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July 18, 2006
UN Advances Business Case for Materiality of SRI, Leaving Skeptics Little Wiggle Room
    by Bill Baue

A new UNEP FI report assesses how investment banks are integrating environmental, social, and governance factors and linking them to financial performance in their research.

With any controversial idea, there comes a point when a critical mass accepts the notion as self-evident and simply abandons the attempt to convince skeptics because their objections fade into irrelevance. The United Nations is ushering the financial community in this direction with the concept of the materiality of environmental, social, and governance (ESG) issues. A significant chunk of the buy-side has bought in, with more than 70 institutional investors from 16 countries representing over $4.5 trillion in assets signing the Principles of Responsible Investment (PRI) launched by UN Secretary-General Kofi Annan in April.

A movement is afoot on the sell-side as well, as evidenced by the recent report sponsored by the United Nations Environment Programme Finance Initiative (UNEP FI) assessing how ten leading global brokerages are integrating ESG factors into their research reports.

"The publication has a simple objective: to unequivocally link ESG issues to financial value in such a manner that the mainstream value-driven investor can no longer disregard or dismiss them as irrelevant to investment performance," states the report, entitled Show Me the Money. "Investors who are not sure what to do would do well to refer to Pascal's wager concerning the existence of God: make believe as if the hypothesis is true, thus at little or no cost avoiding the worst-case scenario."

The very design of the report reinforces the notion of converting non-believers, as each brokerage report is assessed by CRA RogersCasey, a mainstream investment consultancy that admits to "seeing the light" as a result of its involvement in the report. For example, the firm is now seriously considering signing onto PRI.

"We believe incorporating ESG issues in investment processes is likely to become an essential part of all assessments in the future," states CRA RogersCasey in its concluding remarks. "We further believe this trend will be driven by the extent to which investors are convinced of the material links between these ESG factors and the financial impact on their investments."

The CRA RogersCasey commentary enhances the objectivity of the report, providing a clear-eyed appraisal of the strengths and weaknesses of the brokerage research individually and as a whole.

"[W]e were impressed by the quantity of reports that showed a strong link between ESG issues, profits, business activities and, ultimately, stock prices," states CRA RogersCasey. "However, we believe a lot of work remains to both strengthen these links and further document their impact on portfolio value."

"Some reports provided a comprehensive ESG assessment and were successful in identifying specific issues and providing frameworks for evaluating and quantifying the impact of these issues on stock price," the consultancy continued. "Other reports did not explicitly identify ESG issues, and not all reports were effective in quantifying the materiality link of the ESG factors' impact on stock price."

CRA RogersCasey singled out several reports using ESG assessment frameworks warranting praise. It called the WestLB analysis of emissions standards in the auto industry using the Controversy Risk Discount (CRD) "truly innovative." The UBS report on the food and beverage industry using its Q-Series, a comprehensive corporate social responsibility (CSR) assessment tool, is an "effective analysis," though CRA RogersCasey notes that analysts unfamiliar with the Q-Series might have difficulty using this research. And the firm applauds the Goldman Sachs report, adapting the 42-factor ESG framework it developed for the oil and gas industry into a 31-factor framework for the European media industry.

"At 176 pages, it is the most extensive, thoroughly developed report we have received," states the report. "That being said, it could be substantially shorter and still communicate the salient points in sufficient depth."

If these brokerages sound familiar, it is because all three qualified for the first UNEP FI report on the materiality of ESG issues, issued in 2004. UNEP FI's Asset Management Working Group (AMWG), which coordinates this "Materiality Series," dubbed the first set of research MAT1 and the second set MAT2.

Goldman Sachs and UBS were also among the nine brokerages that earned recognition from the Enhanced Analytics Initiative (EAI), a consortium of institutional investors with more than $1 billion in assets that allocates five percent of brokerage fees to firms producing the best ESG research. The Show Me the Money report cites EAI as a prime indication that the former status quo of relative indifference to ESG is radically changing.

"Success is in the numbers: while only 16 reports qualified for [EAI's] first evaluation period in 2003, 173 qualified for its most recent evaluation period in June 2006," states the report.


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