Responsible Investment Report 2011

Shale Gas Driving operational standards higher and environmental footprints lower in a booming industry

Bank Bonuses Striking a better balance between performance and risk management in financial sector executive pay

Nuclear Safety Pressing companies to learn the lessons from the Fukushima disaster Contents

Introduction 3

Investor Engagement in 2011 4

Voting and in 2011 8

Public Policy 12

Outlook for 2012 14

Appendix 16 Responsible Investment Report 2011

Introduction

The second decade of the 21st century has got off to a rocky start. 2011 has seen revolution sweep through the Arab world, economic crisis in the Eurozone, street protests against the capitalist system, and the birth of the seven billionth human being – all of which raise fundamental questions about the ability of mankind to reconcile economic prosperity with the planet’s ever-tighter resource constraints.

In a world facing such economic, social and environmental challenges, what is the role of investors? Often perceived as part of the problem, investors can and should, in our view, be part of the solution. As a pioneer in ethical funds and Richard Wilson Head of Investment and investor engagement, and a founder signatory of the UN Principles for Responsible Investment, F&C is committed to Institutional Business being an active owner and to using its influence to drive better management of the environmental, social and governance risks facing businesses and society. This year’s Responsible Investment Report sets out how F&C has exercised this influence on behalf of its reo ® clients 1. Our engagement has spanned over 1,200 companies in 54 countries. Where we have identified issues of systemic importance, we have sought to make our voice heard in the public policy arena. Areas of particular focus have included: ■ Calling for improved pay structures in the banking sector that encourage a better balance between risk and reward ■ Protecting listings rules from being compromised in London ■ Limiting the environmental and social impacts of shale gas operations ■ Challenging companies operating in high-risk areas to improve their management of human rights We also exercised voting rights on behalf of reo ® clients at a total of 5,381 companies in 64 countries. In just over one-fifth of our votes, we either abstained or opposed management, using our clout as shareholders to call for improvements in governance. This report ends with a look ahead to 2012. We expect to face greater political attention on resource scarcity and commodity prices; continued questions over the social validity of the financial system; a lively debate over the future of energy; and a sharp focus on sound risk management systems. F&C will seek to join with fellow investors to identify where these and other challenges present risks to long-term investor value, and to translate them into a practical agenda for action.

reo ® is operated on behalf of:

1 ® F&C applies its reo approach to both the funds it manages directly on behalf of its clients, worth £25.9 billion / €31.0 billion as at 31 December 2011, and to a further 3 £59.8 billion / €71.6 billion of assets that are managed by third parties. Responsible Investment Report 2011

Investor Engagement in 2011

In today’s volatile and risk-conscious world, F&C sees the principle of investor engagement as more relevant than ever. Gaining a rounded understanding of the entire spectrum of risks facing businesses, including environmental, social and governance (ESG) risks, is a crucial part of a robust investment decision-making process.

Having identified which issues present the greatest threats to long-term investor value for shareholders and bondholders, we engage in in-depth dialogue with investee companies to encourage them to improve their performance. Our engagement encompasses a broad spectrum of environmental, social and governance risks, covering companies across sectors and geographies. Here we summarise the outcomes of some of our key engagement projects from 2011.

Engagement by numbers 2011

480 instances Engaged 1,222 of change achieved companies one-to-one 121 meetings at board level 7,740 companies contacted to explain our responsible Engaged companies in 54 countries investment approach

F&C reaches out to all companies in our clients’ portfolios to Our approach is globally balanced, with roughly one-third of outline our overall approach to responsible investment and companies engaged located in Europe, one-third in the Americas, corporate governance. In 2011 this meant contacting 7,740 and the remainder in Asia, Australasia and Africa. We saw a companies. significant growth in our engagement in Central and South America, reflecting in part our work to assess the risks associated with This broad outreach is complemented by in-depth dialogue with operations in Colombia (below). 2011 also saw a broadly even split carefully selected companies, focused on the environmental, social between our work on environmental, social and governance themes 2. and governance (ESG) issues that we identify as having a material impact on their long-term performance. 1,222 companies were This engagement resulted in tangible outcomes in terms of engaged by F&C in total over the year, sometimes working with companies adopting our recommendations, and in so doing, other investors through collaborative initiatives, and sometimes by reducing the ESG risks facing their business. In 2011 we recorded F&C directly. Our dialogue involved us in 410 company meetings, 480 instances of change achieved at companies (“milestones”), up 121 of which took place at Board level. from 432 the year before.

“Often perceived as part of the problem, investors can and should, in our view, be part of the solution ”

4 2 See full breakdown of 2011 engagement activity in the Appendix. Investor Engagement in 2011

Engagement Programme: Business Ethics Issue: Responsible sales in the pharmaceutical sector Outcomes

Background We have seen significant improvements in the Driving profitable sales growth is essential to the success of pharmaceutical major multinationals including: companies. However, inappropriate sales practices such as recommending doctors write prescriptions for therapies not approved by regulators (aka ‘off-label ■ Disclosure of data from employee marketing’), over-generous ‘gifts’ to doctors, and the outright payment of bribes can hotlines (‘whistleblowing systems’): lead to disruptive enforcement actions, fines, reputational damage and ultimately GlaxoSmithKline, Roche and restrictive legislation. These risks have been compounded by pharmaceutical AstraZeneca companies’ rapid expansion into emerging markets, where regulations are more lax, ■ Publications of payments to doctors corruption risk can be higher and the judicial system less reliable. for speaking engagements and Engagement objectives consultancy: Merck and Eli Lily To press companies to improve policies, strengthen internal controls and board ■ Review of pay structures for sales oversight, create anti-corruption functions, and reform pay structures to avoid forces: GlaxoSmithKline inadvertently incentivising unethical drug sales practices. Overall, we see a positive direction of travel F&C action amongst most of the major companies, although 2011 saw the culmination of a three-year programme of engaging the major this remains a high-risk area. multinational drug companies as well as generics producers to press for better practices. We held one-to-one meetings with twelve global companies including Generics companies are a different matter. Our a deep dive into responsible sales controls at Pfizer’s Brazilian operations; wrote outreach so far suggests this issue is not high on individually to five Asian generics manufacturers to urge greater disclosure of their agenda: one company reported that F&C standards to ensure responsible sales and safe products; and joined with fellow was the first investor to enquire about responsible investors to invite the chairmen of seven of the largest global drug firms into a sales. The generics are increasingly vulnerable dialogue on responsible sales and methods to enhance legal and regulatory given their strategic plans to penetrate further into compliance. developed markets and partnerships with branded drug makers, and can expect to face rising scrutiny.

