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“The entry level” ESG and Risk Management

June 9^th, 9:45-12:30pm

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ESG and Impact Investing

E S G and Impact Investing

E S G PERFORMANCE : E V I D E N C E O N R I S K S

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ESG Performance: Evidence on Risks

DIFFERENCE MEASURES OF RISK

Standard deviation

Measures variability of returns, i.e., how much they bounce around.

Relative standard deviation.

A fund's standard deviation divided by benchmark's standard deviation.

Beta

A standardized measure of systematic risk based on how a portfolio moves with an index.

Residual risk

The unsystematic risk of the portfolio, the part of the portfolio risk that is not related to the index.

Downside risk

A measure of only the downside variability of returns.

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ESG Performance: Evidence on Risks

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ESG ENGAGEMENT BY INSTITUTIONAL INVESTORS

Study by Hoepner et al. (2020).

Argue that negative ESG event can imply substantial legal, reputational, operational, and financial risks for firms.

Deepwater Horizon oil spill showed the importance of robust E policies.

This is a form of downside risk.

Exploit that institutional investors increasingly engage with management to improve

A goal is often said to be reduction of downside risks.

Find that engagement reduces downside risk.

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ESG Performance: Evidence on Risks

D A T A

ESG engagement data from a specialised shareholder engagement agent. Represents institutional investors with USD 500bn+ assets under engagement advice.

Investor provided full access to its engagement database, including action reports, engagement activities, and measures of success.

ESG engagement sample from one large investor:

1712 engagements targeting 573 firms from 2005-2018.

Top 3 engagement concerns: Board structure, Remuneration & Climate Change.

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Source: Hoepner et al.. 2020, ESG Shareholder Engagement and Downside Risk, Working Paper,

Available at https://ssrn.com/abstract=2874252

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ESG Performance: Evidence on Risks

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About 80% of exec. Comp. engagements

ENGAGEMENT THEMES STATISTICS

Source: Hoepner et al.. 2020, ESG Shareholder Engagement and Downside Risk, Working Paper,

Available at https://ssrn.com/abstract=2874252

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ESG Performance: Evidence on Risks

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Milestone 1: Concern Raised with Target Achieved Milestone 1 Only

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17.6%

Milestone 2: Issue Acknowledged by Target

Achieved Milestones 1 to 2	522	30.5%
Milestone 3: Actions Taken by Target Achieved Milestones 1 to 3	350	20.4%

Milestone 4: Engagement Successfully Completed

Achieved Milestones 1 to 4

538

31.4%

ENGAGEMENT SUCCESS

Number of engagements

Source: Hoepner et al.. 2020, ESG Shareholder Engagement and Downside Risk, Working Paper,

Available at https://ssrn.com/abstract=2874252

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ESG Performance: Evidence on Risks

T A K E A W A Y FROM HOEPNER ET AL. (2020)

ESG engagements can lead to a reduction in a firm’s downside risk.

Risk reduction effects are stronger for more successful engagements.

Effects also strongest when E topics are addressed.

Analysis demonstrates one channel through which ESG engagement can create value for investors.

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E - ENVIRONMENT

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Current trends and needs

Who produces the most GHG today?

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Reduction of GHG emission is not the main challenge for developing countries. The main issue is vulnerability of customers
SFDR reporting is one aspect but supporting clients is key
FSP are now committed and engaged in environmental performance strategies

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With the new Universal Standards, a 7th dimension on Environmental Performance Management

Aligned with the
Support with the resource center
Training of the SEPM Pro Network (2022)
Future e-learning
Direct support to FSP or networks

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Practical strategies

Testimonial from Opportunity International and Abler Nordic
Discussion: support that can come from SIWG/Cerise+SPTF as an infrastructure, next steps.

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SOCIAL

Human Rights and Modern Slavery

Deborah Drake, Director Financial Inclusion Equity Council (FIEC)

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What is Social?

“S” is defined in a multitude of (often vague or limited) ways, making it difficult to draw conclusions about company performance.

“S” often refers to a small set of labor concerns such as occupational health and safety, freedom of association, compensation and benefits, or diversity and equal opportunity.

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Social of ESG does not get the attention it needs

Taken a backseat to environmental and governance issues
More difficult to quantify
ESG industry is too dependent on companies’ discretion in what they choose to disclose
Why investors have a role to play – companies are accountable to their investors for best use of capital. This relationship empowers investors to influence companies to adopt business practices.

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Intersecting ESG risks increasing vulnerabilities

Intersecting ESInG risks increasing vulnerabilities Intersecting ESG risks increasing vulnerabilities to modern slavery

to modern slavery

Intersecting ESG risks increasing vulnerabilities to modern slavery

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Environmental Risk - Climate change and environmental damage:

Climate change - droughts, elevated temperatures, erratic rainfall patterns

Illegal ASM activities destroy arable land and water resources

Decreasing sustainability of cocoa

Social and socio-economic riisks - Poverty and financial exclusion:

High poverty levels

Gender inequality in employment and education

Precarious income and negative impact on women and children

Informal, hazardous and exploitative work

Informal debt/indebtedness

Financial and digital exclusion

Governance Risks - Labour rights and practices:

Low integration of the financial sector into national anti-slavery/trafficking policy/action plan

Lack of awareness and limited structures within local financial sector to identify, manage and mitigate modern slavery risks

Lack of ESG reporting and human rights due diligence frameworks

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Human Rights and Modern Slavery

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The Guiding Principles clarify that the responsibility of a business enterprise to respect human rights relates to the adverse human rights impacts to which its operations, products and services are linked in all tiers of its value chain.

