Political risk, ESG and market performance - March 2014
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As the ASX releases new corporate governance guidelines with an increased focus on risk management and environmental, social and governance principles Political Monitor examines the link between ESG, ...

As the ASX releases new corporate governance guidelines with an increased focus on risk management and environmental, social and governance principles Political Monitor examines the link between ESG, political risk & market performance.

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Political risk, ESG and market performance - March 2014 Presentation Transcript

  • 1. www.politicalmonitor.com.au! Poli%cal  risk,  ESG  &  market   performance   Going  beyond  economic  analysis  to  meet  responsible   investment  principles  
  • 2. OVERVIEW! The United Nations Principles for Responsible Investment (PRI) have transformed the way institutional investors and listed entities think about governance and sustainable investment. This has added impetus to the search for new risk models that take account of factors not traditionally monitored in credit and equities analysis, including social and political trends that may alert investors to systemic risk.! The challenge has been establishing a clear link between responsible investment and performance outcomes and developing tools that quantify environmental, social and governance (ESG) risks. This pack addresses this challenge by examining recent findings on the link between governance and performance and then detailing the tools developed by Political Monitor - a political risk research & advisory firm - to identify, score and report on political risk in key markets.! The pack provides summary analysis and more detail is available by contacting:! ! Damian Karmelich ! ! ! ! ! ! !Steve Cusworth! Partner – Sydney ! ! ! ! ! ! !Partner - Melbourne! p. 0407 772 548 ! ! ! ! ! ! ! !p. 0417 178 697! e. karmelichd@politicalmonitor.com,au ! ! ! !e. cusworths@politicalmonitor.com.au !
  • 3. CONTENTS! •  Executive summary …………………………………………………………………………. p. 4! •  The relationship between governance, risk & performance ..…………………………… p. 5! •  Country risk ……………….…… ………………….………..… ……...….……... p. 6! •  Company & market risk ……………………..………… …………..…….……... p. 8! •  Political Monitor methodology …………………………..…………….….……………...… p. 9! •  Country risk ……………………………………………………………………….. p. 11! •  In-country risk …………………………………………………………………….. p. 12! •  Sector & firm risk …………………………………………………………………..p. 13! •  Political Monitor risk scores, ESG and ISO standards ……………………….. p. 14! •  Enough theory: how does it work? ……………………………….……………...………… p. 15! •  Appendix 1 - Economic & investment impact of political and social instability …….….. p. 21! ! Political risk, ESG & market performance! 3!
  • 4. EXECUTIVE SUMMARY
 ! Political risk, ESG & market performance! 4! •  There  is  now  clear  evidence  of  the  link  between   responsible  investment  and  performance  outcomes.     •  Recent  research  by  the  PRI  Sovereign  Fixed  Income   Working  Group  revealed  correla%ons  between  ESG   factors  and  credit  risks.  Those  factors  include   corrup%on,  poverty,  unemployment  rates,  food   security  and  popula%on  distribu%on.       •  However,  quan%fying  ESG  risks  has  been  a  challenge   with  many  investors  struggling  to  measure  such  risks   and  include  this  data  in  risk  models.   •  Poli%cal  Monitor  has  overcome  this  challenge  by   developing  a  number  of  poli%cal  risk  scores  that   consider  and  quan%fy  a  range  of  social  and   governance  issues  providing  insight  into  underlying   social  and  poli%cal  trends  likely  to  shape  markets.   •  One  example  of  the  benefits  of  this  analysis  was  our   January  ra%ng  of  Thailand  as  a  rela%vely  low  poli%cal   risk  for  Q1  2014;  contrary  to  consensus  forecasts.   The  Poli%cal  Monitor  score  assessed  that  a  number   of  underlying  factors  would  limit  the  risk  of  the   poli%cal  crisis  becoming  a  social  &  economic  crisis.   Since  that  ra%ng  the  Thai  benchmark  index  has   increased  over  10%.   80   100   120   140   160   Jan-­‐05   Jan-­‐06   Jan-­‐07   Jan-­‐08   Jan-­‐09   Jan-­‐10   Jan-­‐11   Jan-­‐12   Market-­‐weighted  performance  of  sovereign  bonds  -­‐   sustainable  &  non-­‐sustainable  industrialised  countries     Sustainable   Non-­‐sustainable   World  Government  Bond  Index   1150   1200   1250   1300   1350   1400   Thai  SET  
  • 5. THE  RELATIONSHIP  BETWEEN  GOVERNANCE,   RISK  &  PERFORMANCE  
  • 6. GOVERNANCE, RISK & PERFORMANCE – COUNTRY RISK! Political risk, ESG & market performance! 6! •  The  Sovereign  Fixed  Income  Working  Group  (SFIWG)   –  established  by  the  UN  Principles  of  Responsible   Inves%ng  ini%a%ve  –  argues  that  investors  can  be`er   gauge  the  risks  of  investment  by  considering  social  &   poli%cal  factors.     •  The  group’s  research  revealed  correla%ons  between   environmental,  social  and  governance  (ESG)  factors   and  credit  risks.       •  Of  par%cular  note  the  group  found:   •  corrup%on  and  sovereign  bonds  performance   are  clearly  correlated   •  social  factors  –  such  as  poverty,  employment   rates,  food  security,  educa%on  levels  &   popula%on  distribu%on  –  are  reliable   measures  of  risk.     •  The  data  can  also  be  used  to  an%cipate  future  credit   downgrades.  The  group  noted  comments  from  MSCI   that  a  large  discrepancy  between  ESG  performance   and  credit  ra%ngs  is  a  strong  sign  of  future   downgrades.   80   90   100   110   120   130   140   150   160   Jan-­‐05   Jan-­‐06   Jan-­‐07   Jan-­‐08   Jan-­‐09   Jan-­‐10   Jan-­‐11   Jan-­‐12   Market-­‐weighted  performance  of  sovereign  bonds  -­‐   sustainable  &  non-­‐sustainable  industrialised  countries     (Source:  Sarasin,  Datastream).   Sustainable   Non-­‐sustainable   World  Government  Bond  Index  
  • 7. GOVERNANCE, RISK & PERFORMANCE – COUNTRY RISK! Political risk, ESG & market performance! 7!   •  The  SFIWG  also  found  that  countries  with  poor  ESG   ra%ngs  are  likely  to  suffer  greater  loss  as  a  result  of   unforeseen  nega%ve  events.   •  In  par%cular,  countries  displaying  poor  ESG   indicators  are  ofen  more  prone  to  shocks  from   natural,  social  or  economic  events,  leading  to   greater  credit  risk.   •  The  research  and  experience  of  working  group   members  with  regard  to  materiality  indicates  that   ESG  factors  can  be  material  to  both  creditworthiness   and  investment  performance.   •  In  a  separate  study  the  Chief  Risk  Officer  forum   (CFO)  noted  that  the  tradi%onal  focus  on  credit  &   financial  risk  was  not  designed  to  iden%fy   environment,  social  &  poli%cal  imbalances  and  that   capturing  this  data  will  provide  addi%onal   informa%on  about  emerging  issues  &  help  to  be`er   understand  geopoli%cal  developments  leading  to   disrup%ve  transforma%ons.   80   90   100   110   120   130   140   150   160   170   180   Dec-­‐04   May-­‐05   Oct-­‐05   Mar-­‐06   Aug-­‐06   Jan-­‐07   Jun-­‐07   Nov-­‐07   Apr-­‐08   Sep-­‐08   Feb-­‐09   Jul-­‐09   Dec-­‐09   May-­‐10   Oct-­‐10   Mar-­‐11   Aug-­‐11   Returns  from  poriolios  based  on  the     best  and  worst  ESG  rated  countries     (Sources:  AXA  IM,  JP  Morgan,  Ci%group,  Thomson  Reuters)   Worst  ESG   Best  ESG  
