There is a new emerging trend cutting across sectors, jurisdictions, exchanges and investment products which is becoming a focal point of various stakeholders. The search is on to find which companies have proven themselves environmentally and socially responsible. They are being measured in accordance with specific governing factors framed by what’s known as #ESG or environmental, social and governance.

MACCORMICK, A TORONTO-BASED

management consultancy dedicated to social governance, assurance and performance in the mining sector, recently concluded an extensive survey of ESG to better understand how it factors into the design of social management systems. This is very important, because if what currently constitutes ESG influences investors and financers, then it also influences shareholders’ priorities regarding performance and measures of success in accordance with same. This becomes problematic for social practitioners of CSR implementation and training because what we look at as success factors on the socio economic front is not currently covered under ESG. Therefore, social issues get buried under a different set of priorities. This contributes to misunderstandings between companies and communities which typically can have significant costs and result in material delays in bringing projects on stream.

It is important to distinguish what constitutes social governance, assurance and performance from environmental stewardship, or a philanthropic type donation with which it is commonly confused. Best practice social governance indicators are more along the lines of consultation and consent of local communities, local employment, local procurement, code of ethics to include harassment and diversity, human rights, health, safety and security for communities and standards on involuntary resettlement of local communities and the like. They are geared toward quantifying socio-economic impact rather than environmental impact.

At a high level, in summary, the research that was conducted and supported by major financial and non-governmental organizations Bonnie the world over reveals that what currently constitutes ESG performance is not industry specific, is more generalized and does not address the unique social issues our sector faces through development. Yet these determining factors can govern or influence the ability to obtain mine permits and project financing, without providing the diligence required to ensure the social components of CSR best practice on implementation. Not surprisingly top management is looking for tools to capture and document these requirements.

First, what is ESG?

ESG is a sub-set of indicators under a larger umbrella referred to as #SRI or Socially Responsible Investment. The larger umbrella consists of additional elements on responsible corporate governance which cover items like material disclosure of board issues, financial reporting, executive compensation, and political contributions. The investment community uses a scoring metric which shows how companies perform in accordance with ESG to rate and or value a company on public exchanges.

I think that it is important to recognize that the concept of SRI and good corporate governance were born following the collapse of corporate giants such as Enron and Worldcom due to corruption and mismanagement. This will help to explain why the current metrics of SRI are outdated, and the ESG subset factors, which developed much later than the original SRI factors, predominantly focus on environmental issues such as climate change and carbon emissions – as these were the focal points of the generation in which they were developed.

ESG factors are built into investment products like ETF’s, Mutual and Ethical Funds which most major financial institutions rely on to govern their asset management’s compliance in responsibility.

Current ESG-focussed investment products dominate health care, supply chain, corporate ethics, and philanthropic donations through foundations. There was little to no coverage in this research on the mining or oil and gas sectors specifically.

The current global participation in SRI accounts for $30 trillion dollars (WITH A CAPITAL T) in assets under professional management. That’s twenty per cent of the global capital markets, according to the 2012 Global Sustainable Investment Review produced by the Global Sustainable Alliance and sponsored by major rating agencies like Amundi, BlackRock, Bloomberg, Trillium, Desjardins, Ethical Funds, Mercer, RobecoSAM, MSCI, and Investec to name a few.

A document on sustainable and responsible investment trends published in 2012 by USIF Foundation (The Forum for Sustainable and Responsible Investment) reports that $3.3 trillion of the $30 trillion in assets under management have been invested specifically according to Environmental, Social and Governance factors or #ESG. Here’s how they break it down:

• Alternative investment vehicles (private equity, venture capital, hedge funds,property funds) account for $132B identified in 301 investment vehicles

• Alternative Investment Funds investing in ESG strategies has experienced as much as 250% growth in assets since 2010.

• CII’s (Community Investment Institutions) account for $61.4B between 1043 institutions

• ETF’s and close-end funds account for $644B accounted for in 361 funds

• Institutional investors and high-net worth individuals pooled account for $234.2B within 45 products

• Institutional Investors dominate the sector with 2.7T in Assets involved in ESG incorporation

These trends illustrate a dramatic increase in the number of mutual funds that consider corporate governance criteria, the rise of alternative investment funds that consider ESG criteria, and growth of assets in financial institutions (banks, credit unions, loan funds) with an explicit mission on community development. The research is supported by Bloomberg, Calvert Foundation, CDFI Fund, US Treasury Department, Tellus Institute, Community Development Venture Capital Alliance, GMI Ratings, ISS (a subsidiary of MSCI Inc.), National Community Investment Fund, National Federation of Community Development, Credit Unions, Opportunity Finance Network, and the Sustainable Endowments Institute.

