As the ASX releases new corporate governance guidelines with an increased focus on risk management and environmental, social and governance principles Political Monitor examines the link between ESG, political risk & market performance.

1. www.politicalmonitor.com.au!
Poli%cal
risk,
ESG
&
market
performance
Going
beyond
economic
analysis
to
meet
responsible
investment
principles

2. OVERVIEW!
The United Nations Principles for Responsible Investment (PRI) have transformed the way institutional
investors and listed entities think about governance and sustainable investment. This has added
impetus to the search for new risk models that take account of factors not traditionally monitored in
credit and equities analysis, including social and political trends that may alert investors to systemic
risk.!
The challenge has been establishing a clear link between responsible investment and performance
outcomes and developing tools that quantify environmental, social and governance (ESG) risks. This
pack addresses this challenge by examining recent findings on the link between governance and
performance and then detailing the tools developed by Political Monitor - a political risk research &
advisory firm - to identify, score and report on political risk in key markets.!
The pack provides summary analysis and more detail is available by contacting:!
!
Damian Karmelich ! ! ! ! ! ! !Steve Cusworth!
Partner – Sydney ! ! ! ! ! ! !Partner - Melbourne!
p. 0407 772 548 ! ! ! ! ! ! ! !p. 0417 178 697!
e. karmelichd@politicalmonitor.com,au ! ! ! !e. cusworths@politicalmonitor.com.au !

3. CONTENTS!
• Executive summary …………………………………………………………………………. p. 4!
• The relationship between governance, risk & performance ..…………………………… p. 5!
• Country risk ……………….…… ………………….………..… ……...….……... p. 6!
• Company & market risk ……………………..………… …………..…….……... p. 8!
• Political Monitor methodology …………………………..…………….….……………...… p. 9!
• Country risk ……………………………………………………………………….. p. 11!
• In-country risk …………………………………………………………………….. p. 12!
• Sector & firm risk …………………………………………………………………..p. 13!
• Political Monitor risk scores, ESG and ISO standards ……………………….. p. 14!
• Enough theory: how does it work? ……………………………….……………...………… p. 15!
• Appendix 1 - Economic & investment impact of political and social instability …….….. p. 21!
! Political risk, ESG & market performance! 3!

4. EXECUTIVE SUMMARY
!
Political risk, ESG & market performance! 4!
• There
is
now
clear
evidence
of
the
link
between
responsible
investment
and
performance
outcomes.
• Recent
research
by
the
PRI
Sovereign
Fixed
Income
Working
Group
revealed
correla%ons
between
ESG
factors
and
credit
risks.
Those
factors
include
corrup%on,
poverty,
unemployment
rates,
food
security
and
popula%on
distribu%on.
• However,
quan%fying
ESG
risks
has
been
a
challenge
with
many
investors
struggling
to
measure
such
risks
and
include
this
data
in
risk
models.
• Poli%cal
Monitor
has
overcome
this
challenge
by
developing
a
number
of
poli%cal
risk
scores
that
consider
and
quan%fy
a
range
of
social
and
governance
issues
providing
insight
into
underlying
social
and
poli%cal
trends
likely
to
shape
markets.
• One
example
of
the
benefits
of
this
analysis
was
our
January
ra%ng
of
Thailand
as
a
rela%vely
low
poli%cal
risk
for
Q1
2014;
contrary
to
consensus
forecasts.
The
Poli%cal
Monitor
score
assessed
that
a
number
of
underlying
factors
would
limit
the
risk
of
the
poli%cal
crisis
becoming
a
social
&
economic
crisis.
Since
that
ra%ng
the
Thai
benchmark
index
has
increased
over
10%.
80
100
120
140
160
Jan-­‐05
Jan-­‐06
Jan-­‐07
Jan-­‐08
Jan-­‐09
Jan-­‐10
Jan-­‐11
Jan-­‐12
Market-­‐weighted
performance
of
sovereign
bonds
-­‐
sustainable
&
non-­‐sustainable
industrialised
countries
Sustainable
Non-­‐sustainable
World
Government
Bond
Index
1150
1200
1250
1300
1350
1400
Thai
SET

