ESG Analysis Template for Assessing Companies' Exposure to Sustainable Development Trends
1. Sustainable InvestmentSI
Suisse 25 October 2006
ESN SI Methodology Guide
Our original perspective
• Environment – Social – Governance (ESG) initial risk exposure analysis in order to assess the
value sharing process and its impact on value creation process (see p.16 and following)
• Business model assessment with regards to sustainable development (SD) trends stated as a
set of environmental and social trends (p.21)
• Use of cutting edge business and academic literature (Steven Levitt, Jeffrey Sachs, C.K.
Prahalad among others) in order to structure our analysis and to provide tools to assess social
and environmental trends.
• Examples of original items used in Environmental-Social-Governance ESG to focus on financial
impacts (see glossary)
Our product range
• Online tool of companies corporate social responsibility ranking or involvement
• Thematic research on deepening the analysis of one of the sustainable development trends or a
major emerging or changing regulation
• Sector research on the overview of environmental or social impacts on sales, assets or margins
• Systematic company’s research with an integrated template on extra financial issues
• In depth analysis of one company in order to assess the impact of one of the ESG dimension on
value creation process or the impact of one or more trend of sustainable development on the
company’s business model
2. Sustainable Investment
Page 2
Table
ESN SI Methodology Guide.......................................................................1
Our original perspective
Our product range
Executive summary ....................................................................................3
Why does ESN SI methodology target mainstream..............................4
Overview of the market
Towards an ESN SI methodology
Theoretical foundations of SI....................................................................8
Methodologies, mythologies, missed-ologies ?
Two ambiguous concepts: stakeholder and reputation risk
Why ESN SI methodology is different .................................................. 12
Benefits of ESN’s organizational structure
The four failures of existing methodologies… and our answers
How we want to work: ESN SI methodology....................................... 15
Presentation of the ESN online tool on CSR ratings and initiatives by
companies
Core dimensions of ESN’s SI approach: ESG analysis and SD
ESN SI template........................................................................................ 17
Page 1: Fact s and figures
Page 2: Sustainable Development-Analysis
Scope of assessment and financial impacts....................................... 25
Sector and company assessment
Financial impacts of sustainable development
Glossary..................................................................................................... 28
Appendix: Comparison of CSR rating agencies methodologies .... 31
3. ESN SI Methodology Guide
Page 3
Executive summary
The Sustainable Investment market is evolving quickly but it shifts further and further from its
morally grounded principles to a more sophisticated and integrated analysis. This shift
generates many distinctions and differentiations among the management syles and needs of
the different SRI funds.
ESN identified four cornerstones to set up a breakthrough in the Sustainable Investment
methodologies:
• separate clearly moral and financial implications of SI issues
• move the focus from transparency towards operational or long term economic
performance
• the integration into financial analysis will be done through clear and measurable
variables
• develop a top-down approach identifying impacts on the P&L or the balance sheet
Based on these methodology pillars, ESN introduce will introduce a diversified product range,
among other:
• an ESN online tool to identify companies rankings in the different sustainable
investment indexes and involvement in environmental and social initiatives
• a template systematically integrated in companies’ surveys enabling an assessment
of risk exposure of the company to environment-social-governance issues and an
analysis of the business model vis vis environmental and social trends
• Thematic research on deepening the analysis of one of the sustainable
development trends or a major emerging or changing regulation
Financial impacts of environmental, social and governance issues are described and the
different types of impacts are displayed with real examples.
The survey is concluded by a glossary of the items used in the template.
4. ESN SI Methodology Guide
Page 4
Why does ESN SI methodology target mainstream
Ethical funds strive to achieve two different targets: financial performance and improvement of
environmental social or ethical performance. The aim is to push companies to react to
economic (profit making) incentives, but also to social (taking into account such or such social
pressure) or ethical incentives (stop or start of a specific activity or practice).
The concept of Sustainable Investing, commonly abbreviated to SI, comprises investment
strategies in which investors do not base their asset selection decisions on financial criteria
alone anymore. In particular, they also take corporate governance, social and environmental
criteria into account. Below a short overview is provided of the historical development of
Sustainable Investing and the current size of the European SI market.
Overview of the market
• Historical development
Notwithstanding all the attention that has been drawn to Sustainable Investing during the last
few years, it is by no means a new phenomenon. At the end of the nineteenth century, certain
groups in the United States, primarily religious bodies, had already decided to let the world
know they were not prepared to invest in what they considered harmful businesses. Examples
are companies that produced or sold alcohol and tobacco or companies that made use of
child labour. In later years, other issues such as nuclear energy, gambling, manufacturing of
weapons and pollution were added.
The wave of interest in SI nowadays is largely a result of the various recently uncovered
corporate scandals of large corporations such as Enron or Parmalat. As a consequence,
many investors do not only care about a company’s financial performance anymore, but also
attach great value to its social responsibility.
The early, religion-based SI strategies mainly excluded potential companies (or sometimes
complete sectors) to invest in on the basis of a list with ‘wrong’ activities, but the
contemporary investor prefers to include companies that have adopted leading sustainable
policies and practices in his or her investment portfolio. This is called positive screening.
These investors are looking for companies that perform at the top of their industries on
sustainability issues such as environment protection, human rights and corporate
governance.
But not only investors are striving for more sustainable business practices. On a global level
the United Nations Global Compact, a voluntary initiative between companies and the United
Nations, encourages multinational corporations to initiate and especially share ideas and
actions to establish sustainable globalization. In this way socially responsible practices can be
spread around the world. Companies participating in the Global Compact must adopt ten core
values in the fields of human rights, labour standards, the environment and anti-corruption.
Examples are respecting the protection of international human rights, the elimination of
discrimination within the company, and encouraging the development of more
environmentally friendly technologies.
5. ESN SI Methodology Guide
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Furthermore, the United Nations Principles for Responsible Investment cover issues like
incorporating non-financial criteria into the investment decision and were signed this year by
thirty-nine institutional investors and thirty-six large investment companies.
• Definitions of core and broad SI
In practice, two broadly recognized approaches have evolved over the last years: core and
broad SI. The main difference between core and broad SI concerns the SI strategies that the
two measurements include. Core SI only comprises investors who use so-called ethical
exclusions and/or positive screening. Broad SI also includes investors who implement simple
exclusions, which means excluding single given sectors, and investors who enter into
dialogue on issues of concern with the companies they invest in. This is called engagement.
Furthermore, the explicit inclusion by asset managers of non-financial risks into the
conventional financial analysis, called integration, is included. The figure below clarifies this
distinction.
The difference between core and broad SI
Source: Eurosif (2006)
• Size of the European SI market
Both the core and the broad SI market experienced substantial growth over the past two
years, even after correcting for the overall growth of the entire equity market. Compared to
the general investment market Sustainable Investing still represents much growth potential.
Although the development started somewhat later in Europe than in the United States, the
European market for SI is currently quite advanced. According to a recent study by the
European Social Investment Forum (Eurosif), an umbrella association that covers sustainable
investment issues at the European level, over EUR 1 trillion is invested in Europe taking
sustainability criteria into account. This is only the case when a broad measure of SI is
considered. The size of the core SI market is estimated to be EUR 105 billion. Moreover,
national differences with respect to the scale and scope of Sustainable Investing are large
(see the figure below).
Ethical exclusions
Positive screens, including best-in-
class and pioneer screening
Simple exclusions, including norms-
based screening
Engagement
Integration
CoreSI
BroadSI
6. ESN SI Methodology Guide
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Size of core and broad SI in several European countries (in billion Euros)
Source: Eurosif (2006)
The figure above shows the sizes of the core and broad SI markets in a number of European
countries. As becomes clear, The Netherlands is the leading market in core SI with assets
under management of EUR 41.5 billion. This is mainly due to the heavy presence of the
Dutch pension fund PGGM, who is one of the members of the Enhanced Analytics Initiative.
