The opinions expressed in this presentation are those of the speaker. The International Foundationdisclaims responsibility for views expressed and statements made by the program speakers.

ESG—Environmental, Social and Governance Investing

Thomas CroftManaging Director, Heartland Capital StrategiesExecutive Director, Steel Valley AuthoritySwissvale, Pennsylvania

Murray GoldSenior PartnerKoskie Minksy LLPToronto, Ontario

Dennis R. JohnsonManaging MemberJohnson & Krol, LLCChicago, Illinois

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What Is Responsible Investment?

“Responsible investment is an approach to investing that aims to incorporate

environmental, social and governance (ESG) factors into investment decisions, to

better manage risk and generate sustainable, long-term results.”

-The United Nations’ Principles for Responsible Investment

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What Are Economically Targeted Investments?

An ETI is “any investment that is selected, in part, for its collateral benefits,

apart from the investment return to the employee benefit plan investor.”

-Interpretive Bulletin 2015-01. Department of Labor, Employee Benefits Security Administration.

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A Brief History ofResponsible Investing

• 1994: DOL publishes Interpretive Bulletin 94-01, which “corrected a misperception that investments in ETIs are incompatible with fiduciary obligations”

– “New Guidance on Economically Targeted Investments in Retirement Plans from US Labor Market.” United States Department of Labor News Release.

• IB 04-01 provided that Sections 403 and 404 of ERISA do not prevent plan fiduciaries from investing plan assets into ETIs “if the ETI has an expected rate of return that is commensurate to rates of return of alternative investments with similar risk characteristics that are available to the plan, and if the ETI is otherwise an appropriate investment for the plan in terms of such factors as diversification and the investment policy of the plan.”

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A Brief History ofResponsible Investing

• 2006: The United Nations launches its Principles for Responsible Investment, requiring signatories to implement a set of six voluntary principles that incorporate ESG factors into investment practices

• Today, more than 1,500 asset owners, investment managers, and service providers from over 50 countries are signatory to the PRI, representing $60 trillion in assets

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A Brief History ofResponsible Investing

The Six Principles of Responsible Investing:The Six Principles of Responsible Investing:

PRINCIPLE 1We will incorporate ESG issues into investment analysis and decision-making processes.PRINCIPLE 2We will be active owners and incorporate ESG issues into our ownership policies and practices.PRINCIPLE 3We will seek appropriate disclosure on ESG issues by the entities in which we invest.

PRINCIPLE 4We will promote acceptance and implementation of the principles within the investment industry.PRINCIPLE 5We will work together to enhance our effectiveness in implementing the principles.PRINCIPLE 6We will each report on our activities and progress towards implementing the principles.

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A Brief History ofResponsible Investing

• 2008: DOL publishes Interpretive Bulletin 2008-01, which replaces IB 94-01 in an effort to “clarify that fiduciary consideration of collateral, non-economic factors in selecting plan investments should be rare and, when considered, should be documented in a manner that demonstrates compliance with ERISA’s rigorous fiduciary standards”

– Interpretive Bulletin 2015-01. Department of Labor, Employee Benefits Security Administration.

• IB 2008-01 sparks confusion among plan fiduciaries, resulting in the presumption that ESG factors should be avoided in the context of investment selection

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A Brief History ofResponsible Investing

• 2015: DOL publishes Interpretive Bulletin 2015-01, withdrawing IB 2008-01 in light of the DOL’s conclusion that IB 2008-01 “unduly discouraged fiduciaries from considering ETIs and…[ESG] factors under appropriate circumstances”

– Interpretive Bulletin 2015-01.

• IB 2015-01 clarifies when ESG factors may be considered as both primary factors and as secondary factors in evaluating an investment opportunity

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Interpretive Bulletin 2015-01:Primary Factors

• IB 2015-01 provides that in instances where ESG factors may directly impact the economic value of a plan’s investment, “such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices”

– Interpretive Bulletin 2015-01.

• IB 2015-01 also provides that when “a fiduciary prudently determines that an investment is appropriate based solely on economic considerations, including those that may derive from . . . [ESG] factors, the fiduciary may make the investment without regard to any collateral benefits the investment may also promote”

– Interpretive Bulletin 2015-01.

