Political lobbying risks in the US

4D Infrastructure

July 2023

In recent years, political controversies involving US utility companies have caused significant concern for investors.

There have been instances where lobbying activities have contravened the law and resulted in companies and individuals being criminally investigated and punished. Other instances, though not necessarily criminal, have also resulted in negative market reactions. In both scenarios, political lobbying controversies have been difficult for investors to foresee and, therefore, difficult to avoid.

Utilities' role in US politics

Utilities are responsible for the delivery of power and gas from source to end-customers, and are considered key players in the energy supply chain. As a result of the importance of both energy prices and reliability to businesses and consumers alike, utilities are central to economic growth, efficiency and quality of life in their operating jurisdictions.

For these reasons, utility operators believe their corporate responsibility dictates that they should have a voice in the development of energy legislation. With energy legislation and regulation established at both federal and state levels in the US, lobbying is considered important in ensuring that legislation is in the best interest of all stakeholders, including shareholders.

Risk to investors of inappropriate lobbying

Lobbying undertaken by utilities in an open and ethical manner supports a more thorough understanding of energy markets for legislators and a better outcome for both customers and shareholders. The obvious concern is that utilities and/or management teams lobby for their own self-interest or solely that of their shareholders, with little consideration to other stakeholders such as customers. Problems eventuate when lobbying contravenes the law and/or ethical expectations.

Companies should have ethical charters outlining the values that guide how they operate, including how they interact in the political sphere. The old saying, "would you feel comfortable with your behaviour being published on the front page of the newspaper" is also a good guide for what constitutes ethical political lobbying.

Potential violations of the law are often difficult to identify until it's too late and enforcement agencies are involved. Regardless of guilt, once a review is underway, the utility in question will feel pressure as the process evolves. This potentially includes:

1. a lengthy process in which share prices remain deflated;
2.  significant financial penalties if found liable;
3. management disruption as changes are made and teams focus on remedial actions;
4. disruption to regulatory/legislative relationships held by the company; and/or
5. reputational harm which is difficult to quantify and doesn't go away for an extended period of time.

Utilities across the world are bound by a social license to operate. Regardless of strict legality, that social license may be tarnished based on the public's perception that the company has received special treatment from legislators/regulators based on aggressive/unethical lobbying activities. This scenario could result in public backlash, and regulators/legislators taking detrimental action against the utility to reinforce their independence. This can take the form of fines, difficult regulatory decisions, out-of-cycle regulatory reviews and irrational oversight. Negative financial ramifications and poor market sentiment are the result, and re-establishing customer faith in regulators and utilities takes a long time.

4D's approach to political lobbying risk

Due to the high legal, financial and reputational risk associated with lobbying activities, 4D undertakes significant due diligence to identify utilities that are at higher risk and steps being taken to mitigate this risk.

Internal controls

Political lobbying should be guided by a political engagement policy or a similar document recognised by the company board. It should be easily publicly available and outline a set of criteria guiding lobbying efforts and political contributions, and provide authority for contributions and oversight.

Best practice for authority of contributions is for the annual political contributions budget to be developed by the corporate affairs team (or equivalent). The individual contributions should be reviewed by a legal professional and signed off by the most senior executive in the team. It's often a good idea to include an executive or leadership committee review it to ensure widespread knowledge and acceptance of contributions. In our view, large contributions should be reviewed and signed off by the CEO (~>$1 million).

The board audit subcommittee should also review contributions on behalf of the board. A recommendation should then be provided to the board as part of that oversight. Any newly planned contributions should also be reviewed by an audit committee.

This ensures that senior leadership approve all contributions, approvals involve multiple parties, and the board has ultimate oversight.

Transparency

Ensure public transparency of all contributions to individual political figures and parties, political action committees (PAC), other tax-exempt structures (such as 501(c)4 structures), trade associations and political consultancy/advisory groups.

Stakeholders should have access to all internal control and governance documents relating to political engagement.