Engagement Programme: Health & Safety Issue: Nuclear safety post-Fukushima Outcomes Background TEPCO has implemented a number of The earthquake and tsunami that struck Japan on 11 March 2011 resulted in the biggest nuclear incident since the Three Mile Island and Chernobyl disasters. The measures in line with our recommendations share price and credit rating of Tokyo Electric Power Company (TEPCO), the and following government intervention, operator, plunged as the full extent of the disaster became clear. Whilst some of including: the circumstances surrounding the accident were particular to the site itself and to ■ New safety standards Japan, there were also important wider lessons that the global nuclear industry is still getting to grips with – and the accident triggered a worldwide political and ■ A roadmap for disaster recovery public backlash against nuclear power. ■ Structures for compensation payment Engagement objectives However one year on, TEPCO remains mired To press for a robust management response by TEPCO, and to engage in dealing with the aftermath of the disaster. nuclear operators globally to understand how they are incorporating the The true extent of the losses to the company lessons from the disaster. is still unclear, and questions remain about whether TEPCO – and the Japanese nuclear F&C action industry more generally – has genuinely We travelled to Tokyo to meet the management of TEPCO and make specific addressed fundamental questions about recommendations for action, including communication of progress in safety culture. decommissioning, a comprehensive safety review of all assets and of safety protocols, and improvements to the Board. Meanwhile, we also met nuclear The response of the wider nuclear industry is experts at French power utilities EDF and GDF Suez to learn about how they are still playing out, and will be a focus of F&C responding to the crisis, and wrote to nearly 30 nuclear operators to ask whether engagement in 2012, as we follow up on our safety improvements had been implemented in the wake of the accident. outreach to global utility companies.

5 Responsible Investment Report 2011

Engagement Programme: Human Rights Issue: Operating in high-risk and conflict-afflicted areas Outcomes

Background We were encouraged by the measures Companies operating in parts of the world afflicted by conflict, or under the companies are taking to operate responsibly in an control of repressive regimes, are faced with a heavy burden of responsibilities. environment as complex as Colombia’s. In In 2011, we turned our focus to Colombia. The country has seen a wave of inward investment as its 50-year-old conflict with rebel groups has subsided particular: and the business climate has improved. Yet despite this, major challenges ■ Companies are helping local communities to remain. Natural resources tend to be found in isolated and poor areas with set up systems to improve revenue complex social, human rights and economic concerns. transparency, by auditing the money paid to local governments and tracking how much is Engagement objectives spent on specified projects. This is of crucial To develop a robust approach to managing the risks of operating in conflict- importance to deter corruption and foster affected areas, we have encouraged companies to: accountability: most of the mining regions ■ Engage in a meaningful way with indigenous communities and other remain desperately poor, despite receiving stakeholders; significant royalties and taxes.

■ Take a more strategic approach to social investment, rather than just ■ A multi-stakeholder initiative has been spending on high-profile ‘token’ projects; and established to discuss issues related to human rights risks from the use of security Use their clout with governments in a positive way to call for human rights ■ forces. Crucially, this has won the active protection. participation of the Colombian armed forces, F&C action working alongside companies, NGOs and We travelled to Colombia to meet extractives companies including Anglo American, government. Two major companies are now BHP Billiton, Xstrata, AngloGold Ashanti, Chevron, Ecopetrol and Occidental piloting a set of performance indicators to Petroleum. We visited Cerrejón, one of the largest open-pit coal mines in the world, improve management and monitoring of where we spoke with employees, union representatives and communities to get a security risks. rounded picture of how this high-impact project is being managed.

Engagement Programme: Climate Change Issue: Corporate disclosure

Background Outcomes Since 2000, when F&C joined a handful of fellow investors to launch the Carbon Disclosure Project (CDP), the initiative has made huge strides in its status and Although only a year old, the Carbon Action reach. It is now supported by more than 650 investors representing $78 trillion initiative is already starting to bear fruit. assets under management, with over 3000 companies responding in 2011. Of the 205 companies requested to set However, the quality of responses varies widely. Some companies offer one- targets as part of the Carbon Action request, word answers and minimal data, whereas the very best use the CDP to set out 35 reported targets in 2011. Investor their strategic vision on how climate change will impact on their business. participants are now following up in further depth with selected companies. Engagement objectives To encourage companies to take a more strategic approach to climate change, The real challenge lies in breaking the inertia and to improve their reporting to the CDP so as to enable their data to be used that persists as carbon reduction projects in financial modelling and valuation. continue to be seen by many as a sideline that lies outside their core business, and F&C action returns, while above cost of capital, often still In 2011, F&C joined 34 fellow investors with assets of $7.6 trillion to form the lie below those of competing capital projects – CDP Carbon Action initiative. Participants wrote to the largest global 500 particularly in the current policy environment companies, asking them to: where the outlook for the carbon price ■ Adopt an emissions target if they had not already done so remains uncertain.

■ Make year-on-year emissions reductions

■ Identify and implement investment in greenhouse gas emissions reduction initiatives that have a satisfactory positive return on investment.

