In this episode, Lauren Puffer, Director of Sustainability Banking, and David Erickson, Senior Fellow at Wharton Business School discuss current topics in the ESG market that are pertinent for companies and investors as they set their strategies for 2023 and beyond.
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Hi everyone. I’m Lauren Puffer. My pronouns are she/her/hers and I’m the Director of Sustainability Banking at Cowen. Welcome to our podcast.
I’m joined today by David Erickson, Senior Fellow at Wharton Business School, and today we’ll be talking about current topics in the ESG market that companies and investors should be informed of as they set their strategies for 2023 and beyond. Thanks, David, for joining me. I’ll turn it over to you.
Great, Lauren. Thank you. There’s lots of interpretation of what ESG means. Why don’t we start there? How do you define ESG?
David, you’re right. There are so many different definitions of ESG beyond just environmental, social, and governance, and people interpret it in very many different ways. For me, the way that I look at it is ESG is part of the fundamental investing in the fact that every company is impacted by and gets impacted by the environment, impacts social meaning they have employees, they are impacted by their communities or impact their communities and have governance structures. The way that I look at it is that it’s a wider aperture in understanding a broader set of risks and opportunities that impact a company’s financial or operational performance. Sustainability, on the other hand, I look at, and again, personal view, the way that I look at sustainability is how companies are approaching this economic green transition in a way where they will end up being successful and going concerns in 2050 and beyond.
Great. There’s been significant cross currents in the ESG market this year, both macro and then political issues. For both companies and investors to navigate, it’s been very challenging. When you talk to companies today, what are their biggest questions?
Yeah, there has been a lot of confusion in the market. I think ESG has been somewhat politicized and the midterm elections have happened, so there might be some reasons around that. But for ESG, we’re talking about longer term strategies. ESG includes the way that companies are looking at environmental impacts, social impacts, and their governance structures today, and making decisions about that that will impact the companies and potentially, their value over the longer term.
The questions that I get mostly from companies, it really depends upon where they are in their ESG journey, whether they’re just starting out trying to understand what the investment community is looking for, whether they are very advanced and have for many years incorporated ESG and looked at ESG as value drivers in terms of the way that they’re operating their companies. But generally speaking, I would bucket the conversations into four main areas.
But the interesting thing is that all of them have mostly evolved from the what, so what is ESG, into the how. How do we tackle this? How do we find opportunities? How do we mitigate risks and how do we report it? And so really, the four are number one, what’s going on with the SEC disclosure and what do we expect will come out of the climate disclosure proposals that the SEC made earlier this year, and what are our expectations in terms of what that will look like as a final proposal?
The second is many companies are starting to look more deeply into the S, how are they strategizing around their own employees, their community relations, and what does that look like in terms of attracting talent? What does that look like in terms of voluntary turnover, in terms of operating in different areas that might have sensitivities around communities? Then, how do they measure that? And then how do they report it out to not only their investors, but also their stakeholders at large and what that looks like.
The third is really the trends in the ESG investor landscape. Going back to your first point, there’s been a lot of confusion and a lot of issues around what ESG means, especially from the investor side, so what does that current landscape look like? And then how do companies shift from a focus on reporting to a focus on strategy when it comes to ESG? And then of course there’s the more philosophical, kind of more philosophical, but the way that I put it is we’ve had some bullish markets for the past couple of years, so what does ESG really look like if the economy really takes a downturn? And how do they approach the risks and opportunities that they can see in an economic downturn versus a pure play bull market?
Flip it on now for the investor side. What are the biggest questions that they have as it relates to the current market?
Yeah, so the investor side, it’s really great and I love being in the middle of the questions from the company side as well as the investor side so that you can really see what the gaps are and try and close those gaps when it comes to an informational perspective. One of the biggest questions that I get from the investors are, what are all the other investors doing? I think that comes down to the risks for the portfolio perspective, but also just trying to keep up to date with the way that ESG is evolving. And really, quite honestly, we’ve been in the world of sustainability in ESG for a number of years now, but the pace at which we are evolving as a whole, as a broader scope is moving really rapidly.
Most people are trying to really understand what’s going on right now and how do they interpret that and get ahead of that in terms of opportunities that they can see going forward? Many investors I also see are looking at the thematic trends that are happening. What are the mega trends that are driving this green transition and how is that evolving? So you see a number of years ago, we were looking at the mega trend of kind of divesting from fossil fuels, and we still have that conversation going on, but now you’re seeing investors coming into, how do we finance and how do we look at building up the hard to abate sectors and decarbonizing hard to abate sectors? What does that look like from a financing and from evaluation and from an opportunity perspective? Same thing with methane, with diversity, food scarcity, so on and so forth.
