November 2013 Journal of Sustainable Finance & …...Cornerstone Journal of Sustainable Finance &...

Cornerstone Journal of Sustainable Finance & BankingSM / November 2013 / 1

Journal of Sustainable Finance & Banking

SM

November 2013

©f9photos/CrystalGraphics.com

Regional Imperatives

China Threat? The Challenges, Myths, and

Realities of China’s Rise

Lionel Vairon … p.19

“Extremes vs. Realities: Opportunities for

China’s Urban Development”

Zheng Xiaoping… p.22

Global Sector Research

China: The Elusive Market for US

Technology Companies

Nikos Theodosopoulos … p.24

Living in Regulatory Purgatory

Diane Glossman … p.28

Open Source Excellence

Sustainable Agriculture: When Less is More

Karla Canavan … p.31

Enhanced Analytics

A Zero Sum Game: Assessing Water Risks in

China’s Mega Infrastructure

Lotfipour, Chew, Jin … p.34

Corporate Governance Insights

The Evolution of Company/Shareholder

Engagement

John Wilson … p.37

Accelerating Impact

Jumpstarting Access to Capital

David Robinson … p.43

Sustainable Standout

Food Policy & the Environmental Credit

Crunch

Paul Donovan, Julie Hudson … p.48


CEOs Letter on Sustainable Finance & Banking

Erika Karp

Founder and Chief Executive

Officer of Cornerstone Capital

Inc. and Former Head of Global

Sector Research at UBS

Investment Bank

This month in the Cornerstone JSFB, after a month of continued market rallies

in the west fueled by extraordinary monetary stimulus with near term “taper”

prospects put aside for the moment, we take the opportunity to “pivot to the

east.” Following the outcome of the much anticipated Third Plenary Session of

China’s Party Congress, global market participants puzzle over the extent to

which reforms are discounted in the markets, and we consider optimal paths to

long-term prosperity by including feature articles from two China experts. In our

new “Regional Imperatives” section, former French diplomat Lionel Vairon

addresses both the myths and realities of China’s rise with summary of the

pragmatic approach detailed in his new book “China Threat?” Further this

month, Zheng Xiaoping of the CCDF brings to bear his years of experience in

large-scale urban development work by offering a model for cross border

knowledge and capital flows as China’s urbanization progresses.

Aside from the challenges Zheng highlights in the continued push towards

urbanization, we turn to another critical issue for an economy intent upon

expanding domestic consumption: the need for fresh water. As water risk is

arguably a defining crisis of the twenty first century, this month in our

“Enhanced Analytics” section, we highlight a new report from MSCI Research

entitled “A Zero Sum Game: Assessing Water Risks in China’s Mega

Infrastructure.” Here, Linda Eling-Lee’s team highlights the methodology for

portfolio managers to take a clear-eyed look at water risks in their investment

decisions.

While noting that water is a predominant sustainability focus of the world’s

consumer goods companies, we take the opportunity this month to focus on

commentary from Global Economist Paul Donovan and ESG/Sustainability

Strategist Julie Hudson of UBS. In the “Sustainable Standout” section of the

JSFB, they argue that there is indeed a way to reconcile the political imperatives,

economic challenges, and environmental costs of making cheap food available

globally... focus on addressing the extraordinary amount of waste in the system.

In their latest book entitled “Food Policy and the Environmental Credit Crunch –

From Soup to Nuts”, Paul and Julie continue to help investors come to terms

with the challenges of consuming tomorrow’s finite resources to support today’s

standards of living.

Speaking of the challenges associated with sustainably providing food for a

hungry world, this month we feature an article from Karla Canavan of Bunge

Environmental Markets in our “Open Source Excellence” section. Karla

offers a compelling case of how there are indeed opportunities to address

http://www.amazon.com/Food-Policy-Environmental-Credit-Crunch-ebook/dp/B00F474WGM

http://www.amazon.com/Food-Policy-Environmental-Credit-Crunch-ebook/dp/B00F474WGM


food/resource scarcity by constructively engaging in the empowerment of women

farmers. Karla’s project discussion highlights the extraordinary opportunities to

bring prosperity together with capitalism.

Turning to our work in “Global Sector Research” this month, we continue the

theme of the rise of China with a discussion by Technology Strategist Nikos

Theodosopoulos commenting on the “elusiveness” of the Chinese market for US

Technology companies. Nikos explicitly lays out the opportunities, obstacles,

and competitive dynamics of China’s potential powerhouse technology market.

Having offered a “Sustainable Editorial” this month which discusses the

necessity of a constructive dialogue on the value of derivative financial products

(“The Societal Value of Derivatives”), we next turn to the health of the global

banking industry. We also offer a Banking Sector Strategy note from Diane

Glossman considering the “Regulatory Purgatory” in which global banks are

operating. Diane lends her important perspectives on the prospects for financial

returns and the governance imperatives for the sector in today’s regulatory

landscape. Further from our research colleagues this month, we feature a report

from our Head of Valuation & Accounting Janet Pegg, shedding high-level light

on how financial instruments are handled on bank balance sheets.

This month’s JSFB includes a new section called “Accelerating Impact.”

Here, we will highlight current initiatives being driven by both private and public

sector institutions that are a “call to action” for those who would engage in a

more sustainable form of capitalism. This month we feature work from David

Robinson of Duke University who, with our colleagues on the Global Agenda

Council for Financing & Capital at the World Economic Forum, has created a

survey allowing for an analysis of the challenges to accelerating capital flows to

small and medium sized enterprises (SMEs). We urge our readers to share this

link (http://sites.duke.edu/gacfinance) and gather responses to the survey so the

WEF can support this critical engine of growth and prosperity.

Also in this edition, in our “Corporate Governance Insights” section, we are

pleased to offer a discussion regarding the “state of play” in private sector

Corporate Sustainability initiatives from John Wilson. In this article which is

Part One of a continuing report, the former Head of Corporate Governance of

TIAA-CREF, addresses the evolution of company/shareholder engagement

regarding the subjects of “unburnable carbon”, transparency in disclosures

around carbon emissions, and the need for business model evolution if we are to

move forward on private sector solutions to climate risk.

In closing this month, aside from highlighting TheLastPanda.org as our

“Featured Domain”, I would also add that the Cornerstone team is often

asked about our own definition of “corporate sustainability.” While we have

commented before on the challenges associated with the language in the field of

sustainable finance (see our article in Forbes entitled “Could Sustainability be

Unsustainable?”), we argue that a determination of a single definition to be

http://sites.duke.edu/gacfinance

http://www.forbes.com/sites/85broads/2012/09/26/could-sustainability-be-unsustainable/?utm_source=allactivity&utm_medium=rss&utm_campaign=20120926

http://www.forbes.com/sites/85broads/2012/09/26/could-sustainability-be-unsustainable/?utm_source=allactivity&utm_medium=rss&utm_campaign=20120926


adopted by all, may be futile. And certainly the idea of waiting for that definitive

answer won’t accelerate the velocity of change. That said, for Cornerstone

Capital, the definition of “corporate sustainability” in conjunction with the

strategies and tactics deployed by any company, is “the relentless pursuit of

material progress towards a more regenerative and inclusive

economy.”

We invite our clients to continue the dialogue on this and any other subject

raised this month. And, as noted in the first edition of the JSFB last month, the

above summary is being distributed to a broad group of capital markets

participants. To receive the complete Cornerstone Journal of Sustainable

Finance & Banking, we invite you to subscribe – click here for more information.

If you missed last month’s edition, you can review it on our website.

We also take this opportunity to wish everyone a happy and healthy

holiday season. We look forward to celebrating with many of you on December

6th in New York at the "Embrace the Grey" Black & White Holiday Party. For

inquiries about this event, please contact Matthew Daly with Cornerstone Capital

at +1 212-874-7400.

My sincere regards,

Erika

Erika Karp

Chief Executive Officer

http://www.cornerstonecapinc.com/CornerstoneJSFB_SubscriptionForm.pdf

http://www.cornerstonecapinc.com/CornerstoneJSFB_October2013.pdf


Table of Contents

CEOs Letter on Sustainable Finance and Banking

p. 2

Market Summary

Overview

Market & Global Sector Performance

p. 7

p. 8

Featured Editorial

The Societal Value of Derivatives

Erika Karp

CEO & Founder,

Cornerstone Capital Inc.

and Former Head of

Global Sector Research,

UBS Investment

p. 15

Featured Domain

TheLastPanda.org

Erika Karp

CEO & Founder,

Cornerstone Capital and

Former Head of Global

Sector Research, UBS

Investment

p. 17


China Threat? The Challenges, Myths, and Realities of

China’s Rise

Dr. Lionel Vairon

Author of “China Threat”

and former French

diplomat to Cambodia,

Thailand and Iraq.

p. 19

“Extremes vs. Realities: Opportunities for China’s

Urban Development”

Zheng Xiaoping

Principal of Bazo, Founder

of China City Development

Foundation and author of

“Creative China City“

p. 22

Global Sector Research

Technology – China: The Elusive Market for US

Technology Companies

Nikos Theodosopoulos

Founder of NT Advisors

LLC and former Wall

Street Technology Equity

Research Analyst

p. 24

Financials – Living in Regulatory Purgatory

Diane Glossman, CFA

Consultant and

Independent Director for

Powa Technologies, WM

Holdings and Ambac

Assurance

p. 28


Sustainable Agriculture: When Less is More

Karla Canavan, CAIA

Commercial Director at

Bunge Environmental

Markets

p. 31

Enhanced Analytics

A Zero Sum Game: Assessing Water Risks in China’s

Mega Infrastructure

Cyrus Lotfipour, Emily

Chew, Shuyuan Jin

MSCI ESG Research

p. 34



The Evolution of Company/Shareholder Engagement

John Wilson

Formerly the Director of

Corporate Governance at

TIAA-CREF and the

Director of Socially

Responsible Investing at

the Christian Brothers

Investment Services

p. 37

Valuation & Accounting

Financial Instrument Accounting: Still Waters Run

Deep

Janet Pegg

Head of Valuation &

Accounting at Cornerstone

Capital Inc. and former

Managing Director and

Analyst of U.S. Accounting

Research at UBS

p. 40

Accelerating Impact


David Robinson

Professor of Finance,

Duke University and

member of the World

Economic Forum’s Global

Agenda Council on Capital

& Financing

p. 43

Sustainable Product Review

Nike Fuelband

Erika Karp

Michael Shavel, CFA

Founder & CEO of


Research & Business

Analyst, Cornerstone

Capital Inc.

p. 46


Food Policy & the Environmental Credit Crunch

Paul Donovan

Julie Hudson

Managing Director and

Global Economist at UBS

Managing Director in SRI

and Sustainability at UBS

They have co-authored

“Food Policy and the

Environmental Credit

Crunch – From Soup to

Nuts”

p. 48

Upcoming Events

Global ESG Calendar

p. 50

Journal of Sustainable Finance & Banking Subscription

Form

Articles

Cornerstone Capital Team

p. 51

p. 53

p. 54


Market Summary

Overview

Despite this past month’s macroeconomic and

political cross-currents, the environment for risk

assets continues to be favorable and volatility

remains muted. In the US, two immediate sources of

monetary and fiscal policy risk were addressed when

the debt ceiling was raised and Janet Yellen was

nominated Chair of the Federal Reserve. The

impasse in Washington appears to have had only a

minor impact on the real economy. Payroll

employment advanced 204,000 in October,

significantly better than the consensus estimate of

120,000, and 3Q GDP expanded by 2.8% annualized,

the highest growth rate in a year.

In Europe, the ECB surprised the market by lowering

its policy rate by 25 basis points to 0.25%. In

addition to easier monetary policy, green shoots are

visible in peripheral countries; Spain emerged from

recession on the back of strong exports, Greece may

achieve a primary budget surplus ahead of schedule,

and Ireland may return to the capital markets by year

end, effectively exiting its bailout.

Meanwhile, the market remains focused on Japan’s

push to increase the consumption tax as well as

progress towards structural reform, particularly in

the labor, healthcare and energy markets. While

macro related risks remain, developed market

equities are taking these in stride as they continue to

push higher on improving economic data and

corporate earnings results.

Conversely, emerging market equities began to close

the performance gap with developed markets in

September and early October, but have since given

back their gains. As such, developed markets are

now outperforming emerging markets by over 26%

year-to-date. This divergence has caught investors’

attention and has sparked debate over the

sustainability of this trend. Investors stepping in to

buy emerging market equities note that valuation is

cheap on historical and relative bases and that

emerging market economies are still experiencing

strong growth, albeit at a slightly slower rate. Others

caution using valuation and GDP growth as

guideposts. Instead, they attribute the depressed

valuation to slower earnings growth and contend that

stock market performance is more closely correlated

to corporate profits than economic growth.

