference host Nordic Fashion Association and later presented at the UN Earth Summit in Rio de Janeiro.

“This very comprehensive code and the accompanying manual are valuable tools, which not only the fashion industry but also investors should utilise as a checklist for what responsible textile operations look like,” comments Tytti Kaasinen, Senior Engagement Manager at GES, who is conducting engagement with some listed companies in the fashion industry on e.g. forced child labour (see article on page 21).

The need for the code was underlined by many speakers at the conference, including Kirsten Brodde, Senior Campaigner for Greenpeace on the Detox campaign, which is focusing on one of the less fashionable sides of the industry: toxic water pollution in China.

The fashion and textile industry is the second most polluting in the world (after oil) and third in China, where 70 per cent of the rivers are heavily polluted.

25 per cent of all chemicals produced in the world are used in the fashion industry, including 5,000 toxic chemicals.

While concluding that “a majority of major brands are still stuck in the 70s”, Kirsten Brodde acknowledged that some are now making promising declarations to become toxic-free by 2020. This acceleration within sustainability was further evidenced by multiple other examples at the conference. Industry representatives demonstrated a massive awareness of the problems and a commitment to address them; the question is no longer IF they should work towards sustainability.

They know they have to. The big question is HOW to engage consumers, the missing link in the chain, and this was also the theme of the conference.

“Sustainability is a journey, and it is a no-return journey,” said Rosella Ravagli, Corporate Social and Environmental Responsibility Manager of Gucci. The company considers it a quality issue and part of their DNA, together with craftsmanship and cool design.

In 2004, Gucci took a leadership position in its industry by initiating the certification process for the SA8000 labour standard across its offices, stores and supply chain. Since then it has worked on e.g. reducing paper consumption and CO2 emissions, and most recently designed a line of sustainable footwear made from biodegradable plastic as well as sustainable eyewear made from liquid wood and recycled metal.

Gucci’s sustainability efforts has inspired its parent company PPR and will now be implemented in all its luxury and sport & lifestyle brands, for example Alexander McQueen, Puma, Saint Laurent and Stella McCartney. By 2020 they will be toxic-free and by 2015 they will also have copied Puma’s pioneering Environmental Profit & Loss Account reporting, providing a first monetary valuation of environmental impacts analysis throughout the business operations and supply chain. This will serve as a catalyst to develop a more sustainable business model for the group, which PPR’s Chairman and CEO Francois-Henri Pinault

18 • MAG•E•SINE 2013

has declared is a must in order to keep the brands’ desirability and competitive edge in the future.

Holly Dublin, Acting Sustainability Programme Director of the group’s sustainability initiative PPR Home, confirmed the high priority this work has been given: “We have had support from top-management from the very start. We take a holistic approach and strive to create sustainable brands, not only products. People in our team do not want to talk about risks, they want to focus on opportunities.”

Holly Dublin, Acting Sustainability Programme Director of the group’s sustainability initiative PPR Home

This approach might also set the example for other industries; in fact, the fashion industry might even be the best suited to tackle the largest remaining challenge and make consumers follow suit, she believes.

“Fashion has the power of making us want something new, maybe totally different from what we liked a month ago.

We can create a movement with the power to show the way for other businesses,” said Holly Dublin.

Many designers have touched upon the sustainability issue long time ago but in other contexts, like the famous quotes by Yves Saint Laurent: “Fashion fades, style is eternal” and Giorgio Armani “The difference between style and fashion is quality.” And there is definitely a heritage to follow from, for example, Salvatore Ferragamo, an innovator in materials and design, who despite leather restrictions during the World War 2 made exquisite shoes for Hollywood stars out of almost nothing: fishing line, cork, cellophane, etc.

If the luxury brands could make sustainability as unobjectionable as “the new black”, this would obviously influence less expensive brands. But they also set trends for many other designed goods, like cars

and electronics. In addition, they are especially influential in shaping young people’s consumer habits, as clothes usually are the first products they start spending their own money on. Establishing sustainability as a natural purchase criterion for them, along with design, quality and price, could start a snowball effect.

Many young consumers start spending at H&M, which also has taken significant action within its Conscious program where one of the seven commitments is to make more sustainable choices available - and desirable. Its Conscious Collections in innovative materials like recycled polyester and cellulose-based Tencel®, have appealed to many including HRH the Crown Princess Mary of Denmark, who inaugurated the conference in a CC floral dress made from organic hemp. H&M is already the world’s biggest user of organic cotton and has set the goal for 2020 that all cotton come from sustainable resources. At the same time it will strive for a zero per cent release of hazardous chemicals. However, it is aware that these measures are not enough to make a sustainable fashion future.

“With regard to greenhouse gas emissions (GHG), the biggest impact of our clothes is in the user phase, so we need to find ways to engage with our consumers. We have worked with Ginetex, who owns the symbols on the care labels, and they have now promised to implement a symbol encouraging customers to for example wash at lower temperatures and use air-dry instead of tumble-dry,” said Helena Helmersson, Head of Sustainability at H&M. Anne Prahl, Senior Consultant at WGSN, a leading trend analysis service for the fashion industry, presented a number of other innovative sustainable design concepts: “A really new trend is the role of the designer inspiring the consumer to lead a more sustainable life style and come up with new consumption habits. Durable design also includes emotional durability, which means that the consumer is encouraged to use the product much longer than usual and actually have a relationship with their clothing.”

According to the WGSN report, this can be done by inviting the customers from the start to choose fabrics or even co-create garments, later on to remodel them, and finally to dispose of them responsibly through intelligent disassembly design or mono materials.

Another strong driver of the industry’s sustainability efforts is the prognosis that the global population will

Gown by Valentino, made with Newlife® fabrics from recycled materials for the Green Carpet Challenge 2012.

grow from seven billion today to nine billion in 2040, which obviously will increase the strain on resources needed for the fashion industry, such as water, crops, land, etc. Already today, 80 billion garments are produced annually and we are consuming four times as many clothes compared to 30 years ago, often treating them as disposable goods.

Here H&M and others in the “fast fashion” segment probably face their largest challenge; however, the low-cost business model’s inherent clash with sustainability seemed to be the only question the industry was not ready to address at the conference.

But nor has any other industry depending on fast consumption e.g. food, mobile phones and air travel.

“We cannot ask consumers to consume less, but smarter,” claimed Peder Michael Pruzan-Jørgensen, Managing Director for the European section of BSR (Business for Social Responsibility), representing around 300 member companies.

MAG•E•SINE 2013 • 19

Rick Ridgeway Anne Prahl Peder Michael Pruzan-Jorgensen Patagonia WGSN BSR

Helena Helmersson Kirsten Brodde Rosella Ravagli H&M Greenpeace Gucci

One robust tool for consumers and producers - and a starting point for investor engagement - could be the new Value Chain Index (VCI), which the Sustainable Apparel Coalition (SAC) presented a preview of at the conference. It is under development by over 60 brands, retailers, suppliers, nonprofits and NGOs, lead by Patagonia and Walmart – an intriguing David and Goliath coalition that rapidly attracted for example Adidas, Gap, H&M, Inditex (owner of Zara) and Levi’s.

The VCI measures a product’s environmental and social impacts from cradle to grave on e.g. land use, water, waste, biodiversity, chemicals and toxics, energy consumption, GHG emissions, wages, working hours, health & safety and child labour. The resulting index figure can be used to compare single products, brands as well as whole factories, in order to make better choices.

Next step for SAC is how to include this in a label and replicate it for other sectors and goods like electronics, toys and home furniture. Rick Ridgeway, Chairman of SAC and Vice President of Environmental Initiatives at Patagonia (which in 1991 decelerated its remarkable growth in favour of quality and sustainability), believes this will even resolve the delicate question of price: “Once the true cost to the planet of doing business becomes increasingly visible to everyone, the result will be a major shift in political climate and political will to create policies that internalise our currently externalised costs. Then the t-shirt that is more harmful to the environment will cost more than the t-shirt that is less harmful. And sustainability would simply be the way business is done.”

GES Risk Rating of 6 fashion companies in 3 segments as per Nov 27, 2012 Company

MSCI industry

Industry rank Environment

GES Risk Rating

Social

Overall

Benchmark (scale 0-100)

3/59

b+

54

31 30

Company

3/59

Industry

PPR

Multiline Retail

LVMH

Textiles, Apparel & Luxury Goods

7/99

4/99

b+

57

H&M

Specialty Retail

8/135

4/135

b+

63

33

Inditex

Specialty Retail

1/135

1/135

a-

71

33

Walmart

Food & Staples Retailing

14/96

14/96

b+

61

39

Carrefour

Food & Staples Retailing

5/96

16/96

b+

64

39

GES' comment: Three listed companies from the article have been compared with a prominent competitor in their segment. PPR and LVMH in the luxury segment, H&M and Inditex (owner of Zara) in the middle-low price segment and Walmart and Carrefour in the hypermarket segment. The biggest brands tend to rank well thanks to the resources they are able to allocate to sustainability management and reporting, but these are also the companies which have the biggest potential impact and most to lose – or gain.