Appropriate size of contributions

The size of political contributions should be moderated so that they don't give the impression that a political favour is expected in exchange for the contribution. Many utilities have outlined that any individual contribution over $1 million requires CEO sign-off, suggesting that this size of contribution is rare.

Overall contributions need to be moderated as no financial return should be expected on these funds - it should be perceived more as a cost, rather than an investment with the expectation of receiving something in return.

Focus on the utilisation of structures for contributions

Some tax-exempt structures provide anonymity to contributors. Companies should seriously question why they need/prefer anonymity when making a contribution. Generally speaking, such structures have attracted scepticism from the media and stakeholders, and should be avoided unless there is a specific reason for their use.

Some utilities in the past have engaged political consultancy groups. These groups have historically provided anonymity in political lobbying. Interactions with these groups should be transparent internally and externally, including taking meeting minutes for all interactions. Companies should be very clear on their motivations for engaging such groups, and they shouldn't be considered as vehicles to undertake clandestine political manoeuvres.

US federal election laws prohibit corporations and labour unions from making political contributions to federal candidates and national political parties. As a result, companies often use their own, or third party, PACs to make contributions to individuals and parties.

'Pay for play' legislation

Some utility management teams suggest that when a company makes significant contributions to support or oppose a particular ballot measure, it can be interpreted as a 'pay for play' situation. Rightfully or wrongfully, this could be perceived as bribery or a quid-pro-quo arrangement. Best practice would be to lobby through trade associations or PACs with correct governance practices in place to avoid any direct link between the company and an individual ballot measure or proposal.

Third party verification of lobbying controls and practices

Third party verification of companies' political disclosures and practices can support investors' due diligence efforts. One of the more well-known verification groups is the Center for Political Accountability (CPA), which releases the CPA-Zicklin Index annually. Using 24 metrics, or "indicators", the CPA-Zicklin Index assesses companies' disclosure practices, spending and accountability policies for utilisation of corporate funds to influence elections. It does not address company spending on lobbying or PACs.

4D's actions post lobbying controversies

Recent lobbying controversies have influenced our decision to divest companies from our funds. We have exited positions based on the likelihood that a controversy violated the law, disrupted relationships with regulators and stakeholders, and/or there was a lack of definitive action from boards in identifying and rectifying flaws in lobbying controls, processes and disclosures. By contrast, we have also retained positions where our due diligence suggested the above negative thresholds were not violated. Every situation is considered on a case-by-case basis involving internal due diligence as well as engagement with the company in question.

As part of our research into political lobbying best practice, we reached out to companies who rate highly on the CPA-Zicklin Index for comment on this paper and their approach to lobbying. Two such companies in Southern Company and CMS Energy provided their feedback below.

"CMS Energy is ranked First Tier in the CPA-Zicklin Index. We are engaged in the political process, supporting pragmatic policies that are focused on safe, reliable, and affordable energy for Michigan. Our code of conduct and other policies strictly prohibit impermissible political activity, and we have strong controls and oversight established to ensure ethical compliance with all relevant laws. We include more information regarding our political engagement on our website." - CMS Energy.

"This paper highlights the tangible benefits of a clear and comprehensive approach to political disclosure and accountability. Southern Company takes pride in our status as a Trendsetter in the CPA-Zicklin Index of Corporate Political Disclosure and Accountability as we seek to achieve optimal outcomes for our customers." - Southern Company.

Funds operated by this manager:

4D Global Infrastructure Fund (Unhedged), 4D Global Infrastructure Fund (AUD Hedged), 4D Emerging Markets Infrastructure Fund

For more information about 4D Infrastructure, visit https://www.4dinfra.com/

^{The content contained in this article represents the opinions of the authors. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the authors to express their personal views on investing and for the entertainment of the reader.}

Webinar Podcast | Infrastructure Funds -

Analysing the Opportunities and Risks

FundMonitors.com

01 August 2023

Listen to the podcast to discover the key insights and opportunities in this dynamic investment landscape. In this informative 45-minute session, we explored the potential benefits and risks of investing in infrastructure funds and uncovered the various types of infrastructure assets, including transportation, energy, and social infrastructure.