Regardless of their viewpoint, investors recognize the

importance of China’s economy in the context of

global growth and are anxiously awaiting the details

of China’s Third Plenary Session. As of this writing,

there appears to be an element of disappointment

with the official plenum communique as some

believe it failed to yield concrete policy changes. We

question the fairness of this assessment, however, as

initial documents are often intentionally vague.

Moreover, the government affirmed its commitment

to allow markets to play a “decisive role” in the

allocation of resources, a statement that essentially

sets the stage for smaller government.

As we approach the final month of 2013, the

aforementioned performance dispersion between

developed and emerging markets will clearly be a

primary topic of discussion for investors. On a

trailing one-month basis, the MSCI World index

outperformed the MSCI Emerging Markets index by

approximately 580 basis points. Large-cap

underperformance reversed course as the S&P 500

returned 4.6% and outperformed the Russell 2000

by over 200 basis points.

From a sector perspective, there wasn’t a clear

preference for cyclical or defensive sectors. In the

MSCI ACWI (broad index for both developed and

emerging equities), healthcare, consumer staples,

and technology outperformed while utilities,

financials and materials lagged. Looking at the third

quarter earnings season (most companies have

reported at this point), approximately 75% of S&P

500 companies posted a positive earnings surprise, a

modest improvement from the prior quarter. The

top line results weren’t as impressive with only 54%

of companies surprising positively, consistent with

the prior quarter. The technology sector reported the

highest percentage of earnings beats at 88% while

utilities had the fewest at 58%.

The Cornerstone Journal of Sustainable Finance & Banking SM / November 2013 / 8

Market Summary

Market and Global Sector Performance

MARKET / INDEX PERFORMANCE

As of 11/15/13 (local currency) T1M (%) T3M (%) YTD (%) 2014E P/E 2014E P/B 2014E Div. Yield

US Equity Indices

DJIA 4.06 5.63 24.51 13.9 2.6 2.4

S&P 500 4.64 8.34 28.46 14.7 2.3 2.1

Nasdaq 3.97 10.49 33.53 17.5 2.8 1.3

Russell 2000 2.28 8.5 32.89 21.1 1.9 1.2

Developed International Indices

Euro STOXX 50 1.52 8.15 20.41 12.4 1.3 3.9

FTSE 100 2.26 3.65 17.91 12.4 1.7 4.0

CAC 40 2.93 4.88 21.75 12.6 1.3 3.7

DAX 1.33 9.23 20.44 12.3 1.5 3.1

Nikkei 225 3.65 8.84 48.20 17.2 1.5 1.7

ASX 200 3.52 6.72 21.03 14.1 1.9 4.7

Emerging Market Indices

IBOVESPA -4.5 3.71 -12.31 11.0 1.0 3.8

Shanghai Comp -2.61 1.85 -2.98 8.4 1.0 3.4

KOSPI -1.42 2.47 0.61 9.3 1.1 3.5

SENSEX -0.62 9.96 6.62 12.6 2.1 1.9

Global Market Indices

MSCI World 3.46 8.17 24.18 14.2 1.9 2.7

MSCI All-Country World 2.8 7.85 20.67 13.7 1.8 2.7

MSCI EAFE 2.27 7.48 20.74 13.4 1.5 3.4

MSCI Emerging Markets -2.4 5.24 -2.31 10.4 1.4 3.0


MARKET / INDEX PERFORMANCE (CONTINUED)

T1M (%) T3M (%) YTD (%)

Fixed Income

Barclays US Aggregate 0.59 1.5 -1.49

Barclays US Treasury Index 0.38 1.92 -1.9

Barclays Municipal Bond Index 0.84 1.95 -2.48

Barclays Global Agg. (Unhedged) 0.36 1.89 -2.1

Commodities Levels

11/15/13 5/15/13 11/15/12

WTI Crude 93.84 94.3 85.45

ICE Brent Crude 108.5 103.68 110.98

NYMEX Natural Gas 3.66 4.07 3.7

Spot Gold 1290.18 1393.03 1715.75

LME 3mth Copper 6992 7198 7639.5

CBOT Corn 4.22 6.51 7.21

CRB Raw Industrial Spot Index 518.89 524.42 507.17

Currencies Levels

11/15/13 5/15/13 11/15/12

EUR/USD 1.35 1.29 1.28

USD/JPY 100.19 102.25 81.17

GBP/USD 1.61 1.52 1.59

AUD/JPY 93.86 101.21 83.86

DXY Index 80.85 83.83 81.08

Source: Bloomberg, Barclays. Equity Returns: All returns represent total return for stated period. Dividends and coupons are not included

in the DAX and BOVESPA indices. Bond Returns: All returns represent total return for the stated period. Index characteristics: P/E, P/B,

and Dividend Yield are based on Bloomberg consensus estimates for the stated period.


MSCI ACWI SECTOR PERFORMANCE

as of 11/15/13

1 Month Return (%)

Source: Bloomberg. Sector returns are based on GICS

methodology. MSCI ACWI is a free-float weighted equity index

that includes both emerging and developed world markets.

YTD Return (%)

Source: Bloomberg. Sector returns are based on GICS

methodology. MSCI ACWI is a free-float weighted equity index

that includes both emerging and developed world markets.

U.S. EQUITY STYLE PERFORMANCE

Style box returns are based on Russell Indices with the exception of the Large-Cap Blend box, which reflects

the S&P 500 Index. All values are cumulative total return for the stated period including the reinvestment of

dividends. The index used from left to right, top to bottom are: Russell 100 Value Index, S&P 500 Index,

Russell 1000 Growth Index, Russell Mid Cap Value Index, Russell Mid Cap Index, Russell Mid Cap Growth

Index, Russell 2000 Value Index, Russell 2000 Index and Russell 2000 Growth Index.

1 Month

Source: Bloomberg

Year to Date

Source: Bloomberg

0 1 2 3 4 5 6

Healthcare

Info Tech

Cons Disc

Energy

Materials

Utilities

-10 0 10 20 30 40

Cons Disc.

Healthcare

Industrials

Info Tech

MSCI ACWI

Financials

Telecom

Cons Staples

Energy

Utilities

Materials

4.2

Value Growth Blend

2.3

3.9

4.6

2.3

3.7

4.7

2.2

3.5

Mid

Larg

e

Sm

all

29.1

28.7

31.1

28.5

32.9

31.4

29.0

37.3

31.5

Value Growth Blend

Sm

all

Larg

e

Mid


SECTOR SNAPSHOT – TOP 5 COMPANIES BY MARKET CAP

as of 11/15/13

Company Name Ticker Industry

Mkt Cap (US$ Bn) Currency

Price (Local)

Total Return YTD % (local)

P/E 2013E

EV/ EBITDA 2013E

Div Yield

% 2013E

Consumer Disc. Toyota Motor Corp 7203.JP Automobiles 219.1 JPY 6370.00 62.6 11.0 10.1 N/A

Amazon AMZN Internet & Catalog Retail

169.0 USD 369.17 47.2 149.9 32.6 N/A

The Walt Disney Co

DIS Media 126.0 USD 70.00 40.6 17.8 10.4 1.1

Comcast Corp CMCSA Media 124.3 USD 47.73 29.5 19.2 7.8 1.6

Volkswagen VOW3.GR Automobiles 118.3 EUR 194.00 15.4 9.5 7.5 1.8

Consumer Staples

Wal-Mart Stores WMT Food & Staples Retailing

257.0 USD 79.22 18.3 15.3 8.5 2.4

Nestle SA NESN.VX Food Products 235.9 CHF 66.90 15.8 19.4 13.6 3.1

The Proctor & Gamble Co

PG Household Products

230.6 USD 84.84 28.9 19.8 13.0 2.8

The Coca-Cola Co KO Beverages 177.6 USD 40.22 13.4 19.2 14.3 2.8

Anheuser-Busch Inbev

ABI.BB Beverages 168.7 EUR 77.75 22.0 22.0 12.7 1.5

Energy

Exxon Mobil XOM Oil, Gas & Consumable Fuels

416.2 USD 95.27 13.1 12.8 5.7 2.6

Chevron CVX Oil, Gas & Consumable Fuels

230.9 USD 120.06 14.7 10.5 4.4 3.3

Petrochina Co 857.HK Oil, Gas & Consumable Fuels

228.7 HKD 8.83 -16.2 10.1 5.3 4.2

Royal Dutch Shell RDSA.LN Oil, Gas & Consumable Fuels

217.9 GBp 2095.00 4.2 9.5 4.2 5.5

BP Plc BP/ LN Oil, Gas & Consumable Fuels

147.2 GBp 488.10 20.9 10.4 4.4 5.4

Financials

Berkshire Hathaway- CL B

BRK/B Diversified Financial Services

286.6 USD 116.30 29.7 18.9 N/A N/A

Wells Fargo & Co WFC Commercial Banks

229.4 USD 43.54 31.1 11.3 N/A 2.8

Ind & Comm Bank of China

1398.HK Commercial Banks

223.8 HKD 5.33 3.0 5.7 N/A 5.7

HSBC Holdings Plc HSBA.LN Commercial Banks

207.6 GBp 687.00 10.9 11.7 N/A 5.0

JPMorgan Chase & Co

JPM Diversified Financial Services

206.3 USD 54.87 28.3 11.5 N/A 2.8


SECTOR SNAPSHOT – TOP 5 COMPANIES BY MARKET CAP (CONTINUED)

as of 11/15/13


Mkt Cap (US$ Bn)

Currency

Price (Local)


P/E 2013

E

EV/ EBITD

A 2013E

Div Yield

% 2013

E

Health Care Johnson &

Johnson JNJ Pharmaceuticals 266.3 USD 94.39 37.8 17.2 10.9 2.8

Roche Holdings ROG.VX Pharmaceuticals 240.4 CHF 255.10 43.4 17.0 11.7 2.9

Novartis AG NOVN.VX Pharmaceuticals 213.8 CHF 72.25 30.4 15.3 13.4 3.2

Pfizer PFE Pharmaceuticals 213.2 USD 32.20 32.7 14.8 8.4 3.0

Sanofi SAN.FP Pharmaceuticals 143.2 EUR 79.91 15.7 15.5 10.3 3.5

Industrials General Electric

Co GE Industrial Conglomerates 275.2 USD 27.20 32.7 16.7 10.1 2.8

Siemens AG SIE.GR Industrial Conglomerates 115.0 EUR 96.69 25.9 14.3 9.4 3.1

The Boeing Co BA Aerospace & Defense 102.3 USD 136.08 84.2 20.8 11.2 1.4

United Technologies UTX

Aerospace & Defense 99.6 USD 108.59 35.4 17.6 10.8 2.2

United Parcel Service UPS

Air Freight & Logistics 93.7 USD 100.94 40.8 21.2 10.8 2.5

Info Tech

Apple AAPL Computers & Peripherals 472.4 USD 524.99 1.1 12.1 5.8 2.3

Google GOOG Internet Software & Services 345.3 USD 1033.56 46.1 23.5 13.6 N/A

Microsoft Corp MSFT Software 315.9 USD 37.84 44.8 14.2 8.1 3.0 Samsung Electronics

005930.KS

Semiconductors & Semiconductor 202.6 KRW

1462000.00 -3.9 11.1 3.4 0.5

IBM IBM IT Services 198.9 USD 183.19 -2.5 10.9 8.4 2.1

Materials BHP Billiton Ltd BHP.AU Metals & Mining 179.8 AUD 37.89 5.7 13.4 6.7 4.6

Rio Tinto Ltd RIO.AU Metals & Mining 100.8 AUD 65.51 2.2 12.2 6.9 4.0

BASF BAS.GR Chemicals 96.5 EUR 77.87 13.4 14.6 8.5 3.3

Saudi Basic Ind. SABIC.AB Chemicals 87.0 SAR 108.75 27.7 12.3 6.9 3.7

Vale SA VALE3.BZ Metals & Mining 79.9 BRL 35.88 -10.5 7.1 4.9 0.7


SECTOR SNAPSHOT – TOP 5 COMPANIES BY MARKET CAP (CONTINUED)

as of 11/15/13


Mkt Cap (US$ Bn) Currency

Price (Local)


P/E 2013E

EV/ EBITDA 2013E

Div Yield

% 2013E

Telecom

China Mobile Ltd 941.HK Wireless Telecommunication Ser

210.0 HKD 81.00 -6.4 10.2 3.4 4.3

AT&T T Diversified Telecommunication

187.1 USD 35.43 10.6 14.3 6.4 5.1

Vodafone Group VOD.LN Wireless Telecommunication Ser

180.7 GBp 231.35 55.5 16.2 10.6 5.0

Verizon Communications

VZ Diversified Telecommunication

144.0 USD 50.31 21.5 17.8 5.7 4.2

Softbank Corp 9984.JP Wireless Telecommunication Ser

92.7 JPY 7740.00 148.4 21.5 9.1 0.5

Utilities

GDF Suez GSZ.FP Multi-Utilities 57.4 EUR 17.63 23.4 12.7 7.1 8.5

EDF EDF.FP Electric Utilities 66.0 EUR 26.47 96.5 14.3 5.3 4.7

Duke Energy DUK Electric Utilities 50.7 USD 71.80 17.6 16.6 10.7 4.3

National Grid Plc NG/ LN Multi-Utilities 46.5 GBp 774.00 14.0 14.9 9.6 5.9

Enel SpA ENEL.IM Electric Utilities 41.8 EUR 3.29 11.5 10.3 6.5 4.6

Source: Bloomberg. The securities in each sector represent the largest companies by market cap in the MSCI ACWI in their respective

sectors. Sector classification is based on GICS methodology. Equity characteristics: P/E, EV/EBITDA and Dividend Yield are based on

Bloomberg consensus estimates for stated period.