6 Investor Engagement in 2011

Engagement Programme: Environmental Management Issue: Shale Gas

What is Shale Gas? Background Advances in drilling techniques have unlocked potentially enormous natural gas Shale gas is natural gas that is trapped in layers of deposits trapped in deep shale rock formations. Countries that were once net sedimentary rock and mud as deep as 3000 importers of gas are now contemplating a future of energy self-sufficiency with meters underground. Unlike conventional oil and lower prices from a relatively clean-burning fuel. gas, shale gas is dispersed over very large areas and locked in tiny bubbles within deep layers of The shale gas industry faces great opportunities, but these could be badly rock. Rather than drilling a few big wells to access derailed if its meteoric growth outpaces its capacity to manage operational and a large reservoir, shale gas is released by drilling stakeholder risks. It has come under sustained assault by activist groups, yet thousands of small wells across vast areas. its response has been remarkably ineffectual and has fuelled public mistrust. The gas is removed by blasting water at very high Engagement objectives pressures to break open the rocks and releasing Investors, lenders and insurers need to better understand which companies the gas in a process called hydraulic fracturing or are properly managing risks, which include the following: “fracking”. It has become possible to extract on a Environmental: Groundwater pollution; Unsafe disposal of hazardous commercially viable, industrial scale in the past wastewater; Water resource stress; Air pollution from exhaust; Methane leaks decade thanks to major developments in drilling techniques, including the use of ‘horizontal drilling’ Social: Pressure on infrastructure; Anarchic planning; Social disruption deep underground. including accommodation shortage and influx of workers Worldwide reserves of shale gas are estimated at Project Governance: Inadequate local regulation and enforcement: 6.6 trillion cubic feet 3 – equivalent to an increase of Questionable lease acquisition practices; Political corruption over 40% in global gas resources. Substantial deposits can be found in the United States, F&C action Australia, Argentina, Canada, China, Mexico, F&C is leading an initiative on behalf of a group of financial services companies that Poland, France and many other nations. aims to identify a body of best practice to underpin financing and insurance decisions, and thereby drive adoption of best practices for shale gas operations. Critics have pointed to risks associated with the We convened representatives from industry, finance, civil society, academia and extraction methods used, including the accidental government over two days of collaborative workshops in Washington, DC. release of unburned gas (methane) directly into the atmosphere – a greenhouse gas 25 times more This was followed by a day in the field, where we conducted a site visit to the facilities powerful than CO 2. of Chesapeake Energy in rural Pennsylvania, in order to examine drilling, fracking and pumping operations, and interview staff on the ground. Finally, we met with local farmers who were directly impacted by the industry – small stakeholders who lack the means to travel to major financial centres to voice their views.

Outcomes Some of the oil and gas companies, particularly those that attended our meetings, acknowledge the need for better practices and recognise that irresponsible operators damage the entire industry. Leaders include US-based Apache Corporation, which enthusiastically supported our event, and Royal Dutch Shell, which is developing a best-practice guide that it plans to make public.

Given the dwindling availability of so-called ‘easy oil’, tighter regulations around coal power, and weak federal support for renewable energy, shale gas is likely to Infrared shows what the eye can't see - the extent to dominate US energy development. Going forward F&C will: which methane is released into the atmosphere at shale gas operations 4 ■ Work with financial services companies to develop standards for financing shale gas that will drive best practice across global markets, while ensuring a level playing field for banks and insurance companies. 3 US Energy Information Agency (EIA), 2011 estimate ■ Weigh into regulatory initiatives where a financial services perspective would 4 Still from video by Frank Finan, as cited in presentation by be helpful. Professor Anthony Ingraffea

■ Encourage the most forward-thinking shale gas operators to form a voluntary best practices group.

■ Drive better transparency by requesting more thorough and regionally specific disclosure on shale gas operations, and details of the efforts companies are making to promote good infrastructure planning. 7 Responsible Investment Report 2011

Voting and Corporate Governance in 2011

2011 saw corporate governance issues take centre stage across the world. Shareholders and governments ratcheted up the pressure on boards, with a far less forgiving attitude on payments for failure than had been the case in the past. The calls for firms to become more accountable have been fuelled by rising public anger, especially towards financial institutions – a constant and explosive feature of the news in 2011.

As ever, F&C exercised its voting rights on behalf of its in-house holdings and those of its reo ® clients to encourage good governance. Perhaps unsurprisingly, this year’s resolutions on pay plans proved to be the most contentious voting issue between shareholders and management; the introduction of the right to a ‘say on pay’ in the US this year gave shareholders the right to express their views, even if management did not always listen to them.

In 2011, F&C voted over 73,000 resolutions at 5,381 companies in slower than we had hoped, we shifted our stance to a vote against 64 countries. We engaged companies before the vote, to explain management in many cases. The shift to a ‘say on pay’ vote in the our expectations and invite comment, and afterwards to explain US was significant – with weak practices widespread, we only our reasons for any votes against management. supported management in 53% of advisory votes on pay. Germany bucked the trend, with improved transparency on pay packages Overall, F&C supported management in 76% of all proposals, a resulting in a rise in support for management on pay from 53% in slight increase over 2010. This was mostly accounted for by an 2010 to 85% in 2011. increase in support for resolutions related to Board elections, where we saw an improvement in practices in a number of The 2011 voting record also shows a dramatic fall in the number of markets including Brazil, China, South Korea and Japan. shareholder resolutions voted by F&C, from 1,138 in 2010 to 729 in 2011. This reflects in large part the introduction of the Remuneration remained a contentious issue. In 2010 F&C had mandatory say on pay in the US, removing the need for abstained on a significant proportion of resolutions, but had sent a shareholder resolutions on the issue, which had been common message to companies that remuneration structures had to be in previous years. improved to secure our support in future. With improvements

How we voted in 2011 (2010 in brackets) 5

Number of Description For Management Against Management Abstain No Vote 6 Resolutions

Board elections 35,919 73% (68%) 23% (26%) 3% (4%) 2% (3%) Capital structure 6,213 69% (67%) 21% (22%) 8% (7%) 2% (4%) Remuneration 8,726 68% (67%) 20% (11%) 9% (16%) 3% (6%) Routine & Other Business 21,676 88% (80%) 4% (6%) 2% (3%) 6% (11%) Shareholder Proposals 7 729 30% (40%) 54% (53%) 14% (7%) 2% (0%) All Proposals 73,263 76% (72%) 17% (18%) 4% (5%) 3% (5%)

5 Totals may not sum to 100% due to rounding. 6 The majority of ‘no votes’ take place in markets that employ shareblocking, where most clients elect not to vote so as not to constrain their investment decisions. The ‘Routine & Other Business’ category also includes non-voting proposals which is the reason for the relatively high proportion of no votes. 7 8 Typically companies will advise investors to vote against shareholder resolutions. Hence a vote in favour of a shareholder resolution is counted in our statistics as a vote against management, and vice-versa. Voting and Corporate Governance in 2011

