SustainabilityMeasuring and incentivising ESEG

Consulting

Leon Spruth, Philip ter Meer, Sem de Moel

ConsultingAgenda

1. Benefits of Sustainability

2. Measuring ESEG performance

4. Communication3. Incentives

Benefits of superior ESEG performance

ESEG – also account for “G” ESEG risk and impact on

creditworthiness

Interest rate Sustainability certificates CSV competition

How ESE performance is currently measured

New ESEG performance evaluation approach

ESEG evaluation-Example: KLM

5. Summary

Communication of incentives Reporting benefits of ESEG

outcomes Feedback loops – Networking event

Summary

Benefits of Sustainability Benefits of superior ESEG performance ESEG – also account for “G” ESEG risk and impact on creditworthiness

1

ConsultingBenefits of superior ESG performance

1. Financial Performance• Improvement of corporate accounting & stock performance1)

• Lower volatility in corporate earnings2)

2. Cost of Capital• Firms exhibit lower risks arising from reputational, financial or

litigation concerns (partly affecting credit rating) leading to3):a) Lower cost of debt: “firms with CSR concerns

pay on average 7-8 bp more”4) b) Lower cost of equity5)

3. Investors• Larger investor base as firms get included in potential investment

universe of SRI investors & more dedicated long-term investors6)

4. Management• ESG relevant from a corporate strategic management perspective to Create Shared Value (CSV) 7)

Firms have incentive to improve corporate sustainability as it benefits bottom-line & brand image

Academic findings on effects of superior corporate ESG performance

1) Eccles et al. (2013); Edmans (2011,2012); Derwall et al. (2005); Gompers et al. (2003)

2) Breckinridge Report (2015)3) Clark, Viehs (2014)

4) Goss, Roberts (2011); Chava (2011); Bauer, Hann (2010)5) El Ghoul et al. (2011); Dhaliwal et al. (2011); Derwall and Verwijmeren (2007); Ashbaugh-Skaife et al. (2004)6) Serafeim (2015); Derwall (2011)

7) Porter, kramer (2006, 2011)

High ESG performers have lower earnings volatility2)

ConsultingESEG – also account for “G”

Corporate lending1)

“When providing loans to clients, we incorporate ESE criteria in the credit approval process.”Investment services1)

“We apply ESG criteria to assess potential investment opportunities for our clients.”

Also account for ESG criteria for corporate lending ESEG

1) ABN Amro Sustainability Report 2014, 2) Clark, Viehs (2014), 3) Lo (2015)

ABN AMRO’s incorporation of sustainability metrics for lending/investing

• Governance has strong impact on firm performance and corporate risk2)

• Gordon Gekko Effect3): Corporate culture matters as it might transmit negative values• Poor governance can lead to spectacular corporate failures which might not only affect

shareholders but also bondholders (e.g. Enron, rogue traders, Lehman Brothers) and eventually reduces credit ratings

“G” also matters

ConsultingESEG risks and impact on creditworthiness

∆ Creditworthiness2) 3)

Creditworthiness is a function of multiple elements linked to ESEG factors

Consumer boycotts

Employee satisfaction

Brand value

Environ. regulations

Exposure to fraud

ESEG Examples

∆ Credit ratings

∆ Breach of covenants

∆ Volatility

∆ Bond yield

∆ Default

1) SASB materiality map 2) PRI Corporate bonds: Spotlights on ESG risks 3) Center for International Environmental Law, (Mis)Calculated Risk and Climate Change, 2015

Environment1)

Social1)

Ethical1)

Governance1)

GHG emissions Air quality Energy management Fuel management

Human rights Customer welfare Data security Fair disclosure

Diversity & inclusion Compensation Employee health Fair labor practices

Competitive behavior Systematic risk mgt Accident & Safety Regulations

…

…

…

…

ES

EG

Fac

tors

∆ Profitability

∆ Productivity

∆ Competitive position

∆ Future cash flows

∆ Cost of capital

Elements2)

Measuring ESEG performance How ESE performance is currently measured

New ESEG performance evaluation approach

ESEG evaluation approach:Example - KLM

2

ConsultingHow ESE performance is currently measured1)

Medium sustainability

risk

High sustainability

risk

Above PAR performance

On PAR performance

Below PAR performance

Monitoring level

Client’s are checked against the ABN AMRO Exclusion List

1a. Exclusion List Check

Sustainability risk is determined based on:• Country of operations• Sector• Relationship Manager adjustment

1b. Sustainability Risk Determination

Low sustainability risk

Tailored questionnaire for medium- and high-risk transactions:• Compliance: legislation compliance• Commitment: sustainability policies and initiatives• Capacity: sustainability policy implementation• Track Record: client and/or sector bad press