• IB 2015-01 clarifies that plan fiduciaries need not treat commercially reasonable investments as inherently suspect or otherwise in need of special scrutiny because they consider ESG factors

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Interpretive Bulletin 2015-01:Secondary Factors

• IB 2015-01 also confirms that ESG factors may be considered on a secondary level, as “tiebreakers” between otherwise equivalent investment alternatives

• IB 2015-01 reinstates language from IB 94-01 that authorizes the tiebreaking approach

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Responsible Investing Gains Momentum

• In April 2015, $59 trillion in assets were represented by investment organizations that are signatory to the Principles of Responsible Investment—up 31.1% since April 2014

• IB 2015-01 is adding momentum towards ESG investment integration in the United States

• ESG investing fits with the goals of organized labor and can support union-friendly investment strategies

• Recent Calvert Investments research indicates that DC plan participants are increasingly interested in responsible investing; out of 1,200 plan participants and 200 eligible non-plan participants surveyed:– 87% want investment options that align with their values– 82% are likely to select a responsible investment option if offered

in the plan– 55% of eligible non-participants say they’d be more likely to participate in

the plan if it offered responsible investment options

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Endorsement by U.S. Labor

The AFL-CIO passed Resolution 11 at their 2013 Constitutional Convention.

This measure endorsed the responsible investment of workers’ capital, and moved beyond the many decades of worker-friendly investments to support the E, S and G in RI.

Across the globe, unions have worked in a united front to invest more humanely and sustainably.

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Momentum to ESG Is Global

• A call to action for capital stewards and all of us to responsibly invest workers’ capital.– It scans responsible investments in the US, UK, the

Netherlands, Sweden and Australia, and includes examples from other communities.

– It was commissioned by the AFL-CIO and Heartland, which includes unions, responsible investment managers, academics and sustainable firms.

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What Is Workers’ Capital?

• Workers’ capital is our money, the pension funds and other savings and assets of working people, including 401ks, insurance funds, bank deposits, etc.

• Real pension funds—defined benefit plans—grew from $153 billion in 1978 to $9 trillion in U.S., including $4 trillion in public and T/H plans where workers have a voice.

• Workers own $22 trillion in institutional investments in U.S., and $36 trillion globally.

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Labor’s Capital Stewards . . .

• Were the original “crowd-funders”– Fought for and won the 8-hour workday, weekends

and vacations– Bargained the first pensions

• These investment aviators also: – Led the charge toward responsible

investment– Established the groundwork for

good corporate governance

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Seven Powerful Drivers of RI . . .

1. The growth of the UN PRI.2. The 2015 U.S. DOL pension guidance on legality of ETIs,

strongly advising ESG investing. 3. Responsible investment performance studies demonstrating

financial outperformance4. Post-2008 market crash reforms (Dodd-Frank Act 2010; SEC

“Say on CEO Pay”)5. The 2015 Paris Climate Change Accords, leading to landmark

commitments. 6. The “Fight for $15” movement to pay livable wages and

reverse income inequality.7. Labor’s endorsement, aligning labor with global ESG

frameworks and campaigns.

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2015 U.S. DOL Pension Guidance

• Outside the U.S., modernized laws mandate the consideration of ESG and other non-financial issues in the management of pension assets. A Europe-wide ESG disclosure directive for firms and institutions takes effect in 2017.

• The DOL guidance—Interpretive Bulletin 2015-01—re-confirmed the legality of Economically-Targeted Investments (ETIs) and strongly advised that investors consider ESG matters. Thus, the evolution from ETIs to ESG, bringing the US into the modern, global responsible investment framework.

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ESG and Financial Performance

Meta-studies, academic and industry reports and sustainability data—by Oxford, Harvard, Mercer, etc.—are documenting the financial advantages of investing responsibly and good corporate governance.

Hundreds of studies are now pointing to financial out-performance, thus proving the adage that investors can do good and do well.

Investors and corporations are showcasing the positive impacts of ESG considerations on both investment portfolios and corporate value.

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Post-Crash Financial Regulations

• The after-effects of the 2008 financial crisis shed greater scrutiny on short-termism, financialization, financial fraud and outright ponzi schemes.

• Supported by investors’ concerns, the Dodd-Frank Act of 2010 became law, aiming to increase corporate board involvement and objectivity and improve accountability to shareholders.

• The SEC passed the “Say on CEO Pay” in 2015 to disclose pay ratios.

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Paris Accords and Global Warming

Paris Climate Change Accords of December 2015 garnered a landmark commitment from 195 countries to address climate change, following many other global compacts.

In the U.S. in recent years, the SEC began requiring disclosures of material climate change matters. New disclosures are being discussed for potential adoption.

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The Fight for $15

The “Fight for $15” and other national movements are pressing companies to pay livable wages, part of a global campaign to reverse income inequality.

This comes as part of a broader effort to demand that companies disclose their treatment of workers and unions, captured in the push for disclosure of “human capital management (HCM)” practices and policies.

HCM includes not only compensation, but talent attraction and retention, training, safety and health, and the diversity of the workforce, among other priorities. It is the “S” in ESG.