GDP / CONSUMER PRICE INFLATION / RATES

Region/Countries Real GDP (% YoY) CPI (% YoY) Official Rates Long Rates

2012A 2013E 2014E 2012A 2013E 2014E 2012A 2013E 2014E 2012A 2013E 2014E

United States 2.8 1.7 2.6 2.1 1.5 1.9 0.25 0.25 0.25 1.8 2.8 3.3

Euro Area -0.7 -0.3 1.0 2.5 1.5 1.5 0.75 0.38 0.50 1.3 - -

Europe -0.3 0.1 1.4 2.3 1.5 1.6 0.70 0.44 0.55 2.6 2.8 3.1

Japan 2.0 1.9 1.6 0.0 0.3 2.3 0.10 0.10 0.10 0.8 0.8 1.0

United Kingdom 0.2 1,4 2.2 2.8 2.7 2.3 0.50 0.50 0.50 1.8 2.7 3.3

Australia 3.7 2.5 2.7 1.8 2.4 2.6 3.00 2.50 2.63 3.27 4.10 4.44

China 7.7 7.6 7.4 2.7 2.7 3.2 6.00 6.00 6.00 3.6 4.0 4.1

Brazil 0.9 2.5 2.5 5.4 6.1 5.9 7.25 9.88 10.13 9.2 - -

India 5.1 4.6 4.7 9.3 8.8 9.2 7.00 6.88 6.40 8.2 8.6 8.0

Source: Bloomberg. Estimates are composite of Bloomberg contributor estimates.

MONETARY POLICY

Oct-13 Apr-13 Oct-12

Monetary Base growth (YoY)

37.3% 13.8% 0.2%

M-2 growth (YoY)

6.6% 7.0% 7.7%

Money multiplier (M-2/mon base) 3.03 3.48 3.9

3Q13 3Q12 3Q11

Velocity of money (GDP/M-2)

1.54 1.63 1.66

Source: Federal Reserve Bank of St. Louis


KEY ECONOMIC CHARTS

C&I Loan Growth (%)

Source: Bloomberg

University of Michigan Survey of Consumer Sentiment

Source: Bloomberg

NFIM Small Business Optimism Index

Source: Bloomberg

ISM Manufacturing Purchasing Managers Index

Source: Bloomberg

U.S. Treasury Yield Curve

Source: Bloomberg

U.S. Initial Jobless Claims

Source: Bloomberg

-25

-20

-15

-10

-5

0

5

10

15

20

25

301960

1963

1966

1969

1972

1975

1979

1982

1985

1988

1991

1994

1998

2001

2004

2007

2010

% Y

oY

50

60

70

80

90

100

110

120

19

78

19

80

19

82

19

84

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

12

70

75

80

85

90

95

100

105

110

19

74

19

79

19

84

19

87

19

88

19

90

19

92

19

93

19

95

19

97

19

98

20

00

20

02

20

03

20

05

20

07

20

08

20

10

20

12

20

30

40

50

60

70

80

19

60

19

62

19

65

19

68

19

71

19

74

19

77

19

79

19

82

19

85

19

88

19

91

19

94

19

96

19

99

20

02

20

05

20

08

20

11

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

1M 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 30Y

%

11/15/13 5/15/13 11/15/12

100

200

300

400

500

600

700

1967

1969

1971

1973

1975

1978

1980

1982

1984

1987

1989

1991

1993

1996

1998

2000

2002

2005

2007

2009

2011

(000s)


Featured Editorial

The Societal Value of Derivatives

By Erika Karp, Founder & CEO, Cornerstone Capital Inc.

©sjgh/Shutterstock

This comment reflects a recent dialogue between colleagues

from across various functions of the capital markets.

As a veteran of an industry that has been at the cutting edge of both

public and regulatory scrutiny for the past half decade, a huge lament is

the lack of any opportunity for an honest and open discourse on the

place derivatives play in our society. Why is it worth continuing to

pursue such an opportunity? The simple answer is that the flexibility of

the nation’s business model rests in part on both simple and innovative

financing techniques, and that increasing the cost of these techniques

will trickle through the economy, making our lives more difficult and

expensive.

Why should the average borrower on Main Street care?

Well consider the two primary products that this business owner, let’s

call him Paul, is going to use in his lifetime, the humble mortgage and

the fixed rate bank loan that helped him expand his business. Both are

loans that have been packaged with derivatives. Neither the mortgage

nor the loan offers Paul the same degree of financial flexibility without

the embedded options that allow him to prepay or refinance when rates

go lower or his cash flow increases, or he changes his mind and sells his

house and business to move to warmer climes.

Consider life without the option to prepay, and yes, this is an interest

rate derivative, whose price will be affected by not only Dodd-Frank, but

the global effort to reduce banking risk that includes Basel. Let’s go to

the ultimate extreme of no optionality – well, Paul’s decision to buy a

house now depends not just on his income and opportunities but his

view on interest rates. In particular, if he takes out a fixed-rate

mortgage, his flexibility to sell his house, move and otherwise prepay,

will be materially reduced when rates go down, because he will owe

more than what he originally borrowed. Just like any bond whose value

rises as rates fall, Paul’s mortgage note will be worth more when he

wants to prepay. Alternatively he can take out a floating-rate mortgage

that mitigates this risk if rates were to fall, but he is exposed to the exact

opposite risk that rates rise and his monthly payments increase.

It is not just the humble mortgage, both the cornerstone of our economy

and the instrument at the center of our financial debacle, that will be

affected, but also the traditional business loan. That loan is constructed


Erika Karp is the Founder & Chief

Executive Officer of Cornerstone

Capital Inc. and the former Head

of Global Sector Research at UBS

Investment Bank.

much like the mortgage, albeit materially shorter in duration. Reducing

prepayment flexibility or increasing its cost will change the decision

making process for borrowers and reduce their ability to contribute to

the growth of the nation.

It is still not too late to change the nature of the debate from the

continuing theme of, “LENDING GOOD, DERIVATIVES BAD” that has

driven politicians for the past 5 years. We need to allow arguments to

be presented with empirical evidence and we need regulators to be

considerate of these. Moreover we need to give some time for the

current set of rules to be implemented so that a reasonable study of the

costs versus benefits can be estimated. Only then should we consider

forcing further change on markets and institutional participants that

have already undergone significant structural changes over the past 3

years. If we don’t allow the discourse generated by empirical evidence

or don’t take the time to understand the potential consequences of

further changes, we may be materially poorer for it.


Featured Domain

TheLastPanda.org

By Erika Karp, Founder & CEO, Cornerstone Capital Inc.

Each month in the Cornerstone Journal of Sustainable Finance & Banking (JSFB), we will offer thoughts on a

“Featured Domain” which is selected from our proprietary “Sustainable Domain Bank”. The Cornerstone

“Sustainable Domain Bank” contains 2,000+ addresses on the Internet which are an articulation of business

processes, business practices, and aspirations for a more regenerative form of capitalism. Many of these

domain names have the potential to be developed into business plans reflecting a robust interpretation of

sustainable capitalism and finance. In particular, each “Sustainable Domain” captures a principle, or reflects

a value inherent in the systematic understanding of the Environmental, Social, and Governance (ESG)

imperatives facing businesses and the economy today. Each Domain is intended to facilitate dialogue across

functions and sectors of the capital markets; and each is available for collaborative partnership, purchase or

transfer should it have particular appeal to Cornerstone clients and colleagues.

This week marked the convening of the World

Economic Forum's annual Summit on the Global

Agenda held in Abu Dhabi, UAE. It's notable this

year that the various Global Agenda Councils (GAC)

will be moving more closely together to cross-fertilize

ideas and initiatives. Throughout the venue we are

reminded of the facts around risks to improving the

state of the world.

But, the state of the world is most certainly being

threatened by the prospects of what scientists call

"The sixth great extinction" into which we have

entered. We need to elevate the consciousness of our

population that although not as immediately

dramatic as an asteroid collision, the crisis affecting

biodiversity is major: current estimates are that

species’ extinction is 1,000 more than the natural

rate. The present patterns of human behavior

including consumption, industrialization and

transportation, are leading us towards the prospect

of witnessing the birth and death of "The Last

Panda". Linear economic development, based on

depleting natural resources and accumulating waste

in the environment, is not a sustainable business

model. Today, most of mammals, birds and

amphibians’ existence is affected by habitat loss and

degradation. Beyond the panda, many other iconic

species such as the tiger (3,500 individuals

©Hung Chung Chih /Shutterstock

remaining in the wild), the mountain gorilla (800) or

the Iberian lynx (less than 150) are endangered or

critically endangered, which means that there is a

risk our children will never see these species in their

natural habitat.

Circling back to the work of the WEF's GAC on

Sustainable Consumption reminds us that 72% of

consumers are willing to buy green, yet only 17%

do. And, as is well known across the realm of


business and economics, if you can't measure

sustainability, you can't manage it. So we highlight

that the GAC on Biodiversity & Natural Capital

argues that 13% of global economic output comes

from declining natural resources which raises the

pivotal question: How do we ensure that economic

growth and biodiversity preservation correlate?

Can the private sector encourage corporate

sustainability whereby businesses relentlessly pursue

material progress towards a more regenerative and

inclusive economy? Can capitalism do its part to

preserve the value of the eco-system services of the

planet?

At the Global Agenda Councils of the World

Economic Forum, we say "yes".

With greater consciousness and transparency on the

issues, a prioritization of long-term thinking,

appropriate incentive structures, and the

acceleration of capital flows to innovative small and

medium-sized businesses in collaboration with the

public sector and the many engaged NGOs, we think

capitalism can do its share to help find solutions to

avoid our bidding farewell to “The Last Panda.”

As mentioned in the “Accelerating Impact”

section on page 44, we again encourage our readers

to complete and share the WEF survey at

http://sites.duke.edu/gacfinance.

Erika Karp is the Founder & Chief Executive Officer

of Cornerstone Capital Inc. and the former Head of

Global Sector Research at UBS Investment Bank.




China Threat ? The Challenges, Myths, and Realities of China’s Rise

By Lionel Vairon, Author of the "China Threat? The Challenges, Myths and Realities of China's Rise" and

former diplomat to Cambodia, Thailand, Iraq.

Three decades ago, when Deng Xiaoping launched the “Four

Modernizations” and opened up China to the world, after thirty years of

Maoist “permanent revolution”, claiming that making money was not a

sin and that all receipts to promote the development of China were

acceptable – “do not care if the cat is black or white, what matters is it

catches mice” -, Western leaders and entrepreneurs were delighted and

saw bright prospects in the biggest demographic power of the time. If

the first decades met their expectations, with billions of dollars being

invested in joint ventures in China and US and European companies

offshoring, the picture started to change as China started to emerge as a

global economic power and started conquering overseas markets

through low-cost bidding and State financial support. Then China’s

image suffered a vast change in the media and the official discourses,

focusing the attacks on the political system and human rights violations.