5. THE
RELATIONSHIP
BETWEEN
GOVERNANCE,
RISK
&
PERFORMANCE

6. GOVERNANCE, RISK & PERFORMANCE – COUNTRY RISK!
Political risk, ESG & market performance! 6!
• The
Sovereign
Fixed
Income
Working
Group
(SFIWG)
–
established
by
the
UN
Principles
of
Responsible
Inves%ng
ini%a%ve
–
argues
that
investors
can
be`er
gauge
the
risks
of
investment
by
considering
social
&
poli%cal
factors.
• The
group’s
research
revealed
correla%ons
between
environmental,
social
and
governance
(ESG)
factors
and
credit
risks.
• Of
par%cular
note
the
group
found:
• corrup%on
and
sovereign
bonds
performance
are
clearly
correlated
• social
factors
–
such
as
poverty,
employment
rates,
food
security,
educa%on
levels
&
popula%on
distribu%on
–
are
reliable
measures
of
risk.
• The
data
can
also
be
used
to
an%cipate
future
credit
downgrades.
The
group
noted
comments
from
MSCI
that
a
large
discrepancy
between
ESG
performance
and
credit
ra%ngs
is
a
strong
sign
of
future
downgrades.
80
90
100
110
120
130
140
150
160
Jan-­‐05
Jan-­‐06
Jan-­‐07
Jan-­‐08
Jan-­‐09
Jan-­‐10
Jan-­‐11
Jan-­‐12
Market-­‐weighted
performance
of
sovereign
bonds
-­‐
sustainable
&
non-­‐sustainable
industrialised
countries
(Source:
Sarasin,
Datastream).
Sustainable
Non-­‐sustainable
World
Government
Bond
Index

7. GOVERNANCE, RISK & PERFORMANCE – COUNTRY RISK!
Political risk, ESG & market performance! 7!
• The
SFIWG
also
found
that
countries
with
poor
ESG
ra%ngs
are
likely
to
suffer
greater
loss
as
a
result
of
unforeseen
nega%ve
events.
• In
par%cular,
countries
displaying
poor
ESG
indicators
are
ofen
more
prone
to
shocks
from
natural,
social
or
economic
events,
leading
to
greater
credit
risk.
• The
research
and
experience
of
working
group
members
with
regard
to
materiality
indicates
that
ESG
factors
can
be
material
to
both
creditworthiness
and
investment
performance.
• In
a
separate
study
the
Chief
Risk
Officer
forum
(CFO)
noted
that
the
tradi%onal
focus
on
credit
&
financial
risk
was
not
designed
to
iden%fy
environment,
social
&
poli%cal
imbalances
and
that
capturing
this
data
will
provide
addi%onal
informa%on
about
emerging
issues
&
help
to
be`er
understand
geopoli%cal
developments
leading
to
disrup%ve
transforma%ons.
80
90
100
110
120
130
140
150
160
170
180
Dec-­‐04
May-­‐05
Oct-­‐05
Mar-­‐06
Aug-­‐06
Jan-­‐07
Jun-­‐07
Nov-­‐07
Apr-­‐08
Sep-­‐08
Feb-­‐09
Jul-­‐09
Dec-­‐09
May-­‐10
Oct-­‐10
Mar-­‐11
Aug-­‐11
Returns
from
poriolios
based
on
the
best
and
worst
ESG
rated
countries
(Sources:
AXA
IM,
JP
Morgan,
Ci%group,
Thomson
Reuters)
Worst
ESG
Best
ESG

8. GOVERNANCE, RISK & PERFORMANCE – COMPANY &
MARKET RISK!
Political risk, ESG & market performance! 8!
• The
Poli%cal
Monitor
Australian
Poli7cal
Risk
Index
reveals
an
inverse
rela%onship
between
poli%cal
&
policy
uncertainty
and
market
performance.
As
poli%cal
uncertainty
rises
the
ASX200
has
trended
downwards
and
vice
versa.
• An
increase
in
economic
policy
uncertainty
foreshadows
a
decline
in
economic
growth
and
employment
in
the
following
months
(Baker,
Bloom
&
Davis,
EPU).
• Poli%cal
risk
measures
are
correlated
with
future
equity
returns
(Harvey,
Na7onal
Bureau
Economic
Research).
• Poli%cal
risk
is
applicable
in
more
than
just
developing
economies
despite
the
literature’s
focus
on
these
markets
with
issues
such
as
taxa%on,
transparency,
demographics
and
social
issues
all
affec%ng
the
corporate
environment
with
clear
links
between
the
level
of
risk
and
opera%onal
performance
in
developed
markets
(Restrepo,
Correia,
Poblocian,
Poli7cal
Risk
&
Corporate
Investment
Decisions,
2012).
0
2
4
6
8
10
12
14
16
18
Poli%cal
Uncertainty
Score
Poli%cal
Risk
Index
4800
5000
5200
5400
5600
0
5
10
15
20
ASX
200
Poli%cal
Uncertainty
Score
Poli%cal
Risk
Index
vs.
ASX
200
PRI
ASX
200

