The rise of environmental, social and governance (ESG) concerns is the story of the moment in capital markets. But we are still far from fully understanding how ESG considerations should be incorporated into financial operations. Treasury professionals everywhere have an important part to play in bringing ESG values into the mainstream, writes Calastone’s Ed Lopez
For many, the promise of ESG in the financial world goes far beyond ticking a few boxes drawn up by regulators. What stirs their interest is the promise of a more resilient, less volatile economy – a promise that appeals to every treasury officer. But ask anyone active in corporate capital markets exactly what counts as a good ESG metric, or a good ESG product, or a good ESG strategy, and you will get as many questions as answers.
There is no doubt that this is an environment that is evolving fast. We see a profusion of new products and new investment strategies built around ESG, we see competing regulatory initiatives designed to formalise what is and what isn’t authentic ESG, and propelling it is a huge increase in appetite for ESG-conscious capitalism from an emerging generation of investors and customers. How do we make sense of all this and what is the role of treasury?
To help answer some of those questions I was joined in our latest Calastone webinar by Reyer Kooy, Head of Institutional Liquidity Management at global asset manager DWS, and François Masquelier, Chairman of the Luxembourg Corporate Treasury Association. We began by asking ourselves the obvious question: why should treasuries pay attention to ESG and everything that comes with it?
“I think you have to recognise that this is a unique issue,” said Masquelier. “Yes, it is important to embed ESG into the corporate mission. It is important for reporting, it is important for performance, but it is also a matter of principles. As a corporate treasurer you will hear this from your stakeholders and you will hear it from your team. As treasury leaders we want to be able to attract the best talent, and the upcoming generation sees this as an issue where they want to be part of the solution, not part of the problem. It is an area where we don’t just act as finance professionals, we also act as concerned citizens.”
But what about costs? Don’t ESG ambitions come with a price tag? There are the costs of broad ESG compliance, the costs of transition out of the carbon economy and there are pure financial costs as well. Green bonds still represent a small slice of the investment universe and they command a premium. Do corporate treasurers just have to accept that embracing ESG principles is always going to limit returns?
“It’s important to see the big picture here,” said Kooy. “As of today, there is certainly a cost to – for example – running a money market fund on the ESG model and that is because the main effect of the principle is exclusionary, it limits choice. Some treasuries are not willing to make a compromise that will cost them a couple of basis points. That will change, though, and the most important thing to remember here is that even while there may be a performance lag, we know that ESG adds to corporate performance over time.”
Yet in the meantime there is a strong sense that the appetite for ESG models in investment and treasury management is growing much faster than many expected even just a year ago. Investors and consumers are becoming ever more conscious of the ESG dimension, and if anything it is the consumer and the retail investor who are ahead of the game. According to some estimates, more than 80 per cent of money allocated by retail investors over the last two years has gone to funds and stocks with positive ESG profiles.
“It is not just customer demand and pressure,” said Kooy. “Regulators are also getting increasingly active. We have already seen the Sustainable Finance Disclosure Regulation, which focuses on environment, come into force in Europe and there will inevitably be more regulatory intervention on social and governance issues. This is encouraging a lot more work on creating frameworks for assessing sustainability. At DWS, for example, we are currently working on how to score banks for ESG performance, a notoriously difficult area but one which is very important.”
As common standards on ESG reporting and scoring emerge, it seems likely that sustainability will increasingly be seen as part of the fundamental investment model that rates any investment in terms of its security, liquidity and yield. Corporates and institutions with high ESG ratings also tend to have good credit ratings and that means that ESG is becoming part of the security element in asset selection.
There is an important role here for new technology. In a situation of fluid, emerging standards there is always going to be a hunger for new ways to obtain clarity on how assets have been assessed, how they have been traded and even their provenance. With the arrival of data technologies like blockchain, with its ability to create an immutable record of transactions, it may become possible to make ESG synonymous with transparency.
Yet this is a work in progress, argues Masquelier. “We need to talk the same language on ESG,” he said. “We’ve seen too many ESG labels, we’ve seen too much greenwashing, and to really measure true performance we need to work on several fronts at once. It is not going to be a one-shot change. It’s going to take time and there may be a shake-out when people discover that some assets are nothing like as green as they claim. But the good thing is that disclosure is improving and there is coordinated action.”
Getting from where we are today to where we need to be tomorrow is clearly going to take a lot of work. Yet many are optimistic that the time when ESG is fully embedded in investment processes is not that far off – and believe that everyone in the financial services industry has a role to play.
“We should always remember: asset managers have influence,” said Kooy. “The ESG model may not be mainstream yet – but as long as we keep on taking it seriously, it soon will be.”