3 rd Annual Forum on Responsible Investing

1. 3rd Annual Forum on Responsible Investing Learning From the Financial Market Crisis Keith Johnson, Chair, Reinhart Institutional Investor ServicesNew York City, January 12, 2009 1

2. « We’re still dancing » 2

3. The Morning After • Lehman Brothers • AIG • Fannie Mae/Freddie Mac • Bear Stearns • Merrill Lynch • Wachovia • Northern Rock • General Motors • Chrysler • Bernard Madoff

4. The wasted decade….S&P 500 from 1998-2008

5. 2007 Subprime 2001 Dot com 1987 Crash Increasing Velocity of Financial Crises • 1987 Market Crash • 1989 S&L Debacle • 1994 Mexican Peso Crisis • 1997 Asian Financial Meltdown • 2001 Dot Com Bust • 2007 Subprime Disaster

6. “ … once we stabilize the markets, we then have to take actions to make sure this doesn't happen again. … we have a regulatory system that is broken. It's outdated. It's outmoded. It doesn't fit the world we live in.” Sunday 21 September 2008 HankPaulson, US Treasury Secretary Former CEO of Goldman Sachs

7. Network for Sustainable Financial Markets – A Different Approach • International, non-partisan network of individuals • Currently participants from ten different markets • Finance professionals, academics & others • Interest in long-term health and sustainability of markets • Foster inter-disciplinary collaboration on research, solutions and advocacy • Focused on systemic and fundamental issues 7

8. Robert Adamson Keith Ambachtsheer Rob Bauer Adrian Berendt Ann Byrne Mark Campanale Greg Chipman Cecile Churet Gordon Clark Ronald B. Davis Stephen Davis Paul Dickinson Hans Dijkstra Ralf Frank Murray Gold Jack Gray Danyelle Guyatt Frank Jan de Graaf Stirling Habbitts Mathew Haigh Jonathan Hayward Keith L. Johnson Sean Kidney Eric Knight Janelle Knox-Hayes Floris Lambrechtsen Jinyan Li Steve Lydenberg Michael Mainelli Franz Maritsch Heleen Mees Paul Moxey Mike Musuraca Robert A. G. Monks Louise O’Halloran James O’Loughlin Matthew Orsagh Vasudec Palladam Frank Partnoy Avinash Persaud Poonman Puri Amin Rajan Benjamin Richardson Nick Robins William Russell-Smith Janis Sarra Howard Sherman Penny Sheperd Dan Siddy Michael Siebecker Ken Sewart Nicholas Taylor Raj Thamotheram Jeroen Tielman Mark van Clieaf Ed Waitzer Robert Walker Steve Waygood Helen Wildsmith Cynthia Williams Peer Zumbansen … and more 8

9. Some Key Lessons from the Market Crisis • Excessive leverage/debt • Inadequate risk management • Flawed and excessive incentive structures • Conflicts of interest endemic to financial system • Vicious circles of short-termism at all levels • Separation of risk from product creation and distribution • Segmented regulators with inadequate resources and lack of will • Politics and ideology trump knowledge and policy System is as prone to periodic crises and misallocation of capital as it was before sub-prime. 9

10. The NSFM Principles Lead to Solutions 1. Purpose of markets is to efficiently create sustainable value 2. Identify and value hidden risks and opportunities 3. Balance short-term and long-term interests 4. Improve market participants accountability for their actions 5. Improve governance at financial institutions 6. Reduce conflicts of interest through smarter alignment of rewards 7. Promote a coordinated global approach This is what NSFM participants have signed up to… 10

11. Efficientresource allocation

12. Beyond economic measures “Gross national [or domestic] product measures neither the health of our children, the quality of their education, nor the joy of their play […] It is indifferent to the decency of our factories and the safety of our streets […] It measures everything in short, except that which makes life worth living[…]” Robert Kennedy 1968 12

13. Currently, the active NSFM working groups… • Fiduciary duty and long term investing • Comments to OECD on Pension Fund Governance Best Practices • Modernizing Pension Fund Legal Standards Consultation Paper • Regulatory reform white papers • Survey of financial professionals on who is to blame for the crisis • Credit Derivatives Market Design Consultation Paper • Executive remuneration reform • Climate change and long-term investors 13

14. Climate change is the greatest and widest-ranging market failure ever   Stern Report, 2007 14

15. Identify, value & recognize costs offloaded to society 95% 5% Solution? $4.7 trillion of carbon damage to real economy per year Source: Nick Robins, NSFM

16. Fiduciary duty & long-term investing problems

17. “The obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns and impeding efforts to strengthen corporate governance.” CFA Centre for Market Integrity & Business Roundtable Institute for Corporate Ethics, July 2006 17

18. Short-Termism is a Systemic Cause of Value Destruction “. . . It is shocking that the majority of firms are willing to sacrifice long-run economic value in order to deliver short-run earnings. Companies do this in response to intense pressure from the market to meet expectations. . . . we assert that the amount of value destroyed by firms striving to hit earnings targets exceeds the value lost in these high profile fraud cases. . . . What is worse is that these actions are not even considered to be a ‘problem’ by many CFOs.” Value Destruction and Financial Reporting Decisions, John Graham et al., Duke University, September 2006 18

19. So, do we need more regulations?

20. NSFM/AQ Research Survey of Investment Professionals Who was to blame for the financial crisis? • Bank leaders and their boards: 21% • Shareholders/fund managers: 19% • Politicians and regulators: 14% • Central bankers: 10% • Asset owners: 9% • Investment analysts: 9% • Hedge fund investors: 7% • Accountants: 6% • End customers: 6% Only 7% think solutions should only come from government Source: http://www.aqresearch.com 20

21. For financial markets to change, we need to change together • Mainstream investment and responsible investment professionals both need to think creatively! • Both face same challenges – going beyond their current products, competencies & business models • Both face organisational/group think constraints • Projects like NSFM could help introduce new approaches A challenge to you! Find an important issue you know the responsible investment community doesn't really have a good enough answer to, which you are really concerned about, and join/start a working group! www.sustainablefinancialmarkets.net 21