Marie rosencrantz

Sustainable investments in emerging markets: CDC’s new Toolkit on ESG for fund managers

November 2010

ROSENCRANTZ & CO

is owned by the UK government through the Department for International Development (DFID)

invests through funds in promising businesses in frontier emerging markets:

75% low income countries

50% sub-Saharan Africa

invests mostly through private equity funds but also in microfinance and debt funds

has £1,411m in portfolio value

65 fund managers in 37 countries

134 funds

794 portfolio companies in 71 countries

£207m total return after tax in 20092

CDC is the UK development finance institution with investments through funds focused on the frontier emerging markets

CDC’s investments by year end 2009: 794 portfolio companies in 71 countries

CDC’s 65 fund managers have local offices in 37 emerging markets countries

More than 25 investments

15-24 investments

6-14 investments

1-5 investments

More than 10 offices5-10 offices

2-4 offices

One office

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CDC’s Investment Code sets out investment standards on ESG. The new Toolkit provides practical help to fund managers on ESG for their investments

CDC’s Investment Code on ESG:

The Investment Code defines CDC’s principles, objectives, policies and management systems for sustainable and responsible investment with respect to the environment, social matters and governance (ESG)

The Investment Code also contains CDC’s Exclusion List for businesses and activities where CDC’s capital will not be invested

CDC’s Toolkit on ESG for fund managers:

Provides practical guidance for fund managers on how to implement sound ESG management throughout their investment processes

Gives specific guidance for investments in different industry sectors and for different types of funds

Provides short summaries of the relevant international standards and conventions for ESG, including the IFC Performance Standards, ILO Conventions, and business integrity and good corporate governance standards

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The business case for ESG features prominently in the Toolkit with practical guidance and case studies for fund managers

MARKET ACCESS

CAPITAL ACCESS

LICENCE

TO OPERATE

BRAND

ENHANCEMENT

REVENUE

GROWTH

COST

SAVINGS

RISK

MANAGEMENTINNOVATION

PRODUCTIVITY

BUSINESS

OPPORTUNTIES

Sound ESG analysis and management can contribute to many of the most important value drivers for a business

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Relevant to all stages of investment cycle:

Tool 1 Adding value through ESG improvements

Tool 2 ESG policies and guidelines

Tool 3 ESG considerations at each stage of the investment process

Tool 4 Questions to assess a fund manager’s ESG management systems

Relevant to specific parts of the investment process:

Tool 5 Rating ESG risks

Tool 6 ESG due diligence

Tool 7 Environmental and social impact assessments

Tool 8 Questions to assess a company’s ESG management systems

Tool 9 Investment paper and action plan for ESG improvements

Tool 10 Investment agreement

Tool 11 Investment monitoring

Tool 12 ESG reporting

Tool 13 Information for the public: annual reports and websites

Tool 14 ESG considerations at exit

CDC’s Toolkit on ESG for fund managers contains 14 Tools

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Example of a Tool (4): Questions to assess a fund manager’s ESG management systems

Yes NoPolicy and processes

1. Policy: Are there formal policies and systems to manage ESG? 2. Identifying opportunities: Does the fund manager proactively identify opportunities for ESG improvements for its investments? 3. Risks: Are investments formally assessed for risk and given an appropriate level ofmonitoring based upon this risk rating?

4. Critical risks: Can ESG considerations act as a block on a potential investmentopportunity?

5. Action plans: Are formal action plans drawn up to address ESG deficiencies? 6. Monitoring: Are there any processes in place to manage/ monitor ESGrisks and areas?

Roles and responsibilities

7. ESG resources: Does the fund manager have a designated ESG professional? 8. Top level responsibility: Has ESG responsibility been established at all levels including the fund’s Investment Committee and governing body? 9. Specialists: Are specialist consultants/ external technical experts used to assess and monitor high risk investments? If so when and who? 10. Training: Does the fund manager provide ESG training for all relevant staff?