Our panel consisting of Sarah Shaw from 4D Infrastructure, Ben McVicar from Magellan, and Matt Lorback from Atlas Infrastructure also delved into the regulatory and policy considerations impacting infrastructure investments.

In Conversation with Airlie's Analysts

Airlie Funds Management

July 2023

Airlie Australian Share Fund Portfolio Manager, Emma Fisher, engages in a conversation with Airlie's senior analysts, Vinay Ranjan and Joe Wright. Emma discusses the performance of the Australian market during the past 12 months and asks Joe and Vinay to share insights on how some of their stocks have performed during the year within the Fund. This includes Mineral Resources, QBE Insurance and James Hardie.

Funds operated by this manager:

Airlie Australian Share Fund

Important Information: Units in the fund(s) referred to herein are issued by Magellan Asset Management Limited (ABN 31 120 593 946, AFS Licence No. 304 301) trading as Airlie Funds Management ('Airlie') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation. This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should obtain and consider the relevant Product Disclosure Statement ('PDS') and Target Market Determination ('TMD') and consider obtaining professional investment advice tailored to your specific circumstances before making a decision to acquire, or continue to hold, the relevant financial product. A copy of the relevant PDS and TMD relating to an Airlie financial product or service may be obtained by calling +61 2 9235 4760 or by visiting www.airliefundsmanagement.com.au.

Past performance is not necessarily indicative of future results and no person guarantees the future performance of any financial product or service, the amount or timing of any return from it, that asset allocations will be met, that it will be able to implement its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of an Airlie financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

This material may include data, research and other information from third party sources. Airlie makes no guarantee that such information is accurate, complete or timely and does not provide any warranties regarding results obtained from its use. This information is subject to change at any time and no person has any responsibility to update any of the information provided in this material. Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Airlie. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon.

Any third party trademarks contained herein are the property of their respective owners and Airlie claims no ownership in, nor any affiliation with, such trademarks. Any third party trademarks that appear in this material are used for information purposes and only to identify the company names or brands of their respective owners. No affiliation, sponsorship or endorsement should be inferred from the use of these trademarks.. This material and the information contained within it may not be reproduced, or disclosed, in whole or in part, without the prior written consent of Airlie.

Do they have your back or just your back pocket?

The fun, games, and fees of equity investing

Collins St Asset Management

July 2023

FY23 recap: ASX 200 defies the bears to end up +10% over last financial year 

It is often said that:

When someone with money meets someone with experience, the person with the experience gets the money and the person with the money gets an experience.

For equity investors, regardless of whether or not they choose their own investments or outsource some or all of that responsibility to an external manager/adviser, this remains a very real and important risk to be on top of.

Many Directors and Management teams do not run companies for the benefit of shareholders despite all of the claims and promises of future gold and glory laid out in glossy annual reports. 

Fat salaries for start up company Directors, gifted equity to management in large established businesses and all manner of perks and parties along the way are, all too sadly, par for course.

To that end, its important to understand the governance structure of a company and the way in which senior decision makers are remunerated before deciding whether or not to invest. 

Some key questions we at Collins St Asset Management seek to understand before deploying capital include:

1. Does the Board have a remuneration committee that is chaired by a non-executive Director with a majority of committee members also sourced from outside of the company's management team?

   As obvious as it may sound, you don't want Management to be voting on their own pay rises and setting their own performance targets each year or having the ability to unduly influence the outcome.

2. What metrics are remuneration linked to and what sort of behaviour does is being incentivised?

   Increasing revenue may, for example, sound like a worthy goal but if all it incentivises is excessive levels of new debt being taken to fund dubious bolt on acquisitions then it may (all things being equal) be a red flag to watch out for.