20 • MAG•E•SINE 2013

Tackling fashion’s labour problems at its roots

By Tytti Kaasinen, Senior Engagement Manager, GES

A notorious example of child labour in the garment industry can be found in Uzbekistan, where GES is engaging with a number of companies including one of the world’s largest cotton traders, Olam International. Although extremely challenging, this provides a unique opportunity to tackle the general problem of traceability of fabrics and thereby improve transparency in the whole industry.

Lizette Potgieter / Shutterstock.com

Child labour in the cotton industry is still commonplace with possibly millions of children forced to participate in the production and harvesting every year.

With its long and complex supply chains, typically involving labour-intensive production stages in developing countries, the social risks for businesses in the fashion industry are significant. The news about brands being linked to mistreatment among their suppliers frequently hit the headlines and challenges such as sub-standard working conditions, labour rights violations and even denial of basic human rights require a proactive approach. Particularly emotive amongst these

are the news about children working in the fields, factories and workshops – something all companies want to avoid being linked to not only because the association is extremely difficult to shake even with time, but also because the importance of education and play in children’s lives is universally acknowledged, as is the fact that children form the foundation for tomorrow’s strong economies and conscious consumer classes.

MAG•E•SINE 2013 • 21

While responsible companies are working with their suppliers to eliminate child labour, sometimes the most serious wrongdoing has already happened before the work on the garments even begins. In line with the practice in other agricultural commodities, children are a common sight in cotton fields. They are taken out of school to carry out hazardous physical work, in places exposed to toxic chemicals, while being verbally and physically abused and having to cope with an inadequate supply of food and clean water. The children get very little or no compensation, and those who do get paid may be charged more than their salary for food and lodging, leaving them deeply in debt.

Cotton field in Uzbekistan.

Perhaps the most notorious example of this is Uzbekistan, where the state-orchestrated practice of closing schools and forcing possibly up to two million children (as well as students and public employees) to take part in the cotton harvest every year goes on despite a widespread condemnation by numerous political entities, UN agencies, NGOs, trade unions, industry associations and fashionistas alike. Many household names in the clothing industry have also signed a pledge to not knowingly use Uzbek cotton in their products, although some do not go as far as to threaten with boy-cott due to problems with traceability in the value chain. Uzbekistan refuses to allow independent observers into the country to verify the situation, year after year telling ILO that no tripartite mission is welcome to monitor the enforcement of the core conventions at harvest time.

Forced labour and child labour in Uzbekistan is a theme GES has been closely following and actively engaging on with various stakeholders. In August 2012, we also announced the first confirmed case, when Olam International was deemed to be violating international norms through its continuing purchases of Uzbek cotton despite it being aware that production is enabled only by 22 • MAG•E•SINE 2013

the use of forced labour and child labour. The company argues that it is using its influence as a trading partner to engage in dialogue with the Uzbek government, and indeed this could be a commendable way to effect positive change, especially considering that the boycott appears to have limited impact on the situation in the cotton fields. Olam, however, has admitted to GES that this approach has not been particularly effective in recent years, and that the industry collaboration it works through is struggling even to establish a proper dialogue with the Uzbek authorities. Accordingly, in order to better utilise its leverage as one of the world’s largest cotton traders, Olam should assume a stronger, more determined stance towards the Uzbek government, making clear that the current practice is untenable and setting both goals for its engagement efforts as well as a timeline for withdrawal from the country should the dialogue not reap results.

Turning to the garment value chain as a whole, as a buyer of raw cotton directly from Uzbekistan, Olam is in a unique position in the industry. For it, traceability is not a problem, but instead the company could be making a far-reaching impact by engaging with its clients – the mills and spinners – about the importance of noting the origin of cotton even when combining it with that from other sources. It is in this stage where traceability typically disappears, with cotton arriving at spinners and mills clearly labelled but leaving them in a form that makes it very difficult to know which countries, let alone farms, produced it.

There are typically many more levels separating these actors from the brands we buy our clothes from, and thus more other chances for traceability to go wrong, but tackling this juncture would nevertheless be one important step towards improving transparency in the garment industry. Of course, the benefits would not be limited to being able to avoid cotton harvested by children, but tracing the thread all the way back to the source would also improve companies’ ability to, for instance, assess the environmental impacts where the cotton was grown.

Naturally, pressure should also be applied from the other direction, with the importance of traceability communicated by fashion brands through the supply chain. With so many different aspects to monitor and at so many levels, the industry needs to take a decisive stance towards knowing the history and footprint of the catwalk creations – right from the beginning of their lifecycle.

Note: GES is also in dialogue with three other companies regarding Uzbek cotton: Daewoo International, POSCO and H&M.

FACTS

By Anna Zetterström Bellander, Research Director, GES

CRBPs - an investor tool with specific child rights lens The Children’s Rights and Business Principles (CRBPs) - released in March 2012 - is a joint effort between Global Compact, Save the Children and UNICEF to provide a framework for understanding and addressing the impact of business on the rights and well-being of children. The links between the garment industry and children’s rights are easily grasped in the Olam International case.

However, child labour is only one out of many examples of businesses’ impacts on children’s rights globally. Industries such as food, ICT, tourism and pharmaceuticals indeed have various direct and indirect impacts on children, through their actions and negligence in the workplace, the marketplace, the environment and communities. Children are impacted through their own health, education, school and play, but also through the conditions under which their parents work, as well as through the circumstances and lifestyles in the surrounding environment.

Meanwhile, many companies today fail to recognise that children are one of their most important stakeholders, despite the fact that they constitute one third of the world’s population and are directly and indirectly affected by a company’s actions. For investors, the CRBPs thus gives a tool for assessing and engaging with companies across sectors and on a broad range of issues - with a specific child rights lens.

All businesses should: • Meet their responsibility to respect children’s rights and commit to supporting the human rights of children • Contribute to the elimination of child labour, including in all business activities and business relationships • Provide decent work for young workers, parents and caregivers • Ensure the protection and safety of children in all business activities and facilities • Ensure that products and services are safe, and seek to support children’s rights through them • Use marketing and advertising that respect and support children’s rights • Respect and support children’s rights in relation to the environment and to land acquisition and use • Respect and support children’s rights in security arrangements • Help protect children affected by emergencies • Reinforce community and government efforts to protect and fulfil children’s rights

(Source: http://www.unglobalcompact.org/docs/issues_doc/ human_rights/CRBP/Childrens_Rights_and_Business_Principles.pdf)

MAG•E•SINE 2013 • 23

Key ESG trends in emerging markets

By Erik Alhøj, Managing Director, GES Denmark, and Palle Ellemann, Senior Consultant, GES

Brazilian and South African companies are leaders in environmental preparedness in emerging markets, while Middle East companies fall short on all ESG issues. Korean companies show the lowest preparedness in corporate governance, while Russian companies have the highest potential environmental and social risks. These are some of the conclusions that can be drawn from GES’ extensive company meetings in emerging markets and ongoing Risk Rating of about 1,000 of the largest companies.

General trends GES Risk Rating and analysis of the about 1,000 largest EM companies show that: • The highest environmental and social risks are found in industries like energy, chemicals, construction, mining, paper and forestry, and utilities. The lowest are in media, finance, and the service industry.

• In general, risks and preparedness go hand in hand. Many companies in the high risk industries tend to have built up the strongest ability to handle the risks while companies in low risk industries, like media, tend to have the least ESG preparedness.

• About one third of the 1,000 companies have an engagement challenge, meaning that they either are responsible for a violation of international conventions or operating in an industry with very high environmental and social risks without any preparedness, such as policies, management systems, practices and targets, to handle these risks.

The contrasts within: horse-drawn carriage in vibrant downtown Mexico City.

• Common to most EM companies are issues like climate change, occupational health and safety, labour rights, bribery and corruption, and independence in the board. However, most material ESG issues differ between industries.

• An increasing number of EM companies adopt the Global Compact principles and report in alignment with the Global Reporting Initiative. More than 80 per cent of the largest listed companies in South Africa are using the GRI guidelines and 30 per cent of the Brazilian companies.