After almost five centuries of complete domination of the world by

Europeans and one century of US domination in the international

relations, Western countries found it hard to cope with the rise of a non-

Western country which was competing globally with them and, above

all, refusing to acknowledge the “superiority” of Western values. The

cultural misunderstandings became the dominant rule to analyze

China’s rise, Chinese leaders’ behavior and Chinese policies. The Maoist

era was quite easy in that respect, all moves were put under the term

“communist”, which was a familiar ideology in the West. But Chinese

leaders’ new policies, a mix of communism, capitalism, Confucianism

and cultural traditions were much more difficult to understand

properly.

In this context, China became recently the world’s second largest

economy after the US and is predicted to become the largest

somewhere around 2030 according to American experts. This book

“China Threat?” aims at giving a more balanced, less ideological view of

this major 21st century event which is the rise of China as a superpower,

and tries to explain all the different sides of Chinese policies, from

economy to human rights, while stressing the true reasons to be

concerned – like the rise of nationalism – and demystify some

prejudices and biased about issues like military power or religious

freedom.

Misunderstanding is probably the most important challenge the West


Lionel Vairon, PhD is the Author

of the "China Threat? The

Challenges, Myths and Realities

of China's Rise" and former

diplomat to Cambodia, Thailand,

Iraq. He has a PhD in Far

Eastern Studies and Masters in

Chinese language and culture and

in Political Science and is well

versed on China related current

events, including areas of politics,

security, corruption, human

rights, media and more.

faces when it comes to China. And this is a dangerous issue. When a

partner’s or adversary’s moves are wrongly assessed, as Hans J.

Morgenthau clearly stressed in “Politics among Nations”, both sides

start spiraling out of control, which can finally lead to war. Chinese

people, not only their leaders, do not look at the world the same way as

we Westerners do. They have a thousand years of history, of strongly

entrenched cultural traditions and the strong awareness that they

belong to a very sophisticated civilization which used to dominate most

of Asia for centuries. Doing business with China, or negotiating political

issues, needs a clear awareness of these factors and respect for the

differences. In all fields, including human rights, China has made

tremendous progresses since 1978; one just has to remember the decade

of the so-called “Cultural revolution” until 1977, which left millions

dead, to understand the changes. Today China still has an autocratic

political system and many shortcomings, but there is no chance to go

back to these years and see the killing of millions of people. China is

part of the global economic and financial system, the limits of its

autocratic policy lie in its inclusion in the world’s economic system

which can break its growth suddenly through financial instruments,

mainly the stock markets, in case of red lines being crossed.

China looks as a threat today for many Westerners because it has been,

in fact, too successful until now without accepting some of the Western

diktats. When the economic growth was too high, a few years ago,

analysts and politicians considered the situation as a main threat for

their own economies and asked Chinese leaders to slow down. With the

2008 crisis, the Chinese economy started to slow, approaching a level

around 7% in 2013, and is accused of being a threat for global economic

growth. This has been China’s fate for the last 15 years. No matter which

direction it takes, criticisms will move from one aspect to another

without rationality, many times without considering China’s own

challenges and interests. In fact, Chinese leaders are often asked by the

West to privilege other countries’ economies and help them solve their

problems at the expense of its own problems. This is what makes

Chinese people angry and less accommodating towards US and

European requirements.

Therefore, this book tries to show that China is not a threat by nature

but a threat by reaction. The only way to deal with this 21st century

challenge is to accept cultural and political differences, respect each

other’s constraints and cooperate rather than play the old game of Cold

War through strategies like Pivot to Asia, which is certainly a good

strategy for the US when it comes to privileging Asia rather than sinking

in the Middle East. However, this is not a sound strategy when it

consists of engaging Asian countries militarily to increase tensions

around China in order to regain a high profile in this region after years

of neglect. Despite all propaganda discourse from Washington in an

http://www.amazon.com/Lionel-Vairon/e/B00EKP1NRA




attempt to prove this new policy is not the start of a new Cold War, all

countries of Asia, not only China, realize that they are clearly the target

and they are not happy about it, even those who face tensions with

China. The exception, perhaps, is the Philippines, which is completely

aligned with the US and adopted the most provocative behavior towards

China in ASEAN.

Peaceful rise, as Chinese call it, will mostly depend on the way which

Western countries accommodate this process and, if they are ready to

give China, regardless of its political system, the place it deserves in the

international order that was completely designed by Western countries

decades ago. If not, then China will become a threat as nationalism will

continue to grow and become less and less tolerant for US policies in

Asia.



“Extremes vs. Realities: Opportunities for China’s Urban Development”

By Zheng Xioaping, Principal of Bazo, Founder of China City Development Foundation and author of

“Creative China City”

Watching from the sidelines, China’s urban

development sector can be as dazzling as the Beijing

opera – playing grey roles as overbuilt vacant

districts, pollutions and inflated regional real estate

bubbles; the upbeat characters are presented by the

unprecedented scale of urbanization and abundant

market opportunities. Backstage, however, we see a

lineup of new performers that are moving into the

limelight; among them are grand-scale sustainable

projects and multiple innovative project financing

models. China is initiating open policies to bridge

sustainable urban projects for investment capital; the

first is its RMB 40 Trillion (US $6.4 Trillion) idling

private savings in the banks, and second is the global

institutional capital that can potentially benefit from

China’s quality urban projects.

On 11th November 2013, the China’s third plenum of

the 18th Party Congress pledges to give market

competition a decisive role, and to strengthen

China’s economic and financial reform. This will

further facilitate several emerging investment sectors

for private and foreign capitals to engage.

Primary land development: An investment

sector that lies mainly within reach by state-owned

capital now opens for private participation. Sichuan

Province announced in October 2013 a five-year

investment plan of urban development and

infrastructure projects totaling RMB 4 Trillion (US $

0.65 Trillion), 70% of the capital aiming to be raised

from the private sector.

Senior facility and housing: China’s senior

population now toped 200M, yet the market does not

have a single name brand in senior facility operation.

Much less fortunate compared to the people in

developed countries; the majority of Chinese senior

© Aleksandr Markin/Shutterstock

citizens are getting old before they get rich, and this

trend, coupled with the inevitable consequence of its

one-child policy, forces China to produce a range of

supporting structures and institutional capital

encouraging the well development of the senior

sector, including welcoming the engagement of

foreign capital and experienced senior facility

operators.

Green urban development and products: As of

2011, China has over 230 cities that have labeled

themselves as eco-cities. In August 2013, the

Minister of Housing and Urban-Rural Development

announced its second listing of a testing region for

the concept of Intelligent Cities, upgrading the total

number to 193 cities nationwide. This opens vast

opportunities for new technologies, sustainable

concepts, and environmentally friendly products that

embracing the green movement.


Leisure and waterfront development: With

declining exports after the global financial crisis and

excessive capacity in many industry sectors, China is

steering its focus to stimulate internal spending; this

has led to large-scale leisure and tourism projects

along its coastal and scenic regions. Zhuhai, a third-

tier city next to Macao and Hong Kong, is conducting

waterfront urban planning for its 1700-square-

kilometer urban and suburban regions. Zhuhai is

aiming to be part of the second Free Trade Zone after

Shanghai and to be the marina hub for southern

China. About 30 other waterfront cities are

conducting similar ambitious forward-thinking

planning and development.

When literally thousands of cities and urban projects

are being developed at the same time, the scalability

of effective operational structure is critical, and two

types of tasks rise to importance:

1. Focused research leading to the

establishment of favorable policies and

sustainable operating structures. Such

structures shall measure and shape a range

of urban projects from inception to

development nationwide.

2. Innovative financing models that can

incubate sustainable projects and facilitate

cross-border capital collaboration. Such

models have to be scalable in order to meet

the size and speed of market demand.

With the above principles in mind, teams of Chinese

urban development and finance institutes are

exploring efficient project operating structures that

can consolidate the following domestic and global

resources:

High-quality urban projects in China

Expert teams establishing the frameworks

Domestic capital reducing the project risk

Channels for foreign capital entering China

Overseas institutional capital in scale

When the puzzle pieces are in place, many forward-

looking operational structures are under initiation

and taking shape. These include a research focus on

cross-border capital collaboration and risk

mitigation, a typical financing model that engages

multilateral investment guaranteed to reduce cross-

border investment risk, a green urban development

financing center as an effective incubation hub for

top-quality urban projects from China and southeast

Asia, a line of effort in reviewing and adopting

mature industry standards that can assist niche

sectors of sustainable urban development, and a joint

fund structure that aims to engage Sharia compliance

capital from both side of the borders.

The list goes on with variations; however, the

underlying message is clear – this is an era in which

to connect worldwide resources to opportunities, and

all of us can contribute to and benefit from them. If

there is one domain in the world that is open for

testing innovative sustainable concepts; that has the

market size for global participation; that can match

domestic investment with large-scale institutional

capital from overseas, that domain is China’s urban

development. Positive outcomes and valuable

experiences during the process shall benefit all

participating parties and can be scaled beyond China

to become open welfare for other developing

countries.

While watching from the sidelines, the Beijing opera

can be fun, taking part on stage and shaping the play

to new highs can be much more rewarding.

Zheng Xiaoping is the Vice President of the China

City Development Foundation (CCDF) and Director

of BAZO.


Global Sector Research / Technology

China: The Elusive Market for US Technology Companies

By Nikos Theodosopoulos, Founder of NT Advisors LLC

Apple Store in Hong Kong. ©Helgidinson /

Dreamstime

China ranks as the world’s largest country by population, second in

annual GDP and is likely to rank second in terms of total Information

Technology spending in 2013 at about 10% of global IT spending. It is

estimated by industry analysts that China will grow its IT spending by

close to 10% per year over the next decade as IT spending only

represents about 2% of GDP which is less than half the level of more

developed countries like the US. While China represents a large and

rapidly growing market for US technology companies, the path to

success in this market has proven difficult and sometimes impossible

due to indigenous suppliers, intellectual property protection and

software piracy issues, pricing challenges and other unique market

conditions. China has also grown its own global technology

powerhouses in certain industries like communications equipment and

personal computers, materially impacting the competitive dynamics for

traditional US and European players in not just the China market, but

also the entire global technology market. Finally, China has also

developed its own Internet powerhouse companies that have made it

difficult for leading US Internet and social media companies to succeed

in China. Is China “friend or foe” for US technology companies, and

has history provided technology companies any lessons on sustainable

business practices that can be applied to the Chinese market?

Over the past three decades there have been many failures and

lackluster successes by US technology companies seeking to enter and

profitably grow in the China market. A recent high profile example was

Google, who decided to exit the China market in 2010 after only about

five years of formally entering the market with its own development

center in China (and an earlier failed attempt to acquire local

competitor Baidu). Baidu’s market share only increased from the mid

40s to the mid 60s in the five years following Google’s entry which was

significantly higher than the 30%-35% share that Google was able to

achieve during that period. While Google pointed to censorship issues

as the main driver to leaving the China market, it was also clearly the

case that Baidu did a better job of understating the local market (e.g.

mandarin language searches, music downloads that “crossed” the line

on piracy issues etc.) which contributed to Google not being a success in

the search engine market in China as it was in other markets around the

world.

Google was not the only US Internet giant that failed to achieve its goals

in China, as Yahoo and EBay entered and exited as well. Both used


Nikos Theodosopoulos is the

Founder of NT Advisors LLC, a

consulting and advisory firm for

the Technology Industry. Prior to

founding NT Advisors LLC in

2012, Nikos was a Wall Street

Equity Research Analyst for 18

years covering the Technology

Sector, primarily at UBS

Investment Bank.

acquisitions of Chinese-based companies as part of their respective

entry strategies, but Yahoo could not effectively compete with Baidu in

the search market while eBay lost out to Taobao.com (owned by

Alibaba) in the online auction market. In both cases, both eBay and

Yahoo did not do a good job in understanding the local China market

nuances for search and on-line auctions. Yahoo at least made a

financially smart decision to exit the market and invest in competitor

Alibaba, which took over its Internet operations. It is estimated by

some analysts that Yahoo’s investment in Alibaba is worth 50% or much

more of Yahoo’s current market capitalization.

In all the cases above, US Internet companies stopped their efforts in

China within about a five-year period. While the Internet may move a

rapid pace of innovation, business success in China, especially in the

technology sector, takes a much longer-term commitment. Google’s

CEO, Eric Schmidt, initially stated that China had 5,000 years of history

and Google would have 5,000 years of patience in China. At is turned

out, Google, eBay and Yahoo only had about 5 years of loss-making

patience. Unfortunately for US Internet companies, China continues to

grow much faster than the US in on-line sales and is likely to surpass

the US within the next couple of years as evident by China “crushing”

the on-lines sales record on November 11th, 2013 as part of China’s

annual “Single’s Day” national promotion.

