TouchstoneMetrics Project Touchstone A FRAMEWORK FOR DRIVING CORPORATE SUSTAINABILITY Fall 2015

T ouchstone M etrics

Project TouchstoneA FRAMEWORK FOR DRIVING CORPORATE SUSTAINABILITY

Fall 2015


Executive Summary

The Opportunity

• Interest in corporate sustainability -- whether from investors, regulators, consumers, or companies themselves -- is exploding

• This growing interest has left investors and others in search of standards and frameworks to help them evaluate which companies are truly engaged in sustainable practices and which are not

• As the head of CalPERS’ sustainability investing program recently told her investment committee Board, this is “an area of innovation . . . We have to build reporting, build frameworks and try ideas out.”

• The lack of established standards also allows companies to “cherry pick” the practices they wish to highlight rather than make disclosure about the totality of their sustainability-related practices

CONFIDENTIAL 2


Executive Summary – Continued

The Answer

• Project Touchstone aims to promote corporate sustainability practices by creating an industry standard benchmark for evaluating those practices -- a sustainability parallel to the “credit rating” industry

• Leveraging existing and proven market infrastructure, Project Touchstone accomplishes this goal through a three-pronged approach:

• Engage credit rating agencies to rate companies using public and non-public information based on principles-based criteria developed by an independent entity

• Credit rating agencies have strong existing relationships with companies, robust analytical resources, and established distribution channels. These assets can be leveraged to encourage participation in the process by companies and to “scale” the adoption of sustainability ratings

• Establish an independent criteria entity to establish and promote a set of objective principles and criteria by which to rate corporate sustainability practices

• An independent criteria entity will better facilitate the development of a broad consensus around appropriate principles and address the “conflict of interest” concerns that have plagued the credit rating agencies. This entity need not “reinvent the wheel” given the proliferation of existing thinking around metrics for evaluating sustainability

CONFIDENTIAL 3


Executive Summary – Continued

• Deploy investment capital to concentrate demand for greater transparency around, and measurement of, corporate sustainability practices through the use of sustainability ratings

• The Project calls for a core group of regulatory investors to announce that, as of a date in the future, companies must either have a sustainability rating using criteria approved by those regulators or explain why they do not in order to be eligible as investments

• The initial group is likely to include public funds such as CalPERS, CalSTRS, New York Common Retirement fund and similar investors. These funds not only control significant amounts of capital, but also seek to advance pro-sustainability social policy through their investments

CONFIDENTIAL 4

T ouchstone M etrics CONFIDENTIAL

Project Touchstone

Mission

Result

NeutralityPrinciple

IndependencePrinciple

Mechanism

Empower investors, regulators and consumers to identify and promote corporate sustainability practices

Create a market-standard sustainability rating system that utilizes proven infrastructure and leverages ongoing sustainability initiatives

Meaningful tools for analyzing corporate sustainabilityMore robust and standardized corporate disclosureConcrete incentives for improved sustainability practices

Project Touchstone does not require institutional or public investors to pursue “sustainability” over financial returns; nor does it require them to fund the initiative

Criteria for the benchmarks is developed through a financially self-sustaining independent organization, not the rating agencies themselves, thus forging an industry consensus and addressing broad concerns about rating agency “conflicts of interest”

5


State-of-Play


Significant and Growing Investor Interest in Sustainability

• $45 trillion in investment funds committed to following the United Nations Principles for Responsible Investment:

“As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognize that applying these Principles may better align investors with broader objectives of society.”

• $6.57 trillion in 2014 invested in sustainable, responsible and impact investing (SRI) assets – a 76% increase from 2012:

“Assets managed with SRI strategies now account for more than one out of every six dollars under professional management in the United States.” U.S. Forum for Sustainable and Responsible Investment

7


Sustainability is Critical to the Fiduciary Obligations of Public Investors

• CalSTRS Corporate Governance Annual Report 2013:

“Sustainability has been a principal focus of the CalSTRS Corporate Governance staff for many years.”

• Sustainability is the “First Global Governance Principle” for the CalPERS $300 billion pension fund

• Thomas P. DiNapoli New York State Comptroller and sole trustee of the New York State Common Retirement Fund:

“Our goal is simple: we want long-term sustainable economic growth. And we have found from experience that comprehensively integrating environmental, social and governance considerations into the investment process is essential to achieving that goal.”

• Scott M. Stringer New York City Comptroller and investment advisor, custodian and trustee of New York City Pension Funds:

“Because companies that respect their workers and our planet are companies that will help to grow our pension fund for years to come.”

