UNEP FI Global Roundtable, Melbourne, October 2007

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DAY 2 Thursday 25 October

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Plenary Session 2.1 “The Other R.O.I. - The Responsibility of Investment ”

9:00am – 10:15am

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• Steve Gibbs, Chief Executive Officer, Australian Reward Investment Alliance (ARIA) • Collin Melvin, Chief Executive, Hermes Equity Ownership Services Limited • Matthew Kiernan, Founder and Chief Executive Officer, Innovest • Chanchai Supasagee, Director of Corporate Governance and Compliance, Government

Pension Fund of Thailand • Moderator: Dr. Noel Purcell, Group General Manager, Westpac

“The Other R.O.I. - The Responsibility of Investment ”

Powerful new megatrends in socio-political issues are rapidly becoming the deep roots of business prosperity. These trends are sounding serious alarm bells about risks, but at the same time are presenting “amazing” new opportunities, according to Steve Gibbs, Chief Executive Officer of the Australian Reward Investment Alliance.

Mr Gibbs was launching a comprehensive new presentation titled ‘Enlightened Self-Interest. Solutions for Responsible Investors’ at the plenary session ‘The Other R.O.I. – the Responsibility of Investment’ at the UNEP FI Roundtable.

The presentation was created by the Responsible Investment Association Australasia to promote the sustainable investment message to superannuation trustees, analysts, fund managers and others in the investment sector.

Mr Gibbs said investors were facing a whole new range of issues that were unfamiliar, volatile and complex, including climate change, water shortages, the rise in pandemics, the end of cheap oil, product safety in emerging nations, failures of governments on a massive scale and the scarcity of natural resources in the face of a ballooning population.

“These issues have a cost, and some of the world’s largest financial institutions want to find out exactly what those costs are,” Mr Gibbs said.

“We think of responsible investment in the context of risk, so we look at ESG (environment, social and

UNEP FI Global Roundtable, Melbourne, October 2007

corporate governance risks) from a risk perspective. If a company isn’t managing those risks in an appropriate way, then that poses a risk to our long-term investment in that company. We will either eventually lose money or not get the return that we should if those risks were being otherwise managed appropriately.”

Discussing the 10 megatrends that would dominate the 21st century, Mr Gibbs said that population growth meant the planet was “hitting its limits”, and the next century would be defined as the century of resource scarcity.

“Scarcity is the most fundamental of all economic principles, and with scarcity comes pricing,” Mr Gibbs said.

Climate change

Climate change had also risen to the surface as a “clear and present risk” for investors. The question was how investors would go about identifying companies that had the strategies and plans to handle the significant material risks associated with climate change, and to seize the many business opportunities that lie ahead.

An example was Exelon Corporation, which would sacrifice just .8% of EBITDA to meet the USA’s proposed new regulatory requirements of reducing emissions in the utilities sector by 25 per cent by 2020.

The company had invested heavily in nuclear fuel, renewable energy, bio-fuels and energy efficiencies. By comparison, a direct competitor, American Electric Power would sacrifice 18.7 per cent of its EBITDA because it was mostly reliant on coal generation.

“Stories like this are replicated in economies the world over,” Mr Gibbs said. However, there were upsides such as GE, which had been working on environmental solutions for several years, and in 2005 generated $10 billion, or 10 per cent of revenue, from this area.

Water

Water had become a significant business risk, and although there were alternative sources for energy, there were no alternatives to water.

While Coca Cola had improved its water efficiencies by 19 per cent since 2002, analysts looking at the company’s management of the risk would want to know its plans for the future, and how it would manage licenses to operate regarding humanitarian water needs.

Some 37 per cent of the company’s plants were in areas of extreme water stress. Africa, which was one of the driest continents on earth, was a major market for Coke, but because of water scarcity and production standards, Coke needed to use 3.7 litres of drinking water to produce one litre of soft drink. This was 46 per cent more than its average water use in other countries.

Waste

UNEP FI Global Roundtable, Melbourne, October 2007

Waste was also a mounting problem, growing at about three per cent annually, and landfill was now a scarce resource. This was leading to higher pricing, increasing the operating costs for producers of computers, televisions and white goods.

But waste management companies were the beneficiaries, with the European waste management and recycling industry now earning total annual revenues of 100 billion Euros.

Oil

Another megatrend was that of oil, with the days of cheap oil finished and supply projected to peak in 2011 before declining. But a rise in energy demand coupled with dwindling oil supplies pointed to new geo-political and business risks around security, trade and access to new reserves.