Closer analysis shows that these trends also grew at a rate of a hundred per cent in the four years leading to the publications in 2012. The research attributes the trend drivers for
this growth to be:

• Client demand and values – cited by 72% of surveyed money managers

• Consumer demand and campaigns; this influence also seen in a 73% increase in community development bank assets (2010 to 2012); and 54% asset growth for community development credit unions

• Emergence of specialized stock exchanges with requirement for sustainability data disclosure

• Firms that have not historically identified themselves as SRI are adopting SRI strategies in decision-making; no ‘typical’ type of firm anymore; paradigm shift

• Governance criteria incorporation as leading ESG issue

• Increased investment tied to impact, ‘mission’; investors tying investment to environmental, social challenge reduction.

• Need for comparable standards of reporting = fundamental shift in corporate reporting structure

• U.S. Reporting structures: SASB (Sustainability Accounting Standards
Board), shift to ‘integrated’ reporting

On the surface, this research shows summarized categories by the following titles: Environment, Social, Governance and Products. Naturally, I zeroed in on the social sections as the environmental sections encapsulate the usual suspects: climate change, pollution, green building, sustainable agriculture, and clean technology.

• Environmental factors are among the most frequently incorporated criteria among money managers (551 funds with $240B in assets).

• Increased prominence of environmental issues (mainly climate change and carbon emissions) is a driver in the 23% increase in institutional asset owners in the U.S. who consider ESG.

Corporate governance criteria is focused on board issues, executive pay, and political contributions.

Highlights from the socially focussed components of ESG covered topics like anti-terrorist country boycotts, microfinance, and labour rights.

The challenge with what currently exists is that it’s severely outdated and not relevant to current issues. For example, current ESG labour rights refer to the MacBride Principals, a set of principals developed 40 years ago regarding diversity in hiring practices related to dispersion between Catholics and Protestants targeting issues in Europe and North America, rather than women versus men or cultural diversity. This could be updated with reference to the ILO standards which seem to be widely regarded globally as best practice on current labour standards. Similarly, Human rights issues are mentioned in ESG but as defined in the current context, it relates to issues on child labour and sweat shops, which makes sense since current ESG research dominates product development, consumer-packaged goods and retail related supply chain.

In mining and oil and gas, human rights issues would be better addressed referencing the UN’s Voluntary Principals on Security and Humans rights which are the only human rights guidelines designed specifically for extractive sector companies. They are a set of principals designed to guide companies in maintaining the safety and security of their operations within an operating framework that encourages respect for human rights. These principals address the relationship between private security, company and community.This is a perfect example of where lenders would over look this particular criteria as it’s not currently a benchmark in ESG, and not industry specific enough.

Further research into the process that’s involved from company disclosure to financial institution (FI) and from FI to ESG product provider for compliance approval revealed that for the most part reliance on desktop reporting was the extent of ESG compliance review.

Example – Mining company seeking funding sends the lender a document of facts and data required under current ESG structures, generally known in the practice as an Environmental Social Impact Assessment or an ESIA, which usually comprises of management’s action plans to mitigate environmental or social risk and impact factors. The lender forwards this document to the fund company to vet the credentials and ensure criteria for compliance are met. Analysts within the fund company rate this data against a particular framework or set of priorities set by the fund and the lender under ESG. On occasion, and we have been party to this in our practice, either the lender or the fund company will send out a third party expert to the project site to review the data submitted.

There are several sector specific challenges under this framework, for example:

• Lack of field practice knowledge and experience from the institutions’ desk top analysts

• Focus of any review seems to be predominantly on environmental stewardship versus social assurance and performance

• Lack of physical audit by experienced regulatory professionals on validity or legitimacy of social data, source and methodology of the data, relevancy of the data, participative collation and consent of the data etc. specifically on the social aspects of a project

• When physical audits do occur, third party specialists are usually environmental specialists – rarely and only recently we have seen some inclusion from socio economic specialists involved

What else influences ESG factors in mining?