8


We don’t want to debate climate change. We want to stop it. We recognize that by integrating sound environmental, health, and safety management practices into all aspects of our business, we can offer technologically innovative products and services while conserving and enhancing resources for future generations.”

We cannot close our eyes to the problems the world faces. In Unilever we believe that business must be part of the solution. But to be so, business will have to change. Sustainable, equitable growth is the only acceptable business model.”

Our firm belief is that for a company to prosper over the long term and create value for shareholders, it must create value for society at the same time. Each and every commitment is based on our own convictions, not convenience. Respect, for people, different cultures, the environment and for the future of the world we live in, is the foundation of Creating Shared Value.”

What I challenge all of us to do today, especially around the supply chain, is to figure out how to accelerate the pace of innovation by looking through a sustainable lens. That will result in not only a better planet tomorrow but more inspiring merchandise for our customers today.”

Leading Corporations Value Sustainability

““““

9


Increasing Information Available through Voluntary Disclosures

A number of entities are engaged in efforts to promote the quantity and quality of sustainability reporting. These entities, all of whom are natural partners for Project Touchstone, include:

Global Reporting Initiative: www.globalreporting.org

“Enabling all organizations to report the sustainability information that matters.”

Carbon Disclosure Project: www.cdp.net

Sustainability Accounting Standards Board: www.sasb.org

Largest collection globally of self reported corporate data concerning climate change, water and forest-risk.

“SASB’s mission is to develop and disseminate sustainability accounting standards that help public corporations disclose material, decision-useful information to investors.”

Leading nonprofit advocacy organization that mobilizes a powerful network of investors, companies and public interest groups to accelerate and expand the adoption of sustainable business practices and solutions.

Ceres: www.ceres.org

10


But Analytical Tools Are Less Established

• Sustainable investing requires: (i) meaningful and user-friendly intelligence about the sustainability practices of investments and (ii) established and usable benchmarks

• While many companies have increased their “ESG” disclosures in recent years

o These disclosures are limited to what companies choose to share

o Companies tend to cherry pick facts that will paint them in the best light (“greenwashing”)

o There are no established benchmarks against which to evaluate corporate sustainability practices

• As a result

o Companies have little concrete incentive to “come clean” about the totality of their practices

o Many companies treat sustainability as a PR or marketing matter rather than a core of their operations

o Disclosures beyond “feel good” stories produce little economic benefit for companies and create

potential risk

11


These Dynamics Make it Difficult for Market Participants to Assess and Promote Corporate Sustainability Practices

• Investors and regulators looking to promote sustainability are largely limited to what companies choose to highlight about their sustainability practices, making meaningful evaluation of investments difficult, if not in many cases impossible

• Disclosures, even when robust, can be hard to parse, requiring investors to spend significant time identifying potential investment candidates

• Policy makers looking to deploy investment capital to promote long-term goals have few tools to assess the efficacy of a company’s practices and are often left flying blind when trying to allocate investment dollars in a pro-sustainability way

• Sustainability is often relegated to a niche area of concern for only those companies interested in attracting impact investor money since companies do not pay a concrete price (or gain a concrete incentive) for their overall sustainability profile

An opportunity - and a need - exists for a meaningful benchmark

12


“Today there are more than 100 organizations offering more than 400 corporate sustainability ratings products that assess some 50,000 companies on more than 8,000 metrics of environmental, social and governance (ESG) performance.

However, with the large and growing number of ratings products currently available and a deluge of sustainability disclosure from corporations, investors face substantial challenges in discerning which ratings and factors are most relevant to their needs.”

Dr. Jean Rogers, CEO SASB

Source: http://www.huffingtonpost.com/jean-rogers/focusing-corporate-sustai_b_7156148.html


What Would a Meaningful Benchmark Look Like?


Attributes of a Meaningful Benchmark

• Independent analysis based on transparent criteria

• State-of-the-art analytics

• Reflects the participation of the entities being evaluated

• Readily understood and comparable within and across industry categories

• Supported by major stakeholders

• Broad market coverage

• Freely accessible to all market participants

15


Building a Robust Rating System

• A robust benchmark that reflects the participation of a broad spectrum of relevant participants is vital to integrating sustainability issues into the mainstream of the capital markets

• Using an established benchmark, investors could more easily make a “first cut” without having to do a detailed (and resource-consuming) analysis of every investment as well as assess the overall “sustainability” of their portfolios

• An established and broadly distributed benchmark would also put market pressure on companies with lower ratings to improve their practices

• Market analysts, journalists and commentators could more easily report on the sustainability practices (or failings) of companies they cover