ESG performance management11. Performance indicators: Are there key performance indicators in place to measure and track ESG performance at portfolio companies? 12. Serious incidents: Is there an established protocol for how to follow up serious incidents involving portfolio companies

Comments

Yes No Comments

Yes No Comments

Yes No CommentsReporting & Stakeholder management13. Communication lines: Are there defined lines of communication in place to report on ESG matters, including any serious incidents, to the fund manager’s Investment Committee and governing body?

14. Reporting to the fund’s investors: Are ESG matters reported on to the fund’s investors at least annually and are any serious incidents reported immediately?

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The Toolkit has 10 Appendices with more specific guidance on selected ESG matters

Appendices:

1. ESG due diligence questions

2. Sector-specific risks and opportunities for improvements

3. ESG risks in different regions and selected countries

4. ESG management for different types of funds

5. International ESG reference standards and conventions

6. CDC’s monitoring and evaluation system

7. CDC’s reporting templates and an example of an annual ESG report

8. Investments by different development finance institutions (DFIs): comparing standards and procedures

9. Climate change considerations: risks and opportunities

10. Gender considerations: good practices for investors and businesses

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Fund managers can use the Toolkit to effectively integrate ESG analysis and management throughout their investment processes (1/6)

What to do?

Assess opportunities to add value to potential investee companies from ESG perspectives

Assess whether a potential investment is in line with the fund’s exclusion list and ESG policies and guidelines.

Discuss the fund’s ESG polices with management of a potential investee company to clarify expectations

Rate ESG risks

Ensure awareness of sector specific as well as country / regional ESG risks and opportunities, e.g., countries with weak employment legislation / enforcement

Initial screening

Due diligence

InvestmentInvestment monitoring

ExitInvestment

Toolkit reference:

Tool 1

Tool 2; Appendix 5

Tool 2; Appendix 5

Tool 5

Appendix 2 & 3

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Example of a Tool (1): Adding value through ESG improvements Identifying opportunities where ESG improvements can drive business success

There are numerous examples where sound ESG management is a key business success factor.

Fund managers should consider how each ESG factor can drive or contribute to different business success factors as per this matrix.

Source: Developing Value: The business case for sustainability in emerging markets, Sustainability, IFC and Ethos Institute, 2004. Adapted by CDC and Rosencrantz & Co

Environment Social matters

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Cost savings and productivity

Access to capital

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Human capital

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Governance

ESG factors: improvements during the investment period

Example of a Tool (1): Adding value through ESG improvementCase example: Shelys Pharmaceuticals, Tanzania

• Shelys is a Tanzanian pharmaceutical manufacturer, specialising in over-the-counter products including generic anti-malarial drugs.

• A five year investment by CDC’s fund manager Aureos was successfully exited in 2008.

• The interest from the South African trade buyer Aspen Pharmacare was triggered by the upgrades made to Shelys’ production standards during Aureos’ investment period to comply with WHO GMP, despite no such requirements in Tanzania.

• Improving production standards towards WHO GMP has provided access for Shelys to markets in eight other countries across Central and Eastern Africa.

• The improvements in environmental discharge standards, reduced dust and particle emissions and drug safety scrutiny, along with strengthened corporate governance, were key to Shelys’ business expansion and Aureos’ successful exit.

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Example of a Tool (1): Adding value through ESG improvementsThe ESG business case matrix as applied to Shelys Pharmaceuticals


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Access to capital


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Governance


Source: Developing Value: The business case for sustainability in emerging markets, Sustainability, IFC and Ethos Institute, 2004. Adapted by CDC and Rosencrantz & Co

Business success driven by ESG improvements

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Rating risks: the Environment

Risk category

Description of category Examples

High A proposed investment is classified as Category A if it is likely to have significant adverse environmental impacts that are sensitive, diverse or unprecedented.