The United Kingdom has the second largest core SI market with assets under management
worth EUR 30.5 billion. Church and charity investors are still the most important players in this
market. Furthermore, the UK broad SI market is by far the largest of all European countries
considered, mainly because of the investments by occupational pension funds. Except for
Belgium, Sustainable Investing is still much less pronounced in the other European countries
under consideration, but as explained before the growth potential is substantial.
Possible reasons for the differences in size across countries are the different historical
backgrounds of the market and the varying degree of activism of early investors. For
example, Sustainable Investing can be traced back in the United Kingdom at least to the
1920’s.
Towards an ESN SI methodology
• The need for SI research
In response to the increased interest of investors in Sustainable Investing, currently more SI
research is being carried out than ever before. Many specialized SI research companies
emerged during the last decade and an increasing number of research departments of
traditional investment banks are employing one or more SI analysts nowadays. This latter
trend is partly the result of the demand from large institutional investors.
1
3
7
25
9.5
8.2
2.9
41.5
1.5
30.5
1.2
13.8
5.3
2.9
47.5
7.5
0
10
20
30
40
50
60
Austria Belgium France Germany Italy The
Netherlands
Spain Sw itzerland United Kingdom
Core SI Broad SI
149 781
7. ESN SI Methodology Guide
Page 7
To provide mainstream brokers with an incentive to write innovative research on social,
ethical and environmental issues, a group of leading European institutional investors initiated
the Enhanced Analytics Initiative (EAI). To show the urgent need they have for the integration
of sustainability issues into traditional investment research, the EAI allocates up to five
percent of its commission budgets to brokers publishing high quality SI research. All relevant
research reports are evaluated semi-annually by an independent consulting agency to decide
which brokers qualify for the commissions. Some examples of members of the EAI are ABP
Investments (The Netherlands), BNP Paribas Asset Management (France), PGGM (The
Netherlands), RCM (United Kingdom), which is part of Allianz Dresdner Asset Management,
and Universities Superannuation Scheme (United Kingdom).
So definitely there is a need among large institutional investors for research companies
analyzing and processing information that is frequently not taken into account by the
traditional financial analysis.
• ESN’s point of view: SI is also relevant for mainstream investors
The regional differences of each market certainly complicated the development of a common
ESN SI methodology that fits each member country’s SI market, but after many meetings and
discussions the ESN SI team finalized this methodology document, which shows in great
detail our approach to Sustainable Investing research. The coming sections will explain what
makes our methodology unique and, on a more practical level, how the ESN SI team wants to
work in the future.
In our opinion, information regarding the sustainable development policy of a company is
valuable for all investors, because this information is necessary, just as financial performance
data, to have a complete picture of how a company is doing and where its future risks and
opportunities lie. Many sustainability issues can potentially have large impacts at a company’s
operations. For example, companies using environmentally unfriendly production techniques
or neglecting the needs of their employees might be heavily criticized by environmentalists or
trade unions, which can dramatically reduce their reputation and the demand for their
products or services. As a second example, companies where employees have to work in
unpleasant circumstances might find that their employees lack motivation and productivity,
thereby increasing labour costs. Moreover, the impact of corporate scandals like the ones we
experienced the last few years (e.g. falsification of balance sheets as seen in case of Enron
and Parmalat) would probably have been much smaller if corporate governance issues had
been analyzed more thoroughly.
So the way in which a company manages the above and many other sustainability issues
should be a point of concern to every investor. It is very important to gather information on
which companies’ operations are most sustainable and where each company’s strengths and
weaknesses with respect to sustainability lie. Only in this way investors can identify both
potential sources of risk and opportunities related to corporate governance practices, social
and environmental issues, and anticipate on possible changes in a company’s (legal)
environment.
8. ESN SI Methodology Guide
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Theoretical foundations of SI
There is no way and no need to reinvent an absolute methodology satisfying all needs of
information of SI and mainstream investors. But there is a need to develop a methodology
analysing and processing informations which are not necessarily taken into account by
financial analysis to enrich and deepen it. The aim of such an analysis is to provide
recommendations on companies or sectors that will generate higher value in the long run.
Methodologies, mythologies, missed-ologies ?
Methodologies have been developed for 20 years on sustainable investment and non
financial data. This methodology cannot be ignored, but there is a growing concern about
these works. Are they missed-ologies, mythologies, methodologies?
• Missed-ologies
To begin with, two remarks about “missed-odologies”. SI despite the great research it has
generated has missed opportunities to be considered as a key methodology for financial
markets. Many opportunities have been missed by the SI community and its methodology.
Everybody mentions Enron as a problem, but it has not been pointed as deficient by SRI
investors. It could have. For instance this company had one of the most accomplished CSR
report with disclosure of its CO2 emissions. No SI analyst asked to its financial counterpart
how the company could generate sales with generating CO2. The same demonstration could
be done for Parmalat, Worldcom, Ahold, …
A second issue is the spreading of the potential SRI intuition. Alstom had been identified as
problematic due to its poor employees and customers‘ relationships in 2001 that is a year
before problems popped up. However, it was not considered in the financial community as so
catastrophic as it happened in 2003. By the way the mention of poor employees’ relationships
is not anecdotic as the first decision of Patrick Kron, as new Alstom CEO, was to change its
Human Resources Director.
• Mythologies
Mythologies refer to the belief underneath sustainable investment. Based on the sentence of
John Stuart Mill “One person with a belief is equal to a force of ninety-nine who have only
interest”, some SI investors strive to focus on companies “with belief”. Beyond the discussion
of its relevance, the implementation of it as an investment choice raises two questions:
• How to measure the belief? This raises the problem of the way to measure it?
Intention, implementation, results? This question shows that these methodologies
turn to be very interpretative.
• Which belief should be measured? This raises the problem of what should be
measured? Is it a belief in new activities, new technologies, new practices? These
questions do not only refer to marketing questions about investment style or
opportunities. It also refers to strong beliefs. There is some strong similarities
between the set of investment guidelines of US and UK “ethical funds”.
9. ESN SI Methodology Guide
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SI was theoretically based on the assessment of Corporate Social Responsibility. As
explained in the Appendix, this measurement is extremely complex for the reasons given
earlier.
• Methodologies
After the discussions of mythologies, we would like to insist on the need to focus on the “DO“
part of the word “methodology. The methodology should not be purely theoretic. It should
rather be used as a framework for frequent production ready to be integrated in financial
analysis. It should be reactive and easy to modify in order to enable reactive studies and
possibility to change.
The “DO” part of the methodology should enable to frame the analysis according to the
different incentive it relies upon (economic, social or ethical) Therefore our scheme should
enable us to split the different incentives, and moreover to treat any issue with potential
economic impact. The aim of the framework is to provide a flexible frame to analyse any
company or any sector, and further on any event.
Two ambiguous concepts: stakeholder and reputation risk
For a deep comparative analysis of CSR rating methodologies, please refer to the appendix.
Apart from the CSR rating agencies, a lot of consultants and advisers have been giving the
opinion on corporate social responsibility and its potential impact on financial performance.
This literature is based on two concepts: stakeholder and reputation risk.
To make it short, every stakeholder that may consider to be impacted by the company should
have a word to say as this may impact the company in the short or in the long run.
This idea looks generous but clearly lacks of consistency. These two concepts mix moral and
economic issues and lack of economic relevance.
A first overview of the use of the concept is provided by the following table (next page), where
all potential grievances or demand by stakeholders are listed per sector. This looks interesting
for a company or for student, but this overview raised two questions. Do these challenges
have any financial impact? Are all these issues really important, beside external
communication?