3. Do the timing of option exercise dates line up with the timeframe for key deliverables to be achieved?Are any shares subsequently purchased via the exercise of the option subject to some form of escrow?

Sadly, a rolling stone gathers no moss in much the same way as an upwardly mobile executive can suffer no financial pain by moving from one company to the next just before the next crisis is uncovered.

Of course, Directors and senior Management are not alone in their pursuit of cushy rent-seeking corporate opportunities.  Whilst many intermediaries in the funds management space are often no better, there are a variety of fee models on offer which invariably incentivise different behaviours.

The table below provides an overview of some of the different ways professional fund managers may seek to charge their clients:

Overview of fee structures

Author: Rob Hay, Head of Distribution & Investor Relations

For wholesale investors only

Funds operated by this manager:

Collins St Value Fund, Collins St Convertible Notes Fund

Will service stations be stranded assets?

Tyndall Asset Management

June 2022

Funds operated by this manager:

Tyndall Australian Share Concentrated Fund, Tyndall Australian Share Income Fund, Tyndall Australian Share Wholesale Fund

ChatCB - Artificial Intelligence and Convertible Bonds

Redwheel (Channel Capital)

July 2023

Funds operated by this manager:

CC Redwheel Global Emerging Markets Fund, CC Redwheel China Equity Fund

Key information:

No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment. Past performance is not a guide to future results. The prices of investments and income from them may fall as well as rise and an investor's investment is subject to potential loss, in whole or in part. Forecasts and estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so. The statements and opinions expressed in this article are those of the author as of the date of publication, and do not necessarily represent the view of Redwheel. This article does not constitute investment advice and the information shown is for illustrative purposes only.

Forever Chemicals - PFAS

PURE Asset Management

July 2023

The jungle drums are beating louder as the calls for increased regulation of Per- and polyfluoroalkyl substances (PFAS) become clamorous, and class action lawyers gear-up for their next big opportunity. This comes more than two decades after internal documents revealed that DuPont had known of a link between PFAS and cancer in 1997, and was aware of the potential health risks as far back as the 1960s.

Corporate settlements,  regulatory changes and journalist investigations are proliferating, broadening public awareness of the risks associated with PFAS. Suggestions that these chemicals are the 'asbestos' of the current generation, are a clarion call for strengthened regulation, and the Environmental Protection Agency (EPA) in the US has responded aggressively.

What are PFAS?

PFAS are man-made chemicals that have been used extensively in industry and household products since the 1940's. Non-stick cookware, food packaging, cosmetics, water repellents and fire retardants illustrate the proliferation of these forever chemicals, which don't break down and can accumulate over time. Exposure is difficult to avoid, with ingestion the primary transmission mechanism. 

What are the risks of PFAS?

While scientists continue to learn about the human impacts of PFAS, recent studies have suggested that exposures may lead to the following health effects:

• Increased cholesterol levels;
• Changes in liver enzymes;
• Lowered Immunity;
• Lower infant birth weights;
• Increased risk of blood pressure; and 
• Increased risk of kidney or testicular cancer.

What is being done about it?

In short, plenty. Over the past five years, corporate America has been under attack for its historical negligent use of these chemicals. This ranges from products sold, to how waste has been disposed, and the downstream consequences presented to humans as a result. While the pun is ironic, the 'downstream' issue facing society today is the prevalence of PFAS in municipal drinking water. 

Corporate litigation has been building momentum, with Dupont the first to settle a class action in 2015, made infamous by the Dark Water movie - a must watch for anyone interested in the subject. 

Together with two other defendants, Dupont also recently settled another US$1.2bn claim with water utilities, and in recent weeks, US conglomerate 3M agreed to a US$10.3bn structured payout to water utilities. Analysts at Morningstar, a research firm, estimate that 3M's total liabilities could grow to as much as $30bn as state, foreign and personal injury claims are factored in.