National Stock Exchange of India, Mumbai.

24 • MAG•E•SINE 2013

While the term ”emerging markets” from a financial perspective is losing relevance and often is considered slightly insulting, it does reflect quite well what is happening with ESG on these markets. Emerging, because there is a lot of movement and progress happening, and markets, because ESG increasingly is considered an integrated part of the business strategy and a real market opportunity.

GES Risk Rating of emerging (EM) and developed markets (DM) using MSCI World and Emerging Markets indices shows that EM companies in average show about half the ESG preparedness and performance compared with DM. As the ESG risks are often higher on the EM (depends mostly on type of industry), it is clear that there is a significantly larger “ESG gap” - difference between ESG risks and preparedness/performance - on the EM.

This overall observation covers, however, significant differences between different emerging markets and different industries, which illustrates the need to address each market, industry and even company on its own terms.

During 2012 GES has travelled thousands of kilometers round the globe to meet 77 companies face-toface on the most important emerging markets. Many of them were also visited in 2010-11. Together with GES Risk Rating covering about 1,000 of the largest EM companies, this ongoing risk analysis and broad on-site presence are building a solid understanding within GES of the key ESG trends on emerging markets. This article shares this insight with investors interested in managing risks and exploring opportunities on emerging markets.

Korea The first engagement tour in 2012 began a snow cold morning in the Capital of South Korea, Seoul. GES met with three Korean companies and the stock exchange.

With one of the largest banks we discussed corporate governance as well as corruption and bribery, money laundering, tax evasion, and responsible investing. With another Korean company – a leading insurance company - the conversation quickly focused on the business opportunities in sustainable insurance products.

GES’ rating of ESG preparedness shows that Korean companies are slightly better than the EM average on environmental and social issues while Korean companies show the lowest preparedness of all major emerging markets when it comes to corporate governance.

ESG preparedness rating Korea 30 25

26,9

25,8

20

18,6

15 10 5 0

E

S

G

101 companies rated. Scale 0-100. Source: GES Risk Rating.

Southeast asia In Southeast Asia - including the largest listed companies in Thailand, Malaysia, Indonesia, the Philippines, and Singapore - companies have relatively high corporate governance preparedness, while environmental and social preparedness is significantly lower and below the average of all major EM. In 2012, GES met with eleven companies in Thailand, Malaysia, and Singapore. Among these companies was one of the largest oil and gas companies in the region, with whom GES had had an engagement process for several years focused on a serious oil spill. Now the company had solved the problems and implemented a much better system to prevent new similar accidents.

Palm oil is a hugely important industry in the region and GES met with two of the world’s largest producers and visited a plantation in Malaysia. Palm oil has deservedly received a lot of attention in the past years due to problems with child labour, deforestation, immigrant workers, hazardous use of chemicals, and local communities. The industry is trying to address the issues via the Roundtable for Sustainable Palm Oil, but progress is somewhat slow and it is important that GES and investors continue to influence developments.

ESG preparedness rating Southeast Asia 70 60

64,1

50 40 30 20 10 0

19,9 E

13,9 S

G

265 companies rated. Scale 0-100. Source: GES Risk Rating.

MAG•E•SINE 2013 • 25

China & Hong Kong Corporate governance in China and Hong Kong is well above the average for all emerging markets; in particular, the Hong Kong based companies tend to score well. This is very much in contrast with the preparedness rating for environmental and social issues, where China and Hong Kong score 12.3 per cent and 8.7 per cent out of the maximum 100.

ESG preparedness rating China & Hong Kong 70

69,0

60 50 40 30 20 10 0

12,3 E

Given the investor focus on this region and the significant challenges with regard to environmental and social preparedness, GES has in 2012 visited 19 Chinese companies. The focus is particularly on extractive industries, like oil and gas, where climate change issues and bribery and corruption are discussed, and mining, where health and safety and alteration of land are the focus of the engagement. Contrary to the general impression that Chinese often are reluctant to listen to “western” advice, GES has experienced most Chinese companies as very collaborative and interested in discussing ESG issues in an open and respectful way.

8,7 S

G

233 companies rated. Scale 0-100. Source: GES Risk Rating.

India Despite the poor reputation and numerous environmental incidents in India in general, the 78 largest Indian companies in the MSCI Emerging Markets Index show a relatively high environmental preparedness, only surpassed by South Africa. Social preparedness in India is also above average, while corporate governance is at average.

ESG preparedness rating India 60

56,3

50

In 2012 GES met with six companies in New Delhi and Mumbai and the two leading stock exchanges in India. Local Indian investors do not generally take ESG factors into account, but sustainability indices, NGO, media and government focus on sustainability drive development.

40 30 20

27,5

24,6

10 0

E

S

G

78 companies rated. Scale 0-100. Source: GES Risk Rating.

Middle East Companies in the Middle East, and especially the Gulf countries like the United Arab Emirates, Kuwait, Qatar, and Oman, are by far the laggards when it comes to the ability to handle ESG risks and opportunities. Their GES rating for environmental and social as well as corporate governance preparedness is among the lowest. The level of transparency is extremely low and it can be very difficult just to get in contact with Middle East companies for engagement. Often you will only meet a recorded response on the phone in Arabic.

ESG preparedness rating Middle East 35 30

29,3

25 20 15 10 5 0

9,6

9,1

E

S

Some of the controversial issues in the Middle East include immigrant workers in the construction industry and labour rights related to gender and discrimination. Lack of independence in the boards is a common problem due to the very close links between companies and the authorities in most of the Gulf Countries.

G

48 companies rated. Scale 0-100. Source: GES Risk Rating.

26 • MAG•E•SINE 2013

Africa The African continent represents at the same time the top and the bottom, when it comes to ESG preparedness. Of all major emerging markets, South African companies have the most advanced ESG preparedness. In corporate governance, the South African companies score 81.6 per cent.

However, in the rest of Africa - Nigeria, Kenya, Ghana, Zambia and Morocco - the companies show some of the lowest levels of ESG preparedness. On average, the environmental preparedness among these companies is only eight per cent of the maximum score. Transparency is often very poor and it can be very difficult just to get in touch with the companies.

In 2012, we have met with seven companies in South Africa, in particular from the mining industry. GES was in Johannesburg just a few days after the fatal Lonmin-conflict, where 34 striking miners were killed by the police. The incident has shown some of the social and political unrest in South Africa, where union rivalry, unemployment and poverty are some of the sources of tension.

ESG preparedness rating Africa 90 80

81,6

70 60 50

54,0

40 30

36,7

33,4

Several of the largest mining companies in South Africa have a relatively high level of ESG preparedness, but GES is particularly driving engagement on safety, labour rights and relations, and local community development. In South Africa, the Johannesburg Stock Exchange and corporate governance regulation have been instrumental in driving ESG disclosure to today’s level.

20

77 companies rated. Scale 0-100. Source: GES Risk Rating.

South Africa

10 0

8,4 E

12,1 S

G

Rest of Africa

Russia Due to a high proportion of companies in high-risk industries, like oil and gas, mining and utilities, the Russian companies in the MSCI Emerging Markets Index have the highest potential environmental and social risks of all the major emerging markets. The need for highly developed ESG preparedness, such as policies, management systems and practices, is great in Russia, but environmental and social preparedness is more or less on the average of all emerging markets.

In 2012, GES visited seven companies in Moscow and Siberia. The focus is mostly on the largest oil and gas companies, where climate change, environment, bribery and corruption, and alteration of land are the main issues. Due to GES’s visit to RusHydro in Siberia, it was possible to carry out a substantial review of the safety procedures and thereby successfully close an engagement case with the company.

ESG preparedness rating Russia 60 50

52,9

40 30 20

21,7

10 0

E

17,5 S

G

33 companies rated. Scale 0-100. Source: GES Risk Rating.

Latin America Brazil is one of the emerging markets with the highest level of ESG transparency and environmental and social preparedness. Corporate governance is, however, below the average of all major emerging markets. The rest of Latin America has a slightly lower environmental and social preparedness than Brazil.

In 2012, GES met with twelve companies in Brazil and attended the UN’s Rio+20 events in June. The 2012 events in Brazil have empowered the focus on sustainability among Brazilian companies and led to many new initiatives and new sustainability reports among the midcap companies. Deforestation related to food production, mining and energy is a key issue in Brazil.

ESG preparedness rating Latin America

Also in 2012, GES met with seven companies and the stock exchange in Mexico. The new Sustainability index in Mexico has been a motivating factor for many of the large Mexican companies to further improve ESG disclosure. One issue, however, has very limited disclosure in Mexico. Due to the elevated number of kidnappings and organised crime, Mexican companies hesitate to publish management and board members compensation packages, because it would make them a target for criminals.

