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In this episode of the Better Finance Podcast, EY Asia Pacific Climate Change and Sustainability Services Leader Matthew Bell discusses how ESG performance is shaping companies’ future.
Research from the 2020 EY Climate Change and Sustainability Services (CCaSS) Institutional Investor survey suggests that environmental, social and governance (ESG) information has never been more important, with the majority of investors surveyed (98%) signaling a move to a more disciplined and rigorous approach to evaluating companies’ nonfinancial performance.
Podcast host Myles Corson welcomes Dr. Matthew Bell, EY’s Asia Pacific CCaSS Leader, to discuss his varied career path and key findings from “How will ESG performance shape your future?”
The majority of investors surveyed signal a move to a more disciplined and rigorous approach to evaluating companies’ nonfinancial performance. 83% of investors surveyed consider formal frameworks to be necessary in assessing long-term value.
In addition, the survey also indicates that investors have become increasingly dissatisfied with the information they receive on ESG risks. Investors are looking for companies to provide standardized and rigorous nonfinancial data to support their approach to ESG evaluation. Choosing not to engage on ESG, or weighting performance solely toward positive aspects, may lead to investors coming to their own conclusions.
Lastly, the discussion moves into one of the areas that the investors responded was vitally important to them: third party oversight. Investors want to ensure that there is greater integrity over nonfinancial data sets, which are becoming fundamentally important.
Key takeaways:
Companies failing to meet investor expectations on ESG factors risk losing access to capital markets.
There exists strong investor appetite to see ESG disclosures underpinned by appropriate governance structures, reviews and controls.
The economic recovery from COVID 19 will be heavily influenced by green recovery agenda.
Investors want to ensure that their capital is being allocated to the growth sectors that are going to be supercharged in a decarbonized future.
For your convenience, full text transcript of this podcast is also available.
Myles Corson
Hello and welcome to the Better Finance podcast. A series that explores the changing dynamics of the business world and what it means to finance leaders of today and tomorrow. I’m Myles Corson from EY, and I’m your host. Today, we are joined by Dr. Matthew Bell, EY’s Asia-Pacific Climate Change and Sustainability Services Leader. I’m delighted to have Matthew here to discuss how environmental, social and governance, or ESG, performance is shaping companies’ future. Matthew, maybe you can start by telling us about your career history to date, your role and how you got into sustainability?
Matthew Bell
Thanks, Myles, and delighted to be here. Like most sustainability professionals, it’s a circuitous route that we all took to get to this position. Given that the role itself is a mix of disciplines between the social and environmental sciences, alongside of the sort of harder sciences if you like. My own was no different. So, I have a background in genetic engineering, working as a lab scientist before moving into — for a very short stint — accounting before becoming a consultant and then came to EY around 13 years ago to help to establish the climate change and sustainability teams that we now see around the globe. It’s really a mix of skill, it’s as I say, environmental, political scientists; we now have some behavioral researchers in a range of skills to really bring to our clients that cross-disciplinary requirement around sustainability.
Corson
Well, there’s some great diversity in that background I’m sure we’re going to hear more about. One of things we want to talk about Matthew is the findings from the recent survey with institutional investors that you have been instrumental in leading. Perhaps you can talk a little bit about the study and the goals from it.
Bell
It’s really interesting. It’s the fifth survey we’ve done over around seven years now. And we go out and we ask institutional investors, around 300 or so each year, how they are assessing ESG performance. And we see a pretty broad split in terms of the people who respond so they could be managing directors, CIOs, chief operating officers through to equity analysists, fund managers and portfolio managers, generally. And we ask them for their views on how they are utilizing environmental, social and governance factors in their decision-making as it relates to the allocation of capital. This survey itself is then followed up with some in-depth interviews carried out for us by a third party, Myles, to ensure that EY is at arm’s-length from the data, but certainly some very interesting results this year.
Corson
The timing is very interesting given all of the focus on these areas, particularly given the Business Roundtable and World Economic Forum in Davos were heavily focused. What were some of the key findings from this year’s survey, and did you see some changes from previous surveys?