• Large dams and reservoirs• Forestry (large scale)• Agro-industries (large scale)• Industrial plants (large-scale)• Major new industrial estates• Extractive industries, including mining, major oil and gas developments and

major pipelines• Large ferrous and non-ferrous metal operations;• Large port and harbour developments • Developments with large resettlement components• Large thermal and hydropower development • Projects that include the manufacture, use or disposal of environmentally

significant quantities of pesticides or herbicides• Manufacture, transportation and use of hazardous and/or toxic materials • Domestic and hazardous waste disposal operations

Medium A proposed investment is classified as Category B if its potential adverse impacts on environmentally important areas including wetlands, forests, grasslands and other natural habitats are less adverse than those of Category A investments but more adverse than Category C investments. These impacts are site-specific; few if any of them are irreversible and in most cases mitigating measures can be designed more readily than for Category A investments.

• Agro-industries (small scale)• Electrical transmission• Aquaculture • Renewable energy (except large hydroelectric power projects• Tourism (including hotel projects)• Rural water supply and sanitation• Rehabilitation, maintenance and modernisation projects (small scale) • Manufacture of construction materials • General manufacturing • Telecommunications • Greenfield projects in existing industrial estate

Low A proposed investment is classified as Category C if it is likely to have minimal or no adverse environmental impacts.

• Advisory assignments • Media and information technology• Life insurance companies• Securities underwriters and broker/dealers• Technical assistance

Example of a Tool (5): Rating ESG risks

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What to do?

• Check compliance with all ESG requirements and regulations in the fund’s investment policy

• Assess all relevant aspects of the new investments from the ESG perspectives:

• risks (sector, country, company specific)

• issues

• opportunities to add value

• If high risks: contract specialists to perform an environmental and social impact assessment

• Assess quality of a potential investee company’s management systems

Initial screening

Due diligence


ExitInvestment

Toolkit reference:

Tool 2, Appendix 5 & 8

Tool 6; Appendix 1-3; 5; 9-10

Tool 7

Tool 8


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1 Assess ESG opportunities & rate ESG risks

Tool 5


A proposed investment is classified as Category C if it is likely to have minimal or no adverse environmental impacts.

Low


A proposed investment is classified as Category B if its potential adverse impacts on environmentally important areas including wetlands, forests, grasslands and other natural habitats are less adverse than those of Category A investments but more adverse than Category C investments. These impacts are site-specific; few if any of them are irreversible and in most cases mitigating measures can be designed more readily than for Category A investments.

Medium




A proposed investment is classified as Category A if it is likely to have significant adverse environmental impacts that are sensitive, diverse or unprecedented.

High

ExamplesDescription of categoryRisk category

Rating risks: the environment


A proposed investment is classified as Category C if it is likely to have minimal or no adverse environmental impacts.

Low


A proposed investment is classified as Category B if its potential adverse impacts on environmentally important areas including wetlands, forests, grasslands and other natural habitats are less adverse than those of Category A investments but more adverse than Category C investments. These impacts are site-specific; few if any of them are irreversible and in most cases mitigating measures can be designed more readily than for Category A investments.

Medium




A proposed investment is classified as Category A if it is likely to have significant adverse environmental impacts that are sensitive, diverse or unprecedented.

High


Rating risks: the environment

• Advisory assignments• Media and information technology • Life insurance companies • Securities underwriters and broker/dealers • Technical assistance• Retail

A proposed investment is classified asCategory C if it is likely to have minimalor no adverse impacts on humanpopulations.

Low

• Agro-industries (small scale)• Electrical transmission • Aquaculture • Renewable energy (except large hydroelectric power projects) • Tourism (including hotel projects) • Rural water supply and sanitation • Rehabilitation, maintenance and modernisation projects (small scale) • Manufacture of construction materials • General manufacturing •Textile plants • Greenfield projects in existing industrial estates

A proposed investment is classified as Category B if its potential adverse impacts on human populations are less adverse than those of Category A investments but more adverse than category C investments. These impacts are site-specific; few if any of them are irreversible; and in most cases mitigatory measures can be designed more readily than for Category A investments.