2a. Sustainability Questionnaire Generation

Every 3 years Every 2 years Every year

Dynamic monitoring plan Improvement measures

1) ABN AMRO, Overview of sustainability risk framework

Suggestions: 1) Also evaluate low sustainability risk companies 2) Not only self-evaluation 3) ESEG

ConsultingNew ESEG performance evaluation approach

• Determine sector and industry based on SICS™ classification

• Pre-specified material topics based on SASB

1. Evaluation of corporate ESEG risks based on SASB materiality map1)

1 point: issues likely material for <50% of industries in sector

2 points: issues likely material for >50% of

industries in sector

Survey questions on material topics:

2. Industry-specific questionnaire

0 points: not involved

5 points: small achievements

10 points: large achievements

Company needs to back-up achievements on material topics

3. Provision of proof

ABN AMRO’s CSR department evaluates material topics

4. Internal Evaluation

Scores add up to max. 100

CSR Hub (SASB approach) evaluates material topics

4. External Evaluation2,*)

1) SASB, materiality map, 2) SASB, research & insights

• Integrated-/ sustainability reporting? (+)• CSV; are material topics integrated in the strategy? (+)• Ratings (KLD, ASSET4, Sustainalytics, Novethic…) (+/-)

5. Incorporation of additional sustainability indicators (~30%)

Final score

10 20 30 40 50 60 70 80 90 100

Eligible for interest reductionIneligible for interest reduction

*) Depending on size of companies and availability of prior research

Sophisticated ESEG evaluation approach mitigates the risk of gaming the system

ConsultingESEG evaluation - Example: KLM

SASB materiality map for airlines 5 highly material issues in airline sector 20 points≙• Issues likely material for <50% of industries in sector (0 x 1 Point)• Issues likely material for >50% of industries in sector (5 x 2 Points)

• 100 points ≙ 5 (topics)* 2 (materiality) *10 max. points (achievement)• Each highly material topic 20 max. points≙

0 points: not involved

5 points: small achievements

10 points: large achievements

GHG emissions1)

Fuel management1)

Labor relations1)

Accident and safety1)

Competitive behavior2)

Final score KLM3): 84 (incl. addition aspects)

86 g CO2 / passenger 6.7% reduction compared to 20113.45 liters fuel / passenger / 100 km, Fuel saving in 2014: 50 million liters

88 collective labor agreements signed

Number of workplace accidents: +2%, Frequency rate: +5%, Severity rate: -1%

Extensive competition law compliance

18

17

15

10

13

1) KLM CSR Report 2014, 2) AIR FRANCE and KLM Competition Law Compliance Manual, 3) Based on SLP calculation based on KLM CSR Report, 2014

Additional aspects Integrated reporting (+), CSV (+), ESG score: (+)

+11

E

S

E

G

Incentives Interest rate Sustainability certificates CSV competition

3

ConsultingIncentives I – Interest Rate

Reduction of interest rate• Final ESEG score used as basis for calculation of

potential interest rate reduction:

• Max. interest reduction of 10% of firm‘s credit spread• Firms with total ESEG score >70 eligible for interest

rate reduction

Monetary & non-monetary incentivesCredits Spreads1)

Credit Rating – KLM2)

Evaluate potential interest rate reduction for a 7 yr corporate loan for KLM:ESEG Score: 84 Credit Spread: 335bp

28bp KLM is eligible for a 28 bp interest reduction

Incentive example: KLM

Rating 1 yr 3 yr 5 yr 7 yr 10 yr

30 yr

Aaa/AAA 21 38 53 55 76 121

Aa2/AA 30 42 65 72 121 114

A2/A 43 71 88 92 147 141

Baa2/BBB 96 132 153 160 253 200

Ba2/BB 172 331 343 335 361 -

US Treas. Yield 0.23 0.89 1.36 1.70 2.04 2.87

Rating 1 yr 3 yr 5 yr 7 yr 10 yr

30 yr

Ba2/BB 172 331 343 335 361 -

US Treas. Yield 0.23 0.89 0.89 1.36 2.04 2.87

1) Reuters Corporate Spreads for industrials (in basis points)2) Inferred from corp. Bond (ISIN FR0010814459)

ConsultingIncentives II - Certificates

2) Best-in-Class Certificate

Eligibility Criteria

10 20 30 40 50 60 70 80 90 100

Awarded “ESEG Sustainability Certificate”

Ineligible ESEG Certificate

1) ESEG performance final score:

2) Company with highest ESEG performance score in each industry awarded „Best-in-Class Certificate“