Outside of what currently constitutes ESG for investor products, a host of major sector targeted governing bodies like ICMM, WEC, WGC, RJC , EITI, the UN and in Canadian context PDAC’s e3Plus and MAC’s TSM – have all developed structured guidelines, principals and frameworks which can lend to best practice, which include social facets. Even MacCormick’s own annual publication of Canada’s most Socially Responsible Junior Mine Companies leads by example, demonstrating greater share holder returns with CSR best practice.

Yet, The Equator Principals a risk management framework, adopted by financial institutions, for determining, assessing and managing environmental and social risk in projects which primarily intended to provide a minimum standard for due diligence to support responsible risk decision-making and IFC’s Performance Standards which define clients’ responsibilities for managing their environmental and social risks are two of the most influential governing frameworks which significantly affect the structure of financial institutions frameworks for ESG, both evaluations dominate environmental stewardship in practice because environmental experts are executing on them yet each of them carry some significant, albeit not sector specific social criteria.

How does all of this impact CSR on implementation?

Currently, mining companies are not required, formally, through the process of financing, publically listing with an exchange, mine permitting, or by performance metrics tied managements compensation, to make social performance a priority. I used the term ‘formally’ because informally global sector governing bodies suggest a myriad of best practice frameworks, tool kits and guidelines, but it is not yet required or recognized as a priority measure for success in the sector.

Mining companies’ success metrics currently rely on profitability, productivity and shareholder return. The notion of cost-benefit or return on investment suggests that investing in social risk mitigating activity would increase all of these metrics of success too. Yet, investment behaviours in the sector globally are reactive to market demand and current performance metrics and ignore this ever present risk to an enterprise’s ability to prosper.

From a social practitioners’ perspective, our challenge continues to be lack of priority for participation, budget and commitment – from the top down, and not because there isn’t a genuine interest in doing the right thing for people and the environment, but because it’s not how management teams are measured for success by their peers and shareholders. While the concept of humanity is generally universal, historically it has been perceived as immaterial and therefore not measurable. Mining company’s owners and management teams are at the mercy of their shareholders and financers who measure their success based on by profitability, production rates and shareholder returns. The barriers to social performance making the priority list at the board level are governed by the priorities of funders and those who issue mine permits. A generally accepted notion of social performance is currently controlled by the mining company’s ability to secure their social license, or in other words their ability not to experience socially motivated business interruption. One very important measure of success.

Again, if the finance community globally references current ESG frameworks as a measure of risk mitigation in their investment decisions regarding mining and oil and gas projects and current ESG frameworks do not address the dominant social issues facing our sector, then the social factors of a project will not become a priority in the boardroom. The priorities in the boardroom resonate throughout the organization creating a culture and tone for the organization.

This becomes critical as the extractive sector continues to experience increased pressure notion of cost-benefit or return on investment

to decentralize operations and ensure as much project localization as possible. Therefore, a corporate culture which does not prioritize and measure success against social factors, will become less and less favorable to host communities. The ‘social’ indicators that are missing from existing frameworks become more and more apparent in the analysis of the demands of host communities, and the root of the causes which lead to social protest and costly stoppage of mining operations.

There are too many examples of cases demonstrating the cost to investors for not incorporating social performance indicators, sector specific, into their financing and permitting due diligence process.

In a recent article on global issues, Stephen Leahy discusses how the Conflict with Local Communities Hits Mining and Oil Companies where it hurts.

One of his examples, and one that is still fresh in our minds, is the Pascua Lama gold mining project in Chile which cost Canada’s Barrick Gold (and all of their shareholders) $5.4 billion following 10 years of protests and irregularities. No gold has ever been mined and the project has been suspended by court order. Another recent example is Peru’s $2 billion Conga copper mining project which had been suspended in 2011 after protests broke out over the projected destruction of four high mountain lakes. The U.S.-based Newmont Mining Co, which also operates the nearby Yanacocha mine, has now built four reservoirs which, according to its plan, are to be used instead of the nearby lakes which are vital to the well being of the local communities.

In a recent sector publication “The Cost of Company-Community Conflict in the Extractive Sector” produced by The Center for Social Responsibility in Mining out of Brisbane, Australia – Dr. Daniel Frank ventures the concept of “cost- benefit” and the realm of quantification of cost to the company for not investing in good social governance. The study is based on 45 in-depth, confidential interviews with high-level officials in the extractive (energy and mining) industries with operations around the world. The study is informative and timely and similar to Dr. Michael Porter of Harvard’s publication “Creating Shared Value” where he describes the paradigm shifts in the perception of the responsibility of the cost of being “socially responsible” between company and government. Porter suggests that the company needs to “Re-think Capitalism”, a concept my intro development studies professor would have drooled over twenty-years ago (Hi Dr. Cameron!). Both Frank’s and Porter’s concepts are focused on the quantification of and return for investment of good social governance to the company.