While US Internet companies have generally not faired well in China

against local competitors and did not commit to the market long term,

IT equipment suppliers have also had a difficult time. In addition to

overcoming the local culture and other business challenges in China, IT

equipment suppliers have also generally experienced some level of

Intellectual Property or software piracy issues in the China market,

which has contributed to difficulties in succeeding the market. For

example, according to the World Economic Forum, China ranks 79th in

in the world in Software Piracy Rate vs. the number one ranking of the

United States in 2011. China did fair relatively better in IP protection

ranking 51st vs. 29th for the United States.

The concern over protecting IP and pirating software has been an

obstacle for US technology companies seeking to expand their sales

business operations in China. Taking legal action by US technology

companies has often backfired. For example, Cisco Systems’ first-ever

corporate lawsuit on IP was against Chinese based Huawei in 2003,

which allegedly copied Cisco manuals and software code. Cisco

dropped the lawsuit in 2004 after remedy actions by Huawei, but in my

view the lawsuit cost Cisco more in reputational risk than any benefit

from the lawsuit. To this day, China represents less than 5% of Cisco’s

total sales in China and the company often highlights China as being

“unique” for Cisco when discussing its sub-par performance in the


country. Microsoft has faced software piracy issues around Windows

for PCs in China since the company entered the market in 1992. The

issue of piracy in China is still an issue today for Microsoft as evidenced

from its recent earnings call where it disclosed for the first time the

performance of its Windows business with and without China (i.e.

Windows is declining more rapidly in China than the rest of the world).

Microsoft is hoping to reduce piracy of software by selling cloud-based

versions of its consumer software, thus, hopefully eliminating over time

the availability of pirated software disks sold on the streets.

Cisco's problems in China have intensified recently as the company's

orders from China fell 18% in its recent October 2013 quarter. Cisco is

likely feeling the backlash of Huawei's years of struggle and ultimate

failure in building a US business, which was exacerbated by recent press

reports on spying by the US National Security Agency. Other large US

technology companies like IBM and HP also witnessed recent weakness

in China and there is now a growing view on Wall Street that US tech

firms are seeing slowing sales in China due to the NSA spying claims. It

is interesting that Franco-American company Alcatel-Lucent

announced the day after Cisco reported its poor China results that it had

won the largest market share in China Mobile's network for Enhanced

Packet Core technology among all vendors (including Chinese based

vendors). Alcatel-Lucent sells in China through a joint venture

established in 1984. Perhaps Alcatel-Lucent is not feeling the same

issues as other large US technology firms because it is technically a

French company, but it's long standing JV and the relationships

established by this JV in China also has likely played a role in its ability

to so far overcome the political backlash that others have experienced.

While China based Internet companies like Baidu (search engine),

Alibaba (e-commerce) and Tencent (social media and gaming), have

generally become dominant in their home market, China based IT

centric companies Huawei and Lenovo have established global

businesses which have led to weakening fundamentals for Western

suppliers of communications equipment and personal computers.

Huawei generated sales of $35.4 billion in 2012 and is now comparable

in size to Western leaders Ericsson and Cisco. The dramatic success of

Huawei over the past fifteen years contributed to the bankruptcy of

Nortel, the failed mergers of Alcatel with Lucent and Nokia with

Siemens, and the lackluster stock performance of Ericsson and Cisco.

Lenovo became the world’s largest supplier of personal computers in

2Q13 with both IDC and Gartner estimating their market share at 16.7%

surpassing both HP and Dell for the first time. In 2009, Lenovo ranked

fourth in the world in PC shipments with about 7% share. While HP

and Dell continue to suffer from the fundamental shift from PCs to

tablets and smartphones, the loss of market share to Lenovo over the

past few years intensified this fundamental issue for both companies


and likely was a contributing factor to Dell deciding to go private

through an LBO to realign the company and pursue a more Enterprise

IT and services strategy.

While US Internet companies and global IT equipment suppliers such

as Microsoft, Cisco, HP and others have had either difficulties

succeeding in the China market, or face significant competitive

pressures from China based IT global competitors such as Huawei and

Lenovo, there are examples of US technology companies that have

succeeded in selling in China and competing globally against Chinese

based competitors over an extended period of time. Two such

companies are Apple and Corning. Apple currently generates about 15%

of total sales from Greater China and its operating margin in China is

generally comparable with other regions. This level of success has been

achieved with Apple not yet selling iPhones to China Mobile, the largest

mobile operator in the world based on subscribers. Apple has also been

vocal and active on improving working conditions in China among its

supply chain companies including conducting annual audits on its

suppliers; thus, thus likely helping its reputation in the country.

Corning has been in China for 25 years and competes effectively in

catalytic converter substrates, LCD glass display and fiber optic cable.

China represents 26% of Corning total sales and is the company’s

largest country by annual sales. Corning attributes it success in China

to having a very long-term perspective, developing relationships with

key leaders at the local and national level on important issues such as IP

protection, investing in local manufacturing and developing extra

checks and balances on potential IP protection issues.

While there is no magic formula for succeeding in the China market as a

technology company, there are some common threads among

companies that have shown success in the market. These include, truly

showing (not saying) a long-term commitment to the country,

developing key relationships (including JVs) at the local and national

level to help support a fair playing field and protection of IP, local

manufacturing through long lived assets and R&D, understanding the

risks of reputational damage when taking legal or other public action

against a local company and enacting unique processes to help ensure

IP is maintained. Having products or a distribution of products that

make pirating or copying of your products difficult, is also a big plus.


Global Sector Research / Financials

Living in Regulatory Purgatory

By Diane B. Glossman CFA, who serves as an Independent Director at Powa Technologies, WMI Holdings

and Ambac Assurance.

©Lightspring/Shutterstock

Financial services regulation continues to become more complex and

even contradictory. The regulatory response to the last crisis continues

to broaden and deepen its impact on the banking industry. This has

touched virtually all players involved in a variety of the products and

market segments occupied by commercial banks and broker/dealers –

debt and equity intermediators, corporate and consumer lenders,

deposit taking organizations, payments companies, and exchanges, to

name but a few.

The accountants have also been adding insult to injury particularly via

serial changes in accounting for credit losses and extending fair value

accounting across more of the balance sheet, such that both trend

analysis and comparisons between institutions has been made even

more complicated.

Once upon a time, a “successful” commercial bank generated a return

on assets and equity over 1% and 15%, respectively, during a period of

higher inflation, with somewhat less attention paid to the degree of

leverage. As a particularly pointed example, on the back of what was

then described as the LDC crisis (the annual restructuring of primarily

Latin American sovereign debt) – Citicorp’s CEO and Chairman, John

Reed, opined that the bank didn’t need to hold much capital and would

top up reserves as necessary from operating earnings. In 1989, Citi’s

tangible common equity to assets equaled 3.21% -- the skinniest in the

Salomon Brothers 50-bank composite average of 4.52% -- the most well

endowed being Fifth Third at 9.47%. In comparison, in 3Q13 the

average bank reported a tangible common equity ratio of 6.9% -- with

Citi no longer a questionable outlier at 8.85%.

Nominal return expectations rose with time, with the best performing

American banks generating a 1.5%+ ROA and 20%+ ROE at cycle peaks

in the 90s and 00s. The demise of restrictions on interstate banking,

changes in deposit regulation, gradual opening of capital markets

activities via regulatory and legal fiat, technological advancement, and

expansion of markets (via new products like swaps and junk bonds)

powered these results. This was during a time when both investors and

regulators gradually increased their expectations for capital ratios of

various stripes. Indicative of this “industrial success”, over the course of

my analytical career, the market capitalization of the financial sector

ballooned from approximately 5% of the S&P 500 in the late 1970s to a


Diane B. Glossman CFA serves

as an Independent Director at

Powa Technologies, WMI

Holdings and Ambac Assurance.

Diane has 25 years of experience

in investment research on the buy

and sell sides, specializing in

banks and broker/dealers.

peak of 22.3% in 2006: since that time, shrinking back to 16.2%.

Although by now it should be acutely obvious that the regulatory

pendulum continues to swing to the right, it is by no means clear what

might cause it to begin to equilibrate in the other direction. The bottom

line of this tectonic shift in the operating environment is to lower

returns and profitability across the board, while not altering the normal

earnings volatility experienced over the course of a business cycle. Not

surprisingly, managements have become reluctant to target returns

anywhere close to historical levels.

While banks manage to compete away margin during a cycle –

particularly in categories where other players have a regulatory cost

advantage – legal changes have in some cases capped or reduced peak

pricing. Examples include credit card interchange rates, overdraft

pricing and debit card charges. Each one of these reduces the industry’s

potential revenue pool. Other functions have been moved outside

banks’ ambit by regulatory fiat (e.g. proprietary trading, private equity

investments). In a number of instances, politicians and/or regulators

mandate chunks of bank lending capacity to be directed towards

specific economic sectors -- e.g. SMEs, agriculture, or low income

individuals -- regardless of whether they can be cost effectively served

by all players in that market. By the by, these types of allocations

happen in countries as diverse as Brazil, India, the UK and US.

Further, the arithmetic relating to ongoing changes to capital

requirements – Basel III, leverage ratios, liquidity requirements,

national ringfencing, and all related squeezing of definitions of their

numerators and denominators – per se reduce returns.

Banks take risk for a living: accurate risk assessment has long been the

ultimate differentiating factor between the successful and the dead. This

is why commercial banks generally trade at a discount to the market.

Further, the more plain vanilla players, which used to stick to taking

deposits and making loans, more or less in market, typically trade at a

premium (both price/book and P/E) to money center banks. The latter

were appropriately seen as having a larger risk appetite, a bigger

foothold in capital markets activity, and much greater probability of

unhappy surprises. In fact, today this group has been merged almost

out of existence and is often assessed in concert with broker/dealers.

Investors should be supporting managements that live by the letter and

spirit of the regulations – recognizing that the regulators continue to

move the goalposts around on the field of play. Pressuring

managements to skate close to wherever the new edge of regulatory

compliance forms, is asking for trouble. And managements need to take

reputational risk more seriously, even as they’re trying to figure out how

to serve their communities and still generate a return on shareholder


funds.

On the back of these changes, investors need to temper their

expectations for return targets. It wasn’t that long ago that bank stocks

were considered utility-like, in the sense that they generated a relatively

modest, but reliable, total return, significantly driven by their dividend

yields. Many of these companies were able to raise their dividends with

regularity, so that yield on cost was quite attractive as long as the

standard deviation of earnings during economic downturns wasn’t too

dramatic.

Banks continue to play a key role in every economy around the world,

intermediating savings and investments more effectively than

governments typically do. Yes, they will continue to lose share to the

markets, or other nonregulated players – “shadow banks” of various

kinds -- particularly as domestic bond markets expand in countries

beyond the US. But it is still possible to be profitable, support local

economies in a productive way, provide a safe outlet for savers, and not

embarrass your mother by newspaper or social media descriptions of

your business practices. Ultimately, companies and industries can’t be

regulated into behaving well: ethical mores have to be established by

senior managements and become ingrained throughout organizations

from within.



Sustainable Agriculture : When Less is More

By Karla Canavan, CAIA, is a Commercial Director at Bunge Environmental Markets.

While everyone has heard about food security and

the challenge to feed 10 billion people in 2050, the

solution is yet to be seen and will likely entail global

efforts that will include technology, innovation and

infrastructure among others, as well as contributions

from farmers, both big and small.

Food chains are composed of many links. For this

article I would like to focus on the basis of food

production: agriculture. I believe it is relevant to

bring your attention to a couple of pieces that could

trigger a big change and unfold a sustainable solution

to the food riddle. I am referring to women farmers

as an engine of change a means to achieve optimized

agricultural productivity and resource efficiency.

Productivity which results in income, livelihood

enhancement, and less stress on the environment.

Productivity that results from sustainable

agriculture.

The following project I am going to describe has been

able to achieve the above in practice. Five years ago a

big agribusiness player and an NGO started to work

on a project whose aim was to get women farmers

empowered to develop efficient plantings of soybeans

in Rajasthan, India and improve their livelihoods

through agriculture. The project started in 2008 with

50 people and now has over 15,000 organized

women farmers, who have increased their yields and

income and who have realized their worth to their

communities, not simply as a source of labour, but as

agents of change for a better life for themselves and

their families.