30

50

46,4

40

20

24,6

27,2

10 0

E

S

G

143 companies rated. Scale 0-100. Source: GES Risk Rating.

MAG•E•SINE 2013 • 27

Shareholder engagement

gaining momentum

in Germany

By Patrick Wirth, Managing Director, GES Switzerland

Whilst shareholder engagement is more familiar and has deeper roots in Anglo-Saxon and Nordic markets, the German playing field has been relatively empty - until recently. Churches and PRI signatories are now driving the development, and GES’ and its strategic partner oekom research contribute to it further by providing strong arguments and dismantling prejudices.

German investors distinguish between proxy voting or filing resolutions and engagement through constructive dialogue. In practice, however, most engagement activities are limited to only voting and there it typically addresses the “G” in ESG (environment, social, governance). The “E” and the “S” are largely unaddressed. Furthermore it seems that it is often smaller shareholders or representatives, who are raising their voice, and not the block shareholders. To make a long story short, there is no established culture for shareholder engagement in Germany.

How can this situation be explained?

Until recently, there was a “Deutschland AG”, meaning an exceptionally strong interlinkage between large financial institutions and German companies. The foundation of the Deutschland AG consists of large cross-

28 • MAG•E•SINE 2013

shareholdings and a concentration of board of directors’ mandates. Right in the middle of this structure were institutions such as the Deutsche Bank or Allianz with tremendous shareholdings and governance power related to these companies.

Empirically it is known that companies with a concentrated shareholder base offer less scope for constructive dialogue. Investors that do not own the big blocks may view those companies much harder to achieve results with. Shareholders that own the big blocks are financial conglomerates where conflicts of interest may thwart investor stewardship. For example when the colleague from the investment banking department presses the asset manager operating under the same brand not to offend his clients by engaging in corporate governance matters.

investor without having to rearrange his portfolio all of a sudden. External drivers are the increasing number of PRI signatories in Germany as well as the policy issued by the Evangelical Church of Germany that addresses shareholder engagement in all ESG dimension.

He also outlines some challenges clients are facing when they consider implementing engagement strategies such as the assumption that a smaller investor has no power to influence companies at all. Till Jung is convinced that such concerns are unfounded and points out that also smaller asset owners or asset managers can achieve measurable results through pooling of interests and a coordinated approach as provided by the GES Engagement Forum:

Till Jung, Director Business Development, oekom research

This being said, in the past ten years some of the determining factors have changed. Legal developments, internationalisation of the German banking sector and better corporate governance guidelines attracted more foreign investors in Germany. This in turn enhanced transparency of companies and accountability of company management and boards. Gradually the old tradition of the Deutschland AG was dissolved and at the same time the doors opened for responsible investors to become more active and introduce shareholder engagement strategies.

At the moment there are church investors in the driver’s seat of this movement. However, the dialogue on how to implement shareholder engagement takes more time than planned because it involves several parties such as the national church pension plans as well as church banks. Together they represent total assets of about 60 billion Euros.

Through a combined package of highquality and detailed ESG research by oekom research and the engagement services performed by GES, we can offer a wide spectrum of tailormade solutions to assist our clients in becoming responsible investors. For this we also help clients to set up a responsible investing strategy based on their individual needs. Thus we can dismantle prejudices at an early stage should they occur.

According to Till Jung, Director Business Development at GES’ strategic partner oekom research in Munich, one of the main arguments to support shareholder engagement strategies is the straight-forward opportunity to influence companies towards better ESG performance. But another strong argument is the fact that an asset owner can become a responsible

MAG•E•SINE 2013 • 29

uilding razilian usiness onds

Photo 1-3: Veracel’s paper mill in Southern Bahía, Brazil. To the right: Stora Enso’s Head of Global Responsibility Tehri Koipijärvi and Otavio Pontes, Vice President for Stora Enso Biomaterials, at the eucalyptus plantation.

30 • MAG•E•SINE 2013

Parallel to the UN Earth Summit Rio+20 in June 2012, GES explored responsible business practices with Stora Enso in the Brazilian outback.

By Stina Nilsson, Engagement Manager, GES

It is early morning in Porto Seguro on the Brazilian east coast and we are picked up by Otavio Pontes and Terhi Koipijärvi from Stora Enso, ready for a full day’s onsite visit to Veracel’s paper mill and eucalyptus plantations (Veracel is a joint venture between Stora Enso and Fibria). While we head towards the mill, Otavio gladly shares his knowledge of local social and political conditions, indigenous communities in the area and how it is to run a paper company in this part of Brazil. Otavio is the Vice President of Stora Enso Biomaterials Business Area and is according to Terhi involved in ‘everything that Stora Enso does in Brazil’. Terhi for her part is the Head of Global Responsibility, normally working from Helsinki but also travelling to the company’s operations around the globe. Getting to know the local context by being in the country and meeting knowledgeable people like Otavio and Terhi is one of the great gains from doing these kinds of engagement trips. It definitely improves the way we assess information on the cases and enables us to make the most relevant engagement efforts.

As we arrive at the mill, Ari Da Silva, Operational Director at Veracel in Bahía, welcomes us. He gives us a good tour around the operations. He is proud when he shows the control room and tells us about the efficient use of biomaterials for electricity production and how the water treatment system works. The mill is self-sufficient in energy production and is also able to sell a surplus on the energy market.

It is evident that Ari is taking environmental management seriously; he is very knowledgeable and states that environmental issues have been important since the mill was set up in 2005. Today around 700 people are employed by the mill and an additional 2,600 are working indirectly for the mill, such as contractors and service personnel. This year’s target is to produce 3,200 tonnes of pulp per day. Ari hands us a diagram showing that their goals are met or exceeded almost every day.

MAG•E•SINE 2013 • 31

Such positive trends are also reflected on a much larger scale - in the Brazilian economy as a whole. No one could have missed that the country is developing fast.

Paper storage at the Veracel paper mill.

In such a transition period many choices are to be made about what directions the country should take, decisions that will form the country for many years to come. Large eucalyptus plantations are in the middle of one such hot issue; the issue of land use. Food, fuel and paper production, all have to share the available land. The Brazilians also have to decide to what extent small-scale or large-scale farming should be allowed to dominate the landscape. For the country as a whole about one per cent of the land is currently covered by tree plantations, but with local variations.

The different choices all have their opportunities and problems and it is up to the Brazilians to decide what way to go. However, it also becomes relevant to responsible investors when the choices have environmental and social side-effects. This is where investors can play a positive role in the development of the country and at the same time minimise the risk of environmental and social controversies in their portfolios.

There are voices critical not only of Stora Enso, but also of the paper industry as a whole. The Landless Rural Workers’ Movement, MST, have on a number of occasions occupied land used for eucalyptus plantations, arguing it is better to use it for small-scale food 32 • MAG•E•SINE 2013

production. Such MST camps are visible along the road as we drive around to the Veracel operations.

The pulp companies have also been criticised for their environmental practices; this was the reason why GES started looking into Veracel’s operations. There is an on-going court case and an administrative process against Veracel, accusing the company of logging in protected areas. We discussed the issues during the visit and Otavio has also provided lots of useful information regarding the cases after the visit. According to Stora Enso, the company has not planted in native forest areas and it has all the proper permits in place for its operations. Permits are based on satellite digital photos of the area and the authorities do a physical inspection to ensure that no area includes native forests. The plant planning is based on GPS mapping of the area and training of the employees is a continuous activity carried out

by Veracel to ensure knowledge about the procedures.

With regard to the administrative proceeding, Stora Enso has restored 1,200 hectares and replanted 600 additional hectares. The federal environmental authority however, still demands a fine to be paid by Veracel, which the company has now appealed in court.

After Ari’s demonstration of the mill and a thorough presentation of local conditions and Stora Enso’s operations by Otavio, it is time for lunch. It is not often that you get this much time to discuss ESG issues with a company’s Head of Global Responsibility and we leave the Brazilian operations for a moment to take the opportunity to discuss the situation at Stora Enso’s Chinese operations. The middlemen used by Stora Enso have been accused of using illegal means to gain control of 90,000 hectares of land for eucalyptus plantations in the Guangxi province. Landowners complain that they were not aware of the content of the land deals, others regard the compensation as far too low. Physical threats were allegedly also made against farmers who refused to accept the deal.

