GreySpark Interview: ESG in capital markets
Assessing the capital markets ESG landscape in 2024
This week GreySpark analyst Elliott Playle sat down with GreySpark fintech strategy consultant Archie Charlton to discuss the current ESG landscape in the capital markets industry. The ‘trends in ESG 2024’ report mentioned below, which Archie authored, can be found here.
Elliott Playle: Hi everyone and welcome to our occasional interview series. I am joined by Archie Charlton today. He is a fintech strategy consultant here at GreySpark Partners. He is also the go to ESG guy for GreySpark. So Archie, it is really good to have you on today. I just wanted to speak a little bit today about firstly your Trends in ESG 2024 report, which is available on our website (www.greyspark.com). I also wanted to speak to you about the current ESG landscape in the capital markets.
With ESG, in the context of capital markets, it has notoriously been a confusing topic, where people are still maybe unsure about what ESG actually means. In your opinion, and in the context of capital markets, what does ESG mean to you?
Archie Charlton: Thanks Elliott. One of the reasons why it can be a woolly term and mean different things to different people is because it has had a lengthy history and has been evolving around that time. ESG was first mentioned about 20 years ago in a United Nations (UN) report called Who Cares Wins. Since then, because it was first put forward by the UN rather than a more active body, or being immediately pinned to a significant regulatory framework, people have used the term in lots of different ways.
I think of ESG in two different ways. One as being the regulatory and ideological underpinning of ESG investing, so that effectively means manufacturing and then managing and marketing products for sale which have some kind of subjective tying to ESG principles. So that could be a product which is Article eight or nine under the Sustainable Finance and Disclosure Regulation (SFDR), which is fairly black and white, or it could be a product where through the investment policy, an asset manager has said, this is going to be targeted. For example, investing in green infrastructure in the Asia-Pacific region. It can be thematic or it can sit within one of the regulatory frameworks.
Then the other way I think of ESG, and the way it is commonly used is whether a firm has a positive or negative ESG profile. That obviously applies to banks and asset managers. They can have better workplace practices, they can have better gender diversity, and they can do better in terms of their environmental footprint. But really, at the end of the day, the main impact a financial institution will have on the broader ESG landscape is through the kind of work they do as a financial institution, because a trading system doesn't use a lot of electricity, whereas they might be looking at a manufacturer or an industrial company that is not environmentally friendly.
Elliott Playle: That is really interesting. When I first came across ESG, I thought it was just about carbon emissions and reducing that carbon footprint if you like, but when you go a bit deeper, it is actually a lot more than that. There is equality, diversity and even things such as supply chain management and manufacturing. There are so many different elements that go into it that I didn’t realise. Are there any others, in your view, that typically get missed by the mainstream?
Archie Charlton: Going back to talking about the historical view on ESG, I think that people's focus on ESG comes in order of ‘E’ then ‘S’ then ‘G.’ As you say, the first thing that people think of when it comes to ESG is carbon emissions. But really, as you go further in, there is a lot more to it than that and you realise a lot of ESG principles have been around before. So in our upcoming ESG data vendors buyers guide, one of the areas we’ve considered is Shariah compliance. It is not necessarily always thought of in terms of ESG investing, but that’s been around for well over 1,000 years. Then, we can get into governance and can consider things like how strong the controls procedures are surrounding financial audits. You would also consider how far you can look at a firm’s alignment with proxy voting advice from an institutional shareholder service, like a Glass Lewis proxy. So yes, I think it is so important to understand that while one firm or one financial product might focus more on one theme within ESG it is so broad, and there is so much going on there.
Elliott Playle: Yes. I think as well with such as the broadness of the topic, it has probably made for a lot of regulatory confusion. As I understand it, the European Union is trailblazing the ESG regulatory landscape. There are so many different regulations going on. You have got the EU taxonomy. You have got SFDR. You have the corporate sustainability reporting directive (CSRD) to come in 2026. There are also several different regulatory frameworks evolving as we speak, with their own distinct requirements, with some overlap. There was some data that I saw from IR magazine, which carried out a survey of 4,500 US and European companies and found that between 50 and 75 per cent of ESG data reported in 2022 was unnecessary to comply with regulations. So these companies were reporting on data that they did not have to report on. Some asset managers are spending roughly $1.4 million a year on ESG data. So how do you think financial firms can deal with this regulatory confusion?
Archie Charlton: I think one of the important things for a firm to consider beyond marketing of their ESG products is their current stance toward ESG. By this, I mean establishing whether they want to become a sustainability leader and selling ESG-heavy products and services, or whether they are only looking to achieve a certain level of compliance. However, one of the difficult parts with this is accessing ESG data. Firms need to collect their own ESG data, effectively organise it and make it usable. Where you have got this usable data, it is easier to report on. The firm can then use this data for other activities. An example might be that if you are looking at the Task Force on climate related financial disclosures in the UK, one of the things you look at is how much risk a particular product carries, as well as the total product range operated by the firm, from climate change to the transition to a greener economy?