Allow me to bring some context to the concept:

According to Worldwatch Institute, women farmers

produce more than half of the globes’ food and

The Rajasthan Project: Women Farmers © Karla Canavan

1.6 billion women's livelihoods depend already on

agriculture. With statistics like this, it is clear that

bringing women into the improved productivity

equation is not new, but a matter of training them to

adopt better practices. The first obstacle to overcome

is changing behavior. It has been observed that many

of the decisions people make are not a result of

critical thought, but rather are manifestations of

habit. Changing habits, even after it becomes evident

that such habits can be counterproductive, becomes

more difficult when a society is organized into a

hierarchal system of castes, tribes, and/or where

gender inequality is the cultural norm.

In India, for instance, farmers are members of a low

social caste, and women farmers are the lowest

members of this group. Because of this rural women

in India are accustomed to, for example, eating the

leftovers from family meals. Half of them have no

mobility and are not even able to travel by

themselves to the nearest market. Furthermore,

statistics show that 35% of them are illiterate. This

situation is illustrative of the societal challenges

faced by the majority of women farmers spread

across the world. By teaching these women the

feeling of being entitled to the fruits of their work, we


strengthen the morale of the existing workforce while

also preparing them to take a more active role in the

business of agriculture. It should also be mentioned

that the effects of these changes are multiplicative

beyond the benefits to the woman farmer.

Studies demonstrate that a woman's income is

usually directed towards the improvement of their

families' quality of life. In other words additional

income is not disposed of in banalities, but rather to

ensure that the basic needs of their family are better

met. A particular study by the U.N. FAO, says that

the impact of a woman earning 10 is equivalent to a

man earning 110 when it comes to benefitting the

household. Experience on the ground has

demonstrated that empowering these women is

possible, and as mentioned before there is a

contagious effect on a better life for the whole

community.

Another challenge that needs to be addressed in

developing a successful women's farming project is

proper organization.

For the project in Rajasthan, the women started by

being grouped into small cells. Small self-help groups

that allowed them to share and learn their new

lifestyle. The small groups were then organized into

clusters until they reached the critical mass to form

the business unit or coop. Getting that engine

running was only the first step.

Now turning the discussion towards resource

efficiency as the next piece of the mentioned project,

the adoption of better farming practices

demonstrates results that show the enormous

improvement gap that still exists. While there are

many techniques that can optimize production on the

ground, there are a few that stand out. The

importance of water use and methods that can allow

farmers to be productive in semiarid regions is

critical. For instance, in a place where most crops

depend upon the rain and when the rains schedule

changes considerably, creating a water pond is a

fantastic crop management aid. For the people in the

project, building a common pond is definitely a great

The Rajasthan Project: The Pond © Karla Canavan

investment. The water harvested there allows them

to have more than one crop, or to better manage the

existing crops if there is plant stress due to a lack of

rain. A simple pond pays for itself in approximately

three years and gives the farmers higher, better

quality yields which translate into increased income.

It also makes their farming more resilient by

allowing them to use their water resources efficiently,

at the time and in the quantity they are needed.

The second example is that of seed spacing at sowing,

a technique that demonstrates what I like to call

"when less means more." Typically, farmers sow

seeds in very narrow spaces usually with just 9 inches

between the rows of crops. This method stifles plant

growth and encourages plants to compete for

sunlight by growing taller instead of putting their

energy into production of, for example, more

soybeans. To put this into numbers, farmers would

save 25 to 30% of their seed cost by adopting wider

seed spacing, and would produce between 20 to 25

percent greater yields simply through changing their

plant distance habit.

The Rajasthan project illustrates a winning formula -

using women who are already on the ground for

more and better quality food production while

uplifting their lives and respecting the environment.

There are many cases like this in other markets like

Africa or Latin America. There are many crops,

vegetable trees, and livestock in the food chains left

to be optimized. The opportunity is vast and

generates income.


All this being said, there still remains a step for

projects like these - a big one. That which will allow

them to walk alone without the aid of a corporate

sponsor or NGO and become the owners of a

sustainable, resilient and profitable crop production

company.

The women in Rajasthan have their production

company, are organized, understand the value of

inputs and outputs in the value chain, and have

mastered the best farming practices. However, they

still need to transition to total independence - where

the NGO and the aid funding are not there, where

they can become a credit eligible entity and run their

company and get access to finance. For that, the

story is yet to be written.

They have thought of hiring professional

management in order for them to have a better

market presence, or to seek the services of a social

entrepreneur which could also do the job. They are

too big to operate at the microfinance level, but are

not big enough to be considered a corporation. This

is the key financial transition that will demonstrate

the project's real sustainability, when they can really

walk on their own two feet. With globalization and

people looking more into sustainable finance every

day, I am a believer that this will happen. The

sustainable funding will find its way.

Karla Canavan, CAIA is a Commercial Director at

Bunge Environmental Markets.


Enhanced Analytics

A Zero Sum Game: Assessing Water Risks in China's Mega

Infrastructure

By Cyrus Lotfipour, Emily Chew, Shuyuan Jin of MSCI ESG Research. MSCI ESG Research is a leading

provider of in-depth environmental, social, and governance research, ratings and analysis, with more than

150 ESG specialists worldwide.

Liujiaxia Dam and Hydroelectric Station on

the Yellow River, China. ©Vladimir Menkov

Water scarcity poses an operational risk to companies in the metals,

mining, and power generation industries. However, quantifying these

risks can prove to be a challenging endeavor for investors without

knowledge of industry water intensities, and most importantly, local

operations. In its recently published water report, “Water Issue

Report: Upstream and Downstream Impacts from a Well

Running Dry”, MSCI ESG Research utilizes a process focused on three

core components: location, environment, and value. The exact location

of a company’s facility, the frequency of drought periods, and the value

generated during these periods form the basis of MSCI ESG Research’s

water risk estimates.

Among the key findings, MSCI ESG Research also found that:

Water stress has increased the volatility of soft commodity

prices, which have had a detrimental impact on food and

beverage producers. Over a ten-year period, average grain

prices increased by 150% while gross margins at grain

processors and meat producers dropped by 49% and 21%,

respectively.

The key to mitigating upstream water risks is through supply

chain assessments as agricultural raw materials account for

approximately 98% of a brewer’s water footprint.

The most water-intensive companies, such as electric utilities

and metals producers, commit to direct water use reduction

targets less frequently than the entire MSCI World Index. In

contrast, food and beverage producers have the highest

frequency of direct water reduction targets even though their

primary risk is in the supply chain.

By mapping company sites to watersheds, and factoring in

seasonal fluctuations in water scarcity, MSCI ESG Research

shows that water risks need to be evaluated at the local level.

By using data on basins and seasonal fluctuations, MSCI ESG

Research found that the total value of sales or reserves at risk

http://www.msci.com/resources/pdfs/MSCI_ESG_Research_Water%20Report_Executive_Summary.pdf




MSCI ESG Research is a leading

provider of in-depth

environmental, social, and

governance research, ratings and

analysis, with more than 150 ESG

specialists worldwide.

includes USD 221 billion for MSCI ACWI gold miners, USD

20.7 billion for MSCI US IMI electric utilities, and USD 17.2

billion for MSCI ACWI steel producers.

As a percentage of sales, regional utilities in the U.S. Southwest,

such as El Paso Electric Co. and Pinnacle West Capital Corp.,

face the highest risk, with up to 57% of electricity sales

generated during periods of severe water scarcity. U.S. electric

utilities operating in the Colorado River basin typically face

severe levels of water scarcity five months out of the year. MSCI

ESG Research calculated the percent of sales attributed to each

month of water scarcity based on average capacity utilization

rates by fuel source, average electricity rates in each state, and

the company’s ownership in a generating unit. The total sales

attributed to periods of severe water stress for each generating

facility were then aggregated at the company level.

China in Focus

In order to address severe water scarcity in the northern regions of

China, the Chinese Government has embarked on the ambitious South-

North Water Transfer Project. This multi-decade infrastructure project

plans to pump water along three routes in eastern, central and western

China. When complete, the project will annually transfer 45 billion

cubic kilometers of water from the water-plentiful south to the most

important basin in the north (the Yellow River basin), accounting for

7.4% of the country’s total water usage in 2012. The project is expected

to cost USD 65 billion, more than twice the cost of the Three Gorges

Dam project.

The project will likely benefit miners with operations in Northern

China, including China Gold International Resources, Silvercorp

Metals, Zijin Mining Group, and Yanzhou Coal Mining. Silvercorp in

particular, which derives approximately 60% of its total asset value

from the highly stressed Yellow River basin, is set to benefit from

greater water security.

However, the competition for water resources is a zero-sum game.

Increased water security in the Yellow Basin will likely be at the expense

of the Han River. Beginning in 2014, the project will draw 9.5 billion

cubic meters of water from the Han River annually, which represents

20-30% of the river’s flow.

Zijin Mining will likely face more pronounced water risks, as three of its

gold mines will potentially face lower water allocations and increased

scrutiny of its environmental impact in the Han River basin. Zijin

Mining’s long history of severe pollution incidents, and ad-hoc

http://www.msci.com/products/esg/about_msci_esg_research.html


approach to managing water impacts across its operations has already

been red flagged by MSCI ESG Research. But restrictions on water use

and increased competition with agricultural users in the Han River

basin could expose the company to further scrutiny down the road.

Source: ‘2012 Statistical Communiqué of the People’s Republic of China

on the 2012 National Economic and Social Development’; MSCI ESG

Research

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The Evolution of Company/Shareholder Engagement

By John Wilson, formerly the Director of Corporate Governance at TIAA-CREF and the Director of Socially

Responsible Investing at the Christian Brothers Investment Services.

© iQoncept/Shutterstock

If recent surveys are accurate, adoption of sustainable business and

investment practices appears to have hit a plateau. A recent survey of

CEOs conducted by the UN Global Compact and Accenture indicates

that leading companies – those who have invested the most in

sustainability – are finding it increasingly difficult to justify additional

sustainability efforts. Most recently, the Business for Social

Responsibility (BSR)/Globescan survey reached similar conclusions.

For example, the BSR survey notes a decline in the attention paid to

climate change over the last several years, even as companies expect the

issue to rise in importance in future years.

These findings are particularly troubling in light of the strong economic

case for action on climate change. The United Nations estimates the

potential global economic impact of climate change and related

phenomena at $20 trillion annually by 2050, with substantial economic

impacts on investment portfolios as well as the people and

organizations who depend upon them. Moreover, researchers now

point out that future public policies to mitigate climate change may

render a percentage of fossil fuel reserves “unburnable” and therefore

worthless. This suggests that as long as financial markets value fossil

fuel companies according to their total reserves, certain of these

companies may currently be mispriced.

For decades, sustainable and responsible shareholders have sat across

the table from companies, promoting a just and sustainable vision of

corporate purpose. Shareholders have relied on these economic

arguments to build trust and make the business case for action. While

companies have often initially been resistant to change, dialogue

between shareholders and companies has brought about several

meaningful corporate reforms related to climate change: first the

acknowledgment of the reality of the science of climate change; later the

disclosure of greenhouse gas emissions; and most recently the

systematic reduction of greenhouse gas emissions from operations and

value chains.

But the perception that progress has stalled challenges this

longstanding strategy. In particular, a growing campus movement uses

the same economic arguments to call for divestment from all fossil fuel

producers in service of a political strategy that portrays fossil fuel


John Wilson is formerly the

Director of Corporate

Governance at TIAA-CREF and

the Director of Socially

Responsible Investing at the

Christian Brothers Investment

Services.

companies as “public enemy number one to the survival of the planet.”

The appeal of this more aggressive approach is understandable,

especially to young people who will feel the effects of a changing climate

throughout their lives. Yet, it is hard to imagine an economically and

environmentally sustainable energy future without the participation of

the energy industry.

If companies and investors wish to provide a compelling alternative,

they must more fully integrate sustainability considerations into both

business planning and investment strategies. But this has proven

challenging because mainstream investment managers and companies

each are reluctant to move without clear signals from the other.

Many sustainability advocates within corporations observe that full

integration of sustainability into business planning requires evidence

that financial markets will reward corporate social and environmental

excellence.

However, the long-term financial impact of climate change depends

entirely on the unpredictable future actions of public policymakers.

Most mainstream portfolio managers expect to factor the impact of

climate change into their own models only after governments place

implicit or explicit prices on greenhouse gases, correctly assuming that

the financial markets will not place a value on climate change as long as

policy uncertainty remains.

