Sustainability Investment:Sustainability Investment: Time for Benchmarking29 May 2013Emily Chew, Senior Analyst, MSCI ESG Research

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Market Reaction to ESG: Price, Volatility, and Media

Negative stock returns up to 9 weeks after ESG events Disaggregate and aggregated abnormal returns 

with duration of negative effects clustered directly following the event(On pollution: Hamilton, 1995; on environmental risk: Lundgren and Olsson, 2010; on layoffs: Chen et al, 2001; overall: Lansilahti, 2012, Credit Suisse, Deutsche Bank, etc.)

Increased short‐term volatility andIncreased short term volatility and volume Increasing effect historically to present –

market reaction increasingly strong to ESGmarket reaction increasingly strong to ESG events(Lansilahti, 2012; Credit Suisse; Deutsche Bank; MSCI ESG Research, etc.)

Media reinforcement effect for large‐scale events Increased media focus on ESG events

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Increased media focus on ESG events reinforcing market reactions (Credit Suisse)

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Market Reaction to ESG: Cost of Capital and Balance Sheet

Poor ESG performance over time results in higher cost of capital Strong support for the proposition that both 

disaggregated and aggregated ESG performance has direct effect on credit spreads and cost of capital, including interest on debt, bond coupons, and the cost of equity (20+ studies, both academic and industry)industry)

Strong ESG performance correlates to strong accounting performance Strong governance metrics linked to 

accounting outperformance, particularly emphasizing incentives, compliance t t CSR d b d “A firm that has environmental concerns [ ]structures, CSR governance, and board structures.(Huang, 2010; Bhagat and Bolton, 2008; Cremers et al., 2005; Deutsche Bank; ISS; et al.)

A firm that has environmental concerns [...] pays an almost 20% higher loan interest rate (approximately 25bps) compared to a firm that has an equal number of environmental concerns and strengths.”

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‐ Chava, 2011

Market Reactions to ESG: Application by Asset Owners Asset Owners are redefining fiduciary duty to incorporate long term sustainability issues and increasingly scrutinizing the ESG performance of asset managers UN PRI has more than 1,100 signatories representing $32 trillion in assets (Jan 2013)

Asset owners and manager increasingly finding ESG to be a material topic for engagement: tripling of ‘FOR’ votes on E&S proxy proposals since 1999g g p g p y p p

25%

Average Vote Results for All E&S Proxy ProposalsUN PRI Signatories & AUM

15.0%14 0%

16.3%

18.3%20.6%

20%

7 4% 7.6%8.7%

9.4%

12.0%12.1%

9.8%

12.5%14.0%

10%

15%

7.4% 7.6%

5%

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0%1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: ISS Checklist

Source:  UNPRI 2011 Report on Progress

Two Types of Risk: Event Risk

e.g.Unanticipated Costs:

Negative Externality

E t

Company generates 

toxic waste

Costs:•Penalties•Litigation

•Operational Costs•License to

Company A

Event Risk

waste•License to Operate

Trigger Tipping Point Contaminates 

major river 

•Investigations•Protests

•Change in gRegulations

Which companies are at risk of breaching a tipping point?

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Two Types of Risk: Systemic Riskse.g. 

Company operation is water intensive 

Unanticipated Costs:•Operational Costs, 

Disruptions•License to Operate

Negative Externality

•License to Operate

SystemicRisk

Company SectorRegion

Trigger Tipping Point

Macro Trends

•Conflict between users•Drought

•Population, economic growth increase demand for water•Change in weather, 

•Regulatory responses: taxes, rationing, pricing

•Protests grainfall patterns •Protests, 

negative media

Which companies and sectors will be disproportionately impacted by

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Which companies and sectors will be disproportionately impacted by macro‐level environmental and social changes?

Identifying Systemic Risks through Macro Trends

Macro Trends Systemic Risks Cost to Companies

Resource

Water Stress Operational disruption; License to operate; Cost Increases from rationing, pricing 

Limited

Macro Trends Systemic Risks Cost to Companies

Resource Scarcity

Limited Arable Land

Commodity price volatility; License to operate

Finite Resources  Increased operational costs to uncover ‘unconventional’ sources (waste, H&S)

Geographic Rising wages,

Population, economic growth outstrips natural capacity

Demographic Shifts

Geographic distribution of labor

Rising wages, Labor standards

Changing diet and lifestyle

Increased healthcare burden (for all sectors); Changing disease burden (opportunity for healthcare sector)

Changing Weather Rising insurance costs; Volatile commodity prices; SecurityRicher EM, Aging DM

Climate Change

Changing Weather Patterns

Rising insurance costs; Volatile commodity prices; Security of physical assets; Opportunities in cleantech

Regulations Increased energy costs; Increased compliance costs

Increased operational costs; Litigation; RegulatoryRising temperatures, sea level

Information Revolution

Data Security Increased operational costs; Litigation; Regulatory compliance 

Loss of Privacy Litigation; License to operate; Regulatory complianceDigitalization of all assets 

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ESG Research supporting integration of ESG into the investment process