Outside of reporting, it is one of those things where if you go over the top on that, it is maybe not such a big problem because you are then going to have more data to fall back on. Going back to the leaders versus compliance example, if you are a large asset manager and your main product is an S&P 500 ETF, then you don’t really need to have that extra data. But if you have a relatively small European asset manager, managing around $10 billion, and they are really selling themselves on sustainability and offering those really interesting thematic products, going a step further and building transparent ESG frameworks that they will make public, more data will be required.
Elliott Playle: That is really interesting. So with ESG, and taking a look at an asset manager, for example, they want to be seen as being sustainable in its own operational practices, but it also wants its investment portfolios and investees to be seen in that way. I think with that, in ESG, it can be very beneficial for a firm to be as sustainable as they can, not only from a compliance standpoint, but to attract investment. In your Trends in ESG 2024, there is some interesting data about the increased returns and greater favourability towards firms from investors who adhere to ESG standards. It also seems that investors are becoming increasingly ESG-savvy and putting at the top of their investment criteria. Another of your charts in your report is also intriguing, where it shows a parabolic rise in the number of Google searches for ‘ESG’ over the past few years. So yes, looking at that, do you think that ESG will be one of the leading trends in capital markets in the years to come?
Archie Charlton: Yes, big time. With reference to your point about my graph on Google searches, what we are talking about is that if you look at Google searches over the past 20 years, and look at people searching ESG terms relative to other terms that they search, if we are at 100 per cent now, (the most popular ESG has been as a search term), ten years ago, we were at ten per cent of that relative. One of the ways that I think about this, and maybe it is a little bit controversial, we can see now that a quarter of US equity flow is now retail driven. That really is a very significant proportion and shows just how much retail interest matters and can affect the progress of an equity through the investment interest that is garnered. Also, if you look at the demographics now, and the younger generation, there are lots of people who are interested in the topic of climate change, and are also concerned about social aspects. More and more, I think that you are going to see ESG as kind of a given right. For example, you would only invest in a fund if it is article eight (under the terms of SFDR) and I think this kind of mindset is destined to grow due to the demographics and hence why ESG principles are here to stay.
Elliott Playle: Yes. I just wanted to touch on ESG data, which you mentioned earlier. Obviously, there are quite a few ESG data ratings providers out there right now. So you have got market players like Bloomberg, LSEG and MSCI, who actually provide ratings of a firm's ESG credentials. How beneficial do you think this is for removing ambiguities in the ESG space? It is not always easy to quantify a firm’s overall ESG rating. I know that we are also starting to see these ratings providers face increased regulations in order to prevent practices such as greenwashing and push us closer toward a standardised ESG data framework in capital markets.
Archie Charlton: I think that something is better than nothing. We have quickly come from a position of having nothing in terms of ESG ten years ago to where we are now. As firms increasingly try to be seen as sustainable given regulatory demands and investor preferences, it is understandable that ESG ratings are being questioned more and more. However, because there might not be sufficient publicly-available information on a number of firms that a ratings provider wants to rate, what ends up happening is that they are using estimations. For example, say we wanted to look at carbon input produced by equipment and machinery. That is something that is not really reported within the industry. From a sustainability perspective, machinery that is not necessarily economical will be reported the same as a ‘good’ set of machinery because they are both going to be given the approximate average of their cohorts within that ratings group. Following on from that, there are a number of ESG data providers where they are just aggregating data from other providers. So they can effectively end up aggregating averages that other firms have produced on that basis.
So we are almost at an inflection point. Maybe if CSRD brings out a sufficient level of data reporting, then we could get to a point where there are fewer estimations and aggregations because the data is easily available. But then you get into the question of who sets the weightings and who decides on these different ratings. I was reading a story recently about Tesla, which was excluded from S&P 500 ETFs, and because of its significant market cap, once it was reincluded it had a really significant effect on the price of Tesla itself, as asset managers had to quickly purchase lots of the stock to keep the balance of the ETF – we are talking individual days of more than $100 billion traded volume. So, in an ESG sense, I think that there are question marks around transparency on inclusion and exclusion methodologies. From a research perspective, what we really encourage is for ESG data providers to expose as much of their methodology to users as possible, because ESG is such a subjective area, exposing the methodology allows the users of that data to use it most effectively. If the consumer of the data perceives there to be an improper balance of the weightings, they are able to rewrite it themselves rather than having to consume a black box rating.
Elliott Playle: Thanks Archie. We covered quite a lot there. Really interesting to get your take on things. Just as a reminder, Archie’s ‘Trends in ESG 2024’ report is now available on our website. We also have another ESG-based report in the works, which you will hear more about soon. Thanks again for joining me Archie.
Archie Charlton: Thanks Elliott.
End of transcript.