While entirely rational given current investment practices, this analysis

fails to capture very significant, if difficult to quantify, drivers of long-

term investment performance. Because some companies are better

prepared than others to manage a range of future scenarios, their

valuations should be higher all else equal. But the current information

available to investors does not allow for clear comparisons across

companies, limiting their ability to make judgments. Companies say

that they fail to provide this information because they do not hear any

demand from investors.

However, there may be opportunities to move beyond this impasse.

Large asset owners such as pension funds and sovereign wealth funds

who have endorsed the United Nations Principles for Responsible

Investment have begun to incorporate sustainability into manager

selection and monitoring criteria. Asset managers are attempting to

develop their capabilities to integrate sustainability into investment

management, if only for commercial reasons. Separately, initiatives

such as the Sustainability Accounting Standards Board and the

International Integrated Reporting Council are creating tools to allow

companies to translate their sustainability reporting into a format that

is usable to investors. None of these parallel developments will thrive


for long unless each succeeds individually, because together they form

both sides of the supply and demand equation for sustainability

information.

Because each of these developments requires the support of

organizational leadership, the most important discussions today are

taking place not across organizations but within them. Sustainability

professionals both in investment organizations and operating

companies need stronger tools to make their case to organizational

leadership and mainstream colleagues. To achieve this, the traditional

dialogue between sustainability professionals in corporate and

investment organizations needs to evolve. Representatives of leading

organizations should recognize that they are no longer negotiating from

across the table; they are sitting on the same side of the table,

confronting a common set of challenges that require collaborative

solutions.

Next Month: The Challenge of “Unburnable Carbon”


Valuation & Accounting

Financial Instrument Accounting: Still Waters Run Deep

By Janet Pegg, Head of Valuation & Accounting at Cornerstone Capital Inc. and former Managing Director

and Analyst of U.S. Accounting Research at UBS Investment Bank

© Sommthink/Shutterstock

The Financial Accounting Standards Board (FASB) and the

International Accounting Standards Board (IASB) have been working

since before the financial crisis to improve accounting for financial

instruments. Although the Boards have worked together, it is probable

there could be significant differences between the two sets of final

standards.

The Board’s projects cover three areas: classification and measurement,

impairment and hedging. Our discussion is on the first two, as the

FASB is still in the early stages of its work on hedging.

Classification and Measurement

The classification and measurement part of the project determines how

a financial instrument should be recorded and measured, and where

gains and losses would be recorded in the financial statements.

Currently Accounting Standards Codification (ASC) topic 320 dictates

the accounting for investments in equity securities (other than those

accounted for under the equity method) and debt securities.

Securities are classified as trading if the intent is to dispose of

securities in a short period of time. Securities are marked to fair

value each period, with gains and losses are recorded in net

income.

Securities are classified as available-for-sale if they are neither

trading or held-to-maturity. Securities are marked to fair value

each period, with gains and losses recorded in accumulated other

comprehensive income (AOCI). Upon disposal any gains and

losses in AOCI are recorded in net income.

A security is considered held-to-maturity if there is the intent and

ability to hold until maturity. It is accounted for at amortized cost,

where the yield-to-maturity is applied to record interest income and

amortize premium or discount.

During the financial crisis, there were concerns that securities classified

as held-to-maturity could have significant unrecognized losses. At the

same time, some believed that the reductions in shareholders’ equity

from trading and available-for-sale losses recorded in net income and


Janet Pegg is currently the Head

of Accounting & Valuation at

Cornerstone Capital Inc. and

former Managing Director and

Analyst of U.S. Accounting

Research at UBS Investment

Bank. Janet is an II-ranked

Analyst.

AOCI were procyclical and exhacerbated the impact of the crisis.

The most recent FASB proposal covers the accounting for most financial

assets and liabilities – including a company’s own debt. The accounting

categories under the exposure draft are:

Held-to-collect contractual cash flows: Financial assets where

cash flows constitute solely principal and interest and management of

the asset is to hold for collection of the contractual cash flows. These

assets are accounted for at amortized cost.

Held-to-collect contractual cash flows and to sell: Financial

assets where cash flows constitute solely principal and interest, but

management of the asset may include sale. They are accounted for at

fair value, with gains and losses recorded in AOCI. Upon

disposal any gains and losses in AOCI are recorded in net income.

All other financial assets, including equity securities (other than those

accounted for under the equity method), are accounted for at fair

value, with gains and losses recorded in net income.

Under the proposed model almost all financial liabilities would be

accounted for at amortized cost.

With the loss of the ability to account for equity securities as available-

for-sale, companies holding large equity portfolios could see more

volatility in earnings. This change does alleviate the need under the

current model to determine when equity holdings are impaired and

need to be written down through earnings. Also, the change from the

previous “intent and ability to hold until maturity” model to a “manage

to hold for collection of solely contractual principal and interest” model

could result in changes in the accounting for long-term debt security

holdings.

The FASB is in the process of redeliberating its decisions. The FASB

website indicates a final standard sometime in the first half of 2014.

Although the model is very similar to the IASB’s proposal, there are

some differences.

Impairment

Another important aspect of financial instrument accounting came

under fire during the financial crisis – the impairment rules.

Specifically, both US GAAP and IFRS use an incurred loss model for

loan losses. Under an incurred loss model, losses cannot be recorded,

and an allowance for losses cannot be created, until it is probable that a

loss has been incurred. This resulted in loan losses that were initially


too small and taken too late. Both the FASB and IASB have proposed

changing their impairment models to expected loss models that would

cover most loans, loan commitments, lease receivables, and debt

instruments held as investments and accounted for as “held-to-collect

contractual cash flows” or “held-to-collect contractual cash flows and to

sell.” The question arises as to when a loss is “expected.”

The FASB proposed in a December 2012 exposure draft that at each

reporting date a company would assess the cash flows expected to be

received from a financial asset. The company should consider all

relevant information, including “reasonable and supportable forecasts.”

Decreases in expected cash flows would result in companies recording

losses at the time a decline is expected – rather than current GAAP’s

requirement to wait until the cash flows aren’t being received. Studies

have been done that estimate that if the exposure draft’s model were

currently adopted, financial institution’s loan loss provisions would

increase significantly.

The IASB has a proposal referred to as a dual approach. Loan loss

provisions would initially be based on twelve-month expected credit

losses. However, if an asset’s credit quality deteriorates significantly,

lifetime expected losses would need to be recognized.

Because of the potential use of two different models across the world

and lack of comparability, many of the Board’s constituents have

complained about the lack of convergence. The Boards are currently

redeliberating their decisions. During this phase the Boards will try to

converge, although that is not required and not necessarily likely. The

FASB is also exploring other current loss models, still different than the

IASB’s proposal. The FASB’s website indicates a final standard on

impairment is due in the first half of 2014, although this would be

challenging to the Board.

Although the change to expected loss models could increase loan loss

provisions, it will not change the ultimate losses incurred, as accounting

doesn’t change cash flows. An expected loss model would simply move

GAAP to recording loan loss provisions based on cash flows that are

expected to be received based on current best estimates.

Investors, as well as all parties impacted by financial instrument

accounting, should pay close attention as the Boards work toward

completion of their projects. Although the formal comment period on

the exposure drafts has ended, the FASB and IASB would still consider

any and all thoughtful input on the project and any proposed

amendments.


Accelerating Impact


By David Robinson, Professor of Finance, Duke University and member of the World Economic Forum’s

Global Agenda Council on Capital & Financing

©Fer Gregory/Shutterstock

SME? Help drive policy reposonses

and take a quick survey.


In the wake of the economic slowdown precipitated by the global

financial crisis, governments all around the world have been interested

in accelerating access to capital for small and medium-sized enterprises.

This is predicated on the view that the SMEs are critical for growth and

that the main problem preventing SMEs from scaling is access to

capital.

The US Small Business Administration’s Startup America Initiatives are

a case in point. Through two separate programs operated under the

Small Business Investment Company program, the SBA has committed

$2B in loan guarantees to early stage startups and to small businesses

started in underserved economic areas. Both programs work as SBA-

guaranteed bond programs that match private capital raised by SBICs to

target these businesses. The idea behind these initiatives is that by

pumping more capital into the organizations responsible for funding

startups, the capital that reaches startups will increase.

Swimming Against the Tide?

Programs like this exist in various forms all around the world.

Collectively, they reflect the widely held view that SMEs are the key to

economic growth and that feeding them more capital is essential to

stimulating job creation. But policy responses such as these face a

headwind. In particular, many of the policy responses aimed at

regulating large financial institutions run counter to the spirit of policies

aimed at stimulating startup activity.

Most financial regulation, especially in the United States, has held large

banks and financial institutions to tougher standards than smaller

banks. While this is understandable from a “too big to fail” standpoint,

the law of unintended consequences is at work here just as it is in most

regulatory settings. In particular, the problem in terms of access to

credit for small firms is that most credit to small firms comes from big

banks. As a result, policy responses to the financial crisis have made

access to credit for startups more difficult.

This can be seen in the table below, which presents data from the

Federal Deposit Insurance Corporation (FDIC) from the second quarter

of 2013. The table reports the number of loans made to small

businesses by bank size. It shows that, for example, around 85% of all



David Robinson is a Professor of

Finance at Duke University and

member of the World Economic

Forum’s Global Agenda Council

on Capital & Financing.

commercial and industrial loans of $100,000 or less were made by

banks with more than $1B in assets. Although small banks might lend

more to SMEs as a fraction of their asset size, the asset base of large

banks is so much larger than that of small banks that their lending to

the sector dwarfs what we see from the small bank sector.

Federal Deposit Insurance Corporation 2Q 2013

Bank Size

Loan Type All Banks Small Medium Large

Total loans secured by nonfarm nonresidential properties of $1,000,000 or less

270,060,066 9,736,000 94,968,417 165,355,649

Total with original amounts of $100,000 or less

15,494,636 2,019,722 7,533,204 5,941,710

Total with original amounts of more than $100,000 through $250,000

45,847,207 1,919,675 17,781,890 26,145,642

Total with original amounts of more than $250,000 through $1,000,000

208,718,223 5,796,603 69,653,323 133,268,297

Total commercial and Industrial loans to U.S. addressees of $1,000,000 or less

258,096,564 7,232,303 57,422,714 193,441,547

Total with original amounts of $100,000 or less

102,581,328 3,037,268 15,592,701 83,951,359

Total with original amounts of more than $100,000 through $250,000

44,759,600 1,483,562 12,787,934 30,488,104

Total with original amounts of more than $250,000 through $1,000,000

110,755,636 2,711,473 29,042,079 79,002,084

Are SMEs Financially Constrained?

This raises a broader and more fundamental question about access to

capital. How much capital is actually reaching SMEs? A recent World

Bank study asks exactly this question. In a piece called “What Have We

Learned from the Enterprise Surveys Regarding Access to Credit by

SMEs?” Veselin Kuntchev, Rita Ramalho and Judy Yang develop a

measure of credit-constrained status for firms, classifying firms into

four ordinal categories: Not Credit Constrained, Maybe Credit

Constrained, Partially Credit Constrained, and Fully Credit Constrained.

They use data from the Enterprise Surveys—a firm-level dataset built

from face-to-face interviews with business owners and managers from

around 130,000 companies in 135 countries. This allows them to link

firm size to credit-constrained status. They find that small and medium

enterprises are more likely to be credit constrained (either partially or


fully) than large firms. Furthermore, small and medium enterprises

finance their working capital and investments mainly through trade

credit and informal sources of finance. These two results hold to a large

extent in all the regions of the developing world. On a brighter note,

they also find that high-performing firms, as measured by labor

productivity, are less likely to be credit constrained. This result applies

to all firms but is not as strong for small firms as it is for large and

medium firms, suggesting that even small, high productivity firms face

financial constraints in many parts of the world.

Connecting the Dots

At the World Economic Forum, we have been working to measure the

constraints that SME operators face around the world as they operate in

their local markets. The main idea behind our work is that there is a

dislocation in the capital market: financial capital throughout the world

is abundant, but because it increasingly sits in large institutional capital

pools, it is increasingly difficult for it to reach the SMEs and social

impact organizations with the most scope for improving the economy.

The key to understanding this disconnect is to measure the perceptions

of SMEs around the globe and then compare these perceptions to the

so-called reality provided by macroeconomic indicators.

To test this hypothesis, we have developed a survey aimed directly at

SMEs around the world. Our aim is to measure the perceptions of SME

operators in different economic climates. By providing evidence on how

SMEs perceive their local capital market conditions, we can develop a

new piece of data in the arsenal to improve access to capital.