9. THE
POLITICAL
MONITOR
POLITICAL
RISK
METHODOLOGY

10. POLITICAL
RISK–
proprietary
risk
scores
&
indices
incorporate
a
range
of
social
&
governance
variables
that
increase
the
risk
of
poli%cal
unrest
Political risk, ESG & market performance! 10!
Environmental
Climate
change
Water
resources
and
pollu%on
Biodiversity
Energy
resources
and
management
Biocapacity
and
ecosystem
quality
Air
pollu%on
Natural
disasters
Natural
resources
Social
Human
rights
Educa%on
and
human
capital
Health
levels
Poli%cal
freedoms
Demographic
change
Employment
levels
Social
exclusion
and
poverty
Trust
in
society
/
ins%tu%ons
Crime
and
safety
Food
security
Governance
Ins%tu%onal
strength
Corrup%on
Regime
stability
Poli%cal
rights
and
civil
liber%es
Rule
of
law
Regulatory
effec%veness
and
quality
Accoun%ng
standards
Government
finances
Poli%cal
Monitor
research
focuses
on
social
&
governance
variables
that
can
provide
an
early
warning
of
emerging
social
&
poli%cal
unrest.

11. COUNTRY
RISK
–
proprietary
risk
scores
tracking
underlying
poli%cal
&
social
trends
likely
to
shape
the
macro
environment
Political risk, ESG & market performance! 11!
• Poli%cal
Monitor
country
risk
scores
provide
a
rela%ve
ra%ng
of
risk
for
some
of
Asia’s
most
important
economies.
• The
scores
track
over
10
different
variables
for
each
country
providing
insight
into
the
likelihood
of
social
and
poli%cal
unrest.
• The
variables
include
social
and
governance
indicators
such
as
legi%macy
of
government,
corrup%on
levels,
exposure
to
vola%le
food
prices,
elas%city
of
demand,
poverty
and
core
demographic
trends.
• The
scores
provide
unique
insight
into
the
poli%cal
risk
environment
by
focusing
on
social
and
governance
trends
rather
than
a
singular
focus
on
economic
data.

12. IN-­‐COUNTRY
RISK–
proprietary
risk
scores
and
compara%ve
analysis
of
Australia’s
states
&
territories
Political risk, ESG & market performance! 12!
• The
Poli%cal
Monitor
State
Poli7cal
Risk
Index
tracks
over
twenty
key
variables
that
reflect
poli%cal
risk
in
each
jurisdic%on.
• The
variables
are
classified
across
four
categories
-­‐
Budget,
Policy,
Stability
and
Reputa7onal
risk.
• The
rela%ve
risk
scores
allow
investors
to
assess
compara%ve
risk
across
the
four
categories
and
determine
which
states
offer
the
best
prospect
of
a
‘no
surprises’,
stable
investment
environment.
• For
individual
firms
the
index
allows
compara%ve
analysis
of
which
states
are
most
at
risk
of
introducing
new
revenue
raising
measures
and
regula%ons
that
may
hamper
business
investment
plans.
0
10
20
30
40
50
60
70
80
90
100
Total
Risk
Score
Budget
Risk
Policy
Risk
Stability
Risk
Reputa%onal
Risk
State
Poli%cal
Risk
Index
March
2014
NSW
Vic
Qld
WA
SA
Tas

13. SECTOR
&
FIRM
RISK
Political risk, ESG & market performance! 13!
• Poli%cal
Monitor
examines
the
implica%ons
of
country
and
in-­‐country
risk
for
respec%ve
sectors
and
firms.
• The
process
then
assesses
whether
there
are
any
sector
or
firm
specific
risks.
This
includes
a
review
of
community
aptudes
and
global
and
domes%c
industry
trends
relevant
to
respec%ve
sectors
/
firms.
• The
firm
level
analysis
determines
whether
the
poli%cal
risk
outlook
places
a
firm
at
a
dis%nct
compe%%ve
advantage
or
disadvantage
to
its
industry
peers.
This
isolates
the
nature
of
the
risk
and
allows
for
responses
to
be
tailored
accordingly.
• A
risk
ra%ng
with
key
influencing
factors
is
then
produced
providing
an
understanding
of
rela%ve
risk
profiles.
Tax
Gov
Oversight
Content
Mandates
Adver%sing
Restric%ons
Risk
Map