Alternatively, the concept of social return on investment or #SROI came out of the London School of Economics. It focuses on impact benefit or the change in socio economic baseline metric of a community as the result of an investment in a development program, by a company or government.

Each of these studies discuss what and why we need to include social performance indicators as measures of success of a business. They are developing the business case for a change in perspective and priority on spend within the organizations.

The solution: Additional, material social performance indicators, tied to management compensation, enforced and audited by financers, investors, host government mine permit issuers, purchasers and communities.

That having been said, good news – change is already upon us. There are efforts underway to update these frameworks supported by mass scale research projects supported by most of the above mentioned institutions, some of which MacCormick is also involved with. We can expect 2015 to be flush with this concept.

It is important for mining and oil and gas companies to become familiar with these new frameworks and the changes to come as they will imminently dictate new governing structures that will affect their ability to secure mining permits and financing. The financing community will also be affected by the changes in demand from potential buyers and by public investor demand as awareness and understanding of these indicators becomes a more common knowledge.

One might even suggest that evolution of common understanding of social performance indicators will develop similarly to the analogy of food packaging labels. Regulators will require the disclosure of the degree of metric compliance with said upgraded ESG frameworks, similar to MacCormick’s own score card for sector specific social performance.

The score card above is derived from MacCormick’s SRI on 10 very basic elements of social performance in the sector. In addition to this, MacCormick has developed a social assurance and performance audit tool which covers all of the social governing aspects of 12, sector-specific, best practice frameworks. The tool includes 150 indicators which can be materially rated for performance. These indicators were designed to evaluate compliance, assess and validate materiality, and test the efficiency of CSR activities and social management systems (SMS).

There are some significant challenges to overcome to make a concept like this become a reality in the sector and to change investment behaviors and public perception of social risk mitigating and performance factors in mining.

In my role, I continually interview thousands of sector specific professionals in many capacities on the topic. There seems to be a common confusion, not only in the investment community but with the public at large who, by choice, chose to invest responsibly and can’t understand how we continue to face increased pressure from global communities on social issues if we are meeting the current requirements on ESG. There are a few obvious answers for this, and this is my whole point – Mine permit or financing issuers rarely audit for such issues which are not technically or legally required. We need to make them legally and technically required. Members of my advisory board suggested history is repeating itself here, referencing Justice Berger’s review of the Mackenzie Valley Pipeline in the 1970’s saying that again today we still see echoes in the LNG debates and Keystone Pipeline applications. If you don’t do the ESG spade work, regardless of existing legislation, there will be interested parties who will cost you and even block your project.

What’s more concerning though, is that the whole notion of social performance requirement is coming hard and fast at the sector from international regulators, financers, host countries governing bodies, and by both community and investor demand as awareness of this trend continues to grow. A majority of mining companies are not equipped for this. While others stand to be model examples with social frameworks already in development, though not yet a requirement, such as Anglo American who voluntarily contributes to a number of sustainability indices that benchmark and track the performance of the most socially responsible companies. Their efforts provide investors with an independent evaluation of their approach to sustainable development, and encourage transparent disclosure of non-financial information within our industry. In addition to this, Anglo American also produces their own CSR score card annually to track their performance, including all of the social performance metrics noted above.

Signs of further development in this direction can be attributed to the fact that both the DOW JONES in collaboration with RobecoSAM and Thomson Reuters released updated versions of their ESG rating systems earlier in 2014. While either of them have yet to address the points made throughout this article, there is no doubt they will be in the next edition. Additional front runners fast approaching the concept are FTSE4Good Ratings a trade mark of the London Stock Exchange plc whose robust index criteria is vetted by an extensive consultation process with independent experts including NGOs, governmental bodies, consultants, academics, investors and the corporate sector and which also helped to develop the United Nations-backed Principles on Responsible Investment (PRI).

Mining companies looking to prepare themselves for this can compare what’s to come with previous experience instituting International Financial Reporting Standards (IFRS) or The Sarbanes-Oxley (SOX) Act of 2002. Similarly, companies will be required to demonstrate capacity, management systems, and the ability to support their social performance reports on these specific social indicators as technical and legal requirements.

@MacCormick_IMC

www.maccormickimc.com