Votes against management and abstentions around the world, 2011

Russia 27%

USA 16% Korea 8% China 10% Japan 56% Mexico 32% India 15%

UK 7% Brazil 9% Germany 10% Holland 11% Australia 20%

France 20% Global 21%

European Russia USA Mexico Union

The European Commission’s The Russian business After years of resistance by the Following the lead of other Green Paper on corporate environment has been beset by corporate community, 2011 emerging markets including governance brought a clear focus pervasive corruption, weak rule of was the year when a Brazil, South Africa and Korea, on building stronger and more law and intensive state meddling, shareholder “Say on Pay” finally Mexico launched its own consistent business practices. which have proven a significant became mandatory for US Sustainability Index in F&C’s response underscored the deterrent to international companies under the Dodd- December 2011. Inclusion in importance of the “comply or investors. In 2011, President Frank Act. With the principle the index requires companies to explain” principle and called for its Dmitry Medvedev announced a finally established, attention meet a stringent set of robust application to ensure that series of measures to improve the turned to the question of how sustainability requirements, the flexibilities intrinsic to “soft law” investment climate, including a often the issue would be put to covering issues such as climate do not allow for lax standards. We timetable for privatising State a vote. In a raft of shareholder change, human rights and encouraged the framework to be holdings in Russian companies, proposals demanding that Say- bribery. Elsewhere in the world, supplemented with guidance for enhancing minority shareholder on-Pay votes appear annually, the introduction of such indices issuers with concentrated rights, and removing high-ranking 72% of shareholders, including has proven a spur for ownership structures to enhance government officials from boards. F&C, voted in favour, yet two- improvements in corporate protection of minority Previous efforts to tighten up fifths of companies insist on sustainability; in Mexico, F&C shareholders, a particularly governance and crack down on putting the issue up only once hopes it will encourage important issue in a number of corruption have been hindered by every three years 8. This debate companies to address countries where majority family or State bureaucracy; there appears played out via non-binding longstanding issues such as state ownership is commonplace. to be greater political momentum votes, so discretion ultimately fractious labour relations and F&C’s response also noted that a behind this latest set of changes, rests with company wasteful energy and water company’s creditors also have a although vested interests remain management, but F&C has consumption. strong interest in good corporate powerful, and change will not urged companies to heed governance. come quickly or easily. shareholder preferences.

8 GovernanceMetrics International 9 Responsible Investment Report 2011

Companies: BP, Transocean Issue: Safety

Background environmental and safety risks, and how this will be reflected in At this year’s annual general meetings, BP and Transocean faced their remuneration plans. Since the Macondo accident, BP has significant investor concern over their responses to the Deepwater introduced extensive reforms to its management of safety and Horizon disaster in 2010. Whilst no specific shareholder resolution operational risks. Transocean’s response, in contrast, has been was filed on this issue – in itself a reflection of intense behind-the- largely defensive and the company has failed so far to develop and scenes dialogue - F&C urged both companies to provide more communicate a clear strategy on how it intends to enhance its risk clarity on how their boards will strengthen oversight of management approach.

BP Transocean

Abstained on accounts and reports . We had very significant Voted against discharging the board. We are not convinced concerns about the company’s poor safety record, but noted and of the adequacy of the company’s response to the disaster, and welcomed BP’s safety reforms. urged it to disclose how its new Health, Safety and Environment Committee will ensure more effective risk oversight. Voted against directors who had served on the Safety, Ethics and Environment Assurance Committee (SEEAC) Voted against the remuneration plan. Although the during the Macondo incident. This committee was responsible Compensation Committee exercised some discretion to cut for overseeing the integrity of the company’s safety management bonuses, more than half the payout linked to the overall safety systems. metric was awarded. We urged the company to exercise more restraint in light of the severe decline in share value and ongoing Abstained on the remuneration report. We welcomed the reputational issues facing the company. Committee's decision to withhold bonuses, but still question the company’s ability to reflect safety and risk management issues in pay going forward. We were also concerned that departing executives Hayward and Inglis were treated as ‘good leavers’ for the purposes of the share scheme.

Companies: Olympus Issue: Corporate Governance in Japan

Background F&C action Japan has long been a challenging market for foreign investors to have Within a week of the sacking, F&C: their voices heard. There have been legal reforms to corporate • Led a group of nine global investors to engage with Olympus; governance, but domestic institutional shareholders remain unwilling to • Requested the resignation of Chairman Tsuyoshi Kikukawa, who be assertive with company management and prefer to maintain was allegedly responsible for the payments. A month later, after harmony in cross-ownership arrangements. persistent public pressure, Kikukawa and his two closest directors resigned; However, this may finally be set for a change after • Called for an independent investigation into the circumstances of became a byword for scandal in Japan, following the sacking of its Woodford’s dismissal and into Olympus’ takeover activity, which newly-appointed British Chief Executive, Michael Woodford. Woodford was subsequently established. was dismissed after he uncovered $680 million in unexplained We are urging regulators to learn the lessons from the Olympus payments to advisors relating to a takeover deal in 2008. The Board scandal and introduce wider changes to Japanese corporate refuted claims that Woodford had been fired for whistleblowing, but governance in 2012, including revisions to the Companies Act and within days Olympus’ shares had shed half their value as shareholders new standards for companies on the . questioned the Board’s explanation and lost faith in the integrity of management.

The management was rotten to the core, and infected those around it. “ Independent Panel Report into Olympus scandal ”

Voting key:

10 Voted against management Abstained Voted with management Voting and Corporate Governance in 2011

Sector: Banks Issue: Remuneration

Background Barclays: Voted against remuneration plan due to concerns “Paid for failure” sums up how the public came to view large bonuses about significant short-term bonuses being awarded to to banking executives in the aftermath of the financial crisis of 2008. executives in a year in which the company made an economic Investors have been on the front line in calling for remuneration to be loss. We also believed that the 22% increase in the new CEO’s curbed in the financial services sector where it is out of line with salary was excessive. company performance. As long ago as 2006, F&C was arguing for HSBC: Voted against the pay plan, noting the significant base the introduction of ‘clawback’ mechanisms to recover pay in the event salary increases awarded to the Chairman and Chief Executive that performance turns out to be based on unsustainable practices. relative to their predecessors. Substantial bonus awards were And in 2011, we led the call for banks to bring in a ‘credit quality also made to executive directors in a year in which the bank underpin’ for bonus payments, so that if risk-taking behaviour is so had made an economic loss. We also expressed concerns excessive as to lead to a deterioration in the bank’s credit quality, about the lack of clearly established performance metrics. executives should have to forego their bonuses. Several banks, including RBS and Barclays in the UK, responded positively and : Voted against the release of the Supervisory detailed in their reporting how the remuneration committee assesses Board from its liabilities because the bank did not put its risk performance in the context of executive pay awards. remuneration report to an advisory vote after many shareholders had objected to it the previous year. The focus on bank pay also extended below the level of executive directors, to include bonus payments awarded throughout the bank. Voted against the pay plans at a host of US banks, including The aggregate level of bank bonus pools is increasingly scrutinized by Citigroup , , JP Morgan Chase , Morgan F&C, given the competing demands of paying dividends to Stanley and US Bancorp , reflecting poor pay structures with shareholders and retaining capital in an environment of increasingly an excessive use of discretion. stringent capital requirements.