• Consumers could more easily factor sustainability into their decisions, again providing strong incentives for improvement through the operation of existing market mechanisms

16


Sustainability Indices Are Not Well Suited to Fulfill this Role

• Several entities evaluate companies’ sustainability practices to identify best-in-class socially responsible investments for impact investors, including:

o S&P-Dow Jones Sustainability Index: www.sustainability-indices.com

o MSCI: www.msci.com/esg-integration

o FTSE4Good: www.ftse.com/products/indices/FTSE4Good

• But none of these efforts has become (or is likely to become) a broadly adopted and applied market benchmark:

o They are predicated in each instance on companies’ willingness to participate and are limited to that extent

o By definition they don’t provide a view across the whole market

o They don’t provide a ready means by which to compare potential investments along sustainability lines

o Distribution of the results can get drowned out, particularly since there are so many different measures rather than a single market benchmark

o Sufficiently concentrated investor demand for these measures has not materialized, undermining the incentives for companies to participate (other than those looking to promote existing practices)

o They are generally targeted at “impact investors” rather than investors who must have exposure to the full market

17


Nor Are Current Sustainability “Ratings”

• A handful of firms are currently issuing sustainability “ratings”. These include, for example, MSCI and SustainAnalytics

• These ratings are unlikely to evolve into market benchmarks, however

o Because they are paid for by the users of the ratings, they are, by necessity, limited in their distribution to those users

o As a result, no broad market dissemination is possible

o They are based on proprietary, non-transparent criteria, which makes it hard for other market participants to “buy in” to these ratings as representing state of the art analytics

o They are based on voluntary, non-standardized disclosures, which makes it easier for rated companies to “cherry pick” the information they want to highlight to these raters

o This dynamic also makes it easier for companies to avoid being rated if they want to. MSCI, for example, only covers approximately 40% of U.S. public companies

18


Solving the Problem


"Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.”

Justice Louis D. Brandeis


Solving the Problem: The Pieces for Creating a Successful Benchmark Exist

• Real regulatory and investor interest in promoting greater transparency around sustainability practices

• Significant analytical thinking around appropriate metrics

• Market infrastructure for the analysis and distribution of ratings benchmarks

o For example, the relationships, analytical

personnel and distribution power of existing

NRSROs (i.e. credit rating agencies) can be

leveraged to turn that demand and that

thinking into a meaningful sustainability

benchmark

• What is needed is a way to connect these pieces together to drive the development and implementation of a meaningful sustainability benchmark

Investor Mandate

Improved Reporting

Ratings

21


Three-Pronged Approach to Creating Meaningful Sustainability Benchmarks

Deploy investment capital to concentrate demand for greater transparency around, and measurement of, corporate sustainability practices through the use of sustainability ratings

Engage

Establish an independent criteria entity to leverage existing thought-leadership to establish and promote a set of objective principles and criteria by which to rate corporate sustainability practicesEstablish

Engage credit rating agencies to rate companies using public and non-public information based on principles-based criteria developed by an independent entity

Deploy

22


Prong I - Engage

• Engaging NRSROs will significantly advance the establishment of a meaningful sustainability benchmark:

o NRSROs already have significant experience creating widely used industry benchmarks

o They have teams of analysts and operational infrastructure that can be leveraged to scale the

creation of a sustainability benchmark

o They utilize broadly understood nomenclature (‘AAA’, ‘BB’, etc.) that is already an integral part of the

capital markets

o They have established distribution channels

o Perhaps most importantly, they have on-going relationships with all major issuers of securities and

meet with those issuers on a regular basis

o NRSRO relationships make it significantly easier to gain issuer “buy in” to a sustainability benchmark

since (i) issuers have strong existing incentives to be forthcoming to rating agencies; and (ii) the

“cost” of such engagement to issuers is only marginal to the time and money they already spend with

NRSROs

• The “Issuer-Pays” business model of NRSROs enables broad distribution of ratings to all market participants free of charge

o It also makes it easier to create an industry standard

Engage

23


Prong I – Engage (Con’t)

• Project Touchstone also addresses the issue most likely to cause reservations about using the existing rating agency system: the potential for conflicts of interest inherent in the “issuer pays” business model the major rating agencies use

• The rating agencies were subject to severe criticism – and a flood of lawsuits – following the financial crisis for allegedly “relaxing” their ratings criteria to please the issuers who paid their rating fees

• Project Touchstone addresses this concern through the establishment of an independent entity to develop a market consensus around transparent, principles-based criteria for analyzing sustainability