Source: https://news.bloomberglaw.com/pfas-project/companies-face-billions-in-damages-as-pfas-lawsuits-flood-courts

The scale of the 3M settlement is likely to set a dangerous precedent for this US$28bn revenue industry, with the company just one of 12 major participants, including Merck, Bayer, BASF and Honeywell. Like Dupont, 3M appears to have known and covered up the risks for decades.

Litigation cases have heightened awareness, and regulatory bodies are rapidly responding. Given its importance to society, initial focus has centred on municipal drinking water. 

Many US states, predominantly those on the east and west coasts, have independently moved to regulate acceptable levels of PFAS in drinking water. While a step in the right direction, the Environmental Protection Agency (EPA), with a Federal mandate, has now become engaged, embarking on a radical change to regulations.

The EPA has proposed a revised US national drinking water standard. With formal implementation expected in late 2023, these stringent measures target six common PFAS, with tolerable limits all but eliminating any trace in drinking water. 

"The previous guideline, set in 2016, set a limit of 70 parts per trillion (ppt) for both PFOS and PFOA in drinking water. The new advisories decrease that by more than a thousandfold. The new limit for PFOS is 0.02 ppt; for PFOA, it's 0.004 ppt. Essentially, the EPA wants the limits to be as close as possible to zero as a growing body of research has shown how toxic these compounds are."

Source: https://www.hsph.harvard.edu/news/features/stricter-federal-guidelines-on-forever-chemicals-in-drinking-water-pose-challenges/

Coupled with the availability of US$2bn in Bipartisan Infrastructure Law Funding, all municipal water utilities in the USA must now adopt measures which ensure compliance. 

The proposed rules require public water systems to: 

1. Monitor for PFAS;
2. Notify the public of PFAS levels; and
3. Reduce PFAS levels until they meet standards.

In meeting the levels proposed, the EPA has previously provided guidance on how best to achieve compliance. This has focussed on three measures, namely:

1. Activated Carbon
2. Ion Exchange Treatment
3. High Pressure Membranes

The most commonly used method, and primary recommendation of the EPA as a solution to combat liquid-phase chemical removal, is through filtering using Granular Activated Carbon (GAC). 

Investment opportunity

Unlike asbestos, where profits were derived from shorting companies selling asbestos products, activated carbon appears to offer a profitable long thesis. Pricing has moved aggressively in recent periods, with industry leader Calgon Carbon announcing price rises of 15-40% across its product range in December 2022. 

At PURE, we are investing in this thematic via an exposure to ASX listed company, Carbonxt (CG1.ASX). CG1 has historically focussed on air-phase solutions through powdered and pelletised products. A recent 50/50 joint venture agreement with Kentucky Carbon Processing (KCP) is facilitating the Company's entry into the liquid-phase market. 

Carbonxt's aim is to meet demand from water utilities via the production of GAC, or a superior pelletised product. The Company can produce GAC but also has aspirations to introduce a specialised pellet product that achieves the same results with less pressure drop. In simple terms, this decreases electricity consumption for water utilities, lowering their cost of production. 

Not only is market demand underpinned by regulatory change, but new supply is both long-dated and costly. 

Calgon Carbon announced a 25ktpa expansion at its Mississippi plant in 2020 at a cost of US$185m. We understand this came online in 2022. Carbonxt is expecting saleable product from the JV facility in 1H2024, with an initial 10ktpa delivered at a capital cost of just US$20m. The JV parties believe this can be doubled to 20ktpa for a modest additional outlay. 

Carbonxt's entry into the liquid-phase market appears well timed. The Company estimates that the current Activated Carbon market for the liquid phase is c.US$600m per annum, but the American Waterworks Association estimates the annual cost to comply with the regulations in its current form is US$3.8bn.

Source: https://www.awwa.org/Portals/0/AWWA/Government/2023030756BVFinalTechnicalMemoradum.pdf?ver=2023-03-14-102450-257

Funds operated by this manager:

PURE Income & Growth Fund, PURE Resources Fund