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Investment (SRI) combines investors™ financial objectives with their con-
cerns about social, environmental and ethical (SEE) issues.™
SRI is also viewed as an extension of good corporate governance
responsibilities. From 3 July 2000, the Pensions Act (1995) Amendment,
Section 35, requires trustees to state:
* The extent (if at all) to which social, environmental or ethical consider-
ations are taken into account in the selection, retention and realisation
of investments; and
* Their policy (if any) in relation to the exercise of the rights (including
voting rights) attaching to investments.
The government believe trustees should feel they are able to consider the
ethical considerations in relation to their work and improve the voting
records of pension funds. However, funds are not forced to comply but
must state so in their SIP (Statement of Investment Principles).
The history of SRI can be found at: http://www.uksif.org/Z/Z/Z/
sri/hist/index.shtml




In brief this means that more shareholders will become proactive in engaging
with companies. The box below highlights strategies which responsible
investors are increasingly following.
Part B “ Overview of the Economic Aspects of Business Risks
222




Socially responsible investment strategies
* Best in class: ranking companies according to how well they encompass
environmental, health and safety, and social policies and trying to
invest in the best performing companies;
* Engagement: encouraging companies to implement ethical practices
and improve their policies through persuasion, support and voting.
Approaches may be to communicate ethical policy to companies, sub-
scribe to a corporate governance service, or to invest only with man-
agers who engage with companies. This approach is less exclusive as
managers are able to invest in entire portfolios as long as engagement
occurs, therefore minimising risk. This is viewed by some as the best
way of implementing an SRI policy;
* Integration: the explicit inclusion by asset managers of corporate govern-
ance and environmental, social and governance (ESG) risks into the tra-
ditional financial analysis methodology;
* Pioneer screening and thematic investment: these are based on specific
ESG issues, or criteria, such as an organisation™s transition to sustain-
able development, or its moves towards a low carbon economy by
investment in renewable technology; and
* Screening: positive screening is the creation of a list of acceptable prac-
tices to apply to companies and, from this, to choose the best perform-
ers. Negative screening can be the creation of a list of unacceptable
practices and to avoid investment in companies or sectors using such
techniques. Norms-based screening is a form of negative screening of
companies according to their non-compliance with international stand-
ards and norms such as issued by OECD, ILO, UN, and UNICEF.



In the UK the majority of the largest UK pension funds are now applying some
of these forms of SRI strategies to at least part of their portfolios. Some of the
largest pension funds (e.g. BT™s £29 billion and the Universities Superannuation
Scheme™s £20 billion) are managed entirely on SRI principles.


Insurers
Major adjustments are occurring in the insurance world as the insurers respond
to the new and often unprecedented level and scale of some claims from risks
which materialise. There are increased risks of losses from the following:
Increased environmental catastrophes and hazards: manmade catastrophes
now account for 96% of traditional risks such as fires, explosions and earth-
quakes. Around 4% of US claims are now made as a result of natural catas-
trophes (Annual Report 2002, Institute for Crisis Management (May 2003),
www.crisisexperts.com/). The case study of the Katrina Hurricane and its
disastrous impact on New Orleans demonstrated in a hitherto unprecedented
Chapter 9 “ Shareholder value and reputational risk 223



manner that environmental disasters do not only affect the developing world.
Moreover the earthquakes in India and Pakistan “ and elsewhere “ have to
take account of building standards and the responsibility of the industry.
Many insurance experts are forecasting a huge rise in the impact of manmade
catastrophes over the next decade (Best Review, the monthly insurance mag-
azine, from NewsStand (September 2001), www.newsStand.com);
Flooding: this and other environmental liability covers are seeing premiums
increase in most parts of the world. There are many well-documented case
studies that have recently taken place and demonstrate this point from
Europe to Asia; and
Corporate governance risks: these are increasing as directors and officers of
insurers in the UK are raising premiums to cope with the tougher regulatory
climate. In addition to stiffer financial reporting obligations for companies
listed on the London Stock Exchange, insurers say the ˜cyclical nature of the
market™ and inherent risks in some areas of business forced their hand
(BestWire, O™Connor, R. (May 2004)).


Lenders
Lending criteria are becoming more aware of these risk issues as the banks and
other lending agencies can also receive indirect reputational damage for sup-
porting a contentious project (e.g. banks that fund road or dam building in eco-
logically fragile areas). The main global banks have also developed a code of
conduct, the ˜Equator Principles™, which will seek to set a global standard of
what is acceptable to their sector (see also Chapter 3).
The ˜Equator Principles™ are used to analyse over 36 signature banks™ risk to
investments arising from damage to the environment among other factors. They are:
A financial industry benchmark for determining, assessing and managing social and
environmental risk in project financing.

These voluntary lending criteria have been strengthened recently and will be
applied to a greater variety of projects as a result of this new agreement. They state:
We will not provide loans to projects where the borrower will not or is unable to comply
with our respective social and environmental policies and procedures.
(http://www.equator-principles.com/principles.shtml)


G Governmental organisations
In most jurisdictions a variety of government departments and agencies are
responsible for the establishment of standards seeking to reduce the level of
harmful substances entering the environment and harming the public by:
Imposing penalties;
Prosecuting offenders;
Issuing enforcement notices; and
Raising and enforcing taxes and subsidies.
Part B “ Overview of the Economic Aspects of Business Risks
224