As stated earlier, these issues might not be irrelevant but they are not necessarily the most
important ones. Therefore ESN SI team will stick to more pragmatic methodology.
Stakeholder theory is the philosophical stone of SI analysis. This concept of stakeholder is
taken as such by methodologies without measuring clearly what it encompasses. It might also
referred in a milder way as external pressures, social pressures, and it implies that the
stakeholder is taken into account as such by the investor and by the companies it invests in.
It has been strongly criticised in its early days by Milton Friedman on ideological grounds.
More recently it has been criticized by authors on methodological grounds. As stated by
Antonacopoulou & Meric1, the stakeholder theory was first a instrumental discourse for crisis
management before turning into a management philosophy. However as these authors point
1
Antonacopoulou & Meric, 2006
10. ESN SI Methodology Guide
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out, the stakeholder theory is reductive (as it reduces the issue to stakeholders enabled to
build contracts with companies), normative (as stakeholders’ demands are considered
simultaneously with their own legitimacy and integrable in the corporate strategy).
The second useful definition is the definition of risk provided by Peter Sandman2. He defines it
as a twofold concept, including hazard (itself combining probability and impact) and outrage
(that could be described by other authors as “perceived risk”).
Risk = Hazard + Outrage
Sandman insists that they are different targets and tasks to reduce each of them. In other
words, reducing the danger does not necessarily reduce the hazard and vice versa.
Stockholder’s demands refer to outrage, instead of danger. A company may not address both
issues simultaneously. For example, BP has disclosed heavy investment plans in bio fuels but
has severely neglected its investment in refineries until its accidents in US refineries in 2005
and in Alaska in summer 2006.
Collective layoffs in France are another good example of the distortion of analysis introduced
by stakeholder and outrage. First in 2005, collective layoffs represented merely 30% of total
layoffs. 25% of layoffs end up in legal proceedings (usually won by employees). Therefore the
outrage focus is on termination fee and financial reserves whereas the risk question is more
on the employability and the personal development of employees.
2
In Levitt: Freakonomics, 2005
11. ESN SI Methodology Guide
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Overview of sector related risks
The sector challenges are ranked by importance from 1 (= most important) to 5 (= important).
Risk importance
Sector
1 2 3 4 5
Capital goods
Financing of great
projects
Development of
new products and
new technologies
Efficient use
resources
Compliance
(export control)
Climate change
strategy
Automobile
Quality and brand
management
New mobility
trends (incl. new
urban trends)
Climate change
strategy
Energy efficiency
Energy safety and
carbon intensity
Chemicals reputation risk POPs and toxics Health and safety
Environmental
supply chain
Social supply chain
Electronics
Quality and brand
management
Responsible supply
chain
Outsourcing and
fabless
Human resources
management
Digital divide
Construction and engineering
environmental
impact of great
projects
social impact of
great projects
efficient use of
resource
design of green
materials
Health and safety
Financial Services Reputation risk
Environmental and
social impacts of
project finance
Affordability
Due diligences in
acquisitions
Climate change for
insurance and lenders
Health
Reputation and
brand management
Affordability
Product
responsibility
Responsible supply
chain
Marketing practices
Food & beverage Reputation risk Obesity
Genetically Modfied
Organisms
Social conditions of
production
Environmentally
sensitive production
methods
Wood
Integration in
regional economic
demand
Strategies of
climate change
Genetically Modfied
Organisms
Preservation of
biodiversity
traceability and supply
chain management
Metal and mining Reputation risk Resource scarcity
Impact of mining on
biodiversity
Climate chaneg
strategy
Health and saefty of
employees
Media and leisure
Protection of data
privacy
Protection of
intellectual property
rights
Freedom of
expression
Editorial liability Advertising policy
Oil &Gas Reputation risk
Climate change
strategy
Impact of oil & gas
on biodiversity
Health and safety
of employees
Sharing rent with
countries
Retail
Reputation and
brand management
product safty and
traceability
Supply chain
management
Environmental
footprint
Packaging
Telecom
Protection of data
privacy
Protection of
intellectual property
rights
Digital divide
Supply chain and
end of life
management
Brand management
Transport Reputation risk
Customer
relationship
management
Complete cost of
transport
Climate change
strategy and
efficient use of
biofuels
Environmental impacts
Utilities Brand management
Available water and
financing
Climate change
and renewable
energy
Impacts on
biodiversity
Answer to customers'
demand
Source: Price Waterhouse Coopers, 2006
12. ESN SI Methodology Guide
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Why ESN SI methodology is different
Benefits of ESN’s organizational structure
Driven by the demand from (institutional) investors and the growing sustainability awareness
among society in general and corporations in particular, ESN (the European Securities
Network) now presents its SI methodology. ESN is a strategic partnership in the equity
brokerage activities of ten leading banks & securities houses. So ESN is very well capable to
evaluate SI issues in a multi-domestic context. Each partner intends to provide in-depth
research on current national sustainability matters so that this information can help as many
investors as possible in making their investment decisions. In this way investors can optimally
take advantage again of the multi-domestic character of ESN. In order to write research on SI
subjects, ESN created a SI team consisting of analysts fully or partly allocated to that subject.
The four failures of existing methodologies… and our answers
Based on the overview of existing methodologies (for further details, see Appendix) we can
clearly identify the four mistakes done so far and provide our own answer.
The four failures and our answers
Source: ESN SI Team
• Failure 1: Mixing different targets
The first failure of CSR rating agencies is to mix the different targets focused by the SRI
funds. As discussed in the first part, these funds have a financial target and a moral or social
aim.
A recent book, “Freakonomics” written by Steven Levitt, is of high interest to understand the
lack of grip of CSR rating methodologies. Every human being answers to different incentives.
The problem is to be fully aware of the different types of incentives we rely upon, and not to
mix them up. For instance, replacing moral incentives by economic incentives is not always
relevant. Steven Levitt provides the example of this kindergarten where parents came late to
pick up their children. The kindergarten then decided to fix a 3£ fine per delay. The parents
were then relieved from their moral obligation to pick up their children. Delays multiplied, and
when the fine was raised to higher levels, the delays’ rate stayed high. Giving a (always too
#
1
• Mixing different targets (Economic,
Environmental, Social)
2
• Transparency is in focus
3
• Assume that CSR's impact as a whole
is easy to measure
4
• Accounting for all potential stakeholder
grievances
Source: ESN SI Team
• Analyse targets' characteristics
• Focus on targets driven by economic incentives and
analyse their financial impacts
• Focus on operational and long-term performance to
account for potential economic impacts
• Exclusive application of clear and measurable
variables
• Clearly identify potential financial impacts of the extra-
financial dimensions
AnswerFailure
13. ESN SI Methodology Guide
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low) price to something that does not have one might disable to achieve the target and might
as well pervert the system.
At corporate level, one might raise inspiring questions based on this example, developed in
the ESN survey “Looking at quotas under every angle”. So far the price is much too low to be
economically incentive for European companies. There is a need either to increase the price
(for example by restricting the amount of allowances) or to reintroduce moral or social
incentives (such as stringent regulations) to simply make it work. Although we are keen to the
market we are aware that market can not solve all issues.
Our answer: In a broader picture, every research on SI issues should answer first the
question whether the target is moral or economic. Then the survey should focus (or at least
include one part) on economic incentive, and its subsequent financial impacts.
• Failure 2: Transparency is in focus
The second failure of CSR rating agencies is to focus on transparency. This has induced a
bias in the selection of companies. The majority of SI funds or SI indexes are based on a
reduced set of large caps. This has an impact on its performance. Beyond transparency,
there are many other issues that could be targeted:
- Operational performance: some processes or managerial procedures may improve the
way a company operates its plants; for instance, a quality certification may reduce the
defaults or delays in a production or delivery process.
