If ESG doesn’t have financial value, does it have any value at all?

Niclas During, ESG Manager, CDC Group

11 November 2010

Why its important to quantify the financial value of ESG?

To drive ESG on a broad scale To show that ESG truly is value

Proactive: “Doing the right thing”

Reactive: Reputational / brand risk

Inactive: Doing nothing

• There is no business on a dead planet – ESG is about long term, sustainable and viable companies, countries and economies

• Using language everyone understands - if we don’t measure ESG in financial terms we are not reaching most companies and individuals

•ESG is the essence of adding value – leaving people and planet improved and not impaired in value

Does ESG have a financial value?

What is the value of safe working conditions?

Or the environment?

Or good corporate governance?

Most common perception: ESG downside risk and reputational risks

ESG seen as adding (quantifiable) value to the business

Clearly identified priorities to maximise ESG and financial performance

Proactive, performance managed ESG strategies to deliver value

What an understanding of ESG’s financial value could mean

Traditional ESG approach Value focused ESG approach

AttitudeESG as downside risk, not upside opportunity

FocusUnaware how to prioritise between different ESG actions to get most out of it

ResultsMore committed in words than actions

With a traditional ESG approach there is consistent de-prioritising of ESG and suboptimal selection and prioritisation of ESG actions

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ESG performance

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A value focused ESG approach would:

= Environment = Social = Governance = Small initiative = Big initiative

• Take resources from some less valuable ESG areas…

• …and put them into more valuable ones… • …and continuously identify new areas

A traditional ESG approach

How can we make estimates of ESG financial returns?

Many studies show causality between ESG and financial performance…

1)Abramson, L. & Chung, D. (2000), Socially responsible investing: Viable for value investors?2)Derwall, J., Guenster, N., Bauer, R. & Koedijk, K. (2005), The eco-efficiency premium puzzle3)Gompers, P., Ishii, J. & Metrick, A. (2003), Corporate governance and equity prices4)Opler, T.C. & Sokobin, J. (1995), Does coordinated institutional activism work? 5)Orlitzky, M., Schmidt, F.L. & Rynes, S.L. (2003), Corporate social and financial performance: A meta-analysis6)Statman, M. (2006), Socially responsible indexes: Composition, performance, and tracking error7)Van de Velde, E., Vermeir, W. & Corten, F. (2005), Corporate social responsibility and financial performance

How can this research inform a company’s ESG strategy?

The key questions:

?????The answers from the research:

1) What ESG initiatives to select?

2) How to prioritise among these?

3) How to prioritise against other (non-ESG) areas?

The research findings:

There is a missing link between ESG initiatives and financial returns

Budget line items

Costs & Revenues

Free cash flow

Share price / valuation

Environment

Social

Governance

Missing link

Problems arising from missing link:

• Selection of ESG initiatives

• Prioritisation of ESG initiatives

Consequence:

• Consistent de-prioritisation of ESG

• Partially misguided ESG strategies

What linkages have we found in CDC’s portfolio?

CDC portfolio analysis shows good ESG management system correlate with 15% higher IRRs

Result: Correlation between good ESG management systems and 15% higher IRR

Explanation: Possibly generally better managed companies

Next steps: Improved data and further analysis

For fund managers: CDC ESG Toolkit for fund managers (free)

Feel free to use CDC’s recently launched toolkit to improve ESG management systems

Arch Pharmalabs in India achieved international market expansion through improvements of health and safety and manufacturing standards

Pharmaceutical manufacturing company

ICICI Ventures invested US$35m in 2006

ESG risk/opportunity: Market expansion through adoption of pharmaceutical quality standards

Company

11 sites: WHO Good Manufacturing Practice (GMP) accreditation

3 sites: U.S. Food and Drug Administration (USFDA) accreditation

ESG actions

Turnover growth from US$2m (1999) to US$185m (2009)

GMP and U.S. FDA accreditations resulted in contracts with Pfizer, Sandoz, Glaxo SmithKline, Sigma Tau, DSM and Elan

Results

Outsourcing Services Limited in Nigeria improved working conditions and returned a 45% IRR to the fund manager

Start-up security outsourcing company - supplies security guards

African Capital Alliance invested US$235,000 in 1999

ESG risk/opportunity: Improved quality of service to increase market share

Company

Minimum wage strictly enforced

51% of revenues to salaries (industry average = 41%)

More and better training than competitors

Free medical and life insurance

ESG actions

From a start-up to the leading outsourced security firm in Nigeria

Initial investment of US$235,000, sold to G4S for US$10m in 2009 – IRR of 45%

Results

More case studies available on CDC’s website…

A Fortune 500 company achieved major productivity and risk improvement through targeted health programmes

A large Fortune 500 multinational consumer and personal care products company

More than 150,000 employees and operations in

ESG opportunity: Improving productivity and reducing operational risk through staff health programmes

Company

Four key health issues identified among the general population – metabolic, cardiovascular, obesity and hypertension matters

Company undertook a two-year pilot in which 545 staff were given health awareness materials assessed against a control group of 1,000 other staff

ESG actions

ESG: Obesity: 26% decrease in Body Mass Index at factoryNutrition: Consideration of salt intake increased by 19%Heart disease: Risk reduction for the highest risk group from 6% to 3%

Financial: Productivity: Time not working effectively from 24.5% to 18.2% or £560 per head and year Staff retention: Agreement to the question “I enjoy better health and wellbeing for being employed by Unilever, compared to another employer” from 43% to 64%Absenteeism: Decrease by 17%

Results

Company X financial returns from ESG: Actual breakdown

Financial returns from health initiativeEUR, millions

50.1%

20.4%

11.9%

9.0%8.3% 0.1%

1)Case study and numbers based on research project between CDC, FMO and the consultancy 10EQS, Novermber 2010. Financial numbers are actual company data as well as estimates

How can we link ESG to budget line items?

Costs & Revenues

Free cash flow

Share price / valuation

Environment

Social

Governance

Missing link

Budget line items

How does this apply to the three case examples?

Applying the approach to the examples

Arch Pharma

Arch Pharma

Arch Pharma

Arch Pharma

OSL

OSL OSL

OSLEl-

Rashidi

El-Rashidi

El-Rashidi

El-Rashidi

El-Rashidi

So how can you do it? Conduct a comprehensive analysis of your ESG risks / opportunities and how they match against financial value…

Source: Savings spreadsheet based on examples in Willard, Bob. (2002), The Sustainability Advantage (New Society Publishers)

Measure the right metrics and calculate the returns…

Savings (increase in staff retention)

- Cost (provision of training)

= Financial return on ESG initiative

Collaborate by sharing insights and learning from others

CDC/external consultants: Identification of best practice

• Leading global companies• Specific ESG actions• Quantification of returns

CDC portfolio: Pilot cases• Tracking of individual companies and ESG actions• Selecting specific ESG and financial metrics

Interested parties: External collaboration• GPs/companies outside CDC’s portfolio • Sharing of best practice, modelling of returns, metrics and approaches• Anonymised contributions if required

Continuously improved quantification of ESG financial returns

More effective ESG strategies

Better ESG and financial performance

ESG has a financial value – in showing it we can achieve so much more!

Going from here… …to here

Proactive: “Doing the right thing”

Inactive: Doing nothing

Proactive: “Doing the right thing”

Reactive: Reputational / brand risk

Inactive: Doing nothing

Getting active: Going for financial returns

Reactive: Reputational / brand risk

Thank you for listening!