Issues for ESG ResearchWater -

An Australian Perspective

Mark BythewaySustainable Investment Research Institute (SIRIS)

Presentation to TBLI 2010 Workshop 8 – The Future Of ESG ResearchNovember, 2010

www.siris.com.au

Presentation Outline

• Introduction and context• ESG Research Issues

– Structural• supply & demand models

– Investment proposition

• Water Investment Issues– Structural

• Social & economic issues– Use – Ownership (pricing)

» Price cf cost– Scarcity and access cf cost– Regulation/Disclosure

– Investment Proposition

• Summary Adapted from SIRIS research Report; “Water Investment Risks and Opportunities in Asia”. Photos courtesy of ”Beyond Reasonable Drought”  

Context & Perspective

SIRIS• Dedicated, Asian regional specialised

investment research and advisory group

– Provides sustainable sustainability and governance research across > 1100 companies across Asian-Pac region

– 15 analysts– Established in 2000– Independent – Melbourne based

– www.siris.com.au

Context and Perspective…

ESG Research Issues

• ESG research hitherto largely followed a dichotomised model;

• i.e separation of ESG from other (mainstream) investment research – i.e ESG research & ESG researchers

• In part, a function of early demand; specific SRI and ethical funds

screening and ratings processes (SRI and ethics) Created specific demand for SRI data and info Limited overlap with mainstream investment research

production

• More recently seen move to integrate ESG analysis into investment process and limited demand for new SRI/ethical funds

– facilitated by initiatives such as PRI and Enhanced Analytics Initiative

Time

Values V ReturnTrade Off

Strict Financial Analysis

Ethical Investing

Traditional Investment Process

Values based investing Negative preclusive screening Tobacco / alcohol Gambling etc.

Socially Responsive Investing

Notion of a responsible company generally includes:

Negative screening Positive screening

Sustainability Investing

Notion of risks/ opportunities Generally low priority on negative

screening Strong positive screen perspective

Thematic Investing

Changing regs and consumer prefs generating new products services and asset lasses

Renewable energy/clean tech/leisure

PV Engagement

Values seeking investing

Values enhancing investing

ESG Research Demand “Map”

ESG Research Issues

Supply

• In response, have seen development of separate/boutique ESG research providers e.g. EIRIS, KLD etc.– Focus had been on definition compliance/fulfillment eg

ethical, socially responsible

– More recently, rising demand for research focus on investment risk and opportunity i.e “integration into mainstream investment”

– Rise in integration of ESG seen heightened interest from mainstream investment research and data providers;

• Thompson Reuters, Bloomberg, MSCI etc• GS, Citi, Deutche, ML etc

ESG Research Issues

• Implications of changes – ESG research increasingly subject to same issues as

non-ESG investment research

Investment imperative/pressure on research to demonstrate investment insight/alpha (cf compliance) i.e to provide a discrete value

Fee pressure

ESG Research Issues

Investment imperative •From an investment risk and opportunity, perspective depends upon several issues;

• Certainty, measurability & monetisation– incl ease of monetisation of risks, including

‘internalisation/ privatising externalities’• Materiality• Time horizon

– issue of traditional investment horizon (short-termism

• ESG risks and opps often structural and invariably longer term, less certain and difficult to $ quantify

– e.g. climate change/carbon risk/water

ESG Research Issues

Implications of Changes cont. • Fees

– moving away from subscription based fees, which reflected specific fund/product relationships

fees for investment analytical contribution Moving towards traditional investment research and

financial data fee models

Issues: – Service bundling/cross subsidisation(i.e broker and

financial data providers)

Traditional investment research fee issues marginal revenue allocation incremental fee for incremental coverage

• And finally…– The social/sustainability merits accruing from

ESG research?• Is it reasonable for investors to expect some

demonstrable env./social/governance benefit? How is ESG facilitating ESG benefit(s)? What are these benefits? What is the value of these benefits?

ESG Research Issues

Water

• Why water? – Reflects some of the issues and systemic challenges

for ESG research (and indeed investment research more generally)

important/vital resource (asset/cost) Scarce (very)

But; – Undervalued

• Immaterial cost

– Difficult to access asset

Water in Australia = perfect economic and environmental ‘storm’

– Environmental• Worlds flattest and driest continent • Natural climate cycle (drought)

– Anthropocentric • Increasing population• Human activity and non-sustainable economic systems (misuse)

Climate change

Profound “resource scarcity”

– Economic & Structural Issues• Use • Ownership/pricing

– Price cf cost• Scarcity and access cf cost• Regulation/Disclosure

As a result, a considerable proportion of Australia’s consuming population and many other regions continue to facing severe and transformational water shortages.