- long term performance: the exact assessment of land remediation issues in a company
may lead to the estimation of financial reserves; for example, in 2004, Rio Tinto had to set up
a provision of 250m £ in order to remediate land pollutions in Indonesia and its further
consequences.
Our answer: The set of information provided by our research should focus on operational
performance and long term performance that contain more potential financial impacts than the
search of transparency itself.
• Failure 3: Assume that CSR’s impact as a whole is easy to measure
The third failure is to rely on a belief that CSR performance as a whole has an impact on
financial performance as a whole. This assumption implies that CSR can be measured in an
integrated and standardised way.
A seminal paper written by Margolis and Walsh has demonstrated that these links were not
that simple. They suggest to be more modest and to first deepen research on linkages with
clearly defined variables such as sales, margin, assets or possibly stock price, for financial
performance and staff turnover, environmental management systems, or independence of the
Board for extra financial issues.
Our answer: The integration into financial analysis will be done through clear and
measurable variables, and will not use the easy to manipulate concept of WACC to integrate
extra-financials into financials.
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Executive summary
The Sustainable Investment market is evolving quickly but it shifts further and further from its
morally grounded principles to a more sophisticated and integrated analysis. This shift
generates many distinctions and differentiations among the management syles and needs of
the different SRI funds.
ESN identified four cornerstones to set up a breakthrough in the Sustainable Investment
methodologies:
• separate clearly moral and financial implications of SI issues
• move the focus from transparency towards operational or long term economic
performance
• the integration into financial analysis will be done through clear and measurable
variables
• develop a top-down approach identifying impacts on the P&L or the balance sheet
Based on these methodology pillars, ESN introduce will introduce a diversified product range,
among other:
• an ESN online tool to identify companies rankings in the different sustainable
investment indexes and involvement in environmental and social initiatives
• a template systematically integrated in companies’ surveys enabling an assessment
of risk exposure of the company to environment-social-governance issues and an
analysis of the business model vis vis environmental and social trends
• Thematic research on deepening the analysis of one of the sustainable
development trends or a major emerging or changing regulation
Financial impacts of environmental, social and governance issues are described and the
different types of impacts are displayed with real examples.
The survey is concluded by a glossary of the items used in the template.
15. ESN SI Methodology Guide
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How we want to work: ESN SI methodology
Based on the methodology pillars explained in second part we will describe how we structure
our corporate SI analysis. In the preliminary section we will explain the online information
service we will deliver on all European companies.
Moreover, we describe our SI template that will be included in all reports published by ESN.
The template enlightens how extra financial issues will be assessed and structured into 2
separate parts: one on facts and figures, displaying the risk exposure to environmental, social
and governance issues, and the second on sustainable development trends,.
The second section explains how sector and corporate issues are connected, and how to
process SI information into financial analysis.
Presentation of the ESN online tool on CSR ratings and initiatives by
companies
As stated in the previous paragraph, as a broker, the only way to assess companies is to
assess them according to financial estimates, although we may integrate different items in the
assessment. We will not try to rank companies according to morality.
Regarding moral and social initiatives of the companies, we provide an information on
corporate disclosure and involvement. Our on line “responsibility spreadsheet” displays for
every company of the Stoxx 600, its inclusion in the major European sustainability indexes
(ASPI, DJSI Europe, FTSE4Good Europe) and its involvement in the major responsibility
initiatives (to begin with, Global Compact and Principles of Responsible Investment).
This spreadsheet will be updated monthly, including
• A range of CSR initiatives that will be increased upon opportunity.
• A set of information collected in a specific spreadsheet on alcohol sales, military
sales, gambling sales, tobacco sales, and nuclear production (for utilities)
Core dimensions of ESN’s SI approach: ESG analysis and SD
This SI analytical template will be included in every “company report” published by ESN. It is
made of Environmental Social Governance analysis, a Sustainable Development framework
and a comment on some exclusion activities.
Environmental – Social – Governance (and its acronym ESG) has been emerging in the
wording of SRI and extra financial as a reduction of SRI wide scope, influenced by a wide
range of stakeholders to the “material” impacts. In this ESG analysis we will assess the risk
exposure of company to this issue. In case one issue seems risky for the company it should
be pointed out in the comment, and logically should be integrated in the valuation step of the
company.
This template aims at identifying hidden items or hidden dynamics in the company before
focusing on financial analysis. This approach is inspired by the clinical economics framework
16. ESN SI Methodology Guide
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developed by Jeffrey Sachs, in its last book “The reduction of poverty”. Jeffrey explains that
before realising a traditional macroeconomic analysis of a country it is necessary to analyse
its geography, demography, transport infrastructure and … All these dimensions would be
summarised in a short template of things to know before proposing a standard scheme.
Similarly the aim is to build up a framework of clinical management, where the analyst could
pick up important information before building its valuation model and foreseeing the business
strategy of a company. This template enables an assessment of value sharing process of
the company and its potential consequences on the value creation process.
We see the ESG-criteria named above as the basis of our SI-research as we believe them to
be the decisive drivers for a greater economic benefit of a company if they are widely fulfilled.
Moreover, the three pillars have become more and more established, not only in the literature,
but also in day-to-day practice.
The strategic objectives behind the three dimensions ought therefore to be an important
element of corporate thinking and conduct and support the search for concrete solutions.
Implementation of our criteria can help, for instance, to secure reputational advantages over
competitors, and thus financial benefits, and can therefore be regarded as a strategy aimed at
competitiveness.
ESN believes that these three SI dimensions should not be viewed in isolation but need to be
considered together in a common context since the respective sub-disciplines interact with
each other. The following diagram summarizes these interrelationships:
Core dimensions of ESN’s SI Research
Source: ESN
For example, in July 2006, Faurecia has been involved in a controversy on bribery with some
German carmakers. Apart from any moral considerations, this controversy revealed the high
dependency of Faurecia on a few clients. Volkswagen, for example represented in 2005 22%
of Faurecia’s sales. The controversy had an unexpected consequence in corporate
governance when the CEO was pushed to resign because through the reporting systems he
knew about the bribery system although it had been implemented prior to his nomination as
CEO.
Source: ESN
ESN
SI Approach
Ecological
aspects
Social
aspects
Corporate
Governance
aspects
17. ESN SI Methodology Guide
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ESN SI template
As described above the ESN SI template is made up of a two-fold structure covering relevant
SI issues from the field of ESG analysis: 1) facts and figures and 2) sustainable development
trends. After having identified the three dimensions of analysis we took an in depth-look at the
potential issues to be analyzed. This analysis was conducted in cooperation with various
universities in different ESN partner countries: among others our scope of analysis is based
on specialists’ knowledge gathered at e.g. the University of Applied Sciences of Osnabrück,
the University of Mannheim (both Germany) and at University of Tilburg (Netherlands) and
therefore satisfies theoretical criteria as well as practical needs.
Page 1: Fact s and figures
The underlying thought was to identify such questions which are a) meaningful, b) obtainable
and c) apply on a cross-national level. In the following we provide an overview of when we
regard an issue to fulfill those criteria.
• Is the information meaningful?
In our view, an issue is meaningful if it helps to identify companies which do better in terms of
sustainable behavior than others. In other words: an issue which is fulfilled by a broad number
of companies has only a limited explanatory power, whereas such ESG-issues which are
complied with by only a handful of companies help to filter the “good ones”. Hence, the
meaningful criteria enable the reader to automatically get a feeling whether the company
under investigation can be classified as a sustainable leader, a follower or even a non-applier
of the corresponding sustainable management systems and policies.
• Is the information obtainable?
In order to make a comparison with other companies possible, regardless which sector these
belong to, we have paid close attention to the availability of data for the issues of analysis.
