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Recent trends in ESG

December 2010

Disclaimer These notes should not be used as a basis for investment. Information and advice in this publication is based on sources that East Capital deem reliable, but East Capital can under no circumstances be answerable for the totality or correctness of the information, or for direct or indirect loss that can occur as a result of mistakes or discrepancies therein. Investment in funds is always associated with risks. Historic yields are no guarantee of future yields. Fund units can go up or down in value, and there is no guarantee that investors will get back all capital invested. As East Capital invests in foreign markets, currency fluctuations can affect the f unds’ values. Fund information brochures can be obtained from East Capital.

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Russia shares at a massive discount

1 200 000 1 000 000 800 000 600 000 400 000 200 000 0

Source: Bloomberg, as of September 2010

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+80%

At current P/E

Russia Mcap (mn USD)

at GEM P/E at Brazil P/E 3

Why the valuation discount?

 Political risks  High dependancy on oil  State involvement in business  Corruption  Corporate goverance

Russia is held to higher standards than other EMs, which may be a good thing, but it creates a valuation discount based on sentiment not fundamentals

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# of bad corporate governance cases have risen

 Default on mandatory buyouts  Misleading financial guidance ahead of IPO  Significant and harmful related party transactions  Dilutive share issues without pre-emptive rights  Investments into non-core assets  Violations in share conversions  No access to management

The trend of improvement in corporate governance standards has been broken

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What is Sustainable investing?

Corporate (Social) Responsibility

SRI

R e s p o n s i b l e

Ethical

Social

Non-financial

Triple Bottom Line

Sustainable

”Any investment process that combines investors’ financial objectives with their concerns about

Environmental, Social and Governance (ESG)

issues ” (Eurosif 2010) 26 April 2020 6

Focus on ESG issues

• • • • • • • • • •

Environmental: Climate change GHG emissions Pollution Resource depletion Ecosystem change Waste Toxic chemicals License to operate Renewable energy Energy efficiency

Source: The CFA Institute 2008.

26 April 2020 • • • • • • • • • •

Social: Discrimination Diversity Safety record Forced labour Child labour Indigenous rights Worker rights Labour relations Community relations Harassment

• • • • • • • • • •

Governance: Shareowner rights Cumulative voting Dual share-class Executive compensation Majority voting Say on Pay Separation of CEO/Chairman Staggered boards Takeover defenses Shareholder structure

ESG issues are here to stay

Some examples:

 63% of institutional clients, such as pension funds and endowments, included requirements for socially responsible investing in their new contracts with investment managers in 2009, + 25% compared to 2008 (UN)  Bond/credit analysts look at carbon in corporate ratings and environmental risks in project lending   Asset manager building internal ESG capabilities and multi-level training of investment teams Stock exchange initiatives – new IPOs in China subject to environmental audit  IFC includes ESG standards in transactions 26 April 2020 8

Increased demand from clients

 Demand from institutional investors: – – Increasingly a matter of risk management Growth and implementation of UNPRI  Demand from HNWI: – Sustainable investments represented 11% of porfolios as of 31 Dec 2009, predicted to grow to 15% by 2013  Demand from retail investors: – Growing mistrust of traditional financial offerings following the financial crisis – Particularly visible in Germany, France and Belgium

Institutional vs Retail SRI by country Type of Institutional Investors (By volume SRI)

1 Source: Eurosif 2010 European SRI Study published in October 2010. Market measured since 2003 and originally covers 13 EU countries: AU, BE, DK, FI, FR, DE, IT, NL, NO, ES, SE, CH and UK. As of 2010 the study also includes Poland, Greece, Cyprus, Estonia, Latvia and Lithuania. Growth numbers have been adjusted in order to allow for comparability on a like-for-like basis.

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Different approaches

  Norms-based exclusions: – Exclude companies that violate certain principles based on international ESG standards such as UN Global Compact, ILO  Values-based exclusions: – Avoiding controversial business: ”sin stocks” Best-in-class: – Choose top performing companies in a sector based on selected ESG challenges (Ex: water efficiency or CO2 emissions)  Thematic approach: – Invest in sectors with positive impact (Ex: clean energy or health and nutrition)

About ”Sin stocks”:

”Trimuverate of sin”: Alcohol Defense Gaming Pornography Tobacco …but we all have our own idea of what is sinful: Animal testing Pork Media SUV:s GMO … … 26 April 2020 10

ESG in emerging markets

 ESG pressure in emerging market economies still at an early stage, but growing   Significant country variation, but companies are improving in terms of: – – – Integration Transparency Performance – Reporting  Sustainable investment in emerging markets has increased to above $300 billion ( €210 billion) in AUM in the past five years

Other examples: – Corporate governance code and mandatory integration of ESG reporting for companies on Johannesburg Stock Exchange – Launch of sustainability index in Brazil, Poland, Malaysia 1 IFC & Mercer, “Gaining Ground”, 2009.

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RESPECT index in Poland

   The RESPECT index was launched on Warsaw Stock Exchange in November 2009 Comprises 16 companies with highest ”A” rating Outperformed WIG20 index Index constituents 9 Nov 2010 Company Share in index, % 250 1 2 3 4 PKNORLEN KGHM TPSA PGNIG 28.997

27.692

15.761

6.320

200 150 5 6 7 8 HANDLOWY INGBSK LOTOS SWIECIE 5.595

5.359

2.792

2.375

100 50 0 9 10 11 12 ELBUDOWA BANKBPH APATOR CIECH 1.521

0.942

0.835

0.672

WIG20 RESPECT 13 14 15 16

TOTAL

AZOTYTARNOW 0.502

BARLINEK 0.377

ZYWIEC ROPCZYCE 0.199

0.063

100

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Implications for us as investors

 Understand potential long-term changes in the legal and regulatory frameworks that can impose additional costs or provide opportunties for our portfolio companies: – How do the cost of preventing or limiting negative ESG effects compare to damage costs?

– Will current or anticipated legislative or regulatory changes help or hinder the current and long-term strategy of the company?

– Has the company identified and adressed risks of such changes and communicated them to investors?

– Does the company clearly communicate a strategy for adressing such risks? – Does the company report on ESG issues in a credible manner?

Source:”Environmental, Social and Governance Factors at Listed Companies” CFA 2008.

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Norilsk Nickel: Current concerns

 Norilsk Nickel’s environmental challenges are both large and complex - significant time before any satisfactory progress in reduced emissions is recorded  Lack of formal decisions and plans to initiate more radical environmental progress  Lack of clear and transparent reporting related to environmental issues and the company’s capacity to initiate and manage environmental progress  Corporate dispute is consuming energy from important operative issues  Will ultimately lead to a question of the future acceptability of Norilsk Nickel’s products  These uncertainties currently imply a significant discount on valuation of Norilsk Nickel 26 April 2020 14

Recommendations to emerging market investors

 Encourage companies to: – Strengthen market positions by tracking and anticipating legal and regulatory developments and changes that may impact the competitive landscape – Adjust to a new operating environment sooner rather than later – Eliminate unsustainable corporate practices (such as pollution, human rights abuse or corruption cases) – Manage reputational risk by strengthening their policies, management systems and improving disclosure  Reward companies that understand their specific challenges related to sustainable development and are transparent on ESG issues  Support prominent international ESG initiatives where size can create greater impact  Participate in collaborative networks such as the UNPRI 26 April 2020 15