Stora Enso has since then reviewed all the contracts and is now in the process of renegotiating them directly with the farmers. Terhi states that Stora Enso is “correcting the contracts as fast as possible and having all the contracts corrected is a top priority for our work in Guangxi”. She also admits that there have been some violations from middlemen towards farmers. Terhi continues by saying that “during our regular meetings with middlemen and partners we discuss our corporate social responsibility policies and standards including our strict non-violence policy”. Stora Enso is also trying to reduce the number of middlemen at their operations in China to gain better control over what is happening on the ground.

At the same time as our visit in June 2012, the UN’s Earth Summit Rio+20 is taking place and it becomes evident that it is important for Stora Enso to meet with investor representatives when Terhi states: “I could have spent this day at the Rio+20, but instead I am here to meet with you. These visits are of course interruption for our personnel from their everyday duties and therefore we have to keep it in balance that we do not burden unnecessarily our organisation. Still, investor site visits are valuable for us, because we can present our operations and business to an important stakeholder group and increase the transparency without compromising integrity and disclosure.”

The final stop of the day is a forest reserve which gives you a sense of what the area was like before the native forest was pushed further and further back by cattle ranches decades ago. An area of 6,000 hectares of rainforest, called the Veracel station, has been preserved by Veracel since the late 1990’s. The area is used for training in biodiversity and environmental management of teachers and students, who frequently visit the area.

A group of teachers are just about to end a daylong visit as we enter the reserve. Scholars are also invited to conduct research at the site.

The lunch comes to an end and we leave the mill and continue to one of the many nearby eucalyptus plantations. Luis Alberto, Plant Manager at this location greets us. He has a background in agricultural management and used to work with agriculture in the neighbouring state. When he heard Veracel was starting its business in Eunápolis, he came back to the area where he grew up and started working for the company. He has been working for Veracel during the last ten years and says he has been very pleased with his work. Together with Otavio he explains about the plantation we see in front of us. The trees here have reached the age of seven years and it is already time to harvest. The combination of the local conditions and the fast-growing eucalyptus tree is of course the key to the lucrative business for Veracel and the other paper companies in Brazil.

GES Engagement Manager Stina Nilsson in the rainforest reserve.

As I return to GES’ office and continue working with the engagement cases, I notice how Stora Enso has become much more accessible and the local conditions easier to understand thanks to the visit. I can visualise the plantations and the mill and have a lot more background knowledge about Brazil. It puts the cases into their proper contexts and allows me as an engagement manager to be more to the point in my analysis and dialogue with the company. It also has another great advantage: when I send the first follow-up email to Stora Enso I get a quick response and from several parts of the company - the Investor Relations department, Terhi at the CSR department and Otavio at the Brazilian division.

Luis Alberto and Otavio Pontes at the eucalyptus plantation.

MAG•E•SINE 2013 • 33

Why financial

analysts should follow

ESG engagement

By Hanna Roberts, Engagement Director, GES, and Eric Gelfgren, Business Development Director, GES

The financial rationale is becoming obvious to those who have begun following engagement processes on environmental, social and governance (ESG) issues. Observing a company dialogue allows financial analysts to uncover and/or understand the propensity for change within the company.

Since understanding change agents and their effect is crucial to all business valuation, being in the forefront of an engagement dialogue can put the financial analyst ahead of others.

Previously many asset managers and asset owners have seen ESG engagement with portfolio companies as a communication and governance question, but increasingly insightful investors are looking for ways to extract greater financial understandings from engagement.

The problem however is that effective engagement is extremely resource intensive and often not justifiable for a single organisation to cover all costs. This is also why collaborative initiatives such as PRI (Principles for Responsible Investment) have been created. But even so, some of the collaborative approaches also require significant resources to follow and manage as different collaborative engagement initiatives also result in diverse engagement processes.

To increase resource efficiency, a number of large asset managers and asset owners asked GES to create a well-structured engagement process that is repeatable and scalable with clearly defined goals, follow-up and feedback. GES’ response to this led to the creation of GES Engagement Forum in 2005, an unprecedented interface where clients can follow our engagement process with individual companies.

GES’ engagement philosophy is based on the premise that changes in business conduct drive changes in 34 • MAG•E•SINE 2013

corporate value. Thus, we seek to instigate changes in business conduct where deemed necessary. This provides owners with information on companies’ propensity for change, which can become valuable as an early indication of change in corporate value.

Consequently, GES’ engagement on business conduct helps clients become more informed investors.

Within the forum, asset owners and asset managers have the possibility to focus on the engagement areas they believe contribute the most to shareholder value and stakeholder relevance. These choices can range from fully objective criteria such as international norms and conventions to specific theme-based engagement, for example, emerging markets, Burma, water and climate change, and bespoke engagement support for e.g external managers or a particular portfolio holding.

In effect, GES becomes an outsourced extension of asset owners’ and asset managers’ engagement aspirations and processes. By sharing research resources and creating a shared process, the members of GES Engagement Forum have the benefit of gaining access to the full range of engagement dialogues held on behalf of the members. This means they can minimise their internal staff for engagement and focus their resources on how such information can best be integrated in their own internal processes.

As a result, GES’ engagement becomes the least intrusive and most easily communicated ESG strategy to integrate with traditional asset and portfolio management.

GES provides clients with a due diligence review of corporate non-financial business conduct. Where deemed necessary, we define improvement objectives and put in place an engagement plan with a clear process and defined timeline aiming at improving the long-term value of the business.

At every stage of the process we involve our clients and provide feedback on actions, company responses, progression against plan and next steps. We act as, and are viewed by companies and clients alike as, an owner advocate on material business conduct issues which sets us clearly apart from special interest activists in the engagement field.

The main tool is company dialogue. The dialogue is used to influence the company by suggesting improvements as well as transferring specialist knowledge and experience to the company. The aim is to ensure that the company comprehensively understands what can be achieved and what value such changes might result in for the company and its owners. But dialogue is also a way for GES’ engagement managers and research

analysts to understand the subtleties of the company management culture in order to be an informed advisor for both the company and its owners. Through GES Engagement Forum the clients can follow the dialogue, add to it or take their own initiatives backed up by GES’ team.

For us each engagement objective has to be aligned with the company’s and shareholders´ best interests.

The dialogue has to be constructive, focused and action-oriented as well as having a clearly determined timeline. Once objectives are achieved or in the process of implementation, the market is often quick to recognise the changes and business benefits.

An additional benefit may also be that the risk of the company being involved in corporate-specific non-linear adverse events is often reduced as a result of change.

In the words of one of GES Engagement Forum’s members: ”If you look at the right things, the numbers will follow. If you follow the numbers, you might not look at the right things.” GES’ engagement strives to help asset owners and asset managers look at the right things so that the right numbers can follow.

MAG•E•SINE 2013 • 35

trust

a ticket to the top

36 • MAG•E•SINE 2013

In March 2012, GES was exclusively invited to Shell’s Annual Briefing to Socially Responsible Investors where selected institutional investors, asset managers and a handful of ESG service providers get to mix and hold discussions with Shell’s top executives about the pivotal environmental and social issues facing the company. Out of 33 participants only three individuals from ESG service providers were invited: two of them being myself and my colleague Agnieszka Kulczynska, Senior Research Analyst at GES.

By Shane Chaplin, Senior Engagement Manager, GES

GES has a good relationship and history of engagement discussions with Shell, going back to about 2005.

Over the years we have lobbied Shell for reductions in flaring from its oil and gas production operations in Nigeria, spoken about contaminated sites in Brazil and pushed for the protection of grey whales in Russia, to name a few of the topics. Despite the issues being someShell building, London. times thorny to tackle, we believe the company has kept the door open to GES because of the way we go about conducting our engagement dialogue on behalf of investors. GES institutionalised this conduct in 2011 by developing its Engagement Guidelines, which comprise the qualities we believe are essential for success. The guidelines include aspects related to transparency and having clear objectives, as well as human elements such as respect, patience and trust. Trust built over the long term had been pivotal for getting us around the meeting room table now with Shell in London, as we were later to find out.

The day began with a presentation of the company’s Annual Sustainability Report by Royal Dutch Shell’s Chairman of the Corporate and Social Responsibility Committee Chad Holliday and Chief Executive Officer Peter Voser. This was followed by four paral-

lel half-hour break-out sessions, where issues such as oil sands developments, management of greenhouse gas (GHG) emissions, arctic drilling and deepwater drilling were all discussed in Q&A format. These short meetings were kind of “speed dating” sessions with Shell executives - a rare privilege for anyone to get to hold court with the key decision makers in such a large company, whose reach and impacts, both positive and negative, are absolutely global.