MSCI ESG Research Business Involvement MSCI ESG Research 

Business Involvement 

“I want to avoid investing in companies whose activities I find unethical or where I’m legally 

“I want to avoid investing in companies whose activities I find unethical or where I’m legally 

Supports the integration of ESG screening requirements into 

Screening ResearchScreening Researchg y

required to divest”g y

required to divest”

Analyzes and monitors ‘ESG 

portfolio management

MSCI ESG ResearchMSCI ESG Research“I want to minimize the reputational risks of my“I want to minimize the reputational risks of my

“I t t l t th b t i l“I t t l t th b t i l d f k d

controversies’ and how the impact is managed at company level

MSCI ESG Research Impact Monitor

MSCI ESG Research Impact Monitor

reputational risks of my investments”

reputational risks of my investments”

MSCI ESG Research Intangible Value Assessment

MSCI ESG Research Intangible Value Assessment

“I want to select the best‐in‐class companies and mitigate

financial ESG risks”

“I want to select the best‐in‐class companies and mitigate

financial ESG risks”

Identifies ESG investment risks and opportunities not always captured 

by conventional analysis

MSCI ESG IndicesMSCI ESG Indices“I want to consider ESG factors as part of a passive index‐based 

strategy”

“I want to consider ESG factors as part of a passive index‐based 

strategy”

Supports the integration of ESG research into portfolio management

“I need ESG solutions tailored to my clients needs”

“I need ESG solutions tailored to my clients needs” MSCI ESG Custom ResearchMSCI ESG Custom Research

Builds on ESG methodology and resources to achieve strategic 

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my clients needsmy clients needsinvestment aims

PTT Exploration & Production

195PTT Exploration & Production

August 2009:  ESG Event• 150,000 barrels of oil spilled at Montara drill rig

l f d b ll h l

135

155

175 • Little investor attention at first due to bullish oil sector outlook

• Stock falls 20% between the third unsuccessful attempt to plug the well on 17 October and

95

115

attempt to plug the well on 17 October and eventually containing the spill on 3 November.

• Paid USD 0.5 million penalty to the Australian regulator NOPSEMA, and faces USD 2.4 billion l i i l d fil d b

Montara spill,‐20% in Nov 2009

55

75

Jul‐09 Sep‐09 Nov‐09 Jan‐10

lawsuit over environmental damage filed by Indonesia. 

April 2009: PTT Public Rated ‘B’IVA Rating History

April 2009: PTT Public Rated  B  (Parent Company)IVA 2009 Profile: “The company is domiciled and has a 100% exposure to emerging markets associated with h i ht d i t l i k d t th i l k f

2009

2011

2012

human rights and environmental risks due to their lack of regulatory frameworks and enforcement. There is no evidence of environmental and social risk mitigation mechanisms.”

B PTT Public

BPTT EP

BPTT EP

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Example only, past performance is not necessarily indicative of future results.

Yum! Brands

80

90Yum! Brands

December, 2012:  ESG Event• Inquiry launched by China’s health officials 

regarding KFC purchase of raw chicken with 

60

70

g g phigher‐than‐permitted levels of antibiotics 

• Share price drop of 4.2% following publicity associated with the controversy; Yum! Brands d i 44% f it t t l f Chi

0

50

60Publicity on food safety problems, Dec 2012:‐4.2%

derives 44% of its total revenues from China and expects KFC’s 2012 Q4 sales to fall by 6%

September 2012: Rated ‘CCC’4001‐Sep‐12 01‐Nov‐12 01‐Jan‐13

IVA Rating

September, 2012: Rated  CCCBottom quartile ranking on ‘Product Safety & Quality’IVA 2012 Profile: “The company does not appear to have 

IVA Rating microbiological testing programs for its raw materials or finished products; [...the company faces]  ongoing challenge of overseeing such an enormous number of restaurants, particularly its franchised locations, where 20

10

2011

2012

the degree of operational control is less but the impact on reputation just as great in the event of quality problems.”BB CCC CCC

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Example only, past performance is not necessarily indicative of future results.

MSCI ESG Index Framework

MSCI Global Investable Market IndicesUniverse

Parent Index MSCI World

MSCI  USA IMI

MSCI  World IMI

MSCI ACWI IMI

MSCI ACWI ESG Research Data

IVA

MSCI ESG Research

(ESG Risk Ratings)

Impact Monitor (Controversies)

ESG Index

MSCI World  MSCI USA  MSCI ACWI ESG, Best‐in‐Class

Business Involvement (Screens)

ESG

MSCI World SRI

IMI ESG

MSCI KLD 400

MSCI EM ESGBest in Class

SociallyResponsible

Forthcoming

MSCI Global Climate

MSCI Global Environment

Environmental

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MSCI Global Climate

Ex Controversial Weapons

MSCI ESG Global Client Service

A i 1 212 804 5299Americas + 1.212.804.5299

Asia Pacific  + 612.9033.9339 

Europe, Middle East and Africa  + 44.207.618.2510 

esgclientservice@msci.com

www.msci.com/esg

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