Lazard ESG Integration: 2017 Second Half Report At Lazard, we are committed to providing clients with innovative investment solutions and superior performance. ESG is a critical component of this investment philosophy. We recognize that ESG considerations, such as a company s board structure, environmental practices, or labor policies, can affect a company s valuation and financial performance. Therefore, our investment professionals integrate ESG analysis into their research and decision-making process. Our more than 250 investment professionals worldwide are responsible for identifying ESG risks and opportunities and incorporating them into their investment analysis. Our research is documented in our internal research database and is available to all investment professionals globally. Yet, this ESG evaluation does not end once a buy or sell decision is made. As active investors, we strive to maximize shareholder value for our clients by voting proxies and regularly engaging with companies. In this report, we provide select examples from our wide-ranging ESG-related efforts.
Proxy Voting In 2017, Lazard voted at 3,200 annual company meetings covering more than 36,000 proposals. Globally, we voted against management on one or more recommendations at 36% of these company meetings and we voted against 8% of the total proposals recommended by management. During the year, we also supported 63% of shareholder proposals on climate change and greenhouse gas emissions. This is well above the average support of 33% in 2017, as reported by the Harvard Law School Forum on Corporate Governance and Financial Regulation.¹ Our Proxy Voting Policy was designed with our clients best interests in mind. We do not employ outside vendors to vote on our behalf. Rather, our investment professionals are responsible for providing vote recommendations, which are considered independent of management. Proxy Voting Activity in 2017 Proxy Voting Region Meetings voted Proposals voted United States 680 7,583 United Kingdom 355 5,660 Developed Europe (ex-uk) 481 7,018 Emerging Markets 823 6,973 Other 895 9,087 Total 3,234 36,321 As of 31 December 2017 Source: Lazard, ISS 2
Engagement During the second half of 2017, our investment professionals participated in approximately 2,200 meetings with company management and boards of directors. In 22% of those meetings, an ESG issue was discussed. In many of those meetings, the discussion was elevated to a point where we made recommendations to management or the board because we believed that their ESG practices could have a material impact on the company s financial performance. In instances where our concerns have not been adequately addressed, we may escalate them by writing a formal letter or requesting a meeting with the board of directors, or by voting against management on proxy resolutions at annual general meetings. Ultimately, we may decide to disinvest from the company in question where we believe it is in our clients best interest to do so. ESG Engagements in the Second Half of 2017 Environmental Social Governance Engagements for the period 1 July 2017 through 31 December 2017 Source: Lazard 3
ESG Engagement Case Studies Elior (Governance) Elior is a large commercial catering and food service company with operations primarily based in Europe and the United States. We met with Elior s CEO after its Annual General Meeting (AGM) to address the company s executive compensation program, which was rejected by shareholders. We recommended that Elior widen CEO performance metrics to incorporate return on capital, cash flow generation, and operating profits improvement metrics. We also suggested that Elior change the time frame of its long-term incentive compensation program to cover a minimum of three years. We are encouraged by the company s initial efforts to identify the issues with the original compensation proposal and we will continue to monitor its executive compensation practices. The J.M. Smucker Company (Social) Smucker s is a North America-based manufacturer of fruit spreads, peanut butter, shortening and oils, dessert toppings, beverages, and other food products. We engaged with the company s Sustainability team to better understand its approach to nutrition in order to evaluate potential risks to the company s long-term growth. Our concern arose from the fact that many consumers are becoming more health conscious. In addition, we were concerned that many of its less healthy products are marketed towards children. Smucker s corporate responsibility report has detailed information on steps it is taking to minimize its environmental impact, however it has limited information on its approach to nutrition. Based on the discussion, it is clear Smucker s does consider the role it should play in the food value chain. Initial efforts have been more focused on socially responsible sourcing of products such as coffee beans and palm oil