  • 8. GOVERNANCE, RISK & PERFORMANCE – COMPANY & MARKET RISK! Political risk, ESG & market performance! 8! •  The  Poli%cal  Monitor  Australian  Poli7cal  Risk  Index   reveals  an  inverse  rela%onship  between  poli%cal  &   policy  uncertainty  and  market  performance.  As   poli%cal  uncertainty  rises  the  ASX200  has  trended   downwards  and  vice  versa.   •  An  increase  in  economic  policy  uncertainty   foreshadows  a  decline  in  economic  growth  and   employment  in  the  following  months  (Baker,  Bloom   &  Davis,  EPU).   •  Poli%cal  risk  measures  are  correlated  with  future   equity  returns  (Harvey,  Na7onal  Bureau  Economic   Research).   •  Poli%cal  risk  is  applicable  in  more  than  just   developing  economies  despite  the  literature’s  focus   on  these  markets  with  issues  such  as  taxa%on,   transparency,  demographics  and  social  issues  all   affec%ng  the  corporate  environment  with  clear  links   between  the  level  of  risk  and  opera%onal   performance  in  developed  markets  (Restrepo,   Correia,  Poblocian,  Poli7cal  Risk  &  Corporate   Investment  Decisions,  2012).   0   2   4   6   8   10   12   14   16   18   Poli%cal  Uncertainty  Score   Poli%cal  Risk  Index   4800   5000   5200   5400   5600   0   5   10   15   20   ASX  200   Poli%cal  Uncertainty  Score   Poli%cal  Risk  Index  vs.  ASX  200   PRI   ASX  200  
  • 9. THE  POLITICAL  MONITOR     POLITICAL  RISK  METHODOLOGY  
  • 10. POLITICAL  RISK–  proprietary  risk  scores  &  indices   incorporate  a  range  of  social  &  governance  variables  that   increase  the  risk  of  poli%cal  unrest   Political risk, ESG & market performance! 10! Environmental   Climate  change   Water  resources  and   pollu%on   Biodiversity   Energy  resources  and   management   Biocapacity  and  ecosystem   quality   Air  pollu%on   Natural  disasters   Natural  resources   Social   Human  rights   Educa%on  and  human   capital   Health  levels    Poli%cal  freedoms   Demographic  change   Employment  levels   Social  exclusion  and   poverty   Trust  in  society  /   ins%tu%ons   Crime  and  safety   Food  security   Governance   Ins%tu%onal  strength   Corrup%on   Regime  stability   Poli%cal  rights  and  civil   liber%es   Rule  of  law   Regulatory  effec%veness   and  quality   Accoun%ng  standards   Government  finances   Poli%cal  Monitor   research  focuses   on  social  &   governance   variables  that  can   provide  an  early   warning  of   emerging  social  &   poli%cal  unrest.  
  • 11. COUNTRY  RISK  –  proprietary  risk  scores  tracking  underlying   poli%cal  &  social  trends  likely  to  shape  the  macro   environment   Political risk, ESG & market performance! 11! •  Poli%cal  Monitor  country  risk  scores  provide   a  rela%ve  ra%ng  of  risk  for  some  of  Asia’s   most  important  economies.   •  The  scores  track  over  10  different  variables   for  each  country  providing  insight  into  the   likelihood  of  social  and  poli%cal  unrest.     •  The  variables  include  social  and  governance   indicators  such  as  legi%macy  of   government,  corrup%on  levels,  exposure  to   vola%le  food  prices,  elas%city  of  demand,   poverty  and  core  demographic  trends.   •  The  scores  provide  unique  insight  into  the   poli%cal  risk  environment  by  focusing  on   social  and  governance  trends  rather  than  a   singular  focus  on  economic  data.      