We see a lot of those conversations happening, and much of this is driven from, especially in the US, there are many corporate commitments. I think the majority of large companies have commitments to net zero, but emissions are still going up, so how do we tackle this on paper commitment versus real, actual reduction in emissions and real economic productivity when it comes to diverse populations or underrepresented populations and what that looks like? Then really the crux of it all comes back to, how are companies tying these commitments and tying these strategies back to their financial and operational performance? The investment community that I talk to is wanting to see more of that from the companies that they’re talking to and that they’re trying to invest in.
Many companies already have an ESG strategy, some unfortunately do not. When you talk to the companies that do not, where do you advise them to start?
That’s a great question. From my perspective, I always tell them to start from what’s material to them. There are many consulting firms and there are many ratings firms out there and I think that they are all working towards a common goal, which is to drive companies and actions towards decarbonizing in a way that’s just and regenerative for the economy on the whole. But not every company is going to be impacted by the environment and social issues in the same way, nor does every company impact the environment or social in the same way. Really, I think it comes down to what is material for the company in terms of the ESG factors and how can they look at those ESG, those material risks and those material opportunities in a way that will drive growth and positive impact on the environment and on social?
There’s this interesting play of this dynamic materiality, which means something that was material to a company, a factor that was material to a company 10 years ago might not be material anymore and vice versa. It’s an ongoing process from a company perspective to really look at, what are the main drivers from a material perspective that are driving financial and operational performance? For that, I usually turn to what was formally SASB, it’s still known as SASB, which is becoming the foundation for the ISSB, The International Sustainability Standards Board. Most of the investors that I talk to will look at SASB as well, many of the companies do as well, so it’s really using that foundation from a financial performance perspective, operational performance perspective, and using that materiality.
The second is looking at what are the goals of the company when it comes to how they want to treat their employees, how they want to treat their communities, what are the goals? Take a blank slate, who do you want to be when you grow up? Who do you want to be? What kind of company do you want to be in 2050, 2060, 2070, so on and so forth? So really looking at those goals first and how that gets incorporated into the strategy, and then backing into what that looks like for a company. What does the company need to do in the short term, medium term, long term in order to achieve those goals?
Instead of what we see companies or kind of the 1.0 I’d like to say, is focusing on reporting as much as possible and then backing into what the target should be based upon what they’ve already reported. A lot of time and a lot of resources get used in that way, and the return on that time and those resources, personal view, I don’t think are as big as if you focus on what are the material issues, what are the goals in looking at those material issues, mitigating as much risk around those material issues as possible, capitalizing it on as many opportunities within those material issues as possible, and then setting short term goals, medium term goals, and long term goals.
Really what that comes down to is companies looking at ESG factors as part of the business strategy versus something that’s completely separate and distinct and on its own. A long time ago, not a long time ago, but a few years ago, we looked at ESG in the construct of corporate social responsibility, so much more on the philanthropic side than on the business strategy side. As we’re evolving, I see more and more companies looking at this is actually a business opportunity, lower our risk, mitigate risk, capitalize on opportunities, improve financial performance, improve operational efficiencies. That’s great. I think that those are really the ways that the companies can start looking at their strategy.
Unlike traditional indices, there’s a lot of inconsistency in the ESG indices. I mean, companies like MSCI and S&P have developed hundreds of different in ESG indices. Then you have lots of consultants that are advising both companies, investors to come up with their own ESG metrics. How do you advise companies to navigate these issues?
Yeah, it’s complicated. We don’t have a standard framework yet for what materiality looks like, what the standards are. So right now, part of why the SEC put out the climate disclosure proposal is because the investment community is looking for clear, comparable, and decision-useful information in how they’re making investment decisions based on some of this information. We have many different frameworks, standards, we have many different ways of slicing and dicing positive, negative. Part of the pushback that we’ve seen on ESG lately has been, I think because of these differing definitions of what ESG looks like, what materiality is, what companies should be reporting on, should a company be dinged because they’re not reporting on something that’s not material to them? Should companies be dinged because they’re not comparable to another company? There’s really no set framework right now.
However, we are moving in the direction of the ISSB trying to set global standards and frameworks that every company should, or hopefully it’s not set yet, so I don’t know what it looks like, but hopefully, we will get to that place in the future, but we’re not there. In the interim, I personally think it’s really important to stick with materiality and stick with materiality and drivers of strategy. How is the company being impacted by the environment, social? How is it impacting environment, social? The dynamic materiality, how is that evolving over time? How does that look in terms of not only operations, but also product and also supply chain? Where is the company going to take responsibility for all of those things when it comes to ESG? And how do these factors impact a company’s ability to grow, scale, and have a positive impact on the environment and social ala the business round table a few years back looking at the stakeholder model versus just straight shareholder privacy?