from sustainable sources that do not use any child or slave labor. We are encouraged by Smucker s actions to reduce its carbon footprint, source responsibly, and improve the agricultural upstream. We will continue to maintain a dialogue with the company on its approach to nutrition, particularly with children, as well as efforts to minimize its environmental impact. Petrobras (Governance) Petrobras is an integrated oil and gas producer based in Brazil. In October 2016, we held a meeting with the new CEO and his management team in our offices to solely address governance, given allegations of bribery, fraud, and corruption. The company described its reform agenda, including new market-based pricing policy and new processes to safeguard against bribes and kickbacks. Petrobras appears to have identified the material weaknesses in its internal controls that allowed those payments to take place and has undertaken hundreds of reforms, such as tighter control of the Enterprise Resource Planning (ERP) systems, making it difficult for management to override existing controls. The company has also improved the whistleblower channel and increased counterparty due diligence. Petrobras has added a Deputy Officer for Governance and Compliance to assist the existing Executive Office for Governance and Compliance (DGC). In December 2017, we met with a Petrobras Board Member to address the continuity of changes in the company s corporate governance policy and we will continue to keep an open dialogue with Petrobras. 4
Participation in Collaborative Initiatives Lazard is a signatory to, and a member of, several organizations that promote responsible investing. We are signatories to the Principles for Responsible Investment (PRI), the UK Stewardship Code, and the Japan Stewardship Code. We are also members of the International Corporate Governance Network (ICGN) and International Accounting Standards Board (IASB) Investors in Financial Reporting program. Shaping the Future of Responsible Investment In, we attended the annual PRI Conference, Shaping the Future of Responsible Investment. The main focus of the conference was the PRI s recently issued A Blueprint for Responsible Investors report which seeks to influence the future of responsible investment. The dominant theme included Climate Change and a Sustainable Financial System that incorporates the UN Sustainable Development Goals (SDGs) into investment practices. Lazard is currently reviewing the SDGs to determine how to best incorporate the relevant goals into our approach to ESG integration, where appropriate. IASB Investors in Financial Reporting Programme Principles of Disclosure Roundtable Discussion In the second half of 2017, we participated in an IASB investor outreach project on the Principles of Disclosure. The goal of the project was to improve the effectiveness of disclosures in financial statements. As part of this initiative, several Lazard Research Analysts participated in a roundtable discussion with other asset managers and IASB representatives. Green Bonds of America 2017 Conference In October, we attended the Green Bonds of America 2017 Conference. Green bonds are standard fixed income instruments whose proceeds are applied exclusively toward financing or re-financing new and/or existing eligible green projects. At the conference, panelists discussed the massive growth of green bonds, their transparency, and how green bonds can help mitigate long-term risks. Green bonds provide an option for investors that want to navigate the transition away from fossil fuel investments and reduce exposure to stranded assets, such as coal companies. Certain Lazard investment teams, including our Global Fixed Income team, actively invest in the green bond market as part of their overall ESG integration approach, taking the view that green bond investments offer both risk mitigation and return opportunities. 5
ESG Collaborative Initiative Activity in the Second Half of 2017 Initiative Date Location July Malaysia and December Norwalk, CT CECP Strategic Investor Initiative CEO Investor Forum PRI in Person 2017 Berlin, Germany HSBC Seminar: Green Bonds and the City Future of Urbanisation Virtual HSBC: Sustainable Financing and Innovation Briefing Microfinance Club of Bringing the Efficient Frontier to Impact Investing Credit Suisse: 15 Years of Investing for Impact (ASB Investors in Financial Reporting Programme Principles of Disclosure Roundtable Discussion October London Green Bonds Americas 2017 October Thomson Reuters ESG Investing Forum October PRI Roundtable: ESG in Credit Risk and Ratings November Microfinance Club of - Breaking Down India's Demonetization: One Year in Review November RI Americas 2017 December ICGN Annual Conference Financial Accounting Standards Advisory Council Meeting 6 E S G