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The Responsible Investor Handbook

Published by Greenleaf Publishing in the Fall of 2016 as the fifth title in their responsible investment series, the Handbook is a “how-to” manual for the stewards of workers’ capital.

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Outline

• Ontario’s new ESG regulations– Effective January 1, 2016– What are they?

• Fiduciary obligations and new ESGdisclosure requirements

• Active issues

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Ontario Regulations

• As of January 1, 2016, s. 78(3) of the General PBA Regulation provides:“The statement of investment policies and procedures shall include information as to whether environmental, social and governance factors are incorporated into the plan’s investment policies and procedures and, if so, how those factors are incorporated.”

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Ontario Regulations

• In addition, the same disclosure must be made to members in their annual statements, and retirees in their biennial statements.

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Fiduciary Obligations

• Pension Benefits Act (PBA)– PBA codifies fiduciary obligations in

Section 22 (Ontario)– All fiduciary obligations rest on the

fundamental “duty of loyalty” that requires investment decisions to be made in the interest of plan beneficiaries

– Cannot make fund investments for abstract moral or ethical reasons

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Fiduciary Obligations

• Fiduciary obligations:– Fiduciary obligations also entail a “duty of care”– This requires administrators to utilize all the skills and

knowledge that they have, or ought to have, in making decisions

– The duty of care generally imports the “prudent person” role, and requires trustees to have “regard for all factors that may affect the funding and solvency of the plan and the ability of the plan to meet its financial obligations”

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Legal Commentary and Current Developments

• The Freshfield report concluded (October 2005) as follows:– Conventional investment analysis focuses on value, in

the sense of financial performance. As we note above, the links between ESG factors and financial performance are increasingly being recognized. On that basis, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions

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“Public” Fiduciary

• Idea is that general economic conditions are more important to financial returns than asset allocation or stock picking

• “Alpha” (market returns) are more important than “Beta” (manager outperformance)

• So—fiduciaries must pay attention to factors that influence overall economy

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Pension Plans and Governments

• Pension fiduciaries concerned with general economic conditions, conditions long-term investments– Mandates a level of political engagement where

long-term investment conditions in jeopardy– Common approach to regulation across states

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Fiduciary Obligations—ESG (Climate Change)

• Current issues:– Proxy voting: do companies have business

plans to address Climate Accords (2 degree warming);

– Investment Managers: do they consider ESGcriteria in stock selection

– Public Engagement: are local/state/federal governments coordinating climate policy

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Fiduciary Obligations

• ESG driven opportunities:– ETI: especially retrofits, for electrical, heating

and water efficiencies– Alternative energy sources, energy efficient

products/processes

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Session #I05

ESG—Environmental, Social and Governance Investing

• IB 2015-01 clarifies when plan fiduciaries may properly consider ESG metrics as both primary and secondary factors

• This action follows on the heels of the increased popularity of responsible investing, both within the United States and abroad

• It remains to be seen whether ESG strategies outperform their competitors

We are at the threshold of the most transformational economic change in a generation! • Responsible capital stewards are mobilizing capital for:

– Smart buildings, affordable and transit-oriented housing– Community infrastructure projects– Wind and solar projects– High-speed rail, hybrid buses and electric cars

• They are reclaiming our urban cities, recharging the industrial commons, growing the clean economy and working to make the “boss” more accountable.

• They are buying “Made in America,” which has gained ground from the White House to the coffee house.

• We hope to spur active engagement and action to elevate this new generation of responsible investors into our national conscience and conversations.

• Canadian trend is for disclosure of ESG approach (if any)• Given fiduciary obligations, and Freshfields Reports, not possible to ignore

ESG• For externally managed plans, key is whether investment managers

incorporate ESG into security section decision-making• Consider ESG factors in asset allocation• ESG considerations also relevant to proxy voting (e.g., corporate

governance best practices)

Website Resourceshttps://www.ifebp.org/inforequest/ifebp/0200050.pdf

62nd Annual Employee Benefits ConferenceNovember 13-16, 2016Orlando, Florida

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2017 Educational ProgramsInvestments

63rd Annual Employee Benefits Conference October 22-25, 2017 Las Vegas, Nevadawww.ifebp.org/usannual

Investments InstituteMarch 13-15, 2017 Phoenix, Arizonawww.ifebp.org/investments

Portfolio Concepts and ManagementMay 1-4, 2017 Philadelphia, Pennsylvaniawww.ifebp.org/wharton

Related ReadingVisit one of the on-site Bookstore locations or see www.ifebp.org/bookstore for more books.

The Tools & Techniques of Investment Planning, 3rd EditionItem #9029www.ifebp.org/books.asp?9029

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