Thus, our selection is principally based on information which is a) obtainable in the annual
reports, b) on a company’s homepage or c) in the corresponding sustainability reports
published by a company which mostly comply with international standards such as the Global
Reporting Initiative. Thus, the data can be obtained by consulting publicly available
information helping to avoid a subjectivity bias which is likely to arise when contacting a
company directly.
• Does the information apply on a cross-national level?
As ESN is a strategic partnership in the equity brokerage of ten leading different banks and
securities in Europe our clear aim was to ensure that the issues of our sustainability analysis
can be applied on a cross-national level. Hence, we avoided to filter only those issues which
are of strong interest in just one member country. Thus, our selection represents issues which
do not only stand in the ESG focus in some of the partner countries, but in all of them.
However, we would like to point out that our ESG template consists of a twofold structure:
while the majority of issues to be analyzed is binding for all ESN partners, each member is
free to analyze a maximum of up to X issues in each of the three dimensions which are not
covered by the overall content of the template (for further details please refer to pages XXff.).
The ESG template is displayed below.
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Governance
Shareholders
Double voting right (Y/N)
Comment
Shareholder's agreement (Y/N)
Free Float (%)
Others shareholders holding more than 5% of capital (%)
State (%)
Administration
Combined CEO / Chairman (Y/N)
CommentNumber of Directors (board)
Number independent Directors (disclosed)
Compensation
CEO compensation (excepted SO) (€)
Comment
Variable part in CEO compensation (%)
Executive Committee total compensation (excepted SO) (€)
In which, variable part (%)
Compensation of non executive (€)
Stocks options
Total in circulation
CommentStock options restricted to CEO (€)
Average weighted price (€)
SO dilution (31/12/2005) total (%)
Control
Audit fees/ fees to auditor (%)
Comment
Number of consolidated companies
Source: ESN
Environment and Social Reporting
CSR Report (Y/N) Code of Conduct (Y/N)
Supplier’s screening system (Y/N)
Global or Sector Initiative (eg. Global
Compact) (Y/N)
Source: ESN
Social
Employees R&D
Number of employees R&D (% of sales)
Gender diversity (% woman) Cumulated R&D (% of fixed assets)
Average age of employees (years)
Wages (% of sales) Customers & Suppliers
Average remuneration per employee retreated
from management compensation (€)
Sourcing (% sourcing/sales)
Sales to local/national governments (% )
Pension liabilities (€) Warranty cost (€)
Source: ESN
Environnement
Major environmental impact
(Production/Use/Recycling)
Env. Management System / certification
(ISO14001/EMAS) (% )
Raw materials (% of sales) Water consumption (m3)
Energy consumption (kWh ; Tep …) Waste production (t)
Energy Cost (% of sales) CO2 Emissions (t)
Source: ESN
For every ESG dimension, the analysis describes how we evolved from traditional ESG
reporting questions towards ESG analysis.
19. ESN SI Methodology Guide
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• Governance
In the traditional corporate governance reporting, the issues would focus on these issues.
Governance reporting at a glance
Corporate
Governance
conduct
• Upholding the company's credibility and enhancing its image, thus building reputation capital,
• Improving management and supervisory board decision quality and control by liability being assumed for the
consequences of gross management errors,
• Greater transparency by applying international accounting standards, introducing segment reporting and holding
regular analyst meetings,
• Social legitimation of the company.
Source: ESN SI team
In recent years, Corporate Governance has received a great deal of attention on a global
scale. This has been sparked not least of all by a raft of company failures in Europe and all
over the world that were directly the result of mismanagement and shortcomings in the
supervision over management's conduct of the company's affairs. The most prominent cases
were Enron, Worldcom and Parmalat.
Reporting on Corporate Governance lacked of an appropriate extent and precision for quite a
long time. Hence, it was above all voluntary initiatives or standards set by a number of
countries such as the ‘OECD principles’ to pave the way for a legal framework addressing
Corporate Governance as an essential part of a company’s yearly reporting. In the meantime,
a corresponding code or even laws have been passed in nearly all major capital markets of
the world. Thus transparency regarding the Corporate Governance quality of companies from
different sectors and/or countries has increased by far over the past years.
Therefore, in ESN SI analysis, governance issues are broken down into four issues.
• First there is a need to understand the structure of shareholding (such as the
existence of different shareholders such as state, the existence of a shareholder’s
agreement or double voting rights).
• Second the composition of the Board enables to identify the potential conflict of
interest between different Board members. The problem may be the existence of
Board directors representing the potentially conflicting interests with the ones of the
company. If it is the case that a Board Director represents either a competitor (e.g.,
Nokian Renkaat and Bridgestone), or a predatory client (e.g., Aegis and Bolloré) or a
shareholder with diverging interests (e.g. Vivendi and Vivendi Environment in 2001)
or if Board Directors that may mainly contradict themselves block any strategic
decision (e.g., doubts on Alcatel Lucent).
• Third the remuneration issue is focused on three potential impacts: 1) abnormal
remuneration of Executive Directors: when remuneration is not related to corporate
performance or when related to inconsistent performance indexes. 2) Dilution of
stock value through the attribution of stock options.
• Fourth and last the control issue enables to check the potential difficulties of internal
control through the number of consolidated companies or the discrepancies of
external audit, e.g. in the case Enron.
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Beyond these standard questions, corporate governance might be the most frequent issue in
the analysis. As stated in “Freakonomics”, white collar crime is expected to rise as the control
systems are much lower than the economic incentive to cheat (as previously mentioned
scandals – Enron, …- prove it).
• Social
In the traditional corporate governance reporting, the issues would focus on these issues
Social reporting at a glance
Social conduct
• Advantages in the recruitment market in attracting highly qualified personnel and building stronger loyalty of
existing human capital,
• Enhanced efficiency through improvements on the social front (e.g. employees concentrate better if their work-life
balance is more rounded, resulting in fewer defects in production and thus higher product quality),
• Increased productivity as a result of greater employee satisfaction,
• Lower rates of absenteeism through measures to promote health and to prevent accidents.
Source: ESN SI team
Any company which sees itself as a responsible corporate citizen should also report on its
social management and related activities. Here, the maxim “Do well and talk about it“ applies.
Reporting on the company’s commitment to its employees, the local community and global
development is information which is relevant both for investors and for critical stakeholders.
If this information is withheld from the public, this can lead to a critical perception on behalf of
the public, and especially of critical stakeholder groups, possibly seeing the company’s
activities in a wrong light. This, in turn, can have an adverse effect on sales.
Therefore, in ESN SI analysis, social issues cover three areas of interest:
• First there is a set of questions to assess in a gross idea of the amount, the age and
the gender of employees and its financial impact on the profit & loss sheet (wages)
as well as in the balance sheet (provisions for retirement expenses). Company’s
employees represent one of the most important assets. High employee satisfaction
and employee loyalty can have a positive effect on company’s earnings by
increasing productivity. Also, high employee satisfaction can reduce the probability
of attacks from stakeholders like trade unions and NGOs.
• Secondly, there is a set of question to understand the mount of the brand, the impact
of R&D (again in the P&L as in the balance sheet) and so on the existence of brand
in the intangibles. The social performance of suppliers which is the crucial point for
stakeholder attacks is illustrated because the sourcing of goods from suppliers
aggravates a company’s ability to guarantee social proper working conditions. These
improper working conditions can result in negative customer reactions and
decreasing revenues. Also, customer structure, e.g. a high dependence from state
orders may influence a company’s behavior and damage its reputation in case of
corruption.
• Third point is the investment for Research and Development, which affects a
company’s ability to realize profits in the long-run.