Other notable 2011 votes

Company Resolution Explanation

Bridgestone Election of Directors We welcomed the company’s decision to appoint additional independent directors. However we took Japan the opportunity to press again for the adoption of labour standards and human rights policies given controversies over Liberian operations.

BSkyB Election of Chairman We opposed the election of James Murdoch as chairman, in the light of significant questions around UK management of internal controls at News International while he was CEO.

Hon Hai Report on Results of We voted against, registering serious concerns about the company’s management and oversight of factory Taiwan Operations safety and employee welfare.

HP Remuneration We voted against the remuneration report and two members of the remuneration committee. The US Election of Directors committee showed poor judgment in awarding a generous severance package to former CEO Mark Hurd following his resignation due to violations of the firm’s Standards of Business Conduct.

MAN SE Ratification of We abstained as we do not believe the company has provided sufficient information about the Germany Management Board and responsibility of Board members for the bribery scandals that have hit the company. Supervisory Board Acts

Prudential Election of Chairman Prudential’s failed bid for AIA cost Prudential around £400 million in bankers’ fees, and damaged UK investor trust and confidence. Our concerns about how the board dealt with the transaction, and how it communicated with shareholders, led us to oppose the election of the Chairman.

Woodside Shareholder proposal: We supported this shareholder proposal as we believe that Woodside should disclose the carbon Australia Publish a Carbon Price price assumptions underlying its investment decisions, particularly given the introduction of new Assumption Report climate change legislation in Australia.

Voting key:

Voted against management Abstained Voted with management 11 Responsible Investment Report 2011

Public Policy

F&C views active participation in the public policy process as a central part of being a responsible investor. On global issues such as corruption or climate change, it is often only when government regulation creates a level playing field that a step change occurs. F&C works through numerous organisations and networks to promote sustainable investment and strong environmental, social and governance standards. In the interest of transparency, all our policy submissions are available on our website 9.

Human rights: the Ruggie Principles take effect Bribery and corruption

Professor John Ruggie’s six-year work for the UN culminated in In July 2011, the new UK Bribery Act came into effect, replacing 2011 with the publication of a groundbreaking set of principles that prior laws that had been in place since 1889 and finally bringing clarify the human rights responsibilities of businesses. The Guiding British anti-corruption law in line with its counterparts elsewhere in Principles on Business and Human Rights - or the Ruggie the developed world. F&C had led the investor community in Principles as they are often known - are built around the three calling for these changes for more than a decade. We believe that pillars of ‘protect, respect and remedy’, which were established bribery and corruption diverts scarce corporate resources away and adopted by the Human Rights Council in 2008: from the best financial option for the shareholders to the one that lines the pockets of the few involved in illicit activity. The state duty to protect against human rights abuses The passage of the act was far from smooth as lobby groups by third parties, including businesses. 1 attempted to dilute the content of the act until the last minute. The corporate responsibility to respect human rights, Disappointingly, the act has loopholes that allow overseas 2 implementing due diligence to avoid infringement and companies listed in London to be exempt from the law if they have address adverse impacts. no other business than just the mere “listing” itself. Despite this, the Act imposes much more exacting anticorruption standards on Greater access by victims to effective remedy, companies than was previously the case, and will force them to 3 both judicial and non-judicial. raise their game in order to stay aligned with best practice. Failure to adapt could mean not only hefty fines, blacklisting from bidding The Principles are a set of practical guidelines to help companies on contracts and significant reputational damage, but most implement these, setting out the type of policies and internal damagingly of all the prospect of having top management tied up controls and systems that are needed to prevent human rights in endless investigations and prosecutions. abuses linked to their activities. They were developed in close consultation with the business and investment communities, with The Bribery Act is just one example of a global trend by F&C amongst the organisations providing input, and have already governments to take a tougher line against companies engaging in been incorporated into global standards for businesses, such as underhand activity. Under this regulatory pressure, corruption is the OECD Guidelines for Multinational Enterprises, the IFC swiftly moving from being the tempting but morally-wrong thing to Performance Standards and the new ISO26000 standard. do to win lucrative contracts, to career and corporate suicide for any company or board that is foolish enough to indulge in it. In Whilst the Ruggie Principles signal a major step in the right 2011, F&C reached out to over 330 companies determined to direction, fundamental challenges remain. Many governments have high potential exposure to bribery risks based on the themselves are perpetrators of abuse, and the very root of the geography of their operations to raise awareness of the Bribery problem – weak governments and weak institutions – makes it Act, encouraging them to address these risks through robust difficult to enforce robust protection of human rights. What action policies, procedures, training and disclosures, and urging clear should a company take if it has a business relationship with a leadership by boards. government with a poor record of protecting human rights?

Through its human rights engagement programme, F&C has The Bribery Act is just one maintained close dialogue with more than 40 companies that face “ heightened human rights risks due to either the nature or location of example of a global trend by their operations. We have encouraged companies to identify, assess governments to take a tougher and manage human rights risks at all stages of their operations, and line against companies engaging to clearly communicate how impacts are addressed. in underhand activity.

9 www.fandc.com/publicpolicy ” 12 Public Policy

UK Listing Standards: a badge of honour?

Achieving a listing on the London Stock Exchange (LSE), and inclusion in the FTSE100 Index, has long been a major badge of honour for companies, as it implies that they live up to the highly-regarded standards of the world’s premier international capital market. Of even greater practical significance is the fact that FTSE100 membership means automatic investment by the world’s largest tracker funds, while inclusion in the official benchmarks means – rightly or wrongly – that investment by active funds is far more likely.

