The Environmental, Social and Governance (ESG) Implications of Sovereign Wealth Funds (SWF) in the Capitals Markets and Innovest’s Risk Analysis Approach to SWFs

TBLI Bangkok – May 30, 2008

Afshin Mehrpouya

New York

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Innovest UncoveringHidden Value forStrategic Investors

The Environmental, Social and Governance (ESG) Implications of Sovereign Wealth Funds (SWF) in the

Capitals Markets and

Innovest’s Risk Analysis Approach to SWFs

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Innovest is an investment research and advisory firm which focuses on “non-traditional,”

drivers of investment risk and returns, including companies’ performance on

environmental, social, and strategic governance (ESG) issues.

Core products

Company profiles and ratings

Sector reports

Carbon Beta™ Impact Analysis

Global Compact Screen

Carbon Audits

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Research coverage:

- 2300 companies globally

- 70 MSCI industry sectors

Headquartered in New York with 7 offices in 6 countries in 4 continents.

8 out of the top 25 global asset managers in the world use Innovest research.

70 clients globally including: UBS, HSBC, SSgA, ING, ABP, BNP Paribas, CalPERS

Ranked # 1 independent research provider by 2006 & 2007 Thomson Extel Survey

Introduction to Innovest

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Sovereign Wealth Funds – A perspective

SWFs are large pools of capital controlled by a government and invested in private markets (abroad?), against which the government has no external liability

What are they?

Different from:

•Pension funds

•Government owned and/or managed companies

•Central Banks / Foreign Reserves

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S

Then, why are they in the spotlight?

– Commodity price boom

– Credit crisis

– Increased risk appetite of national governments

– A few highly publicized exposures

– Weaker US Dollar

– SWF move from diversified small shares, to large transactions


Are they a new phenomenon?

Source: Various - SWF websites, IMF, etc. – upper estimation limits in all cases

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Government surplus from commodities ( e.g. Kuwait Investment Authority, Abu Dhabi Investment Authority, Chilean Sovereign Wealth Fund)

Non-commodity surpluses [e.g. CIC (China), GIC & Temasek (Singapore)]– Usually aimed at exchange rate or inflation control

– Usually a debt in local currency from central bank to the fund

Other sources of government surplus

– Privatization (Australian Sovereign Wealth Fund)

– Superannuation support (New Zealand Superannuation Fund)

Sources of capital

Sovereign Wealth Funds – Risk and Opportunities

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Some of the larger transactions:

Sovereign Wealth Funds – A Perspective

Source: Various; SWF websites and news sources

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How large are they?


Source: Morgan Stanley; Sovereign Wealth Funds: A Growing Global Force in Corporate Finance

USD 12 trillion by 2012, given the historical levels of foreign reserve growth and launch of new SWFsSource: IMF Global Financial Stability Report

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Intergenerational Savings (e.g. Norwegian Government Pension Fund, Kuwait Investment Authority, etc.)

– Long term

– Strict government withdrawal covenants

– Lower return pressure Oil Stabilization Fund (e.g. Russian Oil Stabilization Fund)

– Short to medium term

– Low risk tolerance

– Need higher liquidity Reserve Investment Entities [e.g. China (CIC), Singapore (Temasek, GIC), etc]

– Mostly non-commodity surpluses

– Need higher returns

– Higher risk tolerance Development funds (e.g. Nordic Development Fund, European Development Fund, etc.)

– Goal oriented

– Not return focused

– Small relative size

Fund Mission


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Categories and risk appetites


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We believe SWFs can be significant source of extra-financial opportunity and risk primarily to the community of their investees and co-investors, and ESG

research can offer them significant benefits.

Why is Innovest concerned?


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Mission Quality of management Long term vs. short term Active vs. passive Economic vs. strategic mandate Return requirements National values

Factors defining behaviour


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Oil stabilization funds

– Hedging against oil risks through investing in Clean Energy All long term funds

– Long term perspective resulting in higher regard for environmental, social and governance (ESG) performance of portfolio

• Norwegian GPF, NZ SWF

– Commitment to engagement aiming at improving environmental and social performance based on diffusion of national values

• Norwegian GPF, NZ SWF

– Privileged access of the investee to additional liquidity

Key opportunities


Norwegian Government Pension FundThe overarching objective of the active

ownership effort is to safeguard the financialinterests of the Pension Fund. The ethical

guidelines are premised on favorable returns over time being dependent on sustainable development, in the financial, ecologic and

social sense.