Medium

• Large dams and reservoirs • Agro-industries (large scale) that involve use of pesticides and herbicides that

can be toxic for workers • Industrial operations (large-scale) that involve machinery or substances that can

be hazardous for workers from a health and safety perspective • Major extractive industries operations, with on-site workers who often work on

remote locations • Projects with large resettlement components and all projects with potentially

major impacts on human populations • Projects affecting indigenous or tribal populations • Projects that include the manufacture, use or disposal of environmentally

significant quantities of pesticides and herbicides • Manufacture, transportation and use of hazardous and/or toxic materials • Domestic and hazardous waste disposal operations • Any projects which pose serious occupational or health risks • Any projects which pose serious socio-economic concerns

A proposed investment is classified as Category A if it is likely to have significant adverse impacts on human populations that are sensitive, diverse or unprecedented.

High


Rating risks: social matters

• Advisory assignments• Media and information technology • Life insurance companies • Securities underwriters and broker/dealers • Technical assistance• Retail

A proposed investment is classified asCategory C if it is likely to have minimalor no adverse impacts on humanpopulations.

Low

• Agro-industries (small scale)• Electrical transmission • Aquaculture • Renewable energy (except large hydroelectric power projects) • Tourism (including hotel projects) • Rural water supply and sanitation • Rehabilitation, maintenance and modernisation projects (small scale) • Manufacture of construction materials • General manufacturing •Textile plants • Greenfield projects in existing industrial estates

A proposed investment is classified as Category B if its potential adverse impacts on human populations are less adverse than those of Category A investments but more adverse than category C investments. These impacts are site-specific; few if any of them are irreversible; and in most cases mitigatory measures can be designed more readily than for Category A investments.

Medium

• Large dams and reservoirs • Agro-industries (large scale) that involve use of pesticides and herbicides that

can be toxic for workers • Industrial operations (large-scale) that involve machinery or substances that can

be hazardous for workers from a health and safety perspective • Major extractive industries operations, with on-site workers who often work on

remote locations • Projects with large resettlement components and all projects with potentially

major impacts on human populations • Projects affecting indigenous or tribal populations • Projects that include the manufacture, use or disposal of environmentally

significant quantities of pesticides and herbicides • Manufacture, transportation and use of hazardous and/or toxic materials • Domestic and hazardous waste disposal operations • Any projects which pose serious occupational or health risks • Any projects which pose serious socio-economic concerns

A proposed investment is classified as Category A if it is likely to have significant adverse impacts on human populations that are sensitive, diverse or unprecedented.

High


Rating risks: social matters

• Investments in countries classified as higher than 7 by Transparency International’s Corruption Perceptions Index•Investments in countries classified as 3-4 by Transparency International’s Corruption Perceptions Index in, e.g., the following industries: information technology, fisheries; and agriculture.

A proposed investment is classifiedas Category C if it is likely to havelow risk for corruption or other issuesrelated to business integrity.

Low

• Investments in countries classified as 2-4 by TransparencyInternational’s Corruption Perceptions Index in the followingindustries: heavy manufacturing, pharmaceutical and medicalcare, utilities, civilian aerospace, power generation andtransmission, forestry, telecommunications and equipment andtransportation and storage

• Investments in countries classified as 4-7 by TransparencyInternational’s Corruption Perceptions Index and within thesectors and with the characteristics listed above as high risk forcountries classified 2-4 by Transparency International’sCorruption Perceptions Index.

A proposed investment is classified as Category B if its likelihood of corruption or other issues related to business integrity are less than those of Category A investments but nevertheless a concern.

Medium

• Investments in countries classified as lower than 2 by Transparency International’s Corruption Perceptions Index

• Investments in countries classified 2-4 by Transparency International’s Corruption Perceptions Index and

– in sectors which involve large contracts, including with public sector entities or the government, such as construction, public works contracts, real estate and property development, oil and gas; or mining;

– companies with significant state ownership interests;– privatizations; and/or– investments which use local agents or intermediaries or which involve

Politically Exposed Persons (PEPs).