In practice, however, adherence to high standards of the issue. Within days of the letter’s publication, governance has increasingly been inconsistent – in there were reports that Polyus was considering Timeline some cases leading to egregious breaches. A raising its free float to 20 percent from 13 percent, growing number of overseas-based companies have while fellow shareholders mobilised to call for a 2006 incorporated as UK holding companies so as to review of the minimum free-float rule. Rosneft lists Global Depositary avoid the higher free-float requirements for overseas Receipts (GDRs) on the LSE with companies, thus obtaining “back-door” entry to the Meanwhile, following a market-wide consultation, a 15% free float. F&C raises FTSE100 Index and putting at risk the reputation of the FTSE Group announced in December 2011 questions about the governance the LSE. that new companies wanting to be included in its standards of foreign-domiciled UK series indices must ensure at least 25% of issuers tapping the LSE. In 2010, listing standards were reformed to their shares are freely tradable from January 1st differentiate between entrants to the London Stock 2012, up from 15% previously. This brings its 2007 F&C convenes bankers, lawyers, Exchange’s Premium and Standard segments. The criteria into line with the LSE standards. auditors and investors to former requires companies to maintain high Companies already listed on the indices that do develop best-practice standards of corporate governance, shareholder not meet the criteria will have two years to comply. governance standards protection, reporting and disclosure, and opens the for foreign-domiciled issuers. door for potential inclusion in the FTSE100 Index Investors have become emboldened by the and all the advantages that come with higher liquidity unfolding debate, noting that even a 25% 2008 and better access to capital. minimum free float is insufficient to safeguard Financial Services Authority minority rights in controlled companies, and (FSA) launches a consultation on One of the basic criteria for a Premium listing is a suggesting that a rise to 50% may be necessary. its listing regime. F&C calls for 25% free-float requirement. Yet in 2011, Russian This promises to raise fierce protests from issuers new Premium and Standard mining company Polyus Gold was reported to be and their advisors, who warn about threats to categories, arguing that all seeking a waiver from this rule, following precedent London’s attractiveness relative to competing companies should be free to choose their level of listing set by previous issuers such as miners Eurasia listing venues. But investors have begun to learn irrespective of domicile. Natural Resources Corporation (ENRC) of the lessons of the crisis: compromising on Kazakhstan and Fresnillo of Mexico which were standards in order to safeguard fees may store up 2009 granted waivers from the 25% free-float rule. costly problems for the future. F&C will continue to FSA announces new listings work with issuers, banker and fellow investors to regime based on Premium and F&C sent a letter to the in October develop better listing standards that ensure good Standard listing segments. Entry to highlight concerns about the vulnerability of governance and efficient and transparent markets. into the Premium segment minority shareholders and prompt public debate on requires compliance with a more stringent level of governance We said… standards. 2010 Letter to the Financial Times – 20th October 2011 New listing regime comes into The news that Polyus Gold is seeking a waiver of the 25 per cent free-float minimum raises fresh effect in April. concerns about the rigour of the listing process – particularly given that a premium listing serves as a passport to inclusion in the FTSE 100 index and a large range of UK passive funds… 2011 Polyus Gold reported to be Premium listings should be reserved for companies that are truly “premium”. Rather than continue to seeking a waiver of the 25% exacerbate a bad precedent, we believe the UKLA should do the right thing and stand by its 25 per LSE free-float requirement. cent free-float standard for a premium listing for Polyus, as well as for other – as yet unknown – UK market aspirants. FTSE announces that new listings on its indices must have Karina Litvack, Head of Governance and Sustainable Investment, F&C Investments, London a 25% free float from 2012.

13 Responsible Investment Report 2011

Outlook for 2012

The ripples from the 2008 financial crisis continued to be felt in 2011, with the enormous financial cost of bailing out the banking sector taking its toll in the form of fiscal austerity measures, rising unemployment and sluggish growth. Meanwhile the economic and demographic balance of power shifted further eastward as the major emerging economies grew in size, population and power.

The challenges of 2011 threw a glaring spotlight on the role of the investment community, which is unlikely to dim in 2012. Investors are accused of being part of the problems that led to the crisis – they will now be called upon to be part of the solution, exercising more effective oversight over the companies in which they hold a stake.

Following is an overview of some of the key areas where F&C intends to make a contribution in the coming year.

Regaining the social license to operate Rio+20: reflecting on a resource-constrained world

The financial crisis and its aftermath raised fundamental questions Governments will gather in Brazil in June 2012 for the Rio+20 about the role of banks and other financial institutions in society. Summit on sustainable development. The first Earth Summit in Effective banking services are an indispensable part of a healthy 1992 was a watershed moment in the understanding of the economy, yet the public perception of the sector – in the US and interlinkages between environmental issues, resource management Europe in particular – is at an all-time low, with anger boiling over and human development. The two decades since have been a into occupations by protesters of Wall Street, the City of London mixed picture at best. Undoubtedly, awareness of sustainable and numerous other cities around the world. development issues has risen amongst policymakers, corporates and the public. However, this has not prevented a rapid rise in Whilst banks have taken some steps toward more responsible greenhouse gas emissions, and a depletion of biodiversity and operations, so far they have singularly failed to win the trust of the natural resources across a wide swathe of the planet. public. 2012 may be the year when governments lose patience. In the UK, the government is looking to shift the burden of As policymakers work to find a meaningful outcome from the responsibility to investors, by pressing for a binding vote on pay. Summit, one area that is coming under increasing scrutiny While this initiative applies to all companies, not just banks, it is concerns the role of commodities markets in driving damaging clear that bank remuneration will come under particular scrutiny swings in prices, particular of food and fuel. Investors will have to given past rewards for failure and the systemic importance of the understand their role in ensuring that markets serve rather than banking system. F&C will remain at the heart of this debate, and hinder economic efficiency, and demonstrate their added value to will both respond to government consultations on pay reform and an increasingly distrustful and even hostile public. maintain one-to-one dialogues with key banks about a range of And whilst the deal at Durban rescued the international climate issues linking remuneration, risk, capitalisation and responsible change negotiating process from collapse, global action to cut banking. emissions remains largely stalled and will continue to be driven by a patchwork of domestic policies. With the political landscape in Meanwhile, as the pain from fiscal austerity measures across much the US dominated by the forthcoming elections, and Europe of the developed world kicks in and social pressures mount, the preoccupied with keeping the eurozone together, the most arguments for greater fairness in taxation are becoming more significant policy shifts are likely to continue to be in the emerging compelling. The closure of lucrative tax loopholes and avoidance markets – where the desire to create ‘green-collar’ jobs and to cut schemes could hit corporates with higher tax bills – with, inevitably, reliance on imported fossil fuels is aligning with the need to cut some threatening to move to parts of the world where regulations emissions to create a powerful force for change. remain lax. F&C believes that the nexus of issues around natural resources, food production and climate change increasingly presents a systemic risk to investments. In 2012, we will engage with policymakers and companies to urge them to take greater action to improve their resilience to the challenges ahead.