During the meetings, the theme of trust popped in and out of my mind several times. How does one ask good incisive questions, without sounding accusing? Focus on the key issues. How do GES and investors become a part of the solution, instead of just critics with nothing positive to contribute? Don’t destroy the trust – the seat at the negotiating table may not be offered again.

The famous Australian scientist Dr Karl Kruszelnicki had a saying that went: “It’s not the answer that wins someone the Nobel Prize, it’s the question”. So good questions are key, but so too are careful delivery and follow-up.

We asked questions on the conflict between policy and practice, where Shell’s policy is to reduce GHG emissions, but where its practice involves increased involvement in GHG intensive oils sands extraction.

In another session we sought assurance from Shell that it was collecting sufficient baseline environmental data, and had good spill prevention and contingency plans in place before venturing off into the Arctic.

We left these sessions impressed with the depth of knowledge on social and environmental issues that top Shell execs possess. On the other hand, we were disappointed to hear that solar is no longer a renewable energy focus area for Shell (the story is similar at other oil majors), and that there were not more Shell sustainability experts from the company present.

MAG•E•SINE 2013 • 37

SCANPIX / AFP Photo / Pius Utomi Ekpei

A fishing boat is abandoned on Bodo waterways polluted by spilled crude oil allegedly caused by Shell equipment failure in Ogoniland, Rivers State, August 11, 2011.

In the morning on day two we had the privilege of a “one-on-one” meeting with Mutiu Sunmonu from SPDC Nigeria and Kyle Jarton, Shell’s Head of Investor Relations, to drill down into some of the specifics of the social and environmental challenges Shell faces in Ogoniland in Nigeria. This meeting was arranged in collaboration with Kempen Asset Management, a Netherlands based client of GES who meets regularly with Shell in The Hague, and also joined us via a teleconference line.

Shell’s challenges and controversies in Nigeria seem to have a history that goes back forever. Indeed, it was half century ago that Shell, along with BP, discovered oil in Nigeria. In GES Engagement Forum, for investors wishing to collaborate on company engagement, we have had cases relating to Shell’s Nigeria operations for quite some time now. This work received a “shot in arm” in 2011 following the release of the United Nations Environment Program’s (UNEP) report on the environmental impacts of oil pollution in Ogoniland. Shell provided support to the UNEP researchers and the result has been a landmark report, which scientifically documents the full extent of pollution in the region. In the executive summary of the report the researchers conclude that: “The findings in the report underline that there are, in a significant number 38 • MAG•E•SINE 2013

of locations, serious threats to human health from contaminated drinking water to concerns over the viability and productivity of ecosystems. In addition that pollution has perhaps gone further and penetrated deeper than many may have previously supposed”.

The Ogoniland problem is many times bigger than the Deepwater Horizon or Exxon Valdez spills and may take at least 30 years to properly clean up.

The report has received some criticism, but GES, while acknowledging these criticisms, believes that it represents a solid body of evidence that Shell and other stakeholders in Nigeria can now use in planning future clean-up activities. The size of the problem is enormous and the local socio-political setting highly complex.

On top of this, the oil theft and trading industry (colloquially known as “bunkering”) is also growing out of control in the Niger Delta, itself contributing to further serious oil pollution and social problems.

Shell’s success relies on other parties, several of whom it cannot control. In short, plenty of resolve, diplomacy, competence and cooperation will be required by all parties in order to effectively address the problems.

Our meeting with Messrs Sunmonu and Jarton went well. Mutiu Sunmonu conveyed a deep understanding of the issues related to Ogoniland and expressed that

he wants to leave a positive Shell legacy in Nigeria.

He admitted the task ahead was difficult. We learned that the company has completed considerable on the ground work in Ogoniland: capping wells, securing infrastructure, remediating contaminated sites and providing clean water to villages. When asked what the ingredients for success were in the land rehabilitation and other programs conducted to date, he said that demonstrating community needs were being provided for, in addition to gaining trust and showing care were the key factors. Getting influential community leaders onside was also an important step.

During the meeting we heard of initiatives which were not at that time published on the Shell’s website, so we made the suggestion that the company could improve in communicating these positive stories to stakeholders. We also floated the idea of the company documenting for investors a detailed plan of how it intends to respond to the UNEP’s report - one of the engagement goals that GES has set in the Engagement Forum.

Our suggestions were positively received.

Shell and the other stakeholders including investors need to succeed in Ogoniland. It is only with a seat at the table that one gets to participate in the process of addressing complex ESG issues and the making of improvements. Coupled with trust, all stakeholders need to have solid knowledge of the issues and science (in this case) at hand, and a knack for diplomacy.

Shell’s problems in Ogoniland may not have changed in recent years, but we saw positive signs of change within the organisation. The UNEP report, whilst exposing the sores, also provides impetus for something different and more positive to occur. It is in effect a game changer. For the sake of the Nigerian people, the environment and Shell’s credibility, tangible success on the ground in Ogoniland is needed.

A purely CSR-PR exercise would not be in the best interests of any of the stakeholders. An early positive sign is that Shell has resolved to act on the findings of the UNEP report.

We believe that success in cleaning up Ogoniland can only be achieved by growing and expanding those small wins and successes described above that the company has already achieved. The building and restoring relations part is perhaps more difficult than the technical challenge of cleaning the environment itself, so any goodwill gained needs to be leveraged to the maximum extent possible.

Maybe there is a parallel here with GES’ work. It is trust and goodwill that have gained GES a place at the Shell discussion table, and it is those qualities that

GES Engagement Guidelines Knowledge

We provide a profound understanding for the company and its operations.

Trust

We handle confidential and sensitive issues appropriately.

Expertise and influence

Our track record and client stock add weight to the engagement process.

Respect

We listen to the company and involve it in the collaboration.

Reasonable attitude and long-term perspective We are willing to see the company’s side and negotiate.

Professionalism

We keep the investor hat on instead of replacing it with an activist hat.

Clarity on the issue

We clearly communicate why a matter is of concern to investors.

Clear objectives

We refer to international standards.

Common framework

We speak with one voice in collaborations.

Result orientation

We focus on change not just socialising.

Patience

We know from experience that it takes two-three years on average to change.

Documentation and transparency

We provide both the client and the company with accurate information on the engagement process in order to ensure efficiency and quality.

MAG•E•SINE 2013 • 39

Bridging the gap between asset owners and fund managers

By Fredric Nyström, Key Account Manager and Engagement Coordinator, GES

An increasing number of asset owners face the dilemma of how to align their sustainable and responsible investment beliefs with the short-term interest of fund managers. Mentoring and monitoring managers could be one solution, as practised in GES’ engagement overlay service for e.g. Strathclyde Pension Fund.

40 • MAG•E•SINE 2013

Fund managers are mostly pretty self-confident.

When they meet an institutional investor and do their sales-pitch they can talk at length about their unique investment model, philosophy and their unique selling points. They present their own, pre-packaged solution.

But when the potential client starts asking about the funds environmental, social and governance (ESG) approach and responsible investment philosophy, the fund manager often loses momentum. And now a strange situation emerges: the roles are suddenly reversed and the fund manager asks for instructions, what to do and how, and sometimes also why.

More and more asset owners believe that responsible use of the rights attached to shares strengthens the way companies are managed and contributes to creating long-term value for the companies and its shareholders. They also believe that they have a role to play in a sustainable development and hence integrate ESG criteria into the investment process. As a logical consequence of this, the owners want to ensure that these beliefs trickle down the investment chain.

Examples of investment beliefs: Responsible asset owners who exercise best-practice portfolio management should have concern for environmental, social, and governance (ESG) issues of companies. Improving ESG factors can improve the long-term financial performance of a company. (New Zealand Superannuation Fund)

Responsible investing requires a full view of risks and opportunities. Environmental, social and governance (ESG) factors should be integrated into the investment process of our managers, whether in-house or external.

(Universities Superannuation Scheme, USS)

The challenge for a pension fund is to align its investment beliefs and the long-term objectives of the pension fund with the short-term interest of the fund manager.

One can conclude that there is a potential gap between what owners seek and what managers can offer. Offering “investment solution strategies” is not longer enough; it no longer satisfies institutional investors’ requirements. Pension schemes that have an interest in sustainability should seek to discuss those issues with potential external managers during the appointment process and include ESG search criteria in the request for proposal. Ideally, these criteria should be equally as important as the financial criteria. But for

many asset owners a responsible investment policy is still just a contributing factor and not a deciding when they choose who shall manage their money.

In order to bridge the gap between what asset owner clients want and what fund managers offer, asset management will have to reinvent itself. Part of that reinvention is spelled stewardship. It have to adapt to a new environment where asset owners seek to build intrinsic corporate value over long term and not only increase short-term shareholder value.