Bell
The timing was really interesting for us. This survey itself was undertaken as COVID-19 was really taking a grip globally. And I think the realistic implications were starting to be well-known not just of course to the companies that were having to deal with them, but the investor community that was seeing the economic consequences of that. And so, probably fair to say that as a sustainability professional, Myles, I gritted my teeth in dire expectation of what the results might be, with a fear that institutional investors might be moving away from their focus on ESG, which we’ve seen increasing in every single survey that we’ve undertaken until this one. My fears were immediately allayed when the results came through though, because what was fundamentally clear, was that there was a profound upswing, in relation to the number of investors who are formally assessing ESG, that had shot up a number of basis points on our expectations from prior year. But even the total quantum, 98% of global investors who we surveyed came back and said, that they were assessing ESG performance of the companies in which they invest. That’s a pretty profound statistic when you take that back the seven years since we started those surveys. It was really fundamental to see that investors are assessing ESG performance as a core element now of what’s driving now, effectively, the returns that they are seeking in their investment approach. Ultimately, they are seeking to achieve long-term value from the clients that they invest in. There was a number of other things that came through from the survey. Clearly, the topics of interests, for example, supply chain implications — no longer a focus just on the company and isolation but the context of the global environment which it sits. Climate change remains a number one issue for investors with greater expectations, both on disclosures and management of performance around climate risk, as well as aspects such as human capital, which, again, is heading up the agenda in Europe, North America and across the Asia-Pacific.
Corson
You mentioned, obviously, the COVID impact, Matthew, and one of the things, I think we are seeing more broadly is, obviously, the disruption as a result of the pandemic, but also perhaps an acceleration of some of the things that may have been in-process, but actually of being accelerated as organizations respond to the aftermath of the pandemic. Are you seeing something similarly in ESG? Is this acting as a catalyst to accelerate some of the actions that company’s may have been thinking about?
Bell
Yeah, it certainly is. The detailed interviews really did highlight how they’re expecting the economic recovery from COVID 19 to be not just tinged but heavily influenced by a green recovery agenda. We’re clearly seeing that play out at the moment. Europe, for example, allocating 550 billion Euros, towards green outcomes. That’s going to be the largest individual contribution to climate action that we’ve seen from governments over the last few decades. And what we’re seeing from the investors survey is that public is funding is being followed by private funding as well. So, institutional investors are seeking to ensure that the green outcomes from their investments are held and they’re probably going to be more highlighted post-COVID. That makes sense, because if you’re looking to invest capital right now, you’ve got a couple of options. You can seek to put a band-aid over the economic issues that we are currently facing and create short-term economic opportunities and jobs, or you can seek to invest in things that are going to deliver long-term value. We’ve got a pretty good view on some of the things that are likely to influence the value equation over the next few decades. Climate change is clearly front and foremost in that. We know that climate change is likely to be one of, if not, the largest economic transformations that we’ll see in our lifetimes. The decarbonization agenda trying to get to net zero carbon emissions by the mid-point of this century is going to fundamentally impact all industry sectors. So, if we’ve got a reset that we’ve effectively seen through this COVID-19 period, it makes sense that investors would want to ensure that their capital is being allocated to the growth sectors that are going to be supercharged in this decarbonized future than they are those sectors that are going to be more easily impacted by those over the next decade and beyond. COVID-19 really is the reset button that’s driving a lot of this ESG allocation.
Corson
Building on that point, Matthew, there is certainly some evidence in the market that companies that are able to start telling that story and painting that longer-term picture are being well received by investors in terms of share price performance.
Bell
I think that’s entirely right. One of the issues that we are seeing in that space is the ability for organizations to appropriately manage this information. This came through from the investors survey too, when we asked them what are the current challenges around the current disclosures or engagement with companies on their ESG performance? One of the highlighted aspects was the connection between financial and nonfinancial value. The material nature of disclosures of organizations — so, are they really focusing on what’s most material in terms of their environmental impact, their social contexts or their ability to create value over the longer term? That isn’t translating especially well to the office of the CFO. How are they getting across measuring the intangibles that we understand is going to be far more important to investors going forward?