14 Outlook for 2012

Unconventional energy, unconventional risks bribery and fraud. Scrutiny from the top also needs to be strengthened, particularly in Asia, which has seen some of the As the stock of cheap and easy-to-extract fossil fuel resources worst abuses. Independent board directors should have a greater continues to dwindle, energy producers have turned to a range of representation on the board, demand better information and take a unconventional sources to feed the world’s voracious demand for more active interest in driving through robust controls. energy. Oil sands, gas shales and other related sources have transformed global energy markets, but carry a whole new range of Investor responsibility in turbulent times: If not now, when? environmental and social risks, including controversies over their greenhouse gas footprint, water use and pollution, and social Stock markets suffered a terrible year in 2011, with global stock issues associated with the massive expansion of operations. market capitalisation dropping 12.1% over the year as a whole, and over $6 trillion wiped off the value of markets. Debt markets Considerable engagement has already taken place between F&C and fared little better, battered by concerns over debt crises in the EU. fellow investors and companies on how these risks are being For much of the year, investors were in crisis mode. It remains an managed, and some progress has taken place. But some of the open question whether 2012 will see more of the same. more systemic issues are too big to be managed by any one company alone. Regulators are struggling to keep up with fast- In these turbulent times, with budgets strained and deeper job cuts moving technological developments, understand the risks and looming, is there still space for investor responsibility? We believe enforce sensible rules. As well as monitoring their own impacts, in that the answer is a resounding yes – indeed now more than ever. 2012 companies will need to work with governments to address Never before has poor governance had such a devastating impact some of the fundamental issues at stake – or risk a public backlash on value, and never before have investors been so sharply focused that could put the very future of some of these energy sources at risk. on risk and the need for reform. At the same time, they are under increasing pressure from regulators to demonstrate that they have Investors have a key role to play in this process. F&C this year will identified these risks, are integrating them into investment continue its efforts to drive the adoption of better operational decisions and are engaging proactively with companies to drive standards and contribute to the fast-evolving regulatory debate – through the necessary improvements. Investors should be more particularly in the EU, where it is just beginning. wary of short-term earnings built on unsustainable foundations, Accounting for failure and focus instead on the drivers of genuine long-term performance. When economies are booming and profits are high, internal controls can become lax, and fraud and malpractice can pass Investors are at a crossroads: they have escaped much of the unnoticed. But it is often when times are tough and companies blame for the crisis of 2008, despite having, by and large, tighten the purse strings that irregularities come to light. The tough neglected to speak up and sound the right warnings, preferring economic conditions of 2011 were accompanied by a wave of instead to join in the dance while the music played. Now the scandals, including a $2.3 billion rogue trader incident at UBS, a pressure is on, and they must demonstrate that they have what it still-unfolding scandal over manipulation in the LIBOR market, and takes to avoid the next crisis and drive sustainable prosperity. But ongoing controversies at companies such as Sino Forest and political posturing, election campaigns and intra-Eurozone Olympus. The problem has been most acute with Chinese squabbling are taking their toll. As F&C went to press, Eurozone companies – some with US listings – where investors have lost political leaders were pressing to dilute badly-needed reform in billions of dollars in total. More than 20 revealed accounting flaws bank capital requirements, spooked by the impact of deleveraging or auditor resignations in 2011. on lending levels, and the Dodd-Frank Act’s Volcker rule forcing banks to hive off proprietary trading was under major assault. This, F&C will continue to encourage companies to introduce robust risk and many more such difficult choices, will put investors to the test controls and to improve compliance systems, including as they seek to apply the lessons of 2008. whistleblowing systems that encourage staff to report corruption,

“In these turbulent times, with budgets strained and deeper job cuts looming, is there still space for investor responsibility? We believe that the answer is a resounding yes – indeed now more than ever. ” 15 Responsible Investment Report 2011

In Summary: Engagement in 2011 10

Engagement by region and issue Milestones by region and issue

1 Europe 33% Europe 41% Americas 34% Americas 21% Asia (ex Japan) 23% Asia (ex Japan) 17% Japan 5% Japan 15% Other 4% 2 Other 5%

Environment 39% Environment 28% Climate Change 24% Climate Change 10% Ecosystems Services 7% Ecosystems Services 15% Environmental Management 8% Environmental Management 2%

Social 34% Social 21% Business Ethics 18% Business Ethics 11% Public Health 2% Public Health 3% Human Rights 7% Human Rights 3% Labour Standards 7% Labour Standards 5%

Governance 27% Governance 51% Corporate Governance 15% Corporate Governance 43% Sustainability Management Sustainability Management & Reporting 12% & Reporting 8%

10 Totals may not sum due to rounding 16 Appendix

2011 Viewpoints viewpoint

George Dallas, Director, Corporate Governance September 2011

F&C’s approach to bonds, corporate governance February Focus On: Indigenous Peoples - An Investor Perspective and stewardship Background While creditors’ main rights and protections come in the rights as outlined in individual debt issues, they can have an interest in influencing companies to This document is F&C’s policy statement on bonds, corporate governance be healthy over the long term and not allow their credit quality to deteriorate and stewardship. It articulates how F&C approaches engagement on behalf materially. They can have influence over companies – beyond the rights of its reo® clients that have requested engagement on their corporate as outlined in individual debt agreements – to the extent that companies bond holdings. This document has been sent to all companies in these Credit quality as a bonus underpin want to maintain a loyal base of creditors ready and willing to provide cost- clients’ corporate bond portfolios. It frames how long-term creditors and effective debt capital. shareholders have similar, but not identical, interests with regard to corporate governance, and outlines F&C’s expectations of good Creditors and shareholders – at least in a going concern context – have governance from the perspective of bondholders. In particular it notes that something of a symbiotic relationship. They need each other. A shareholder corporate bondholders have a strong interest in robust governance of ESG wants the firm to be able to access debt at a cost effective rate to fund (environmental, social and governance) risks as a dimension of overall long term and short term assets. A creditor wants a company to be able to enterprise risk management, and encourages companies to manage these attract additional equity capital, as required, to strengthen its solvency and risks actively to protect their underlying credit quality and financial strength. financial standing. Indeed, this is called “financial flexibility” in many circles and is a cornerstone to credit analysis.