If the asset owner has the resources, it can be a mentor in the process. If a fund manager scores poorly on responsible investment in a beauty contest, it can be picked up under the circumstances that it is willing to change and listen to the client and improve its score over time. This requires the fund manager to keep an open mind.

A key factor in the evolution of responsible investment from a “feel-good” investment idea to a core valueadding investment proposition will be the measurement of the impact of responsible investment activities.

This is a difficult area but some investors are attempting to develop metric for this.

Logically, sustainability needs to be a natural item on the agenda in the manager meetings. The fundmanagement industry has to take greater interest in the evolution of the new business world in which it and its clients will have to exist.

Today these ideas have gained a critical mass among pension funds that together send a clear message: it is in the duty of the fund manager to use the shareholder rights and assume the responsibilities for corporate governance. Asset owners want to see steps taken toward greater activism by their agents, which is essential to sound long-term investing.

The ideal outcome would probably be a personalised sustainable, long-term relationship creating shared value. This requires a far higher degree of engagement between investors and their managers. Fund managers that dare to be in the forefront and provide their clients with stewardship products will be the winners.

But nothing will happen without engaged shareholders and asset owners.

For a practical example on how this dilemma can be handled, please see article on next page.

MAG•E•SINE 2013 • 41

Cost-effective engagement overlay For a couple of years GES has offered a structured engagement overlay service to asset owners, with the aim to bridge the gap between them and their fund managers, and, on behalf of asset owners, integrate their fund managers into a collaborative active ownership process.

By Fredric Nyström, Key Account Manager and Engagement Coordinator, GES

GES works with the asset owner clients to monitor their managers’ engagement activities and how the information from these activities feed into fund managers’ investment process. This is a process devel-

oped to support pension funds without internal ESG capabilities and pension funds that have externalised their investment management, especially typical for small and mid-sized pension funds.

Since early 2012, GES has supported the Strathclyde Pension Fund with an active engagement overlay service. Below is the process that GES undertakes with Strathclyde and other asset owner clients: 1. Together with the asset owner client, GES sets up a process based on well-established international guidelines for ESG issues.

2. GES checks the holdings in the underlying funds and reports back to the client which companies are identified to be systematically and/or severely breaching such norms.

3. The client decides which companies are relevant for engagement, based on their policy.

4. GES arranges engagement meetings with the fund managers to present the engagement cases in the portfolio. In these meetings GES Engagement Managers outline the long-term

In addition to company specific engagement reports that the client can extract from GES Engagement Forum, they also receive regular reporting about the dialogue with the fund managers and their progress.

This includes minutes from the engagement meetings, evaluation of the fund managers’ engagement performance and a rating of the fund managers’ responsible investment policy and engagement preparedness.

42 • MAG•E•SINE 2013

engagement objective as it is explained in GES Engagement Profiles, which are also distributed to the investment managers. The managers are encouraged to speak to the management of the companies in which they invest and hence, to be part of the collaborative engagement process; the fund managers can exert influence on the companies due to the positions they hold.

5. GES follows up after six months to evaluate the fund manager’s progress - if they have assessed the case and taken any actions. This discussion will also include questions to determine if and how the fund manager is using this information in their investment processes.

A major challenge in the process is convincing the fund managers of the importance of each individual case. To overcome this challenge, it is helpful to have an asset owner representative participate in the engagement meeting in order to reinforce the message presented to fund managers.

European angle meets American twist GES’ upgraded partnership with US shareholder advocacy veteran ICCR offers a diversity of collaboration opportunities for investors on both sides of the Atlantic.

By Tytti Kaasinen, Senior Engagement Manager, GES

legal developments in the US. Of course, certain issues remain ‘hot’ year after year, but even with those there is often an ‘American twist’ , which is very useful for widening our horizons.

GES’ Senior Engagement Manager Tytti Kaasinen meets in New York with Alison Bevilacqua (left), Vice President and Head of Social Research at Legg Mason Investment Counsel, and Lauren Compere (right), Managing Director at Boston Common Asset Management.

For many years, GES has been cooperating with the US-based shareholder advocacy veteran Interfaith Center on Corporate Responsibility (ICCR), which comprises around 300 institutional investors with over USD 100 billion in assets under management. In 2011, we became an associate member, thereby formalising the link between our European roots and the investor community on the other side of the Atlantic. ICCR offers an excellent platform for strengthening our knowledge and engagement activities when it comes to Northern American companies, and extends our collaborative possibilities beyond the signatories to the UN-backed Principles for Responsible Investment (PRI). At the same time, we contribute to the organisation by giving a ‘European angle’ on responsible investment and sharing insights gained through GES’ engagement expertise.

A great forum for all this – aside from the ICCR members’ database, which GES uses on a daily basis - are ICCR’s triannual member conferences in the US. During 2012, I attended two of them. The weeklong events provide useful opportunities to find out how other investors perceive different environmental, social and governance topics, how they are planning to address them and to refine GES active ownership strategies accordingly. They also offer valuable insight into what issues are of particular interest to our North American counterparts, with conflict minerals and responsible investment in Burma being two topical examples from the 2012 meetings, reflecting the related 43 • MAG •E •SINE 2012

Indeed, investors’ approach to shareholder activism and engagement has traditionally been somewhat different in the US and Europe, but there is a clear interest on both sides to learn from each other and integrate the parts found to be working best into current strategies.

Speaking at a panel, which looked at different engagement styles across Europe and compared and contrasted those with the USA, I had the chance to explain how we at GES view engagement generally and collaboration specifically, and to offer some examples from our back catalogue of successful company dialogues.

People participating in ICCR meetings are very active and skilled engagers and we have already embarked on many joint efforts with several members, most lately in 2012 with e.g. Toyota, KBR, Boeing, Nestlé and business in the Occupied Palestinian Territories.

Another area where GES hopes to combine forces with other ICCR members is Western Sahara, which I hosted a session on at one of the conferences. Few ICCR members were familiar with the topic but many had previously expressed interest in finding out more.

Western Sahara is a Non-Self-Governing territory occupied by Morocco where human rights offences against the native Saharawis are frequently reported and the people’s right to self-determination remains unfulfilled. Since GES has been leading international investor efforts to encourage companies to act responsibly in connection with Western Sahara, we like to take every opportunity to raise awareness about this issue to prompt more investors to get involved. Accordingly, I explained to the ICCR membership why they should be concerned about investees’ involvement in this territory. With human rights and community issues at the top of most members’ agenda, acting on Western Sahara is well aligned with their values, and indeed the attendees’ reacted very positively to GES’ session.

MAG•E•SINE 2013 • 43

Looking ahead from five years of Burma engagement

By Anna Zetterström Bellander, Research Director of GES

Five years have passed since GES began its engagement on Burma and a lot has happened with the country and the world’s attitudes towards it that is well worth reflecting upon.

Our journey started in the wake of the media storm prompted by the military regime’s brutal crack-down on monks in 2007. As the spotlight was turned to Western companies active in Burma and their owners, divestment voices grew loud and investors with holdings in the French oil company Total and others were automatically written off as irresponsible. The engagement strategy, which GES believed in already then, gained little, if no, recognition in the public debate.

As always, the media storm eventually passed and the public’s eyes turned to other corners of the world.

Meanwhile, human rights violations, corruption and oppression continued in Burma. However, behind the scenes, changes were slowly about to unfold and as the new President Thein Sein introduced political and economic reforms in 2011, Burma was yet again on everyone’s lips. This time around, attitudes were a lot more optimistic, though cautious. Focus shifted from divestment to the question of how investments can be “democracy-friendly and human rights-friendly”, to quote Burmese opposition politician Aung San Suu 44 • MAG•E•SINE 2013

Kyi. Hence, engaging with companies and pushing them to adopt international standards and best practice in Burma has almost become mainstream.

GES has kept more or less the same position throughout the ups and downs, believing firmly that engagement is a more fruitful strategy for exercising active ownership than divestment. It has never been an easy route to take in a context like Burma’s though and the merits of engagement with the oil and gas sector that has provided the junta with significant revenues have rightfully been questioned. Was it right for Total to stay in the country and continue to defend its business and ethics? On one hand, some argue that the economic sanctions, which prevented Total’s American and European peers from entering the market, may have been effective and actually contributed to motivating the recent reforms in the country. On the other hand, Total was recently publicly labelled a responsible investor by Aung San Suu Kyi and, today the company, which has been present in Burma since 1992, is certainly many steps ahead of its peers in terms of

local understanding as well as leverage with authorities and other actors in the country, which makes it well positioned to play a positive role.