  • 12. IN-­‐COUNTRY  RISK–  proprietary  risk  scores  and  compara%ve   analysis  of  Australia’s  states  &  territories   Political risk, ESG & market performance! 12! •  The  Poli%cal  Monitor  State  Poli7cal  Risk   Index  tracks  over  twenty  key  variables  that   reflect  poli%cal  risk  in  each  jurisdic%on.     •  The  variables  are  classified  across  four   categories  -­‐  Budget,  Policy,  Stability  and   Reputa7onal  risk.     •  The  rela%ve  risk  scores  allow  investors  to   assess  compara%ve  risk  across  the  four   categories  and  determine  which  states  offer   the  best  prospect  of  a  ‘no  surprises’,  stable   investment  environment.   •  For  individual  firms  the  index  allows   compara%ve  analysis  of  which  states  are   most  at  risk  of  introducing  new  revenue   raising  measures  and  regula%ons  that  may   hamper  business  investment  plans.       0   10   20   30   40   50   60   70   80   90   100   Total  Risk   Score   Budget  Risk   Policy  Risk   Stability  Risk   Reputa%onal   Risk   State  Poli%cal  Risk  Index  March  2014   NSW   Vic   Qld   WA   SA   Tas  
  • 13. SECTOR  &  FIRM  RISK   Political risk, ESG & market performance! 13! •  Poli%cal  Monitor  examines  the  implica%ons   of  country  and  in-­‐country  risk  for  respec%ve   sectors  and  firms.   •  The  process  then  assesses  whether  there   are  any  sector  or  firm  specific  risks.  This   includes  a  review  of  community  aptudes   and  global  and  domes%c  industry  trends   relevant  to  respec%ve  sectors  /  firms.   •  The  firm  level  analysis  determines  whether   the  poli%cal  risk  outlook  places  a  firm  at  a   dis%nct  compe%%ve  advantage  or   disadvantage  to  its  industry  peers.  This   isolates  the  nature  of  the  risk  and  allows  for   responses  to  be  tailored  accordingly.   •  A  risk  ra%ng  with  key  influencing  factors  is   then  produced  providing  an  understanding   of  rela%ve  risk  profiles.       Tax   Gov     Oversight   Content     Mandates   Adver%sing   Restric%ons   Risk  Map  
  • 14. POLITICAL  MONITOR  RISK  SCORES,  ESG  &  ISO  RISK   MANAGEMENT  STANARDS   •  Poli%cal  Monitor  risk  scores  track  and  weight  economic,  social  and  governance  variables  including  unemployment,   infla%on,  poverty,  corrup%on,  government  transparency,  food  security,  consumer  exposure  to  price  vola%lity  and   popula%on  demographics.   •  The  scores  and  suppor%ng  methodology  are  consistent  with  a  number  of  the  principles  detailed  in  the  Interna%onal   Standards  Organisa%on  Risk  Management  –  Principles  and  Guidelines  standard  (AS/NZS  ISO  31000:2009),  including:   •  Principle  (d):  Risk  management  explicitly  addresses  uncertainty  –  the  scores  are  designed  to  track   variables  that  provide  early  warning  signs  of  poli%cal  and  social  uncertainty  and  for  a  number  of  scores  /   indices  this  is  the  explicit  objec%ve   •  Principle  (e):   Risk  management  is  systema7c,  structured  and  7mely  –  the  scores  are  backed  by  a  clear   methodology  and  are  dynamic  in  nature  (meaning  they  are  regularly  refreshed).  In  some  instances   Poli%cal  Monitor  scores  are  refreshed  daily   •  Principle  (f):   Risk  management  is  based  on  the  best  available  informa7on  –  the  scores  rely  upon   datasets  not  tradi%onally  used  in  economic  and  credit  risk  assessment  and  therefore  provide  an   addi%onal  level  of  informa%on  that  is  directly  related  to  the  market  environment   •  Principle  (j):   Risk  management  is  dynamic,  itera7ve  and  responsive  to  change  –  the  scores  are  dynamic   (meaning  they  are  regularly  refreshed)  with  some  scores  updated  daily.  The  underlying  methodology  is   also  revised  regularly  to  ensure  appropriate  factors  are  taken  into  account  and  weighted  accordingly.   ! ! ! ! !! Political risk, ESG & market performance! 14!
  • 15. ENOUGH  THEORY:     WHAT  WILL  YOUR  SCORES,  ANALYSIS  &   METHODOLOGY  ACTUALLY  SHOW  US?  