There’s obviously lots of topics that we could go and areas that we can go on, but I just want to end this conversation with really best practices. When you think of those companies that have really the best ESG strategies, what are the best practices that distinguish them and how do they measure impact?
Oh, it’s a great question. I think one of the big underlying themes of this conversation is that it continues to evolve, so what was best practices 10 years ago is probably no longer best practices. However, a lot of it is around information and action. A number of years ago we saw a really big drive towards net zero commitments, so lots of companies were making these commitments, but with very little substance around, but how do you actually get to a net zero in 2050? Now, after a couple of years, both companies and the investment community is saying, huh, well emissions still having a continuation of net zero commitments increasing.
We’re in the first week of COP27, so we’re having a lot of discussions around climate specifically, but emissions are still going up. The economic divide between haves and have nots, which usually falls on diversity lines, continues to grow, so are we actually tackling these real-world issues or are we putting a lot on paper that is not actually happening and we’re not strategizing in how to get there collectively and individually?
What we’re seeing is in terms of best practices, it’s companies who are really taking action from a strategic perspective and having those actions benefit both the company, as well as the environment and the people. We’re moving farther and farther away, thankfully from the idea that there’s a trade off between doing well financially and doing good on an ESG perspective and really understanding that by doing good on the ESG side, actually helps to drive financial performance.
There are many studies that have come out in recent years that talk about how companies that pay more attention and look at ESG factors within their strategic scope of their business, actually perform better on a financial basis, which is great, and you see valuations increase for that. Some people say, well, isn’t this just a better run company? I’d have to say yes, because the people who are looking at a broader scope of risks and opportunities will most likely perform better because they’re looking at more of the things that might impact the financial performance or the operational performance of their companies.
In terms of how they measure, I think it really comes down to measuring in terms of financial and operational performance. Moving away from, and this is where I think the world of ESG is moving from we’re measuring it in terms of our philanthropic activities, which is still great and very important. But moving from that into the business strategy and how it’s impacting financial and operational performance and saying, this is how we’re benefiting our communities, this is how we’re benefiting our people, this is how we’re benefiting the environment, this is how we will benefit from this over time because we won’t be as impacted by the environment. We will attract talent, which will lower our voluntary turnover and therefore, lower the cost to the company for replacing employees. We will drive innovation. There are real factors that companies can look to when they embed these best practices into their strategies of pulling it back into the financial and operational performance of the company.
Do you find these companies, these best practice companies, if you will, that they integrate how they measure impact into their quarterly and annual presentations? Or is it just reported separately as part of their ESG impact statement that they have every year?
Most companies still report their ESG data on an annual basis in an ESG report. Now, we’re seeing the trends that are happening there. We’re seeing kind of two trends. One is that even the reporting of that data is becoming a little bit more dynamic where the information is going on, for example, the website and it’s being updated on a more regular basis than annual and not, again, not all of these ESG factors can or should be necessarily reported more frequently than annual because it takes a lot of resources sometimes to report on some of these bigger factors like emissions within a supply chain. Like that just takes a lot of time and a lot of resources to look at. But we’re seeing a little bit more dynamism there and we’re starting to see companies more and more embed it in their financials.
If we’re really talking about strategy and we’re really talking about how this is impacting the company, as well as the environment and people, then reporting it and actually having an integrated report on a financial basis is the direction that we’re going in. If you go back to the SEC climate proposal that I talked about, part of that proposal as it currently stands is incorporating some of these risks and opportunities into the financial statements. We see the SEC going there, we see the investor community going there. We see some leaders in the corporate world have already gone there, and I think it’s really helped not only the investment community, but companies understand that these can be strategic drivers versus this is just something that we’re doing on the backside that falls into it a totally different department.
But with that, to be very clear, one of the best practices that we’re seeing that gets a lot of kudos from the investor community is the C-suite really understanding how to talk about these issues in terms of their strategy and the financial performance. It’s an educational process. You take the leaders that are able to talk about it, and then that helps to inform the investor community and then vice and vice versa. Then they go back to other companies, ask for information, so on and so forth.
We’re seeing a lot of the asset owners driving these conversations where the asset owners are asking the managers for better information on how they are strategically using ESG in their investment process, and then the investors then asking the companies how they’re using or looking at ESG in their operational process or in their strategy. It kind of goes full circle on that side.
I think that’s a great place to stop for now. Hope you’ve enjoyed it. Thanks so much, David, for joining me today. It’s been a great conversation and I look forward to the next one. Bye, everyone. Thanks so much for listening.
Thanks for joining us. Stay tuned for the next episode of Cowen Insights.
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