Corson
Let’s come back and talk about some of that connectivity of the messaging. I did want to pick on this point around long-term value. It actually resonates with me in another survey that we are doing with global CFOs, and we found in our research that over 80% CFOs very much acknowledge the importance of long-term value creation messaging and, at the same time, balancing that with the need to deliver short-term performance, particularly, given presence of activist shareholders. What are some of the approaches CFOs can be identifying to evaluate company relevant value drivers and balance the financial and nonfinancial metrics to help tell a clear story of this value creation?
Bell
I’m encouraged to hear those results from your own studies. Eight out of 10 CFOs telling us that that’s important is a fundamental shift in mindset. It’s short-sided of us to imagine the office of the CFO isn’t thinking more broadly than the last 12 months and reporting appropriately on the financial accounts. There is a much greater appreciation for enterprise value. The challenge comes down to a few aspects here. The first is, how do you determine what’s important? This is this materiality concept that I touched on a second ago, where we understand that organizations, largely when they report on their sustainability context, tend to go through a process of determining what’s important to most of their stakeholders. That isn’t to say what’s important to their shareholders but to their stakeholders more broadly. That’s important because of course that’s around their license to operate. It’s around the political contexts, the social contexts, the customer contexts that establishes whether or not your business is going to succeed into the long term. That element of your materiality is so fundamental. There’s a number of tools available now to organizations to do that well. The second part is really thinking through appropriate scenarios out into the futures, so that you can start to put a line in the sand and to say, well this is where we stand today, and these are some the possible futures that we see in front of us and how our business model is resilient to them or how it does incredibly well in the context of those scenarios. There’s none more profound in terms of the current context of disclosures where we are seeing that done well than in climate change. The Task Force on Climate-related Financial Disclosures, TCFD, which is a global approach to try and get organizations to produce more insightful information around how decarbonization and physical climate risks impact their business, requires that you go through a process of considering some of those scenarios. How does your business fair if we have a rapid decarbonization action in your local economy, in your business sector or even in the global context vs. delayed action that means that we have more physical risks associated with those climate changes? What it’s led to is some pretty nuanced disclosures that organizations now globally produce. We actually keep a barometer of those now annually to try and get a bit of a sense check on how companies are reporting, and what we are seeing both in terms of the investor survey that we’ve undertaken and our assessment of those TCFD disclosures, is that the organizations who are thinking through the material nature of their disclosures and thinking through the scenarios that are likely to impact their business over the longer term are the ones that are really resonating with investors. We actually asked investors, you know, what is the best mechanism to produce ESG performance data and information within companies? And almost as the last thought we added in the TCFD disclosures framework as one of the options that investors could select; it turned out that that was the most preferred method for all ESG disclosures, 21% of the investors came back to us and said they love to see all ESG disclosures in the context of TCFD. And whilst we kind of scratched our heads initially, because it seemed very pinned to the climate change concept, when you break that down, that makes a lot of sense, because it gets organizations thinking about risk management, about the metrics and targets associated with their management of that risk, around strategy and then, lastly, governance. Going back to your original question, for the CFO, thinking through those elements that are most material and the metrics and targets that are appropriate to be able to communicate to a broad set of stakeholders how they are managing that value equation over the long term, that’s really where their focus should be.
Corson
You raise the question of risk management, and for many CFOs, enterprise risk management frameworks, you know, there aren’t many more existential threats to the business than some of these things you’ve been talking about. So, getting this right is going to be really fundamental to each RM approach going forward. And I suppose listening to some of the complexity you’re describing, in terms of how you pull all this together, there’s the stakeholders across the organization that need to be involved. One of the things I would also point to from the CFO research is the strength of the relationship between CEOs and CFOs. A lot of this CFO focus is being driven because CEOs are very focused on these topics and, really, they are the ones that have the mandate to set the tone from the top within organizations. Anything anecdotally you would point to it in terms of organizations that are doing this well and how that tone from the top resonates down through the organization.