  • 16. COUNTRY  RISK  –  we  track  social  &  poli%cal  variables  and   iden%fy  trends  ignored  by  tradi%onal  economic  analysis   Political risk, ESG & market performance! 16! •  In  December  2013  Poli%cal  Monitor  rated   Thailand  a  LOW  poli%cal  risk  for  the  quarter   ahead.  This  ra%ng  was  unique  within  the   market.   •  The  Poli%cal  Monitor  risk  ra%ng  for  Thailand   reflected  our  analysis  of  underlying  poli%cal   and  social  trends  that  pointed  to  high  levels   of  stability  despite  the  poli%cal  turmoil.   These  included  low  levels  of  youth   unemployment,  drama%c  improvements  in   poverty  rates  and  rela%vely  high  levels  of   food  security.   •  At  the  %me  of  wri%ng  (March  14,  2014)  the   Thai  benchmark  index  had  increased  more   than  10%  YTD  and  the  Thai  Bhat  had  traded   in  a  consistent  band,  apprecia%ng  around   1.3%  against  the  USD  YTD.       31.8   32   32.2   32.4   32.6   32.8   33   33.2   USD  vs  THB   1150   1200   1250   1300   1350   1400   Thai  SET  
  • 17. COUNTRY  RISK  –  our  Australian  Poli7cal  Risk  Index  tracks   poli%cal  &  policy  uncertainty  on  a  daily  basis   Political risk, ESG & market performance! 17! •  Since  its  incep%on  the  index  has  shown  a   clear  correla%on  with  the  ASX200.  As   poli%cal  and  policy  uncertainty  rises  the   market  trends  downwards  and  vice  versa.   •  The  index  tracks  a  number  of  variables  that   reveal  both  the  manner  in  which  poli%cal   events  influence  markets  and  the  nature  of   that  influence.   •  The  index  is  dynamic  providing  a  daily   reading  of  poli%cal  and  policy  uncertainty  in   Australia  and  allowing  for  daily  comparison   against  key  indices.   •  Consistent  with  best  prac%ce  risk   management  principles  the  index  regularly   undergoes  review  to  deepen  its  insight  and   maintain  robustness.       0   2   4   6   8   10   12   Poli%cal  Uncertainty  Score   Australian  PoliQcal  Risk  Index   4800   4900   5000   5100   5200   5300   5400   5500   0   2   4   6   8   10   12   ASX  200   Poli%cal  Uncertainty  Score   Australian  PoliQcal  Risk  Index  vs.  ASX  200   PRI   ASX  200  
  • 18. ACCESSING  THE  DATA  &  INSIGHT   •  There  is  no  ‘one  size  fits  all’  model  for  assessing  social  and  poli%cal  risks.  Every  investor  and  each  company  has   different  challenges  and  processes  and  the  Poli%cal  Monitor  services  are  tailored  to  meet  specific  needs.  However,   there  are  a  number  of  ways  in  which  firms  are  currently  accessing  and  using  this  data:     •  Risk  audits  –  twice  yearly  review  of  the  social  and  poli%cal  risks  confron%ng  firms  in  respec%ve  regions   or  sectors.  These  audits  are  usually  conducted  for  a  firm’s  risk  management  commi`ee  as  part  of  their   broader  commitment  to  ensuring  management  and  investors  are  apprised  of  emerging  and  ongoing   risks.  The  audits  provide  an  opportunity  for  firms  to  gain  a  unique  perspec%ve  on  risk  that  goes  beyond   economic  analysis  and  helps  firms  meet  their  repor%ng  obliga%ons.  Audits  include  both  quan%ta%ve  and   qualita%ve  analysis.   •  Consul.ng  &  advisory  –  a  dedicated  and  focused  review  of  the  social  and  poli%cal  risks  confron%ng  a   firm  or  investor.  The  advisory  service  considers  the  implica%ons  of  country  and  in-­‐country  risk  and  then   drills  down  to  iden%fy  sector  and  /  or  firm  specific  risks  that  are  likely  to  influence  the  opera%ng   environment  over  the  coming  months.  These  bespoke  advisory  services  include  both  quan%ta%ve  and   qualita%ve  analysis   •  Poli.cal  Monitor  subscrip.on  –  our  subscrip%on  service  provides  daily  access  to  our  risk  scores,  indices   and  analysis  providing  execu%ves  with  comprehensive  but  concise  analysis  of  the  poli%cal  risk  outlook  at   a  country  and  sector  level.   ! ! ! ! !! Political risk, ESG & market performance! 18!