14. POLITICAL
MONITOR
RISK
SCORES,
ESG
&
ISO
RISK
MANAGEMENT
STANARDS
• Poli%cal
Monitor
risk
scores
track
and
weight
economic,
social
and
governance
variables
including
unemployment,
infla%on,
poverty,
corrup%on,
government
transparency,
food
security,
consumer
exposure
to
price
vola%lity
and
popula%on
demographics.
• The
scores
and
suppor%ng
methodology
are
consistent
with
a
number
of
the
principles
detailed
in
the
Interna%onal
Standards
Organisa%on
Risk
Management
–
Principles
and
Guidelines
standard
(AS/NZS
ISO
31000:2009),
including:
• Principle
(d):
Risk
management
explicitly
addresses
uncertainty
–
the
scores
are
designed
to
track
variables
that
provide
early
warning
signs
of
poli%cal
and
social
uncertainty
and
for
a
number
of
scores
/
indices
this
is
the
explicit
objec%ve
• Principle
(e):
Risk
management
is
systema7c,
structured
and
7mely
–
the
scores
are
backed
by
a
clear
methodology
and
are
dynamic
in
nature
(meaning
they
are
regularly
refreshed).
In
some
instances
Poli%cal
Monitor
scores
are
refreshed
daily
• Principle
(f):
Risk
management
is
based
on
the
best
available
informa7on
–
the
scores
rely
upon
datasets
not
tradi%onally
used
in
economic
and
credit
risk
assessment
and
therefore
provide
an
addi%onal
level
of
informa%on
that
is
directly
related
to
the
market
environment
• Principle
(j):
Risk
management
is
dynamic,
itera7ve
and
responsive
to
change
–
the
scores
are
dynamic
(meaning
they
are
regularly
refreshed)
with
some
scores
updated
daily.
The
underlying
methodology
is
also
revised
regularly
to
ensure
appropriate
factors
are
taken
into
account
and
weighted
accordingly.
!
! ! ! !! Political risk, ESG & market performance! 14!

15. ENOUGH
THEORY:
WHAT
WILL
YOUR
SCORES,
ANALYSIS
&
METHODOLOGY
ACTUALLY
SHOW
US?

16. COUNTRY
RISK
–
we
track
social
&
poli%cal
variables
and
iden%fy
trends
ignored
by
tradi%onal
economic
analysis
Political risk, ESG & market performance! 16!
• In
December
2013
Poli%cal
Monitor
rated
Thailand
a
LOW
poli%cal
risk
for
the
quarter
ahead.
This
ra%ng
was
unique
within
the
market.
• The
Poli%cal
Monitor
risk
ra%ng
for
Thailand
reflected
our
analysis
of
underlying
poli%cal
and
social
trends
that
pointed
to
high
levels
of
stability
despite
the
poli%cal
turmoil.
These
included
low
levels
of
youth
unemployment,
drama%c
improvements
in
poverty
rates
and
rela%vely
high
levels
of
food
security.
• At
the
%me
of
wri%ng
(March
14,
2014)
the
Thai
benchmark
index
had
increased
more
than
10%
YTD
and
the
Thai
Bhat
had
traded
in
a
consistent
band,
apprecia%ng
around
1.3%
against
the
USD
YTD.
31.8
32
32.2
32.4
32.6
32.8
33
33.2
USD
vs
THB
1150
1200
1250
1300
1350
1400
Thai
SET