Source: NPF Report to Storting 2008

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All non-transparent funds

– Influence aiming at non-economic gains

• Conflicts with the economic objectives of co-investors and the investee

Passive SWF Investors

– Dilution of shareholder voting power

Stabilization and local currency debt funds

– Possibility of short to mid-term sovereign wealth investments

• Instability in the target firm and/or capital markets

All SWFs

– Lack of sufficient outsourcing management or internal management skills

• Unpredictable fund behavior both on portfolio adjustments and engagement


Key Risks

CIC has invested USD 5 billion in Morgan Stanley and 3 billion in Blackstone without demanding any

managerial role and claiming passivity.

Furthermore it declined the offer of a board seat offered by UBS, though it may exercise its voting

stake in some cases

Source: Financial Times

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Best practices: Norwegian Government Pension Fund - Global

Capital Markets

Source: Petroleum

Stated type: Trans-generational saving

Size: USD 328 billionSource: Norwegian Ministry of finance

Norwegian Ministry of

Finance

Active and Long

Negative Screening based on national values

ESG engagement

Discloses Portfolio

‘The fiscal rule’ for withdrawal

which is mostly limited to fund

returns

Norges Bank

Portfolio highly diversified;

maximum ownership threshold set to 10% ( increased from 5% in 2008)

Design of index

portfolio

And Guidelines

Outsourcing of

Management Quarterly public reports

Annual public reports

Storting

(Parliament) SWFOil revenues

Council of Ethics

Guidelines and Supervision

Key areas for improvement:

No proxy voting disclosure

Lack of independent executive board for the fund exposes it to short term political volatility

Guidelines Recommendations

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Investment Guidelines (including Negative Screening)


Best practices: Kuwait Investment Authority

Capital Markets

Source: Oil

Stated type: Trans-generational saving

Size: USD 213 billionSource: IMF

Board of Directors (Kuwaitian Ministry of Finance)

No withdrawal right without parliamentary

ratification

SWF

Internal Audit

National Assembly

Reports

Annual Closed doors

presentation of full activity

External Asset Managers

Daily / Monthly / Quarterly

private reportsExternal Audit

Executive Committee

Assist in Strategic goals and Objectives

10% of Annual Oil Revenue

Active and Long Term

Commercially driven

Investments (stated)

Key disclosure gaps:

No portfolio disclosure

No investment process disclosure

No ceiling on percentage of shares

Lack of transparency on external managers and quality process

No Proxy voting disclosure

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Innovest’s SWF opportunities and risks analysis platform

Investment time horizon

Stated Investments horizon / type of reporting in national accounts

Scale of influence on the investee

Passive or active

Frequency of portfolio adjustments Percentage of shares

Regulations for withdrawal of money from the fund Voting rights

Economic mandate

Stated mandate Seats on the board

Transparency of the investment process Type of government

Independence of Board of Governors

SkillsInternal & external management teams and control processes

Type of legal entity

Environmental and Social Opportunities

Specific E&S investments Mandate

Degree and type of dependency on external entities

E&S Engagement practices

Proxy voting analysis

Ethical risks Mitigation

Code of ethics

Portfolio transparencyEthics governance platform

Portfolio deviations from market (the visible portion)

Portfolio analysis for inter-investee conflict of interests (the visible portion)

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SWF comprehensive report

– Comparative opportunities / risks analysis

– Analysis of best practices

SWF profiles and ratings

– Detailed factor analysis

– Relative rating

– Outlook


Innovest’s SWF opportunities and risk analysis products

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Afshin Mehrpouya

Senior Analyst - FranceInnovest Strategic Value Advisors

Tel: +33 (0)1 44 54 04 [email protected]

www.innovestgroup.com

Thank you.

Perrine Dutronc

Managing Director - FranceInnovest Strategic Value Advisors

Tel: +33 (0)1 44 54 04 [email protected]

Bill Hartnett

Managing Director - Asia PacificInnovest Strategic Value Advisors

T: +61 2 9940 [email protected]

The Environmental, Social and Governance (ESG) Implications of Sovereign Wealth Funds (SWF) in the Capitals Markets and Innovest’s Risk Analysis Approach to SWFs

Business

pension funds government

investment research

new swfs source

perspective source

nordic development fund

perspective swfs

kuwait investment authority

new phenomenon