Business & Money
Investors are asking utilities questions about environmental and social risks. Answers can be a challenge.
When the tech-stock bubble burst in 2001, investors were outraged to learn that many stock analysts were being paid to over-hype stocks. The following year, Enron's ugly public death revealed the presence of a virulent infection in governance of many large and respected companies. Then, in 2003, just as the Sarbanes-Oxley serum appeared to have purged most of the sickness, reports of improprieties spewed forth from the mutual fund industry. And less than halfway into 2004, questions about oil and gas companies' characterizations of "proven" reserves have started to emerge.
Needless to say, investors are sick and tired of shysters and scandals, and they're not going to take it anymore.
In this context, a letter sent recently to Securities & Exchange Commission (SEC) Chairman William Donaldson bears consideration. The letter, signed by the state treasurers of Connecticut, California, Oregon, Maine, New Mexico, and Vermont, calls upon the SEC to require that publicly traded companies disclose the effects of climate change on their businesses. The group estimates that climate-change costs could total as much as 15 percent of the market capitalization of some companies.
"Our investment portfolios were hurt by irresponsible corporate governance," said Denise Nappier, treasurer of the state of Connecticut, speaking at a press conference. "We've seen some positive moves from the SEC as pertains to Sarbanes-Oxley, and in new stock-exchange rules, but much more needs to be done. Climate risk should be part of routine analysis disclosed to shareholders."
The SEC letter indicates the pressure that is building to encourage companies to report their environmental risk exposure.
"Investors are very interested in knowing what pollution control will cost going forward," says Ed Tirello, managing director and senior power strategist with Berenson & Co. in New York. "This is becoming a key issue, and if Democrats win the White House it will become a major factor for the next four years."
In the post-Sarbanes-Oxley world, investor demands are moving beyond environmental issues. Investors are increasingly aware of social and cultural factors that can affect a company's long-term financial health-cumulatively termed "sustainability."
While sustainability reporting stems from green roots, its effects transcend ideological or philosophical boundaries. In the wake of corporate-governance scandals and stock meltdowns, more investors are reading-and scrutinizing-companies' financial reports. Accordingly, their expectations are rising.
"Investors are demanding this information from big, publicly traded companies," says Alyson Slater, an associate director with the Global Reporting Institute (GRI) in Amsterdam. "That's where the hottest demand is today, and where companies feel the most pressure to report this information."
Indeed, nearly one-third of the companies in the Fortune 500 are now issuing sustainability reports using GRI guidelines. U.S. utilities, however, have been relatively slow to adopt such practices, with only about 10 U.S.-based investor-owned utilities issuing standardized sustainability reports of one kind or another ().
"Compared to other industries, utilities are not leading, but they definitely are progressing," says Urs Schön, a sustainability analyst with Zurich, Switzerland-based SAM Research, which developed and manages the Dow Jones Sustainability Index (DJSI). "Some utilities are really attacking the sustainability issue and trying to integrate it into their strategies, both in terms of environmental and social issues. They are trying to grasp the opportunities and reduce risks at the same time."
Investor pressure is also having a demonstrable effect. In late April, shareholder resolutions calling for greater transparency prompted agreements from Southern Co., TXU, and Reliant Energy to issue reports on environmental risks. And in February, AEP and Cinergy agreed to report climate-change risk exposures in response to shareholder resolutions.
"After a year of negotiations we withdrew our resolution because AEP recognized its fiduciary duty to reveal environmental risks to investors," Nappier said. "This kind of program was only a dream a few years ago, and it goes a long way toward establishing best practices to be shared by others."
Such best practices are still a work in progress, however. Various organizations are seeking to bring greater consistency to sustainability reporting. In general, sustainability covers risks and measures across a range of areas that can affect companies' strategies, and ultimately their financial health. These areas include, of course, environmental factors; health, safety, and other human resources policies; cultural diversity, both in the workplace and the supply chain; community relations policies; and various other social issues that affect companies' strategies and ultimately their financial performance.
Sustainability reporting approaches fall into three main categories. First are procedures that comply with formal standards, primarily those of GRI and its founding organization, the Coalition for Environmentally Responsible Economies (CERES). These standards provide a programmatic framework for companies to use in measuring and reporting their performance.
Second are stock indexes, especially the Dow Jones Sustainability Indices (DJSI) and the Financial Times Stock Exchange 4Good index, which track the stock performance of companies that adhere to certain prescribed principles.