Bell
There’s a few things to unpack from that that are important, and the first thing is, the CFO and his or her office plays a much larger role in the context of sustainability than they are given credit for. So, whilst the sustainability groups or the environmental health and safety or equivalent management teams within organizations have largely taken carriage of the sustainability contexts of the companies, in particularly their disclosures, historically. What we’re now seeing from the investors is a demand for this greater connectivity between the nonfinancial performance and the financial performance. That really sits squarely with the CFO’s office to try to unpack what that looks like and how that can be achieved. There’s organizations that are getting that connectivity right. They’re starting to build out metrics that isolates the material aspects and puts some context or some quantum to them over time — is really resonating with the broad set of stakeholders, and including the providers of financial capital. You also talked to the role that they play with the CEO and the importance of the CEO. We think about this whole long-term value and ESG context of companies in two ways. There is the top-down approach that we’ve seen in many, many sustainability leaders. Look at Unilever as an example. Paul Polman, the past CEO, very much heralded as a leader in sustainability for the organization because he took a top-down, driven approach where he made it an expectation across the business that they needed to manage their ESG context acutely and perform against it. KPIs were established on that basis, quality of metrics, and then it flowed through all the divisions of the organization to drive their performance over time. It isn’t the only way. The other approach is the percolator effect, getting that embedded across organizations and allowing innovation to drive upward through the business as opposed to that top-down approach. My personal view is that you don’t have require one or the other, but you do need to have leadership. And whilst I don’t need to hang this entirely on the CFO, I do think they play a pretty critical role in ensuring this is communicated well to shareholders and prospective investors, but also that it’s meaningful within the context of the business. It isn’t a stand-alone activity that’s out there managing this ethereal concept of ESG that somehow abject from the business itself, but it’s actually embedded within the organization and what it does. It’s part of its DNA.
Corson
Matthew, to your point around to good disclosure, you mentioned the Task Force on Climate-related Financial Disclosures. There’s a number other organizations putting forward standards, and one of the things that struck me from this survey was the number of investors, over 80%, saying that they’ve considered formal frameworks to be necessary in assessing long-term value. And interested in your views on how you see that shaping up. We’ve seen Blackrock recommending a use of SASB standards. How would you suggest our audience thinks about the frameworks? Does the framework matter or is it about getting the substance right?
Bell
In the long term, the frameworks do matter. We are not quite in our infancy, but we are out of the crawling stage and we’re stumbling along as toddlers. When we think about this in broader context of business management and disclosure, financial accounting, you could argue, it has an 800-year history; whereas we’ve had a little over two decades now of broader ESG disclosures and standards. There are, though, a couple of pretty significant standards out there, and interestingly, we’re starting to see them work much more closely together. You mentioned the Sustainability Accounting Standards Board, but also the Global Reporting Initiative, the GRI, possibly the two largest standards setting organizations right now in terms of this nonfinancial value element of organizational disclosures. GRI and SASB have started to work in a much more meaningful way together, which is a really positive context. They have themselves, though, been largely focused in the same way that financial accounting has on point-in-time thinking. How do we think about the context of the business in the prior 12 months — which has been entirely appropriate. I believe the investors have started to see some real value and meaning in the TCFD disclosures because they have been much more forward-facing. The real push here is moving towards long-term value [LTV] thinking. EY has put a lot of its personal capital and time into developing out LTV frameworks, and we came together at the World Economic Forum to join with a number of institutions, including some of the accounting bodies and nonfinancial accounting bodies to think through how we determine what an appropriate long-term value framework would look like, and we’ve spent a number of years now working through that process. So, we are not there. There are frameworks for people to assess the moment. There is though the appropriate flexibility for organizations to be able to tailor them for their specific need. And whilst I would love to say here is the off-the-shelf standard that we should be applying, I think that flexibility is quite important at the moment to enable organizations to genuinely demonstrate to their stakeholders how they are creating value.