A proposed investment is classified as Category A if it is likely to have significant risks for corruption or other issues related to business integrity.

High


Rating risks: business integrity

• Investments in countries classified as higher than 7 by Transparency International’s Corruption Perceptions Index•Investments in countries classified as 3-4 by Transparency International’s Corruption Perceptions Index in, e.g., the following industries: information technology, fisheries; and agriculture.

A proposed investment is classifiedas Category C if it is likely to havelow risk for corruption or other issuesrelated to business integrity.

Low

• Investments in countries classified as 2-4 by TransparencyInternational’s Corruption Perceptions Index in the followingindustries: heavy manufacturing, pharmaceutical and medicalcare, utilities, civilian aerospace, power generation andtransmission, forestry, telecommunications and equipment andtransportation and storage

• Investments in countries classified as 4-7 by TransparencyInternational’s Corruption Perceptions Index and within thesectors and with the characteristics listed above as high risk forcountries classified 2-4 by Transparency International’sCorruption Perceptions Index.

A proposed investment is classified as Category B if its likelihood of corruption or other issues related to business integrity are less than those of Category A investments but nevertheless a concern.

Medium

• Investments in countries classified as lower than 2 by Transparency International’s Corruption Perceptions Index

• Investments in countries classified 2-4 by Transparency International’s Corruption Perceptions Index and

– in sectors which involve large contracts, including with public sector entities or the government, such as construction, public works contracts, real estate and property development, oil and gas; or mining;

– companies with significant state ownership interests;– privatizations; and/or– investments which use local agents or intermediaries or which involve

Politically Exposed Persons (PEPs).

A proposed investment is classified as Category A if it is likely to have significant risks for corruption or other issues related to business integrity.

High


Rating risks: business integrity

Rating ESG risks, tool 5

3Assessment of a company’s ESG management systems in relation to risk level

Tool 8

Yes No

Stakeholder management

16. Local community: Does the company have a good relationship with the community?

17. NGOs: Does the company have a constructive dialogue with NGOs (where NGOs are interested in engagement)?

18. Employees: Does the company have good labour relations (e.g. have there been strikes)?

15. Reporting to investors: IS ESG performance reported on to investors at least annually?

14. Communication lines: Are there defined lines of communication in place to report ESG issues to the company’s management and board?

Reporting

Stakeholder management

16. Local community: Does the company have a good relationship with the community?

17. NGOs: Does the company have a constructive dialogue with NGOs (where NGOs are interested in engagement)?

18. Employees: Does the company have good labour relations (e.g. have there been strikes)?

15. Reporting to investors: IS ESG performance reported on to investors at least annually?

14. Communication lines: Are there defined lines of communication in place to report ESG issues to the company’s management and board?

Reporting Comments

Yes No Comments

Yes No

12. Track record: Does the company have a good safety record Have there been accidents? Were issues subsequently addressed?

9. Specialists: Are specialist consultants/ external technical experts used to assess and monitor ESG areas (particularly for high risk companies)? If so, when and who?

7. ESG resources: Does the company have an allocated ESG professional on staff?

4. Action plans: Are formal action plans drawn up to address ESG issues?

6. Sector initiatives (if applicable): Is the company involved in relevant sector initiatives,e.g., the Extractive Industries Transparency Initiative (EITI) for mining?

5. Monitoring: Are there defined processes in place to manage/ monitor ESG Matters and the implementation of action plans?

3. Risk: Does the company provide an appropriate risk assessment which can be used as a basis for ongoing monitoring?

Policy and processes

1. Policy: Are there a formal policies and systems to manage ESG?

2. Identifying opportunities: Does the company pro-actively identify opportunities for improvements?

13. Serious incidents: Is there an established procedure to follow up any serious incidents to prevent their reoccurrence?