The scarcity/pricing equation meant that there were opportunities for alternative fuels, with the bio-fuels industry worth US$27 billion annually and projected to grow to $80 billion by 2016.

Obesity

Obesity was a growing social trend and investors should be asking how regulators were responding to this problem, and what opportunities it opened up for the food and beverage market.

While there was now pressure on companies such as breakfast cereal producers to improve nutritional content, people’s tastes were also changing.

“The booming market for organics is a terrific example,” Mr Gibbs said. It is now the fastest growing of all retail categories, according to Citigroup.

Pharmaceuticals

There were also emerging and new risks for the pharmaceutical sector, including threats to its lucrative use of patents, growing pressure for preferential pricing for poorer nations and the increasing difficulty of breaking through with pandemic solutions because of the tougher barriers put up by drug resistant bacteria.

Risk was also rising in the form of pressure from third world countries for drug companies to focus on ‘neglected diseases’ such as TB and malaria. This pressure would only increase, as the third world’s share of pharmaceutical demand grew from eight per cent today to 19 per cent by 2030.

But the greatest threat to the big pharmaceutical companies was that generic drug companies were on the rise, defying patent laws and gaining the trust of the third world.

ESG

Turning to the issue of ethical and governance failures, Mr Gibb said “alarming cases” of accounting fraud and other corporate crime had come at considerable cost.

The latest governance collapse was in the USA’s sub-prime market, which the leading global

UNEP FI Global Roundtable, Melbourne, October 2007

researcher Innovest had identified through its ESG research a full 10 months before it occurred.

Research into the governance behaviours of 4,000 companies by global leaders on governance ratings, GovernanceMetrics lnternational, concluded that the difference in return on equity for well-governed companies could be as much as 56 per cent over the long term compared to poorly governed companies.

Outsourcing

The megatrend of manufacturing outsourcing to emerging nations such as China and India also meant that companies had gradually outsourced corporate responsibilities such as human rights, labour rights and product safety standards.

But companies which depended heavily on the third world for their future growth were highly exposed to a combination of regulatory pressure, consumer boycotts and NGO campaigns.

“The notion of the supply chain is now moving beyond company logistics to a more holistic examination of a company’s value chain,” Mr Gibbs said.

The rise of the civil society

The final megatrend was the rise of civil society, with the growth of the internet paving the way for civil society to take on a policing role like never before. There were now 40,000 recognised international NGOs, which responsible investors knew were an invaluable source of credible research into a wide range of environmental and social risk issues.

Examples included the anti-apartheid groups who put an end to the South African regime, the successful campaign against Bayer Crop Science’s developments of genetically modified foods, and the animal testing strikes in the UK which ultimately savaged the share price of Huntingdon Life Sciences from three pounds to one pence.

“What becomes clear when we look at the world we’re in, is just how interconnected and interdependent civil society and the corporate sector have become,” Mr Gibbs said.

“And that is the reason these megatrends are starting to have such a deep effect on company value.”

Just over half of the global Fortune 250 companies now provide data on their ESG performance, and more than 1,000 companies in 60 countries report against the Global Reporting Initiative (GRI).

Companies were being driven toward sustainability planning because it provided the perfect structure to monitor regulatory and reputational risk.

There was now a price being set for ‘externalities’, such as factoring into plans the real cost of water, pollution, landfill, toxic chemicals and social costs from products and services which cause harm to individuals and communities.

The pressure for externality costs to be pulled back inside companies was an important shift for fund

UNEP FI Global Roundtable, Melbourne, October 2007

managers, because the introduction of an anticipated price allowed investors to adjust their standard investment models and key investment ratios such as discounted cash flow, price to earnings, price to book or price to cash flow ratios.

“As a consequence, managers are now much more likely to want to engage in open dialogue with the companies they invest in about issues that simply can’t be understood by just reading the spreadsheets,” Mr Gibb said.

“AMP Capital Investors estimates that on average, 77 per cent of company value is now tied up in issues which are invisible to the naked eye.”

In the last few years there had also been an exponential increase in the number of asset owners who took ESG into account in their investment practices.

Investing in ESG research was a perfect match for long term investors, because long term economic stability and enduring prosperity depended heavily on social cohesion, high standards of governance and the careful management of natural resources.

In 2005 international law firm Freshfields Bruckhaus Deringer set out to clarify a question on the minds of trustees around the world:

“Does fiduciary duty permit the integration of ESG issues into investment decisions?” It concluded that integrating ESG issues did not infringe on fiduciary duties.

Mr Gibbs said that ESG would become regarded as market sensitive data, and companies would be negligent if they did not inform the market. He expected a shake-out in ESG frameworks as a result.