Corson
As these kind of standards become more established, the disciplines around nonfinancial reporting, the consistency, the controls to establish that trust in numbers, particularly given the kind of a scrutiny that investors are starting to pay to these disclosures, is an area where finance potentially has a role given its history in this space on the financial metrics. Any perspectives on the role for finance audience?
Bell
There’s a number of things that you’ve alluded to that are really important. The first is connectivity in the finance function across the business. How are you truly getting a view of risk management if you aren’t embedded in thinking through how your risk function, your COO’s office, your CEO’s office and others are really thinking through risk and strategy, and how are you, therefore, playing a meaningful role in helping them to underpin their decision-making processes. Strategy in the absence of information is naïve and the finance teams arguably have some the most insightful information that you can draw on. The other thing is that the finance functions have been very used to working, for example, with assurance providers and to ensure that there is third-party oversight across their disclosures so there’s integrity to the information that is being produced publicly and that scenario where there is still a lot of evolution needed in the ESG space. One of the areas that the investors told us was important for them was third-party oversight. How, for example, do we ensure that there is greater integrity over those nonfinancial data sets that are becoming fundamentally important to investors, so that they are seen as the same grade of information as the finance function is currently delivering in relation to the accounts? That’s the real area they should be focusing on. And then lastly, this connectivity between financial and nonfinancial information. Research shows that the investors are concerned about the gulf that often exists between financial and nonfinancial information. They don’t necessarily understand the connectivity between the two, and how do they take those to inform their decision-making? Resolving this is complicated by the lack of regulation related to the alignment, as we’ve touched on, but investors are starting to build their own more credible and nuanced approaches to understanding what influences long-term value and, therefore, applying that to the companies. The finance function should be standing up, thinking through how value is created over time for their businesses, what are the most important factors that are reshaping it? Again, that materiality concept. And then looking for ways to connect those nonfinancial value drivers with financial proxies or KPIs that are important to the business. And at that point, you are starting to lead your investors and perspective investors and the direction of as to why they should invest in your business.
Corson
That’s a great note to start to wrap up on Matthew, so I appreciate you sharing some of those perspectives and findings from the survey. Finally, are there any key takeaways or practical recommendations you would share with other listeners?
Bell
We haven’t really touched on appropriate governance. The “G” element of ESG is around appropriate governance. We should be establishing effective governance practices and assurance of nonfinancial processes controls and data outputs. That’s really going to help to build trust and transparency, and this is the area where the CFOs and their finance teams, who’ve got extensive experience in establishing processes, controls and assurance can bring their best practices and experience to bear. Governance elements shouldn’t be overlooked. It’s interesting because, historically, investors have been much more focused on governance than they have on environmental or social aspects. That is tipping. This survey shows that the environmental and social aspects are much more front and center in terms of this value paradigm that the investors are wrestling with, but it doesn’t mean we can take our eye of governance because as we know, the research shows, well-governed organizations, both in the context of their financial and nonfinancial management, will outperform in the market.
Corson
Matthew, where can our listeners find additional information?
Bell
Go to the EY Better Finance link and find a link there to the survey and I encourage everyone to read it. It’s a really a great survey. I’m very proud of the work that the teams have undertaken, and the interviews, certainly, have given us a great insight in terms of current and future thinking of the investor community.
Corson
Matthew, I appreciate you taking the time to share those insights. The survey has some really interesting and timely insights, both into the research and the interviews, so I encourage our listeners to take into more detail. For listeners, as always, thank you for listening. If you have enjoyed the episode, please remember to subscribe to the series or leave a rating review. As Matthew mentioned, if you like to find out more about the topics discussed we’ll post related links on EY.com/betterfinance. I look forward to speaking with you on the next episode of the Better Finance podcast, a series of that explores the changing dynamics of the business world and what it means to the finance leaders of today and tomorrow.
End of recording