In the UK the present government™s approach to many environmental issues is
to use market mechanisms as corrective forces. This has led to a range of envir-
onmental taxation, which includes:
Aggregates tax;
Climate change levies;
Tax for company cars and business vehicles used for private use;
Landfill taxation; and
Utility bill increases (sanctioned by government regulators) to pay for envir-
onmental remediation. For example, the water companies will be allowed to
raise customer charges to invest environmental improvements.
The main development for the UK was to be the proposed Operating and
Financial Review (OFR) and will now be the EU Accounts Modernisation
Directive. The OFR was to: ˜Simply demand that directors explain their steward-
ship to their shareholders,™ as stated by Patricia Hewitt, Secretary of State for
Health. Therefore obliging all listed companies to provide details of factors affect-
ing future performance, including the social and environmental risks they face.
The objective of the OFR was to ˜improve transparency and accountability
by providing shareholders with better and more relevant information on the
business, its performance in the past and its prospects for the future™
(www.dti.gov.ukcld/financialreview.htm).
It was to be intended that if directors were to agree an OFR and later they
were found to have included false information, or omitted important informa-
tion, and then try to plead that they don™t know of a company™s situation or
activities, then they may be guilty of a new criminal offence of ˜recklessly
approving an OFR™, for which the penalty is an unlimited fine. This threat may
have encouraged pressure upon the UK Chancellor to abandon this legislation,
although many companies follow the spirit of the disclosure requirements
(having prepared for years anyway) but now without the threat of prosecution.


H Local and regional governmental organisations
Again in most countries local authorities can directly regulate some elements of
business activity, such as:
Planning consent for expansion of business operations, activities or works
access; and
Planning consent for developments, which is especially important for some
sectors like house building, construction and sectors that use a lot of land
capital (i.e. out of town retailers).


I International governmental organisations
There are a wide range of international bodies that can affect an organisation™s
risk management systems. There are bodies like the United Nations (UN), World
Health Organisation (WHO), International Labour Organisation (ILO) and a
Chapter 9 “ Shareholder value and reputational risk 225



myriad of others that make recommendations on industrial sectors. They can
recommend advertising bans, launch crackdowns on industries and even pro-
nounce dangerous products (i.e. WHO stating that passive smoking is deadly).
Within the European Union (EU) the European Commission and Parliament
hold increasingly large legislative power over a wide range of issues. The impact
of the European Union on the environmental agenda has been dramatic, and it
has been responsible for a range of environmental measures including the pre-
ferred instrument, the directive. Noteworthy directives are the chemical restrict-
ing REACH, or the Integrated Pollution Prevention and Control (IPPC) Directive
96/61/EC, which facilitates Europe-wide comparisons of environmental per-
formance of operations.

J Journalists and media organisations
Media interest activity works to create public awareness. If the issue is news-
worthy and a major stakeholder in a company raises an issue (e.g. an NGO™s
campaign launch or a shareholder revolt), that issue will keep gaining momen-
tum and lead to ever-increasing public awareness.
For example, the Co-operative Bank™s estimated losses at Esso, due to the
boycott of their parent company Exxon Mobil Corporation, run into the hun-
dreds of millions of pounds each year. Exxon Mobil Corporation is one of two
companies that are losing the most ground as highlighted in a study on reputa-
tions by Harris Interactive and the Reputation Institute, reported in the Wall
Street Journal, 19 February 2004:
Exxon Mobil is financially robust, but its continuing fight over punitive damages in the
1989 Exxon Valdez oil spill keeps the Alaskan disaster fresh in people™s minds and
lowers its rating for environmental responsibility.

Journalists focus on these companies and their continual negative commentary
acts as a magnet for them to be sent additional information by whistleblowers
and other aggrieved stakeholders. Once a journalist is in this envious position
it is very difficult to shake them off.
It is possible to reverse these factors, as can be seen from a case study on
Microsoft.


Case study: Microsoft
It is a company, which always scores well for leadership, vision and finan-
cial performance, but it has suffered from an identity problem which
revolved around its monopolistic power base and how it purchased as many
potential competitors as possible. In short, Microsoft was viewed as abusing
its power (as the recent large EU fines might suggest). However, largely as a
result of Chairman Bill Gates™ philanthropy, there are fewer critics now
accusing Microsoft of monopolising the software market, and indeed there
are more people praising the company; reputations can therefore be turned
around (reported in the Wall Street Journal, 19 February 2004).
Part B “ Overview of the Economic Aspects of Business Risks
226



K Key competitors
The review should determine the extent to which major competitors affect the
˜competitive environment™ like resource and product prices, their reporting and
stakeholder engagement activities.


L Local communities
Local communities can prove of critical importance and can pose risks of their
own from activism and objections to planning applications and business
operations. They are also the source of employees and local reputation is of
importance.


Chapter summary
As this book seeks to demonstrate risk is part of the entrepreneurial culture
needed by any organisation that wishes to develop, expand and improve. An
effective risk management structure allows an organisation to understand the
risks in any initiative and take informed decisions on whether and how the
risks should be managed. Risk management is now a practical feature of doing
business in today™s world, just as due diligence should be recognised as another
proactive tool that is of vital assistance in the management of risk.


Reputational risk management
Nowadays no matter where an organisation operates “ and whatever its
size “ risk management is becoming an increasingly essential part of
today™s business environment and is of interest to:
CEOs, financial directors, other executive and non-executive directors;
*
Company secretaries;
*
Heads of internal audit, risk management or other assurance functions; and
*
All managers with an interest in risk management.
*
Residual reputational risk
Residual reputational risk can then be calculated by dividing the inherent
reputational risk by the risk reduction scores for each of the issues:
Inherent reputational risk
Residual reputational risk
Risk reduction score

The owners are now in a position to map their risks and consider
where additional effort can increase the risk reduction score and will

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