You can help. Do you know SME managers and owners who can take

two to three minutes to complete an online survey? If so, forward this

link: http://sites.duke.edu/gacfinance. The survey can be completed

anonymously, or respondents can provide contact information to stay

abreast of the work that the Council is doing to improve access to

capital for the global SME community.



Sustainable Product Review

Nike FuelBand

By Erika Karp, Founder & CEO, Cornerstone Capital Inc. and Michael Shavel, CFA, Research & Business

Analyst, Cornerstone Capital Inc.

Why would anyone sport a Nike FuelBand rather

than a stunningly beautiful precision built Swiss

timepiece? The latter is an expression of elegance,

professional achievement, and style. It can speak to

the fortunes and success of the wearer. The Nike

FuelBand costs about $150, is made of

rubber/plastic, must not be submerged in water, and

requires two hands to tell the time. Given these

apparent shortcomings, it may seem paradoxical that

the FuelBand is one of several in the wearables

product category that is gaining traction with

consumers. Having made the switch, some of us are

hooked.

The FuelBand monitors an individual’s activity with

“NikeFuel,” a universal way to measure all types of

activities and body movement regardless of age,

weight and gender. The FuelBand then transmits

data to a personalized account, enabling the owner to

track progress towards a goal and compete with

other FuelBand consumers. In essence, Nike has

created a bundled product – a product that addresses

the “bundled needs” of consumers. It serves our

need to address our health and activity levels; our

need to measure, to benchmark progress and to

compete; our need to accomplish multiple goals

simultaneously in a time-constrained world.

The FuelBand also serves as a simple watch, but

more importantly it provides a personalized fitness

monitor and a direct link to others in the fitness

community. Product bundling has been common in

the software business (ie. Microsoft Office),

telecommunications industry (ie. internet, cable, and

phone packages), and the fast food industry (ie value

meals) for some time, but technology is now

facilitating its use in the wearables market.

From a technology standpoint, there are several key

factors that are driving wearables adoption. Of these

factors, perhaps the most significant is the growing

installed base of smartphones and tablets. These

devices act as personal cloud networks and enable

wearables to have access to powerful computing

power and ubiquitous connectivity. In addition,

advancements in material sciences, low power

wireless connectivity, battery power, and sensory

accuracy are contributing to the improved

functionality of wearables. Taking these

technological innovations and the aforementioned

application of product bundling into consideration,

the potential growth in the wearables market is

raising eyebrows across various industries. Credit

Suisse estimates that the wearables market could

grow from $3-5 billion this year to over $42 billion in

the next three to five years. ABI Research, a

technology market intelligence company, pegs the

wearables market at 485 million annual device

shipments in 2018, up from approximately 14 million

in 2011.

As with any emerging technology, estimates are

exactly that – estimates. That said, actions speak

louder than words and what we’re observing is

prominent companies dedicating substantial

resources to product development in the wearables

market. Perhaps more important than the number of


companies taking notice is the diversity of those

companies across economic sectors. In retail, the

apparel industry has been an early adopter of

wearables technology and global athletic companies

such as Nike, Adidas, and Under Armor have

introduced fitness products designed not only to

monitor physical activity but to increase consumer

engagement. Meanwhile, we’ve seen fewer

mainstream product launches in the technology

sector. Samsung launched its Galaxy Gear

smartwatch to mixed reviews, but Google Glass is

still in the “Explorer” stage (product testing) and

Apple has yet to announce a product, though many

speculate an iWatch is in the works. The wearables

market is nascent, however, and technology

companies leveraged to software (ie operating

systems) and internet/networking stand to benefit.

There are also countless applications for wearable

technology in the healthcare sector, ranging from

products that monitor blood pressure and glucose

levels to those that aid the blind by utilizing

wayfinding technology.

The Nike FuelBand is likely only the tip of the

wearables iceberg. It will certainly be interesting to

see how the market develops and which companies

capitalize on the emerging opportunity.

Erika Karp is the Founder & Chief Executive Officer

of Cornerstone Capital Inc. and the former Head of

Global Sector Research at UBS Investment Bank.

Michael Shavel, CFA is a Research & Business

Analyst at Cornerstone Capital Inc. and a former

Research Analyst on AllianceBernstein’s Global

Growth & Thematic team.



Food Policy & the Environmental Credit Crunch

By Paul Donovan, Managing Director and Global Economist at UBS Investment Bank. Julie Hudson,

Managing Director, SRI & Sustainability at UBS Investment Bank.

The global economy is at a remarkable stage of human development.

The current generation is the first ever to know a world where famine

can be defeated by modern economics. Globalisation of transport

networks, agricultural productivity, and medical knowledge have

combined to make famine an accident of human policy (wars etc), but

not an accident of nature.

The global economy is at a dangerous stage of human development. The

(relative) cornucopia of plenty has bred a sense of complacency about

food that is certain to be challenged by the economic and environmental

circumstances of the next generation. The way we eat now is financed

by a considerable borrowing of environmental credit. Humanity is

consuming tomorrow’s finite resources to raise today’s standard of

living, and to provide low cost food in an unsustainable manner at the

point when the numbers of humans on the planet are about to swell still

further.

The real challenge in dealing with this is the interaction of politics and

economics conspires against an environmentally desirable outcome.

Food occupies a peculiar place in the mind of the average consumer. As

a high frequency purchase, food is something that the consumer is

acutely sensitive to when it comes to pricing. Politicians know this, and

as a result the price of food is something that is peculiarly important to

policy makers.

Politicians and markets have an incentive to provide as much food as

possible, as cheaply as possible, today. Not much has changed from the

“bread and circuses” of ancient Rome. Today it may be “pizza and

reality TV”, but the importance of food as a source of electoral well-

being, and thus political support, is as relevant today as it was two

millennia ago. The fact that food is produced at the cost of finite

resources (the energy required to produce fertiliser, for instance) or at

the cost of environmental degradation (soil erosion) is overlooked .The

political imperative of providing cheap food today overwhelms the

politically abstract but environmentally certain cost of more expensive

food in the future.

So how can economics and environment be reconciled, at a time of

rising population and finite resources? There is, in fact, a solution that

is at once both simple and complex. The global food crunch can be


Paul Donovan is Managing

Director and Global Economist at

UBS Investment Bank.

Julie Hudson is a Managing

Director in SRI & Sustainability

at UBS Investment Bank.

They have co-authored the books

“Food Policy and the

Environmental Credit Crunch -

From Soup to Nuts”

and “From Red to Green: How

the financial credit crunch could

bankrupt the environment”

solved by controlling food waste.

In a developed economy like the United States, around 50% of food is

wasted. What is often overlooked in the moral outrage at such statistics

is that in an emerging market like India around 50% of food is never

consumed either. The difference between the two societies is where the

food waste takes place. In a developed economy it is primarily at the

end of the food “food-chain”, with the consumer throwing away food

uneaten. In an emerging market waste occurs far earlier in the food

chain, generally in the distribution network that lies between farmer

and market. Reducing that food waste, even moderately, would easily

provide the calories that a growing global population requires.

“Cutting waste” is the simple part of the policy prescription. The

difficulty is the complexity of the way in which our food reaches us

today. Controlling waste in one part of the food food-chain (if

consumers switch from weekly shopping trips to daily smaller shopping

trips, as has happened in the United Kingdom) may simply transfer

waste to a different part of the food food-chain (the producer, perhaps).

Well-meaning attempts to control waste at a personal level can end up

as some environmental game of “whack a mole”; waste is controlled in

one area only to pop up defiantly elsewhere in the distribution process.

What is needed is to invest in waste control in a holistic way – seeking

to control waste across the entire food food-chain (accepting that such a

strategy may increase waste in one area, but generate greater efficiency

overall). This is where private investment should focus. Food is going to

become an increasingly politically contentious area. Investing in

agricultural land or food retail may lead to higher returns, but as an

investment it could just as equally be subject to price controls, export

bans, or constraints on foreign ownership. Investing in technologies or

business practices that promote efficient food consumption and

minimise waste across the entire food food-chain are less susceptible to

nationalistic political pressure. Moreover, such investments can

produce an outcome that is optimal both in an environmental and an

economic sense.

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Recent Articles from Cornerstone Capital Group

Cornerstone Journal of Sustainable Finance & Banking – October 2013 Inaugural Edition


Wall Street Week: “Embrace the Grey” by Erika Karp, Derek Yach – September 2013

www.wallstreetweek.com/guest-post-embrace-the-grey

Forbes: “The Power to Convene” by Erika Karp – December 2012

http://www.forbes.com/sites/85broads/2012/12/10/the-power-to-convene/

Forbes: “Sustainable Capitalism…If Not Now, Then When?” by Erika Karp – November 2012

http://www.forbes.com/sites/85broads/2012/11/08/sustainable-capitalism-if-not-now-then-when/

Forbes: “Could Sustainability by Unsustainable?” by Erika Karp – September 2012

http://www.forbes.com/sites/85broads/2012/09/26/could-sustainability-be-

unsustainable/?utmsource=allactivity&utm_medium=rss&utm_campaign=20120926

Wharton Magazine: “The Clients of my Clients....Sustainable Selling” by Erika Karp – July 2012

whartonmagazine.com/blog/sustaining-selling-success/

Wall Street Week: “Leaving Rio....and Going Towards Corporate Sustainability” by Erika Karp – June 2012

http://www.wallstreetweek.com/leaving-rio-and-going-towards-corporate-sustainability/

Harvard Business Review | HBR Blog Network "Why Go it Alone in Community Development?" by Andrew MacLeod – June 2012

http://blogs.hbr.org/2012/06/why-go-it-alone-in-community-d/

Forbes: “Sustainable Investing and Moments of Truth” by Erika Karp – March 2012

http://www.forbes.com/sites/85broads/2012/03/28/sustainable-investing-and-moments-of-truth/

Wall Street Week: “Investing in Diversity…Painful but Profitable” by Erika Karp – March 2012

http://www.wallstreetweek.com/guest-post-investing-in-diversity-painful-but-profitable/

Wall Street Week: “Noise Cancelling Investment Research - ESG Analysis and Sustainable Investing” by Erika Karp – February 2012

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Forbes: “Superheroes of Capitalism” by Erika Karp – January 2012

http://www.forbes.com/sites/85broads/2012/01/13/superheroes-of-capitalism/

Forbes: “Superheroes of Capitalism: Part II - The Women” by Erika Karp – January 2012

http://www.forbes.com/sites/85broads/2012/02/01/superheroes-of-capitalism-part-ii-the-women/

Wharton Magazine: “The Poetry of Sustainable Investing” by Erika Karp – January 2012

http://www.whartonmagazine.com/blog/writing-the-verses-of-sustainable-investing/


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http://www.forbes.com/sites/85broads/2012/11/08/sustainable-capitalism-if-not-now-then-when/

http://www.forbes.com/sites/85broads/2012/09/26/could-sustainability-be-unsustainable/?utmsource=allactivity&utm_medium=rss&utm_campaign=20120926

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whartonmagazine.com/blog/sustaining-selling-success

http://www.wallstreetweek.com/leaving-rio-and-going-towards-corporate-sustainability/

http://blogs.hbr.org/2012/06/why-go-it-alone-in-community-d/

http://www.forbes.com/sites/85broads/2012/03/28/sustainable-investing-and-moments-of-truth/

http://www.wallstreetweek.com/guest-post-investing-in-diversity-painful-but-profitable/

http://www.wallstreetweek.com/noise-cancelling-investment-research-esg-analysis-and-sustainable-investing/

http://www.forbes.com/sites/85broads/2012/01/13/superheroes-of-capitalism/

http://www.forbes.com/sites/85broads/2012/02/01/superheroes-of-capitalism-part-ii-the-women/

http://www.whartonmagazine.com/blog/writing-the-verses-of-sustainable-investing/


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Cornerstone Capital Inc. doing business as Cornerstone Capital Group is a Delaware corporation with headquarters in New York, NY. The Cornerstone Journal of Sustainable Finance and Banking (JSFB) is a service mark of Cornerstone Capital Inc. All other marks referenced are the property of their respective owners. The JSFB is licensed for use by named individual Authorized Users, and may not be reproduced, distributed, forwarded, posted, published, transmitted, uploaded or otherwise made available to others for commercial purposes, including to individuals within an Institutional Subscriber without written authorization from Cornerstone. The views expressed herein are the views of the individual authors and may not reflect the views of Cornerstone Capital Group or any institution with which an author is affiliated. This publication is for informational purposes only and nothing in this publication is intended or should be taken as investment advice. This is not an offer or solicitation for the purchase or sale of any security, investment, or other product and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. Cornerstone Capital Group cannot accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication.











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