Robust human rights due diligence enables and contributes to sustainable development. For businesses, the most powerful contribution to sustainable development is to embed respect for human rights in their activities and across their value chains, addressing harm done to people and focusing on the potential and actual impacts.

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8.7

“Take immediate and effective measures to eradicate forced labour, end modern slavery and human trafficking and secure the prohibition and elimination of the worst forms of child labour, including recruitment and use of child soldiers, and by 2025 end child labour in all its forms”

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Scale of Modern Slavery

The scale of modern slavery, which comprises human trafficking, forced labor and child labor, is global, affecting every country in the world and virtually every economic sector. There are an estimated 49.6 million people in conditions of modern slavery and human trafficking (MS/HT) worldwide. Each year, these crimes generate $150 billion in profits. In fact, MS/HT has become the most pervasive criminal economy globally.

Detecting Financial Flows of Modern Slavery and Human Trafficking: A Guide to Automated Transaction Monitoring.

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Lessons learned

Climate and environmental risks to modern slavery in these supply chains needs to be simultaneously and proactively anticipated and addressed

There is a shared responsibility and shared value in all stakeholders within public and private sectors to play their part in addressing modern slavery issues

There is a need to improve visibility and labour practices in these value chains.

The financial sector can be an active partners in the national or international modern slavery governance systems

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Recommendations	Investors and Stock Exchanges
Increase the finance sector’s participation in collaborative efforts to identify, address and reduce modern slavery	Incorporate modern slavery risks into environmental and human rights due diligence processes and collaborate with other investors to increase leverage on portfolio companies. Require companies to map their whole value chains to identify red flags and investigate, verify, and manage the identified risks. Seek opportunities to engage with partners working to identify, reduce, and prevent modern slavery in cocoa and gold value chains.

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Recommendations
Reduce and manage environmental and social risks as part of due diligence on agricultural and extractive value chains	Effectively apply environmental and human rights due diligence and traceability programmes at all stages of the value chain, considering and mitigating risks to the environment and people. Develop and support the use of modern slavery guidance for publicly listed companies. Ensure labor rights and environmental protection are upheld through expectations in the terms of investments, environmental and human rights due diligence and remedy. Build ESG reporting requirements, including modern slavery reporting, into investments and investment loans for responsible financing of these value chains. Support and direct investments that focus on improving sustainable agricultural and ASM practices which do not exacerbate risks of modern slavery, climate change or environmental damage.

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Recommendations
Facilitate access to remedy for survivors of modern slavery	Undertake environmental and human rights due diligence on portfolios, before and during investment, which engages community/survivor knowledge partners, e.g. Sierra Leone’s mining law. Work with companies in value chains to ensure decent work is promoted and upheld. Identify, address, and remediate those experiencing modern slavery by working with worker-led initiatives, such as trade unions and worker-driven social responsibility programmes. Remediation should include supporting financial literacy, financial inclusion, and economic empowerment.

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Find it, Fix it, Prevent it

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The Client Protection Pathway

Proposal from the

Accelerating Action group

Anne-Laure Behaghel, CP Pathway Director – June 2023

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From Smart Campaign to CP Pathway

Client Protection had always been an integral part of the Universal Standards and the SPI4 evaluation tool
In a wide market consultation conducted in 2020-2021, we heard that:

Client protection standards and evaluation should remain a stand-alone product.
Investors need an easy way to identify committed providers.
FSPs want to demonstrate progress, not just the “ultimate achievement” of certification.

The key additions to Smart Campaign’s heritage:

The commitment requires more than a simple endorsement. Now we want proof of self-assessment.
Certification is now granted on 3 levels of recognition: Bronze, Silver and Gold with minimum requirements
Validity of Certification is now of 3 years without check-in.

Background: A new role for SPTF/CERISE & consultation with the industry

Client protection is a fundamental part of social performance management. Upon the Smart Campaign’s closure in late 2020, SPTF and CERISE committed to taking on much of the existing client protection work, as well as creating new offerings, based on market demand.

We gathered market feedback on the future of client protection by consulting funders, FSPs, auditors, rating agencies, and others. SPTF’s Social Investor Working Group created a subgroup on client protection, which gave us great insight into how a new client protection initiative can create value for these stakeholders. Additionally, over 80 FSPs answered a survey on the future of client protection in the industry. Finally, a group of rating agencies gave detailed feedback to multiple proposals for a new client protection certification framework.

From this deeply consultative process emerged three primary needs:

Though client protection is an integral part of SPM, the Client Protection Principles and evaluation standards should also be made available as a “standalone” product.