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Why does ESN SI methodology target mainstream
Ethical funds strive to achieve two different targets: financial performance and improvement of
environmental social or ethical performance. The aim is to push companies to react to
economic (profit making) incentives, but also to social (taking into account such or such social
pressure) or ethical incentives (stop or start of a specific activity or practice).
The concept of Sustainable Investing, commonly abbreviated to SI, comprises investment
strategies in which investors do not base their asset selection decisions on financial criteria
alone anymore. In particular, they also take corporate governance, social and environmental
criteria into account. Below a short overview is provided of the historical development of
Sustainable Investing and the current size of the European SI market.
Overview of the market
• Historical development
Notwithstanding all the attention that has been drawn to Sustainable Investing during the last
few years, it is by no means a new phenomenon. At the end of the nineteenth century, certain
groups in the United States, primarily religious bodies, had already decided to let the world
know they were not prepared to invest in what they considered harmful businesses. Examples
are companies that produced or sold alcohol and tobacco or companies that made use of
child labour. In later years, other issues such as nuclear energy, gambling, manufacturing of
weapons and pollution were added.
The wave of interest in SI nowadays is largely a result of the various recently uncovered
corporate scandals of large corporations such as Enron or Parmalat. As a consequence,
many investors do not only care about a company’s financial performance anymore, but also
attach great value to its social responsibility.
The early, religion-based SI strategies mainly excluded potential companies (or sometimes
complete sectors) to invest in on the basis of a list with ‘wrong’ activities, but the
contemporary investor prefers to include companies that have adopted leading sustainable
policies and practices in his or her investment portfolio. This is called positive screening.
These investors are looking for companies that perform at the top of their industries on
sustainability issues such as environment protection, human rights and corporate
governance.
But not only investors are striving for more sustainable business practices. On a global level
the United Nations Global Compact, a voluntary initiative between companies and the United
Nations, encourages multinational corporations to initiate and especially share ideas and
actions to establish sustainable globalization. In this way socially responsible practices can be
spread around the world. Companies participating in the Global Compact must adopt ten core
values in the fields of human rights, labour standards, the environment and anti-corruption.
Examples are respecting the protection of international human rights, the elimination of
discrimination within the company, and encouraging the development of more
environmentally friendly technologies.
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Page 2: Sustainable Development-Analysis
The concept of sustainable development originates from the so called Brundtland report,
which was published under the title “Our Common Future” by the World Commission on
Environment and Development, also known as the Brundtland Commission in 1987.
According to the Brundtland report sustainable development is closely linked to three different
categories, namely the social, environmental and economic dimension.
The most recent text from the United Nations – the World Summit Outcome Document –
dates back to 2005 and refers to the "interdependent and mutually reinforcing pillars" of
sustainable development as economic development, social development, and environmental
protection.
There is a need to separate Sustainable Development from ESG analysis. Sustainable
Development is a set of long term trends and as such refer to intergenerational balance. As
demonstrated by Rawls, there is no possibility to achieve an intergenerational equilibrium by
contractual means only because there is a need of moral grounds and incentives. Therefore
we will consider sustainable development issues as long term issues based on moral
incentives with potential economic impacts (not necessarily in the long run).
Based on the work provided by various international institutions (among others, the United
Nations and the World Resources Institute) we will consider sustainable development as a set
of eight long term trends.
Set of sustainable development trends
1. AGEING POPULATION
• Answering to the new needs of population
• Adapting its workforce to ageing employees
2. GLOBALISATION
• Developing global supply chain and sales
• Managing global supply chain and the process acceleration
3. GLOBAL POLLUTIONS
• Fighting climate change
• Fighting acid rain and other global pollution (ozone layer, oceans),
4. NEW POWERS IN THE SOCIETY
• Defining a new relation with government and fighting corruption
• Answering to the rise of NGOs
5. REDUCTION OF POVERTY
• Seizing the opportunities of bottom of the pyramid
• Answering to specific needs of poor employees or poor
neighbouring populations (availability of basic services)
6. RESSOURCE DEPLETION & LOSS OF BIODIVERSITY
• Increasing resources efficiency
• Protecting biodiversity
7. RISE OF PRIVACY & SEARCH OF IDENTITY
• Protecting individual identity
• Respecting tribal rights to land and customs:
8. HEALTH
• Occupational health in a long range perspective
• Global Health issues (AIDS, malaria)
Source: ESN SI Team
As stated by Al Gore in his conferences and movie “An unconvenient truth”, there is not “one
trend explaining everything”, but rather a set of potentially contradicting trends to which
companies should answer if they want to survive in ten to twenty years.
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Therefore these trends are used as a set of questions to the business model of the company
in order to know whether it is relevant given the future trend. For instance it has proved
irrelevant for American carmakers to produce high gas guzzling cars as the climate change
trend has made these cars useless.
For each SD question, the analyst will define which kind of financial impact it could have on
the company (impact on sales, margin or assets). Trends that would be considered not
relevant would be left aside. 4 to 5 trends are expected to be activated per company.
In the following paragraphs, we provide a quick description of the trends.
The first trend, ageing population, addresses a key issue that encompasses all countries.
Except India and Africa, all countries have been undergoing an ageing of their population.
There are two potential impacts. The first one is related to the development of new products
an services for this ageing population. The second one is related to the adaptation of
production processes to ageing employees.
The second trend, globalisation, refers to the extension of supply chain and markets
globally. It raises two questions. First, is the company able to develop its supply chain and
sales globally beyond its continent? Second is the company able to manage its supply chain
without overstretching it (traceability and logistics chain issue) and taking advantage of
countries, not only by the wage level.
The third trend, global pollutions, addresses the major issues regarding pollutions globally.
First there is a need to identify climate change. It may have an impact on sales (car industry,
capital goods for any related innovation), cost (cement) or asses (utilities). Second there is a
need to address other global pollutions (acid rain, zone layer, ocean)
The fourth trend, new powers in society, refers to two main questions. First there is a need
to the company’s dependence on government and to think about the relationship (corruption,
lobbying). Second there is an issue with the rise of NGOs and their implication in the
relationship between company and government.
The fifth trend, poverty reduction, addresses two phenomena. The first is the emergence of
effective demand from low revenue population (India, South East Asia). These populations
represent 80% of the word population and, are not addressed by western companies yet,
except two or three examples (Unilever). The second one is the demand of employees (Wal-
Mart and health insurance expenses) or neighbouring local populations (Shell and other oil
companies in Nigeria) to get (relative) minimal services.
The sixth trend, resources efficiency and biodiversity, refers to two partly addressed
issues. The first one is the resources efficiency. It has been improved by 20% to 50% in the
last 20 years but it has not been enough to avoid resources depletion as the growth and
globalisation implied a 80% improvement (factor 4 concept by the Wuppertal Institute in
Europe)
The seventh trend refers to the need of data privacy and protection of identity. Our
ways of life have turned more and more standardised and electronics development have risen
the fear of 1984 fiction by George Orwell turning reality. There is a need of diversity3
, that
3 Without diversity and personal creativity, there is no need , no demand and no growth.
24. ESN SI Methodology Guide
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companies should protect and if possible develop. And that is for individual rights of the
computer user as well as for the native tribes in remote areas.
The last trend refers to the health issue. Two separate questions will be assessed. First
there is need to understand impact of global health issues on product (for pharmaceuticals)
as well on its impact on workforce (for companies settled in Asia or Africa). Second there is a
need to assess the long range diseases of clients (obesity) or occupational illnesses of
employees (asbestos). These issues will change dramatically their sectors.
Once the framework is explicit, we will explain how we integrate these in the valuation.
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Scope of assessment and financial impacts
Adding the (ESG+SD) issues does not only give a more complete image of the past
performance of the company, but will also reflect future strengths and weaknesses.