  • 19. ! To find out more contact:! ! Damian  Karmelich              Steve  Cusworth   Partner  -­‐  Sydney                Partner  -­‐  Melbourne   p.  0407  772  548                p.  0417  178  697   e.  karmelichd@poli%calmonitor.com,au      e.  cusworths@poli%calmonitor.com.au! ! About Political Monitor! Political Monitor is a political risk research and advisory firm. Our analysis provides insight into the implications of political risk for commercial valuations, asset selection, investment decisions, strategic planning and operational decisions. ! ! Political risk, ESG & market performance! 19!
  • 20. DISCLAIMER & COPYRIGHT! Disclaimer ! Information in this document is subject to change without notice and does not represent a commitment on the part of Seller.! Seller does not warrant the accuracy, completeness or timeliness of any of the data and/or programs (“Information”) available within the report. The Information is provided “as is” without warranty of any kind, express or implied, including, but not limited to, implied warranties of merchantability, fitness for a particular purpose, title or non-infringement.! In no event will Seller or its affiliates be liable to any party for any direct, indirect, special, consequential or other damages for any use of or reliance upon the Information found within the report, or on any other reference documentation, including, without limitation, lost profits, business interruption, loss of programs or other data, even if Seller is expressly advised of the possibility of such damages.! The disclaimer is in addition to the specific terms and conditions that apply to the products or services offered by Seller.! Copyright! Copyright © Political Monitor Pty Ltd 2014. This document is copyright and contains confidential information that is the property of Seller. Except for the purposes of executing or applying this report, no part of this document may be copied, stored in a retrieval system or divulged to any other party without written permission. Such rights are reserved in all media.! Intellectual property rights associated with the methodology applied in arriving at this document, including templates and models contained there in, reside with Political Monitor Pty Ltd, excepting client information it contains that is demonstrably proprietary to the client or covered by an agreement or contract defining it as such.! No part of this report may be reproduced, transmitted, stored in a retrieval system, or translated into any language in any form by any means, without the written permission of Political Monitor Pty Ltd.! © Political Monitor Pty Ltd 2014. All Rights Reserved . ACN 166 162 572.! Political risk, ESG & market performance! 20!
  • 21. APPENDIX  1  –  THE  RELATIONSHIP  BETWEEN  POLITICAL   RISK  AND  ECONOMIC  PERFORMANCE   •  Poli%cal  risk  is  the  second  ranked  concern  for  publicly  traded  companies  …  "Looking  ahead,  investors   con%nue  to  be  wary  about  the  effects  of  systemic  risk,  poli%cs  and  regula%on  on  the  world's  markets  and   how  they'll  perform.”  (BNY  Mellon,  Global  Trends  in  Investor  Rela7ons,  2014).   •  In  general  poli%cal  instability  results  in:     •  (a)  lower  economic  growth  (Aisen  &  Veiga,  2013)   •  (b)  reduced  private  sector  investment  (Alesina  &  PeroX)   •  (c)  increased  infla%on  levels  &  vola%lity  (Aisen  &  Veiga,  2008).   •  The  economic  effects  of  poli%cal  &  social  instability  remain  for  an  observable  period  of  2  –  3  years.  The  key   determinant  of  whether  the  effect  of  instability  ceases  at  that  point  is  the  speed  with  which  countries   implement  reforms  &  improve  governance  (Bernal-­‐Verdugo,  Furceri  &  Guillaume,  IMF  Working  Paper,   2013).   •  An  increase  in  economic  policy  uncertainty  foreshadows  a  decline  in  economic  growth  and  employment  in   the  following  months  (Baker,  Bloom  &  Davis,  EPU).   •  The  Interna%onal  Monetary  Fund  (IMF)  es%mates  the  economic  loss  to  Libya,  Egypt,  Tunisia,  Syria,  Yemen,   and  Bahrain  in  2011  at  USD$20.56  billion  as  a  result  of  poli%cal  and  social  conflict.     ! ! ! ! !! Political risk, ESG & market performance! 21!