17. COUNTRY
RISK
–
our
Australian
Poli7cal
Risk
Index
tracks
poli%cal
&
policy
uncertainty
on
a
daily
basis
Political risk, ESG & market performance! 17!
• Since
its
incep%on
the
index
has
shown
a
clear
correla%on
with
the
ASX200.
As
poli%cal
and
policy
uncertainty
rises
the
market
trends
downwards
and
vice
versa.
• The
index
tracks
a
number
of
variables
that
reveal
both
the
manner
in
which
poli%cal
events
influence
markets
and
the
nature
of
that
influence.
• The
index
is
dynamic
providing
a
daily
reading
of
poli%cal
and
policy
uncertainty
in
Australia
and
allowing
for
daily
comparison
against
key
indices.
• Consistent
with
best
prac%ce
risk
management
principles
the
index
regularly
undergoes
review
to
deepen
its
insight
and
maintain
robustness.
0
2
4
6
8
10
12
Poli%cal
Uncertainty
Score
Australian
PoliQcal
Risk
Index
4800
4900
5000
5100
5200
5300
5400
5500
0
2
4
6
8
10
12
ASX
200
Poli%cal
Uncertainty
Score
Australian
PoliQcal
Risk
Index
vs.
ASX
200
PRI
ASX
200

18. ACCESSING
THE
DATA
&
INSIGHT
• There
is
no
‘one
size
fits
all’
model
for
assessing
social
and
poli%cal
risks.
Every
investor
and
each
company
has
different
challenges
and
processes
and
the
Poli%cal
Monitor
services
are
tailored
to
meet
specific
needs.
However,
there
are
a
number
of
ways
in
which
firms
are
currently
accessing
and
using
this
data:
• Risk
audits
–
twice
yearly
review
of
the
social
and
poli%cal
risks
confron%ng
firms
in
respec%ve
regions
or
sectors.
These
audits
are
usually
conducted
for
a
firm’s
risk
management
commi`ee
as
part
of
their
broader
commitment
to
ensuring
management
and
investors
are
apprised
of
emerging
and
ongoing
risks.
The
audits
provide
an
opportunity
for
firms
to
gain
a
unique
perspec%ve
on
risk
that
goes
beyond
economic
analysis
and
helps
firms
meet
their
repor%ng
obliga%ons.
Audits
include
both
quan%ta%ve
and
qualita%ve
analysis.
• Consul.ng
&
advisory
–
a
dedicated
and
focused
review
of
the
social
and
poli%cal
risks
confron%ng
a
firm
or
investor.
The
advisory
service
considers
the
implica%ons
of
country
and
in-­‐country
risk
and
then
drills
down
to
iden%fy
sector
and
/
or
firm
specific
risks
that
are
likely
to
influence
the
opera%ng
environment
over
the
coming
months.
These
bespoke
advisory
services
include
both
quan%ta%ve
and
qualita%ve
analysis
• Poli.cal
Monitor
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Political risk, ESG & market performance! 18!

19. !
To find out more contact:!
!
Damian
Karmelich
Steve
Cusworth
Partner
-­‐
Sydney
Partner
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Melbourne
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Political risk, ESG & market performance! 19!

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Political risk, ESG & market performance! 20!

21. APPENDIX
1
–
THE
RELATIONSHIP
BETWEEN
POLITICAL
RISK
AND
ECONOMIC
PERFORMANCE
• Poli%cal
risk
is
the
second
ranked
concern
for
publicly
traded
companies
…
"Looking
ahead,
investors
con%nue
to
be
wary
about
the
effects
of
systemic
risk,
poli%cs
and
regula%on
on
the
world's
markets
and
how
they'll
perform.”
(BNY
Mellon,
Global
Trends
in
Investor
Rela7ons,
2014).
• In
general
poli%cal
instability
results
in:
• (a)
lower
economic
growth
(Aisen
&
Veiga,
2013)
• (b)
reduced
private
sector
investment
(Alesina
&
PeroX)
• (c)
increased
infla%on
levels
&
vola%lity
(Aisen
&
Veiga,
2008).
• The
economic
effects
of
poli%cal
&
social
instability
remain
for
an
observable
period
of
2
–
3
years.
The
key
determinant
of
whether
the
effect
of
instability
ceases
at
that
point
is
the
speed
with
which
countries
implement
reforms
&
improve
governance
(Bernal-­‐Verdugo,
Furceri
&
Guillaume,
IMF
Working
Paper,
2013).
• An
increase
in
economic
policy
uncertainty
foreshadows
a
decline
in
economic
growth
and
employment
in
the
following
months
(Baker,
Bloom
&
Davis,
EPU).
• The
Interna%onal
Monetary
Fund
(IMF)
es%mates
the
economic
loss
to
Libya,
Egypt,
Tunisia,
Syria,
Yemen,
and
Bahrain
in
2011
at
USD$20.56
billion
as
a
result
of
poli%cal
and
social
conflict.
!
! ! ! !! Political risk, ESG & market performance! 21!