Andreas: Completely by accident initially. My whole career just “happened”; things fell into place, but I love it and it’s my passion. Before I joined IHS Markit, I started at a boutique advisory firm which dealt with shareholder advisory for investor relations teams and C-suite globally. Twenty years ago, I didn’t even know what ESG meant. I learned that it is still is not clear for companies who their shareholders are, how they truly invest, what drives their capital allocation and even more so what their stewardship priorities are. It was around 20 years ago, and a lot of things have changed. ESG is not new, it has been labelled many things such as CSR. Recently the factor of extra-financial information that drives investment decisions has significantly increased in importance and it created this whole new ecosystem around ESG and sustainable investment, to some degree a “blackbox”.
The other reason why I got into this is out of personal interest. I feel like this is the right thing to do within corporate finance, in capital markets: to tackle climate change, energy transition, diversity, equity and inclusion through active corporate governance, stewardship and engagement. To me it’s just sane to run your company by treating your employees right, by giving equal opportunity, by having independent people on the board, by aligning your goals and strategy with some of these outside risks and opportunities that will influence your business.
Andreas: Next to digitalisation, in my opinion, it is the biggest megatrend in finance out there right now.
ESG is really going to change how companies are run, how they are governed and how you need to communicate and engage with a whole new and wider set of stakeholders and ecosystem.
By now people can really see how quickly the markets changing, whether they believe in ESG or not. It’s changing and it’s changing very fast. I think it’s just a very exciting place to be.
Andreas: That is a very complex question when you drill down into it. You need to think about who the stakeholder group is. You have this new ecosystem that has built up and changed over the last couple of years. In addition to the financial institution and investor-issuer landscape, you have all the third-party data providers, ratings and scores, consultants, and specialty teams within banks. All of a sudden you have all these people in that space and they have different perspectives, requirements and development levels. Right now we are in a place where probably for the first time there is a certain amount of data available that you can actually start to analyse what is going on and what effect certain ESG factors have. Data is the key driver, in my opinion, for the further development of ESG as a concept. A lot of investors are building their own teams and conduct research because external data consumed via scores or ratings does not live up to what they need to build out their models. As they don’t have access to the raw data, the unbiased datasets that allow true comparison, they look for ESG and alternative datasets to build their intelligence.
For us at IHS Markit, we “dare to data”, it is part of our DNA and I am convinced it will revolutionise the business over the next couple of years because of the upcoming developments in regulation, reporting, data access and the area of reporting frameworks and (lack of) standardisation. A company’s data granularity, data transparency is going to form the base of its ESG profile which directly will influence and drive investment decisions, for example. In my opinion, within the ESG megatrend, data will become the most important asset. Issuers need to drive their ESG story by disclosing, reporting, and communicating their ESG profile proactively and in the form of the relevant material metrics. The investor universe needs a way to be able to compare their portfolio companies across the different frameworks, with ESG and extra-financial data.
Andreas: A company must ask itself:
What are the issues? What is required? What do my stakeholders want? Do I truly know my investors and the right decision makers? Do I have an understanding of the degree of ESG integration that my investors currently have?
Companies are used to pitching their equity story, but now they have to translate all of these ‘E’ ‘S’ and ‘G’ data metrics and link it to their strategy, and a story they can pitch. Companies that are newer to this journey struggle to actually understand what the KPIs are. A lot of companies believe they have a sustainability and ESG story, but they don’t if you ask the market. You’ve got to be really granular from an issuer perspective of what your story is, how you envisage your story to develop and then guide the market over time (e.g. scenarios, goals, remuneration etc), and some companies struggle with that.
We recently worked with a company whose water use and waste management were specific issues for them. They knew about their issues, but they didn’t understand the effect of these metrics made them laggards, how they influenced the investor community and how the capital markets perceived these gaps. There was a significant message gap, which effected the company’s ratings, investor base and likely also their performance and valuation. For example, external rating companies had a completely different peer group against which they measured this company. The company conducted a benchmarking and gap analysis which was followed by a diligent market perception assessment, to understand the status quo. They realised their ESG profile was actually much stronger than what the market perception was, but they lacked some data, they were not using all information externally and had significant potential in communication and proactive engagement outside of investor relations. There were some quick wins just by re-organising and getting people on the same page, and then there were some mid- to long-term changes that the board and management understood they needed to make in order to reduce the risk and take advantage of some of the market opportunities in their sector. They adjusted: the disclosure, the communication, the engagement and now, are slowly seeing change and improvements which they continue to measure.
Andreas: The regulatory aspect is a big challenge because it is very complex. Trying to understand the regulatory changes, the directives and also market best-practice is almost a full time job. Almost every week there is something new. On climate there are +1500 different pieces of legislation or directives that deal with climate change affecting companies and investors. ESG regulation in Europe has increased to record levels in the last 3 years, and it is very difficult to stay on top of. By speaking to the capital markets participants our experience is you will actually quickly understand what the market considers their material legislation and what the regulatory drivers truly are. Clearly, the EU taxonomy is quite something, with global market participants considering this leading edge and mimicking (parts of) it in several regions.
From our experience the investor community is quickly and often going significantly beyond the regulatory requirements. If you speak with your top 20 investors and have a good dialogue on ESG and sustainability, you get the best sparring partners because they usually will tell you what the main direction really is. There are several thought leaders out there, so if you stay close to them you will get an idea about where trends are going. TCFD and SASB gained a lot of traction in terms of reporting frameworks amongst the investor community.
Andreas: From our discussions with the leading financial institutions and also issuers, I would say that net-zero initiatives as well as the EU Taxonomy and the Non-Financial Reporting Initiative are very much in the focus right now. They are currently considered globally as very ambitious, not perfect, but the best that is out there. Countries such as Japan and New Zealand have been active as well, several regions are following up with similar initiatives and climate-related reporting requirements, as the UK and potentially even the US after Biden’s win. Watching what investors are doing, by simply tracking the signatory lists of UNPRI, ClimateAction100+, Net Zero Asset Owner Alliance and others, makes it quite obvious where asset owners and asset managers will be pushing the market over the next years.
Andreas: ESG will not go away. It is very clear that E,S and G factors have a financially material impact on any company. Do not be fooled by greenwashing nor be surprised by the incredible pace of change in the market - in my opinion data & intelligence should form the base for strategic decision making. This should be reflected in the way companies are managed & governed, their disclosure & reporting as well as their communication & engagement.