Third are organizations and compacts, such as the e7 and the Global Environmental Management Initiative (GEMI), that require members to meet certain requirements or report certain information. Some of these organizations provide formal reporting standards; others don't.
U.S. utilities are taking up various sustainability mantles, to varying degrees. AEP, for example, publishes an environmental performance report every two years, and follows CERES guidelines. AEP is not, however, a member of either CERES or GRI, but it is a member of the e7 organization, which includes the largest utilities from the world's leading industrialized nations.
"We wouldn't be a very competitive company if we hadn't already been looking at these issues internally," says Diane Fitzgerald, AEP's vice president for governmental and environmental affairs. Although sustainability is an explicit part of AEP's environmental tenets, thus far the company hasn't issued a full-fledged sustainability report. "We are taking a serious look at enlarging our report to include economic and social benefits to our communities," she says.
The company hasn't decided which reporting approach it should take, however. "If we move to a standardized format, does that make it more credible and robust, or will we be criticized if we don't pick one of these standard formats?" Fitzgerald asks. "If you look at the GRI standards, there are sections that don't apply to all companies, and some elements are missing that are important for the electric sector," she says. One example is technology transfer, both within the United States and internationally. Fitzgerald points out that numerous new power plants are being built in developing countries. "If we don't transfer state-of-the-art environmental technology to them, they aren't going to use it," she says.
Such shortcomings might be inevitable in an ambitious effort like developing global sustainability reporting standards. The situation is improving, however, according to Juan M. Carrasquillo, assistant to the chairman and CEO at Wisconsin Energy Corp. in Milwaukee. "Like everything else, there is a learning curve," he says. "You are starting to see things happen toward better tracking of successful sustainability. The biggest question is how can analysts talk the bottom-line language in terms of sustainable strategies. That hasn't been as clearly defined as people might want."
Internal issues also have proved difficult. "The biggest challenge has been getting access to our performance information," Carrasquillo says. "We don't have an enterprise-wide performance-tracking system. Each business and department has its own scorecard. But for a large and comprehensive sustainability report, you need access to data on a daily basis, and we don't have that now. It's sitting on someone's Excel spreadsheet, and we can't get to it."
Wisconsin Electric is in the process of cataloging the locations of all that data, so the company can figure out how to automate the performance-measurement process and make it more manageable.
In general, companies are finding that sustainability reporting is a complex undertaking. "You need to commit the time and resources to accomplish the task," says Ed Fox, vice president of communications, environment and safety for Arizona Public Service in Phoenix. "The process of collecting and verifying data is improved through clear communication and through the use of topic-specific coordinators." In other words, the company assigns an officer to coordinate the effort to gather waste-related data, for example, and others on air emissions, health and safety, community relations, etc.
Fox notes that the process requires buy-in from the top down. "It takes a commitment throughout the company to provide the data," he says. "It is important to have executive-level commitment before initiating the process."
Carrasquillo echoes that sentiment. "Internal salesmanship is very important," he says. "In our case, it began as a directive from the CEO, and that made it a lot easier. But at first our own management was wondering why we were doing this." The company conducted a campaign to educate executives and directors about its motivations and goals for the program. "Doors begin to open if the stakeholders understand the vision and strategy," he says.
While investor concerns are driving the sustainability-reporting trend, the outcome is expected to be better performance. "It's not just about reporting, but also about improving our processes and the way we do business," Fitzgerald says. "We're taking a hard look at our progress on environmental stewardship. In the reporting process, some actions have more of an effect than others. We ask why, and work to improve accordingly."
The exercise seems to make companies more forward-thinking in their plans, in part because executives begin to recognize the advantages of being ahead of the curve. APS, for example, is undertaking voluntary emissions-reduction pilot programs at some of its power plants. "These projects will result in significant reductions of SO2, NOX and mercury many years before regulation would require it," Fox says. "The reason we are doing this is that we know emissions reductions are inevitable in our industry, and we'd rather do them early and control our own operations, rather than wait and be mandated to do so on a timetable that is not of our choosing."
Such decisions are motivated by strategic, economic judgments, and ultimately will bring value to investors. "Having done this report has forced us to start thinking and planning in terms of sustainability," Carrasquillo says. "Internally we evaluate the data that we are capturing, and consider what we can actively start to improve that [which]will bring the highest impact to stakeholders."
Thus sustainability reporting may produce benefits that come full circle-satisfying the demands of shareholders, improving the company's performance on environmental and social factors, and ultimately increasing value for investors.
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