1) ESEG Sustainability Certificate

Company X Company YAwarded for top performance in ESEG Sustainability

Awarded for Best-in-Class in ESEG Sustainability

ConsultingIncentives III – CSV Competition

Bank

Donors1) 2)1. Proposals submitted to ABN AMRO –

3 best ideas per sector get to present2. Each company outlines business case to integrate

material ESEG issues into a profitable business plan

3. Judged by committee of ABN AMRO& sustainability experts (research professors, Sustainalytics)

4. Best idea in each sector awarded “leader in sustainability” award

5. Winners get project specific loan at discounted interest rate (10% discount on credit spread)

CSV Competition

Case Outline

Share project insights

Competition fundingDiscounted interest rate

1) RVO, Sustainable Water Fund (FDW), 2016 2) IDH The Sustainable Trade Inititative, What we do 3) Porter & Kramer, Creating Shared Value, HBR, 2011

• Introduce sector-specific CSV project competition forcorporate clients

• “Creating Shared Value”3) = Practises that enhance business competitiveness as well as economic and social conditions in the community

• Only material investment projects linked to core business are eligible for competition

• Project with greatest benefit for firm and society in each sector wins

Communication Communication of incentives Reporting benefits of ESEG outcomes Feedback loops – Networking event

4

ConsultingCommunicating Incentives1)

1) YEC, Three Ways To Improve Your Communication With Clients, 2013

• Communicate the positive link between superior ESEG performance and firm performance (academic findings)• Contact corporate clients privately about new ESEG program and communicate CSV competition before making it public• Clearly highlight financial & non-financial benefits of programs (reduced corporate loan interest rates, sustainability

certificates, and project-specific interest rates reductions)

1. Share valuable information before clients realize it themselves

• Give valuable feedback on ESEG performance evaluation score/CSV competition• Communicate potential actions to firm on how to improve on ESEG aspects and guide corporate client to achieve

eligibility for interest rate reduction & sustainability certificates

2. Give feedback

• Surprise clients with: 1) Networking events 2) New academic findings 3) Communicate with clients how much they saved on interest rate reductions

3. Surprise corporate clients with regular updates

Increase Corporate Client Satisfaction, Foster ESEG Involvement

ConsultingReporting ESEG outcomes

GSRI Ratings Outcomes

Top ESEG ranked firms:………

Become part of our networking event!

Best-in-class

Env. leader

Social leader

1. Determine ranking of all firms in ESEG ratings2. Contact top 10% firms and establish willingness to

publish results3. Contact other firms privately giving feedback on how to

improve results4. Publish approved firm results

To gain new customers• Integrated Reporting1): Outlines commitment of board to

ESEG. IR attracts longer-term investors• Adaptive marketing2): Market to particular client need. i.e.

environmental/social interests

To established customers• CSV Competition• Certificates

Establishing leaders in ESEG

ESEG results as marketing tool for ABN AMRO

1) Knauer, Regulation and Capital Markets, 2014 2) Bowthorpe, The 10 Fundamentals of Adaptive Marketing, 2012

ConsultingFeedback Loops

Sector workshops on material issues in their industry• Leading ESEG companies per industry invited to present• Other corporate clients invited to participate in event• Large networking event per industry discussing relevant

material issues to improve ESEG performance of firms -knowledge transfer

Early Stage: Determine level of ESEG interest, clients customer base to determine area of focusDevelopment Stage: Convince requirements will be fulfilled, make adaptations and identify future ESEG interestsLong-Term Stage: Establish ESEG bonds important to clients but difficult for competitors to imitateFinal Stage: Solidify relationship through financial and social bonds

ABN AMRO “Networking Event”

Feedback loops through PRLC1)

1) Zineldin, "Bank‐corporate client “partnership” relationship: benefits and life cycle", International Journal of Bank Marketing, 1996

Partnership-relationship life cycle (PRLC)1)

Summary5

ConsultingSummary

Superior ESEG performance is a “triple-win”Benefits ABN AMRO, benefits clients, and benefits society

Communicate incentives and report benefits of ESEG outcomesEncourage feedback loops through network events, and use ESEG outcomes as marketing tool

Use monetary and non-monetary incentives to foster corporate sustainabilityInterest rate reduction based on ESEG score and credit spread, sustainability certificates, and CSV competition

Implement comprehensive ESEG measuring approach based on SASB Materiality Map™

Tool to prevent gaming of the system

Appendix6

ConsultingSASB Materiality Matrix

SASB Materiality Map identifies material sustainability issues across sectors/ industries

1) SASB, materiality matrix

ConsultingSASB Materiality Matrix

1) SASB, materiality matrix

KLM’s Materiality Matrix

KLM is doing a good job at accounting for material topics / integrating them in strategic planning in line with SASB

Carbon footprint (GHG emission)Reduce CO2 emissions by 20% compared to 2011 (tons/km)

Biofuels (Fuel management)Operate regular flights powered by sustainable biofuel

KLM’s corporate objectives

NoiseExpand activity while keeping noise emissions below 2005 levels

Local air qualityGround operations: Electrically powered equipment and APU use procedures

Waste100% of non-hazardous waste and 60% of hazardous waste recovered

mat

eria

l