It is now imperative that companies make use of and move beyond past experiences and grievances and show willingness to share insights with peers and stakeholders to get things right for the future. It is therefore promising to witness how the developments in Burma have gained such wide attention globally and how actors from various sectors are convening to form multi-stakeholder dialogues and initiatives in Burma and outside for that very purpose; to pool and share resources, competences and experiences.

For investors, it is still important to pro-actively minimise risk by engaging with or avoiding low performers in high-risk sectors with a significant footprint in Burma, but it has become equally relevant to engage with companies waiting at the door-step and contemplating their opportunities in “Southeast Asia’s final frontier”.

Many of them are the companies that could play a positive role in contributing to re-building the country’s future, if they are diligent. However, the anticipated surge in investments that some feared would happen as soon as EU and US sanctions were eased does not seem to be happening in the short term. While some, including Nordic telecommunications companies, seem tempted to be first movers on the new market, many foreign companies, including several large multinationals GES has spoken to, are cautious about moving too quickly into this immature business environment, still characterised by restrictive regulatory frameworks, weak legal enforcement and inadequate transparency.

It makes good sense to any company, regardless of its CSR-profile, to invest in due diligence before enter-

ing such a context. It is equally vital to ensure that the process also integrates human rights aspects and that it allows enough time to consult relevant experts and stakeholders, in order to make well-informed decisions before entering the market and, potentially, ending up entangled in business relations linked to the junta and its cronies.

There is no lack of guidance documents and standards defining what is expected of responsible businesses, but one should humbly accept that implementing them remains a challenge in a context like Burma, given that the country is in flux and no one can predict where it will be even two years from now, after the parliamentary elections in 2015. If things go wrong, the positive trajectory may slow down or even turn completely. In the worst case, peace negotiations may be halted and ethnic conflict escalate, while the junta takes a tighter grip on power, further excluding the opposition from any political influence. In this negative scenario, companies invested in the country would find themselves in the midst of a highly unstable and unpredictable business environment. On the other hand, if things go right in Burma, businesses that do invest and remain in the market in five, ten or even fifty years from now, may find themselves operating in an environment governed by the rule of law and benefiting from a growing base of healthy and educated workers and consumers as well as efficient value chains.

If anything, it should be clear to all businesses with a serious interest in tapping into the business opportunities in Burma that they cannot shun away from contextual and political factors like democracy, human rights and peace, as they are intrinsically linked with the prospect of thriving as a business in the country.

3 of 36 ready to handle human rights As a basis for GES’ engagement with companies operating in Burma, we have analysed and compared 36 companies on seven key performance indicators (KPI s) derived from well-established international guidelines. These include a public commitment to respecting human rights globally, human rights due diligence in Burma, risk management related to contracting of security personnel, engagement with business partners, peers, authorities and local stakeholders as well as transparency and accountability.

One conclusion to be drawn is that very few companies operating in Burma are prepared to deal with the human rights risks that they are exposed to, as illustrated in the graph. Another notable result is that approximately 50 per cent of the companies lack the equivalent of a human rights policy, which is the most important KPI.

3 companies (8%) rank as best-in-class performers, i.e. all 7 KPIs are fulfilled.

8% 11%

28%

17%

36%

4 companies (11%) rank as very good performers, i.e 4-6 out of 7 KPIs are fulfilled.

6 companies (17%) rank as medium performers, i.e. 3 out of 7 KPIs are fulfilled.

13 companies (36%) rank as poor performers, i.e. 1-2 out of 7 KPIs are fulfilled.

10 companies (28%) rank as worst-in-class performers, i.e. no KPIs are fulfilled.

Source: GES Burma Benchmark Report Update, Jan 2013.

MAG•E•SINE 2013 • 45

Dr. Craig Mackenzie, Head of Sustainability, Scottish Widows Investment Partnership

46 • MAG•E•SINE 2013

Time to raise investors’ voice in public policy On the face of it, responsible investment (RI) has made great progress in the last decade. It has moved from a niche activity focused on retail ethical funds, to an agenda backed by most of the world’s largest pension funds and asset managers (as signatories of the UN-backed PRI). Yet it is not easy to see how this change will make much of a difference to the major sustainability crises we face: climate change, food and water scarcity and environmental depletion. It is not clear that current RI practices are meaningfully mitigating the serious long-term risks to investment returns that these challenges pose.

own. They are like a steering wheel and a set of car tyres without an engine. You need them once you’ve got an engine, but they’re not much good without it.

This comes down to basic economics. Most of our biggest environmental problems result from ‘externalities’. Companies and consumers do not bear the costs of carbon emissions, depletion of scarce water resources, fisheries or forests, and so they lack the strong economic incentives necessary to reduce these impacts.

Companies are mostly unable to voluntarily ‘internalise’ these costs, because doing so would make their products uncompetitive in the market place.

This insight is not new. For example, several large European pension funds and asset managers have been engaging with the EU and some national governments on climate policy for several years. There have also been some coordinated attempts to send an investor message to the UNFCCC climate talks. But relatively few investors are active in this area, and some see it as totally beyond their remit. But the externalities argument above challenges this view – particularly for long-term, diversified investors whose investment returns could be harmed by severe climate change, resource scarcity and resultant conflicts. Arguably supporting effective public policy on externalities and other systemic issues should be a fundamental principle of responsible investment.

This is a challenge to the contemporary consensus about RI. The first plank of this consensus is that responsible investors should ‘integrate’ environmental social and governance (ESG) issues into investment decision-making. But, by definition, externalities cannot sensibly be integrated into investment decisions – this is part of what it means to say they are ‘external’ costs. Externalising costs is profitable. This is why most institutional investors continue to provide capital to carbon intensive sectors - oil, coal, coal power etc.

Unless, and until, governments look likely to set a meaningful carbon price, it does not make sense to price carbon into company valuations.

The second plank of modern RI is engagement. While investors can engage with companies to encourage action on carbon emissions, the best they generally hope for is that companies will improve efficiency and disclosure, for carbon, water, sustainable agriculture etc. Engagement rarely has much impact on major externalities: the scale of economic incentives externalities create cannot be opposed by the ‘soft’ power of shareholder engagement.

Integration and engagement are good things; but when it comes to externalities they are not effective on their

The missing engine is public policy. Externalities are collective action problems. Without action by governments to put a price on external costs they cannot be eliminated. If investors are serious about mitigating the serious long-term risks associated with our biggest sustainability challenges, effective support for public policy action on externalities is a prerequisite.

The PRI has recently shown some valuable leadership on this topic. At the PRI in Rio event in July 2012, the PRI announced a new strategy, recognising the critical importance of systemic issues, and the need to address externalities and other collective action problems at the system level. The PRI plans to consult signatories about the direction this new strategy should take in 2013. There is also potential for service providers like GES to coordinate policy engagement on behalf of their clients, much as they do with companies.

There is a lot for investors to learn in order for us to effectively support the efforts of governments to implement the policies we need. But we are a fundamentally important voice in international capitalism. It is in the long-term interests of our customers and beneficiaries that this voice is heard by policy makers.

Dr. Craig Mackenzie Head of Sustainability, Scottish Widows Investment Partnership

MAG•E•SINE 2013 • 47

GES is Europe’s leading provider of engagement services focusing on supporting asset owners and asset managers develop and implement integrated investment strategies with environmental, social and governance (ESG) considerations. Our due diligence of companies’ non-financial business conduct aims at identifying financially material improvement objectives that can deliver increased shareholder value with the highest degree of stakeholder relevance and external credibility. We act as an owner advocate and add proven value to €750 billion of investments worldwide by assessing and engaging with clients’ portfolio companies.

GES is a privately held, bank and investor independent, company founded in 1992 with over 50 employees globally, of which 40 are dedicated entirely towards corporate engagement. We have offices in Sweden, Denmark, Poland and Switzerland with engagement professionals based in Europe, Asia, North and South America, as well as a strategic business partnership with oekom research in Germany and France.

GES’ engagement is the least intrusive and most easily communicated ESG strategy to integrate with traditional asset and portfolio management.

Kungsgatan 35, 111 56 Stockholm, Sweden Phone +46 8 787 99 10 Vestergade 27, 1456 Copenhagen K, Denmark Phone +45 30 86 03 70 ul. Kupiecka 19/6, 65-426 Zielona Gora, Poland Phone +48 68 422 13 26 Hohlstrasse 489, 8048 Zurich, Switzerland Phone +41 43 535 99 38 www.ges-invest.com