ESG in Focus: Giving Credit Where It s Due Emerging markets investors are increasingly focused on ESG considerations when making investment decisions. Several studies, as well as demonstrated market behavior, show a clear correlation between a country s bond performance and the strength of its institutions and governance. We developed a scoring methodology that allows the Lazard Emerging Markets Debt team to rank the country constituents of the J.P. Morgan EMBI Global Diversified Index by their ESG strength and differentiate between countries with similar ESG profiles. A cross-comparison between the ESG scores we assigned to each country and its respective credit rating has reaffirmed our hypothesis that wider sovereign spreads generally correspond to a deterioration in ESG rankings. Further to our analysis, we leveraged a version of our scoring approach to estimate the ESG portion of our five-year spread targets. From this we formed some insights about the relationship between different types of sovereign credits, our assessment of their creditworthiness, and their ESG spread premiums (see exhibit). We once again saw a strong relationship between a country s ESG standards and its cost of borrowing, consistent with the findings of several multilateral and nongovernmental organizations. 7
Projected ESG Premium by Credit Type Types of Credits Lazard Rating Score Range Approximate ESG Premium Extremely Solid Credits AA >85 30 50 bps Solid Investment Grade (IG) A >75 85 50 100 bps Weak IG BBB 70 75 100 200 bps Strong Non-IG BB >60 70 200 300 bps Weak Non-IG B >40 60 300 600 bps Risk of Default in Medium Term CCC 40 600 bps+ As of 30 June 2017 Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard Although this scoring method is not foolproof, as it may not completely capture a country s strengths and vulnerabilities (for reasons that include lagging ESG indicators, stale macroeconomic forecasts, and issues not captured by the macroeconomic and ESG indicators we monitor) we believe it provides an excellent starting point for assessing the ESG components of spread targets. Our findings have also compelled us to refine our ESG investment analysis to include a broader set of ESG indicators now fourteen in total. We show the results for Colombia as an example, with median values for all BBB-rated credits represented by the dark green ring. 8
Colombia Has Room to Improve Fragile States Index Environmental Performance Press Freedom UN World Risk Voice and Accountability Political Stability Govt. Effectiveness Regulatory Quality Rule of Law Our research underscores the importance of monitoring and quantifying ESG developments in emerging markets, particularly in the highly influential area of governance. It also affirms the importance of structural reform progress in the developing world, not least as a way for countries to enhance their credit profile in the eyes of investors. Global Competitiveness Control of Corruption Human Development Ease of Doing Business Corruption Perceptions Median Standard Deviation As of 30 June 2017 Source: Lazard Our Commitment At Lazard, we conduct independent ESG analysis to ensure our clients receive differentiated insights that can be critical to investment outcomes. And we go further by engaging with companies to advocate for positive change on behalf of shareholders. As the global business environment evolves, we are committed to continuously improving our ESG Integration approach. 9
Notes 1 As of July 2017 Important Information Published on 12 April 2018. This document reflects the views of Lazard Asset Management LLC or its affiliates ( Lazard ) based upon information believed to be reliable as of 17 August 2017. There is no guarantee that any forecast or opinion will be realized. This document is provided by Lazard Asset Management LLC or its affiliates ( Lazard ) for informational purposes only. Nothing herein constitutes investment advice or a recommendation relating to any security, commodity, derivative, investment management service or investment product. Investments in securities, derivatives and commodities involve risk, will fluctuate in price, and may result in losses. Certain assets held in Lazard s investment portfolios, in particular alternative investment portfolios, can involve high degrees of risk and volatility when compared to other assets. Similarly, certain assets held in Lazard s investment portfolios may trade in less liquid or efficient markets, which can affect investment performance. Past performance does not guarantee future results. The views expressed herein are subject to change, and may differ from the views of other Lazard investment professionals. This document is intended only for persons residing in jurisdictions where its distribution or availability is consistent with local laws and Lazard s local regulatory authorizations. Please visit www.lazardassetmanagement.com/globaldisclosure for the specific Lazard entities that have issued this document and the scope of their authorized activities. HB28537