• Investment risk and Opportunity Not generally – by exception! Why?• Historic and current impediments to investment appropriate

investment analysis1. Climate change understandings 2. Structural

• Misplaced view of scarcity• Water pricing• relatively easy and abundant access• ownership of water in public hands • fragmented & uncoordinated regulatory environment

2. Not short term issue4. Mismatch of consumption and listed economy

– Listed economy not a relatively large water user

5. Pricing - water use not a material production cost

6. Poor disclosure

Importance of water to investors in Aust.

The Environmental Dimension

• Australia is the driest inhabited continent on Earth.• Rainfall is variable and droughts are common, and

water resources in many areas are very scarce

• However, Australia is a continent of extremes with respect to water resources; – relative abundance in the tropical north where

few people live and – relative scarcity in the more populated,

temperate south.

• The Australian continent and the south, in particular, is reflecting increasing climate variability marked generally by declining rainfall

• as a whole has shown a consistent drying trend over the past 50 years

The Environment cont.

Rainfall anomaly - 2004-05

Social and Economic Dimension

• Australia is confronted with a major challenge. There is increasing competition for water from

irrigators, urban/domestic, industrial and mining users

Change the way we think about water– Increase water productivity;– Improve water governance;– Change they way we value water (cost and price)

• The response lies in;– Good science– Changed paradigm incl

• Ownership (social) and value/valuation of water (economic)

• use

But….

• unsurprisingly, hitherto water under-considered as a cost and asset undervalued

• Limited risk consideration of investment risk to listed companies

• offered limited investment opportunities,

Water–Under valued–Under priced–Under reportedUnder analysed (most analysts don’t care – ie not ‘spread sheeted

Water Ownership

• Key features of institutional regulatory arrangements in Australia:

– The management of (control and use) water is vested in the Crown - the States and Territory governments;

– The (mains) water supply industry is (with a few exceptions) publicly owned; and

– Various govt regulatory bodies administer an array of regulation over matters such as water resource management, water quality, pricing, ect.

Water Pricing

• Price still does not meet full production cost

• Not to mention scarcity value Water relatively minor cost of production,

despite its importance and increasing scarcity Limited economic incentive to ‘reduce’

• Access variously bigger driver than cost i.e the “cost of none”

Issue of Price v Cost

Pricing– Current water crisis generating view that water

has been and is mis and undervalued in Australia.

– public ownership of water supply sector water has historically been viewed as and priced as a free (public) good

until late 80’s h/hold water bill based on property values. Industrial users

paid a fee

Demand not able to be managed via price signal.

– More recently, there has been a recognition that water must be priced to reflect the principles of consumption-based pricing and full cost recovery – starting to drive change

Water Use

The biggest industry users not widely represented on the stock market (agriculture)

The largest listed sectors are not relatively large users of water

Not particularly relevant to a large part of the investment universe

Corporate Disclosure

• Limited in scope and range and inconsistent– Reflects

• fragmented regulatory regime• Relatively immaterial cost• Limited investment risk/opportunity• SIRIS Study - only 38/200 even ‘mention’ water

• In Australasia, disclosure not from cost perspective– Never seen cost of water set out as expense item in P/L– Material cost by exception

• Access variously a risk management (access) issue– eg Newmont Mining, BHP Billiton, Elders Limited (agriculture)– Are starting to see it as a Balance Sheet item (water licenses– Indeed, seeing rural properties (businesses changing hands ostensibly

for the value of licenses)

Investment Implications:

• Regulation of water access, quality and pricing is;– Not uniform across the country and

– Not coordinated Unclear and inconsistent investment• Currently are limited opportunities to develop a

significant investment strategy in response to the current water shortage– Risk and opportunity

• Still limited value in modeling water use • Listed water = approx. 100m AUD

Investment Implications

● This is changing an intergovernmental reform agreement called the National Water Initiative

– Included a package of reforms covering;• Infrastructure,• water pricing, • allocations and trading,

• environmental and water quality –

– Direct investment opportunities • Distribution• Water entitlements (trading)• Alternative water supply

– Desalination – water mining– Recycling

Summary

• ESG research becoming mainstreamed– ESG research issues

Certainty, measurability & monetisation Materiality Time horizon

– Mainstream research issues Implications for access fees Investment relevance

Summary cont.

• These issues are challenging analysis of and investment into developing new costs and assets– e.g water

Certainty, measurability & monetisation MaterialityTime horizon

unsurprisingly, hitherto water under-considered as a cost and asset undervalued

Limited risk consideration of investment risk to listed companies

offered limited investment opportunities,

– Cant be solved by market alone– Require regulatory change (externalities)