Stewardship beyond equities The legitimacy of the creditor in a stewardship role also reflects the reality Investor stewardship is a relevant concept across all asset classes. In that corporate bondholders typically are exposed to the residual risk of the particular, the role of corporate creditors in the stewardship process is a firm in the event of failure; in extremis they can become shareholders even growing area of focus. F&C has been engaging companies on behalf of if they do not want to. The recent discussion of “bail-in” for senior bank client bond portfolios since 2009, and in its 2010 submission to the debt reflects the ultimate fungibility of debt as an asset class on company Financial Reporting Council (FRC) consultation on the UK Stewardship balance sheets. March Calling for Change: How the humble mobile phone Code, F&C encouraged the FRC to broaden the purview of investor stewardship to include creditors as well as shareholders1. This reflects the Can differing risk preferences be recognition that a company’s bondholders and other creditors benefit from good corporate governance – and share many common interests with reconciled? While their interests can differ – particularly as a company approaches shareholders in promoting healthy governance practices. It is also the case insolvency or engages in leveraged transactions – it is the case that both sparked a revolution in Egypt that creditors can bolster investor stewardship by significantly increasing creditors and shareholders want a company that has good corporate the assets under management represented by active engagement. governance and good management generally. However, good corporate governance to a creditor may not be entirely the same as good corporate Creditors and shareholders: governance to a shareholder. Since creditors have no upside potential and common ground face downside risks, creditors tend to be risk averse. Shareholders, on the While shareholders and creditors can have different, and sometimes other hand, stand to benefit significantly from a risky strategy if it is successful. conflicting, perspectives on a company’s governance, there is also a So in effect, the preferences of shareholders and creditors can be skewed The Great Leap Forward 2.0: China’s Climate Change significant overlap of interests that supports engagement on behalf of all with regard to risk. But companies cannot and should not avoid taking well- key financial stakeholders. A fundamental premise here is that long-term calculated risks to generate adequate returns for equity investors. At the same shareholders and creditors have a similar interest in the long-term time, achieving a sustainable and fair balance of risk and reward is what is sustainability of the firm. needed to attract bond investors. Achieving this balance – and ensuring it strategy leaves rivals in the dust While individual corporate bonds are issued and (usually) repaid, is well-communicated to both creditors and shareholders – is one aspect of companies typically refinance maturing debt. As such, debt, like equity, how creditor and shareholder risk preferences might be reconciled. forms a permanent part of a company’s capital structure. Long-term creditors want sustainable financial performance to generate cash flows for debt service and to maintain their credit quality (and hence control the cost of debt). Long-term shareholders also want sustainable financial performance to allow for earnings growth, dividend payments, capital retention and capital appreciation.

1 See: http://www.fandc.com/FundNets_FileLibrary/file/FRC_Stewardship_Code_April_2010.pdf

For further information on F&C’s reo® engagement services please contact April F&C calls for Australian oil producer to price carbon [email protected] +44 207 011 4153

May Russia’s bold play… and own goal “Creeping takeovers” in Germany: A fitting end to an unacceptable practice

June Hungry Planet: Food security, 9 billion people and the companies that feed them The Ruggie Principles: A turning point for business and human rights “Two cheers” for the UK Bribery Act

August All eyes on the Mexican exchange

September F&C’s approach to bonds, corporate governance and stewardship The lesson’s of “India’s Enron”: Can investors serve as guardians of India Plc.?

October Banking as if the economy mattered London must stand by Premium rules for Polyus Gold listing

November Board diversity

December The Durban Climate deal: Keeping the show on the road

17 Winning gold with F&C Contact us

Delivering highly effective investment strategies is just one part of the service we provide. As principled asset managers, we are For further information please contact: determined to lead our industry in all aspects of our business. Karina Litvack George Dallas Head of Governance and Director, Corporate In 2010 F&C were voted winners of the ‘Gold Standard’ in the Sustainable Investment Governance Fund Management category for the fifth year in succession. Only a Tel: +44 (0) 20 7011 4219 Tel: +44 (0) 20 7011 4246 few companies have been privileged enough to win a Gold [email protected] [email protected] Standard award, and as such, this is an exceptional achievement. The Gold Standard Awards aim to identify financial services companies that excel not just in service but in five key areas Vicki Bakhshi Sandra Carlisle important to consumers of financial products and services: Associate Director, Director, Institutional Governance Business Financial strength and Sustainable Investment Tel: +44 (0) 20 7011 4153 Ability to meet and exceed customer expectations Tel: +44 (0) 20 7011 4473 [email protected] [email protected] Capability Outstanding expertise and aptitude as a fund manager

Service Head Office Ability to maintain and grow an effective post-sales relationship Exchange House Fair value Primrose Street, London Assessing whether customers receive great value for money EC2A 2NY Tel: +44 (0)20 7628 8000 Trust Ability to instil confidence in consumers

As a result, the Gold Standards are one of the hardest, most Offices sought after awards in the place. Germany Portugal Tel: +49 (0) 69 597 9908-0 Tel: +351 (0) 21 003 3200

Hong Kong United Kingdom Tel: +(852) 3965 3160 Tel: +44 (0) 20 7011 4444

Ireland United States Tel: +353 (0) 1 436 4000 Tel: +1 (0) 617 426 9050

Netherlands Tel: +31 (0) 20 582 3000

Important information

This document has been produced for information only and should not be construed as investment advice. Past performance should not be seen as an indication of future performance. Stock markets and currency movements may cause the value of investments and the income from them to fall as well as rise and investors may not get back the amount they originally invested. Where investments are made in emerging markets, unquoted securities or smaller companies, their potential volatility may increase the risk to the value of, and the income from, the investment. All sources F&C Management Limited unless otherwise stated. F&C Management Limited is Authorised and regulated by the Financial Services Authority (FSA) FRN:119230. Limited by shares. Registered in England and Wales, No. 517895. Registered address and Head Office: Exchange House, Primrose Street, London EC2A 2NY F&C Asset Management plc is the listed holding company of the F&C group. F&C Management Limited is a member of the F&C Group of companies and a subsidiary of F&C Asset Management plc. F&C, the F&C logo, reo and the “reo” logo are registered trade marks of F&C Asset Management plc. F&C Investments and the F&C Investments logo are trade marks of F&C Management Limited. © F&C Management Limited 2012. F&C398 03/12