Investors need an easy way to find out which FSPs are serious about client protection. In the same way, FSPs that are serious about client protection need a way to differentiate themselves from less responsible actors in the industry.

The industry needs better ways to recognize not only the “gold standard” of client protection—full compliance with certification standards—but also intermediary steps still indicate significant effort.

Certification is now granted on 3 levels of recognition:

Reduces the risk of failing to certify by incorporating 3 levels of achievement
Encourages FSPs to start the Client Protection pathway to receive recognition of their achievements and measure their progress
Gold level corresponds to previous Smart Campaign’s Client Protection Certificate

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The 8 Client Protection Standards

NEW

… are fully incorporated in the Universal Standards

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It all starts at the top ….

The board makes strategic decisions based on social and financial data

Management makes strategic and operational decisions based on social and financial data

The provider trains all employees on its social goals and on client protection.

The provider evaluates and incentivizes employees based on social and financial criteria.

8.1

8.2

8.3

8.4

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The Client Protection Pathway describes the steps that an FSP can take to improve its client protection practices and communicate this progress to investors.

The Pathway gives providers a roadmap for implementing the Client Protection Standards and helps them stay on track.

Client Protection Pathway, which describes the steps that a financial service provider can take to improve its client protection practices and communicate this progress to investors. The Pathway gives providers a roadmap for implementing the Client Protection Standards and helps them stay on track. 

Describe each of the three steps and what is expected at each step. And what Cerise+SPTF offers at each step.

Commit to implement client protection: The FSP will sign a commitment statement that expresses their intention to implement the CP standards found in the Universal Standards. They also provide the names of all CP assessments they have completed in the past three years. At this point, we create an institutional profile for them on our website.
Assess and improve practices: Here, FSPs should complete a formal assessment of their CP practices, if they haven’t done so in the past 2 years. Right now, FSPs can use existing tools like the Smart Campaign’s Getting Started Questionnaire or the SPI. Early next year, we will have an updated set of standards and an updated SPI. After their assessment, the FSP should improve the weak practices identified by the assessment. At this step, SPTF and CERISE have tools to support their progress, including trainings, guides, and TA providers.
Demonstrate progress and achievements: Many FSPs will want to go to the final step, which is to demonstrate to external parties that they have achieved a certain level of good practice. The best way to do this is through a rating or client protection certification.

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Who is on the CP Pathway

163 committed institutions
31 banks | 6 Fintechs
A fairly even distribution across the globe
50 are certified

87 active certified FSP

38 Smart certified, 37 expire this year
37 Gold, 11 Silver, 1 Bronze

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Convening a community of responsible investors

In 2021, Cerise+SPTF launched a call for action amongst investors and DFIs to raise awareness and engage these key stakeholders on client protection risks.
The aim is to create global uptake in the industry on the existing work – to create transparency, comparability and share examples of successful implementation
Signatories of the Joint Statement now include over 40 MIVs, DFIs and networks

Joint Statement Signatories

“The Pathway helps us ensure that client protection remains an important concern of our investees so that our indirect beneficiaries are protected enough.”

Edouard Sers, Grameen Crédit Agricole Foundation

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Engaging investors on implementation

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Joint Statement

CP Accelerating Action Group

Consensus on reasonable requirements

Translate it into concrete implementation

What actions could and should be taken globally by the investor community at each step of the investment process

+ Transparency

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1st commitment - Transparency

Investors commit to report on the concrete actions taken with their clients/investees along the following categories:

◊ Type of assessments of CP risks

→ in-house or aligned with Cerise+SPTF CP standards

◊ Level of formal engagement with investees

→ binding or non-binding

◊ Support in improvements related to CP

→ financial or non-financial

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Would FIEC members be willing to join this Transparency effort ?

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Minimum actions in the investment process

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Before an investment | Screening, Eligibility criteria, Due diligence

The investor verifies that the investee/prospect is not doing significant harm to its clients, and raises the awareness around client protection and international standards

At signature | Contract, Disbursement

The investor brings the investee to join the CP Pathway, and to commit on improvement

During the investment term | Monitoring - By the end of the contract

The investor encourages the investee to improve its CP practices.

Could this be translated in a shareholder agreement?

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Example of a shareholder agreement clause

The shareholders agree that the Company shall formally commit to implement Client Protection Standards by joining the CP Pathway within 90 days of this agreement’s signature, and that the Company shall remain at all times committed to delivering fair and safe financial services to its clients.
The Board of Directors shall ensure that this commitment is fulfilled through the regular monitoring of client protection risks (over-indebtedness, unfair treatment, lack of transparency, privacy of client data, complaints, fraud, corruption and bribery).
The Board of Directors will make strategic decisions based on annual reporting of client protection risks provided by management and internal audit, and shall take corrective action when it identifies risks to clients.
The Board of Directors shall hold the management accountable for achieving client protection through formal targets included in the CEO’s performance evaluation.

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Wrap-up

Investors are an important lever for driving change in industry practices
We would all benefit from knowing how CP is incorporated in your processes
Ultimately, there is a dialogue that needs to start with FSPs

The SIWG agreed to discuss this proposal internally and revert back to us with a formal “YES” by Friday June 23^rd.

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