11. Performance indicators: Are there performance indicators in place to measure and track ESG performance?

ESG performance management

10. Training: Does the company organise training for its staff on ESG?

8. Top level responsibility: Has ESG responsibility been established at all levels up to the company’s board?


12. Track record: Does the company have a good safety record Have there been accidents? Were issues subsequently addressed?

9. Specialists: Are specialist consultants/ external technical experts used to assess and monitor ESG areas (particularly for high risk companies)? If so, when and who?

7. ESG resources: Does the company have an allocated ESG professional on staff?

4. Action plans: Are formal action plans drawn up to address ESG issues?

6. Sector initiatives (if applicable): Is the company involved in relevant sector initiatives,e.g., the Extractive Industries Transparency Initiative (EITI) for mining?

5. Monitoring: Are there defined processes in place to manage/ monitor ESG Matters and the implementation of action plans?

3. Risk: Does the company provide an appropriate risk assessment which can be used as a basis for ongoing monitoring?

Policy and processes

1. Policy: Are there a formal policies and systems to manage ESG?

2. Identifying opportunities: Does the company pro-actively identify opportunities for improvements?

13. Serious incidents: Is there an established procedure to follow up any serious incidents to prevent their reoccurrence?

11. Performance indicators: Are there performance indicators in place to measure and track ESG performance?

ESG performance management

10. Training: Does the company organise training for its staff on ESG?

8. Top level responsibility: Has ESG responsibility been established at all levels up to the company’s board?


Comments

Yes No Comments

Yes No Comments

2Due diligence questions

Tool 6 & Appendices 1-2

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Access to capital


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Tool 1

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What to do?

• Address key ESG matters in the investment paper.

• Assist potential investee companies to develop action plans to address ESG issues identified during due diligence, with appropriate targets and timetable for improvements.

• Procure formal investment undertaking from portfolio companies on ESG where fund managers have effective control or significant influence.

Initial screening

Due diligence


ExitInvestment

Toolkit reference:

Tool 9

Tool 9

Tool 10


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Area of ESG concern as identified through due diligence and management systems questions

Level of ESG risk

(high, medium, low)

Action required

By when Responsibility (company staff, management and board member)

Cost (US$)

X

Y

Z

Identified issues and mitigating measures should be specified in an action plan to be agreed between an investor and the company’s management

Example of a Tool (9): Investment paper and action plans for ESG improvements

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What to do?

• Check on-going ESG compliance

• Encourage managers of portfolio companies to:

• work towards continuous improvements on ESG

• adopt and implement sound ESG policies

• Monitor portfolio companies’ performance on ESG and progress towards action plans. If ESG issues arise, assist portfolio companies to address them in a timely manner

• Report annually to investors

• Monitor and record any serious ESG incidents in portfolio companies and inform investors

• External communication to the general public through annual reports and websites

Initial screening

Due diligence


ExitInvestment

Toolkit reference:

Tool 2 ,11

Tool 1,11; Appendix 5

Tool 11

Tool 12; Appendix 7

Tool 12; Appendix 7

Tool 13


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What to do?

• Consider ESG matters at exit:

• any ESG issues with potential buyers?

• will sound ESG practices continue under new owners?

Initial screening

Due diligence


ExitInvestment

Toolkit reference:

Tool 14; Appendix 1, 2


• A printed version of the Toolkit has been distributed to CDC’s fund managers

• An electronic version of the Toolkit is accessible from:

• CDC’s website

www.cdcgroup.com

• Rosencrantz & Co’s website

www.rosencrantzandco.com

• CDC and Rosencrantz & Co conducts workshops for CDC’s fund managers based on the Toolkit during Q4 2010

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The Toolkit is a resource for CDC, fund managers, other development finance institutions and commercial investors

Please let us know if you would like to receive printed versions of the Toolkit or collaborate with CDC or Rosencrantz & Co in workshops or otherwise

Economy & Finance

Marie rosencrantz