Integrating sustainable development items into valuation could bring us to the question of
what could be the effect of sustainable development on sales, margins, assets and valuation.
Sector and company assessment
• Sector assessment
At sector level, the first step is the financial framing whose need was already mentioned in
the second part. The aim is the identification of major environmental and social impacts
on financial performance (balance sheet or profit & loss sheet) and therefore the gross
assessment of potential impact on sales, margins and assets.
However this sector overview is not the ultimate solution for companies’analysis. First only a
few sectors are homogeneous in the activities. In Industrial goods and services, it is difficult to
compare Schneider Electric and Randstad, or even in industrial services, Randstad and
Bunzl. Second, even in standardized sectors, the comparison is difficult. For example, in
chemicals, companies producing industrial gases are specific as they do not generate toxic
releases, and as Co2 issue may impact their sales growth (instead of the margin impact
borne by other chemicals). Third some companies have business areas in different sectors,
making difficult the assimilation to one sector. Therefore the sector level of analysis will
constitute a frame but not an aim as such as the aim is to achieve integration in the
company’s valuation.
• Company assessment
The company analysis starts first with the ESG “facts and figures” that displays the risk
exposure of the company to the most important issues from Environmental, Social or
Governance dimensions. Second the business model is assessed regarding long range
questions.
Based on this broad picture, the analysis could focus on
• One of the ESG facts and deepen the analysis, on the gender diversity issue and analyse
the potential glass ceiling issue within the company or the lack of career management
and its consequence regarding staff turnover.
• One of the SD trends and assess the impact of the trends on costs, sales or assets of the
company.
The result of this focus could be displayed and reused in the following sections of the
company report:
- in the risk and strategic analysis
- in the valuation process.
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Financial impacts of sustainable development
• Impact on sales
Investing in sustainable development items can have an impact on companies’ sales. On the
one hand the company can attract new customers and on the other hand they will avoid their
products to be boycotted by some organisations. We often see specific types of customers
like students impacts sales of specific products (Nike, …) when it appears companies’
operations harm the environment or the social environment. Furthermore we should be
looking for companies developing product that will solve future problems like desalination of
seawater, recycling, … Companies investing in these new technologies could add a new
product line and new sales line to the group’s turnover.
Three examples of impact on sales
Negative impact from
poor supply chain
management
• A supply chain management based on low cost of materials may generate disruption of raw materials
stocks and prevent production and therefore negatively impact on sales growth. Nissan has bitterly
experienced this situation in Japan in 2003 with work stop up to 3 weeks in its plan due to a lack of steel4.
Negative impacts from
human resources
management (or lack of
it).
• A traditional human resources policy may assess whether the company has the capacity of developing new
projects. For example, after its massive layoffs and resignations, Boeing in 2000-01 had not enough skilled
workforce to develop new aircrafts, military or civil. Its two major projects were actually rejected in 2001-02.
• In August 2006, a 20 days strike in the mine of Escondida has not impacted the cost structure of the mine
and its main owners (BHP Billiton and Rio Tinto) but it had a direct impact on sales of Rio Tinto as the
company had no copper stock to alleviate the shortage. There was a direct loss of sales of raw and
processed products.
Positive impacts on
sales and growth
• A new market whose potential would not be clearly identified yet is an opportunity to identify new sources
sales and growth for a company. For instance, the market of desalination may represent an increase of
sales for some European companies depending on their technological and strategic advantage to succeed
on this market5.
Source: ESN SI Team
• Impact on margins
The impact of socially related investments on margins is more difficult to measure. Investing
in training facilities and other social initiatives could weight on the short run performance as
the company’s costs would increase. Again in the long run the company could benefit from
lower employee turnover, absenteeism or would avoid strike costs. This would increase
productivity and reduce long term investments in new forces benefiting the margins.
Ecological initiatives as energy savings can be quantified. In the short run when the company
decides to invest in waste reduction or limitation of energy consumption costs will increase.
Indeed these investments will need additional capex having its impact on the company’s free
cash flow. However immediate cost reduction related to energy savings will be integrated into
4
GERPISA, 2005
5
ESN- CM CIC Securities : would you like a glass of seawater ? 8 September 2006
27. ESN SI Methodology Guide
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the cost of goods sold reducing the cost per product and supporting a possible increase of the
operational margin of the company.
Two examples of impacts on margins
Avian Flu
• A research on avian flu assessed the impacts of avian influenza on sales and margins of European
pharmaceuticals6. Impacts on sales might not be as important as it has been expected as medical organisations
strive to circumvent the disease. A strong discount has been bargained by government in order to make margins
flat for companies. A potential impact has been identified in the assets.
Carbon
• Another research has assessed the amount of CO over-allocation on the EU ETS market. It concludes that in
case carbon quota were not given (as subsidies) but paid by companies (as cost) it would impact the pre tax profit
of highly emitting companies (cement, utilities) up to 16%.
Source: ESN SI Team
• Impact on asstes and liabilities
Asset is an important impact as there exists a huge number of latent liabilities. Reducing
these latent liabilities add reliability to the company which in the longer run could lead to
additional business for the company.
Two examples may be provided
Impact of land remediation Impact of water scarcity
The analysis of land remediation management would enable to assess the need of
supplementary provisions for liabilities in order to clean up contaminated land. In
this area, the lack of rehabilitation strategy accepted by authorities can be
damaging. For instance, An extreme case is the closure of Kelian mine in Papua
New Guinea. Rio Tinto had to set up financial reserves up to 250 m€ in 2002.
The assessment of water scarcity risk on asset has proved interesting for 20
European companies (see footnote 6). Considering a set of countries suffering from
water scarcity known as “the thirst triangle”, a research has assessed the
percentage of assets that could be at risk given its location in the “thirst triangle”.
For 3 sectors (paper, steel, fertilizer) and 20 companies, it has been proved that 4
of them have a percentage of assets over 10% located in these “thrsity” countries.
Source: CM CIC Securities
6 ESN – Van Lanschot : Avian Influenza, 21 September 2006
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Furthermore, the United Nations Principles for Responsible Investment cover issues like
incorporating non-financial criteria into the investment decision and were signed this year by
thirty-nine institutional investors and thirty-six large investment companies.
• Definitions of core and broad SI
In practice, two broadly recognized approaches have evolved over the last years: core and
broad SI. The main difference between core and broad SI concerns the SI strategies that the
two measurements include. Core SI only comprises investors who use so-called ethical
exclusions and/or positive screening. Broad SI also includes investors who implement simple
exclusions, which means excluding single given sectors, and investors who enter into
dialogue on issues of concern with the companies they invest in. This is called engagement.
Furthermore, the explicit inclusion by asset managers of non-financial risks into the
conventional financial analysis, called integration, is included. The figure below clarifies this
distinction.
The difference between core and broad SI
Source: Eurosif (2006)
• Size of the European SI market
Both the core and the broad SI market experienced substantial growth over the past two
years, even after correcting for the overall growth of the entire equity market. Compared to
the general investment market Sustainable Investing still represents much growth potential.
Although the development started somewhat later in Europe than in the United States, the
European market for SI is currently quite advanced. According to a recent study by the
European Social Investment Forum (Eurosif), an umbrella association that covers sustainable
investment issues at the European level, over EUR 1 trillion is invested in Europe taking
sustainability criteria into account. This is only the case when a broad measure of SI is
considered. The size of the core SI market is estimated to be EUR 105 billion. Moreover,
national differences with respect to the scale and scope of Sustainable Investing are large
(see the figure below).
Ethical exclusions
Positive screens, including best-in-
class and pioneer screening
Simple exclusions, including norms-
based screening
Engagement
Integration
CoreSI
BroadSI
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Stock Option weighted price : this item enables to assess the cost for the company of the
stock price, through the difference between this weighted price and the average stock price.