Engage

24


Investors

NRSROsCriteria

Organization

ACollaborativeFramework

25


Prong II - Establish

• Project Touchstone calls for the creation of an independent entity to engage a broad range of relevant stakeholders to forge transparent and objective principles-based criteria for use by the rating agencies in arriving at their sustainability ratings

• This criteria will be updated and improved periodically

• Stakeholders will include regulators, private investors, asset managers, thought-leaders, ratings experts, and companies

• The entity will be independent of investors, issuers and the rating agencies to insulate the criteria development process from potential conflicts of interest

• The entity will be self-sustaining through the collection of licensing fees from the rating agencies for the use of the criteria in their ratings

Establish

26


Criteria Development

Criteria

27


Prong II – Establish (Con’t)

• By engaging stakeholders the independent entity helps develop a market consensus around identifying and weighing the key drivers for rating sustainability along each of the relevant dimensions:o Environmentalo Socialo Governanceo Financial

• The principles-based criteria will be transparent so that stakeholders have sufficient tools to make their own determinations about the different drivers that comprise the benchmark

• The entity will use an iterative criteria development process to incorporate market feedback and be responsive to stakeholder concerns

Establish

28


Continually Improving Criteria Process

CriteriaProcess

RatingsCriteria

NRSROBenchmarks

Responsible Investors

Corporate Sustainability

Practices

29


Prong III - Deploy

• Regulatory capital, and the policies that govern its use, can have a tremendous effect on the behavior of those who receive it and markets as a whole

• For instance, just four public pension funds (CalPERS, CalSTRS, NY State Common, and NY City Retirement) together control over $750 billion in assets

• Each of these funds uses credit ratings from one of the major NRSROs (S&P, Moody’s, Fitch) to assess eligible investments

• As numerous commentators have observed, such use has led to an enormous demand for credit ratings and, as a result, increased transparency around those being rated

Deploy

30


Prong III - Deploy (Con’t)

• Project Touchstone uses a similar approach to drive demand for sustainability ratings

• Specifically, the Project calls for a core group of regulatory investors to announce that, as of, for example, January 1, 2018, companies must either have a sustainability rating from an NRSRO using criteria approved by those regulators or explain why they do not in order to be eligible as investments

• Importantly, unlike with credit ratings, regulators need not set a “minimum” rating level for investment (and thereby limit their investment options to only “highly sustainable” companies). The key here is to drive demand for the ratings themselves and the increased transparency and measurability they provide

Deploy

31


Conclusion

• Investors have successfully pushed companies to improve their disclosures about their sustainability practices

• Notwithstanding the proliferation of new information, there is little industry consensus on how to measure and compare corporate sustainability practices

• There are also precious few tools investors can use in making a “first cut” as to where to look more closely to target their engagement

• Project Touchstone solves these problems by forging an industry consensus around robust analytical benchmarks for corporate sustainability and using the existing market infrastructure to scale them

32


Potential Timeline

Confirm support from a sufficient core pool of regulatory capital(Fall 2015)

Enlist additional capital interested in developing sustainability benchmarks (Winter 2016 - onward)

Announce Project Touchstone and set a launch date (First Half 2016)

Publish initial criteria(Second Half 2017)

Engage with NRSROs to secure their participation (Fall/Winter 2015)

Host “Kick-Off” conference to gather core participants and establish working group(Spring 2016)

Assemble ratings criteria (Spring 2016-2017)

Launch initial sustainability ratings(2018)

33


Adam Zurofsky

• Education: Stanford University (A.B. in Political Science, Phi Beta Kappa, 1994); Harvard Law School (J.D. cum laude 1997)

• Cahill Gordon & Reindel, LLP. (1997-2015). Partner in the litigation and corporate advisory practice area. Highlights include:

o One of the three principal partners that represented Standard & Poor's in all ratings-related litigation and investigations arising out of the subprime crisis

o Represented numerous corporate boards and audit committees, including WalMart's audit committee in connection with alleged FCPA matters relating to its international operations

o Represented the Board of Homestore.com in connection with misstated financial statements. Cahill's investigation on behalf of the Board was singled out by the U.S. Attorney General and used as a model for internal investigation standards

o Extensive regulatory experience, both with respect to rule-crafting and enforcement matters

o Named in 2010 as one of the top 10 legal stars in the country under 40 in securities litigation by Law360. Has received similar recognition From The Legal 500 and Benchmark Litigation

34


“Yes, the planet got destroyed. But for a beautiful moment in time we created a lot of value for shareholders.”

35

Documents

TouchstoneMetrics Project Touchstone A FRAMEWORK FOR DRIVING CORPORATE SUSTAINABILITY Fall 2015