The second item (SO dilution) assesses the loss for the shareholder.
Audit fees to auditor: this question enables to check the potential conflict of interest of
auditors to make sure the remuneration for audit higher than the one for advice.
Number of consolidated companies: it gives the amount of companies integrated in the
Group.
Environmental and social reporting
CSR (or SD) report or Code of Conduct: enables to check the level of environmental and
social communication disclosed by company.
Suppliers screening system: enables to check the first step of suppliers’ policy
Global or sector initiative: indicates the involvement of a company in sectoral or global
initiatives to improve social or environmental issues
Social
Number of employees: size of the company
Gender diversity: it provides an indication whether the company restricts its entry to women
(physically hard work, for instance) or whether it is rather feminine work (with a potential
problem if the management is mainly male)
Average age of employees: enables to check whether the company is subject to ageing
employees
Wages (% sales): assess the importance of labour in the cost structure
Average remuneration per employee retreated from management compensation : the
aim of this item is to assess the average cost per employee so that the contribution is better
identified, and could be compared to traditional productivity ratios.
Pension liabilities: it may impact severely on fixed assets.
R&D/ sales: it enables to check if differentiation and innovation is source of value creation by
the company
Cumulated R&D/ sales: it enables to check whether the value creation ay be embedded in
the assets
Sourcing (%sales): it describes the degree of vertical integration of a company and enables
to assess the financial impact of suppliers relationships
Sales to governments (% sales): it is a first overview of the degree of dependence to
government clients; dependence to other clients may be added in the comments
Warranty cost: it may impact severely on fixed assets
Environmental impact in the life cycle: the idea is to understand where exactly lies the
environmental impact of a product/service, during its production, its use or its recycling. The
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subsequent financial impacts are fairly different. Use Impacts usually generate impacts on
sales, recycling a margin impact, production an impact on assets
Raw materials (% sales): this assesses the dependence of the company on one natural
resource
Energy consumption (kWh, Pet…): this data is a first approximation of the company’s
dependence on energy and its exposure to the climate change issue
Energy cost (% sales): tis item displays whether the energy impact is a long terme issue or
has already a financial relevance for the company
Environmental management system: as per the energy consumption, the unit remains
open as its disclosure depends on sector.
Water consumption, waste production and CO2 emissions: physical items enabling to
assess the degree of disclosure of the company and the potential direct impact of
environmental items on financial performance
Exclusion
Geographic breakdown enables to assess the risk exposure of the company to different
geopolitical threats and its ability to catch the growth potential of some areas. Therefore the
item on BRIC estimates o disclosure is typically related to this last point.
All activities exclusions are based on sales units except nuclear, which is restricted to
utilities and the paart of nuclear in the energy mix (assessment of capacities, not
generation).
31. ESN SI Methodology Guide
Page 31
Appendix: Comparison of CSR rating agencies
methodologies
This comparison is a translation made of the book chapter “Finance and sustainable
development”7,
“CSR rating methodologies differ in two ways:
• the scope of analysis :
1. Activities, with possible exclusion of sin activities (tobacco, alcohol, gambling,
weapons) or politically sensitive ones (nuclear, GMO, furs): EIRIS
2. Management practices, including for example, selection of best anti-corruption
procedures and exclusion of anti-competitive or anti-takeover processes or
behavior : Ethibel, Vigeo
3. Management systems: Arese
4. Long term performance: Innovest
• The processing method : the company may be analysed
1. in a perspective of regulation or sector-related compliance : is such practice or
business development legal ? Did the company implement social certification
procedures already implanted by its competitors in order to outsource in Asia?
2. in management system analysis : is the company aware of climate change? Did it
set up a plan to contribute to its reduction of green house gases, or at least reduce
the impact of climate change on the company’s activity? What are the results?
3. through economic analysis under environmental or social constraint: this analysis
may be based on
4. Risk opportunity analysis: what is the probability of achievement and the expected
result of such or such strategy? What is the risk exposure and potential damage?
5. Scenario assessment (ex ante definition of future evolution and positioning of the
company in this scheme)?
Compliance (legal or sector related) analysis is the most frequently used method in discourse
but even more often in facts. It appears as a consequence of the set of moral and political
choices defined by investors. Economically, it implies a standardisation of corporate
communication and practices at lower range (Berenson, 2003; Hawken, 2004).
Managerial analysis method is useful to deal with emerging issues. When an issue is rising it
is relevant to assess the capacity of the company to build an understanding of the question
and to implement relevant answers. However it is relevant regarding sustainable development
performance if and only a preliminary analysis of sustainability challenges has been achieved.
7 Reynaud E., Schneider-Maunoury G. Et alii : L’entreprise au coeur du développement durable, Dunod Editions, October 2006
32. ESN SI Methodology Guide
Page 32
This analysis was used in early days of CSR rating (without preliminary analysis) by agencies
such as ARESE, KLD or Ethibel. It remains used on some issues by Innovest.
Risk opportunity methodology may be used if and if only reliable estimates of cost and
probability may be delivered. It is therefore delimited to precise questions (climate change,
product safety, among the most obvious ones). This methodology has been implemented by
SAM and Innovest, mainly on environmental issues.
Scenarii methodology is based on the historic analysis of socio-political processes explaining
the development of CSR issues, instead of quantitative measurements of CSR impacts. The
agencies claiming the use of this method merely use it for one or two sectors. For example
Innovest used it for automobile industry, and « utilities ». For automobile industry, Innovest
assesses environmental performance related to product for each carmaker by considering
three layers of actions: short term strategy (energy efficiency of existing engines, percentage
of diesel engines), mid term strategy (biofuel), long range strategy (fuel cell).
The choice of processing method strongly influences the choice of the aim of analysis.
Activities analysis (exclusion of businesses (alcohol, tobacco, nuclear) or geographic areas) is
usually based on compliance method. The answer is usually binary, but it may also include a
threshold, based on significant percentage of sales. However the use of these methods may
become absurd. For example a big oil company, renowned for its innovative social and
environmental policies, has been excluded by some ethical funds in 1999, because of its
sales of alcohol in its tank service stations. Threshold might turn crazy for some business
activities. For some investors wishing to exclude nuclear energy, production of such energy
source should not represent over 5% of sales. But distribution of this energy is not taken
account, and figures are not disclosed by utilities. This calculation turns extremely complicate.
Compliance analysis also enables to assess management systems, assuming that certified
management schemes (ISO 9001 or 14001, ethics hotline) are mandatory worldwide
standards regardless of local regulations and cultures.
Managerial analysis is mainly relevant for the analysis of practices. It may be relevantly used
for the long-range performance analysis, as long as this latter is first defined by agencies.
However it should not be used the analysis of management process, as the analysis would be
a closed loop.
For long-range analysis, analyses based on scenario are the most relevant ones, but they
assume prospective surveys on which assumptions should be based. This restricts the scope
of application to environmental issues such as the climate change or biodiversity.
Last, risk opportunity analysis – in financial meanings, with calculation of damage and
occurrence – may only be used on restrictive issues for determined sectors. However it is not
operating for some issues whose potential damage and occurrence would be calculated.
Based on these differences, the methodological strategies of the main agencies operating in
Europe are displayed in the following table. It is achieved by crossing the choice of method of
analysis and processing method.
33. ESN SI Methodology Guide
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Comparative analysis of CSR rating agencies in Europe
Object
Methods
Activity – Product Practices Processes Performance
Compliance
Management System
Risks/
Opportunities
Scenarios
Source: Schneider-Maunoury 2006
NE PAS SUPPRIMER LE SAUT DE SECTION QUI SUIT
SIRI
ETHIBEL
VIGEO
EIRIS, KLD
To some extent, SAM
INNOVEST