Sudhir Roc-Sennett: Working for a Swiss company with a base in New York, it’s quite clear to me that ESG means different things to different regions. A key part of that is the regulatory environment. Regulations in Europe are specific, fluid and plentiful, and a lot of the emphasis on ESG there has been driven by regulation. That’s not the case in the Americas, where the regulation is much less tight and directional. As a result, in the Americas, it’s much more about how the customers and the managers choose to direct their approach — and that’s based on self-interest rather than altruism because a lot of North Americans need their savings for retirement. So it’s not just about doing good things, it’s about good things leading to better returns.

The other thing is that the managers need to find an effective way of having the most impact relative to their size and asset class. If you’re working in private equity and you’re on the board, you have a close effect on the outputs of your ideas. If you’re in listed equity, it’s more engagement and voting as a minority shareholder. If you’re in fixed income, you generally don’t have a vote. So, investors need to focus on the impact they can make and look for managers that are effectively leveraging their position in the market to promote change.

Victor Schraner: As others have suggested, there are a lot of resources allocated to this on the large plan side. We have many smaller to mid-sized pension fund clients that don’t have the resources and perhaps are in areas of the country that don’t see ESG as important.

Yet, in a very short period of time, even over the past 18 months, these clients have moved from spending five minutes in an update call discussing what we’re doing in ESG to asking us how to integrate ESG because they need to do this on a plan level. It’s been a 180-degree turn from “ESG is important but the managers do it” to “We need to figure this out for ourselves and have something on our website to show that we’re taking this seriously and that we have ESG goals.”

What’s also interesting is it’s coast to coast. ESG is top of mind for pension plans across the country as they come up with an ESG policy at the plan level rather than outsourcing it to the managers they’ve hired.

 GIDEON SCANLON

In 2020, assets in sustainable funds reached $2 trillion — a 50 per cent
increase in one year. Did the subsequent pandemic bring ESG considerations
to the forefront for institutional investors?

Priti: The pandemic created a perfect storm for ESG — a confluence of three key factors. One was demand for sustainability-oriented funds as people realized there are more important things than bottom-line risk-adjusted returns. Second was good, solid performance and some established track record by ESG funds and a long-running bull market after the initial crash in March 2020.  That crash gave investors an opportunity to reallocate with the pandemic in mind, and they favoured companies with good ESG ratings and a history of taking care of employees, steering clear of controversial business behaviour, having a good corporate culture and demonstrating governance best practices. Third, a focus on climate solutions was top of mind for many investors given many extreme weather events as well as increasing awareness about links between biodiversity, pandemics and climate change. All three factors drove a lot of fund flows over the past couple of years.

Anne: At the beginning of the pandemic, a lot of people within the industry were afraid that investors would turn away from sustainable investing and focus more on performance. But then investors realized that health issues and racial issues play a big role in the economic system and also that ESG and the traditional way of analyzing companies are closely linked. It wasn’t ESG factors at the expense of the economy — they’re connected.

Glen: In my view, 2020 was not a precipitating event as much as a catalytic event. We saw a slow escalation in asset growth leading up to 2020 and then a tipping point, but there was a foundation of asset growth there.

In early 2020, as Priti said, pension plans and other large institutional owners were suddenly looking at an unpredictable environment. It gave them an opportunity to revisit how they’d allocated their funds and see what their other options were.

It gave them impetus — as a board, as an asset owner [and] as a fiduciary — to reconsider the asset mix. And when they surveyed the landscape in 2020, there was a change: it was now possible to invest with ESG in mind, in products that had a track record.

 GIDEON SCANLON

What role should governments and regulators play in the ESG space?

Sudhir: The rapid delivery of COVID-19 vaccines showcased a model in which regulators set a framework, including liability for manufacturers, testing with much shorter periods with non-human and human trials run at the same time, and then let the market solve a potentially catastrophic problem rather than mandating specific solutions. It was an illustration of how important regulators are, not to suffocate innovation but to promote it to solve critical issues — and this lesson can inform how we deal with other issues from biodiversity to carbon emissions. Regulators defined the challenge, provided funding, then allowed companies to compete and discover the most effective solutions.

Priti: Governments can certainly provide the right incentive structure for competition and innovation to thrive, and potentially, also penalties for negative behaviour. They can require disclosure by companies, which is a cost for companies but provides investors with consistent metrics. Governments can also

support sustainable development, along with a properly functioning capital market — for example, by issuing green bonds. In Canada, to deliver on its climate promises, the government can use capital markets to gather funds that are directed towards the innovations that can move us from a resource-

heavy economy to a green economy. And, when equity or fixed income analysts cannot put a price on intangibles, as with carbon pricing, governments can play a critical role in putting a price on pollution that can go directly into valuation models.

Glen: Yes, governments can encourage transparency and consistency of disclosure — and also introduce a level of predictability. The unpredictable is problematic for long-term and short-term investors. For example, a couple of banks in the United States have decided unilaterally not to clear trades for companies that are involved in recreational cannabis. If the government had provided guidance or a clear mandate in this area, we could navigate the landscape much more easily in a way that doesn’t cause surprises for our investors.

On the role of government in investment, climate change is a reality that will have an impact on Canada from coast to coast. There will be challenges and the government will be making choices on how it funds climate mitigation and adaptation. There’s a role for us on the market side to support that through investment, but we have to understand the risks as well as the opportunities. That’s where, again, transparency is critical.

Michael: Governments are very good at helping out with disclosure and providing a framework so pension funds and other institutional investors understand the rules of the road. But I think most practitioners would say governments are not positioned to mandate investment best practices. Maybe they can identify some of the absolute worst offenders, but capital markets are predicated on imperfect information. The role of asset managers and asset owners is to take this imperfect information and apply their best knowledge, investment process and insights to add value over the long term. If we let governments do this, what’s the incentive for firms to improve their ESG practices?

Sudhir: I don’t think there’s any evidence that nationalizing investment decisions has ever worked out effectively, but regulatory frameworks can bring significant value. That reaches through to mandating improved auditing disclosures, which are 30 years out of date, to improve the relevance and consistency of annual report data.

 GIDEON SCANLON

What are the most practical ways of measuring ESG impact, and how can plan sponsors make sense of the many ESG ratings to measure success?

Michael: It’s important to focus on outcomes that are both measurable and meaningful to the constituent, and we do need common data standards to assess ESG impact. The CFA Institute is trying to make that happen. But there’s still no single measurement system, and I think we’re still ignoring the interplay among E, S and G.

Glen: The term ESG is really a quick shorthand to cover disparate areas of interest to investors. It’s a challenge to measure something when there are so many factors, which investors will prioritize differently. For example, if you think about electric vehicles as a path to decarbonization, emissions are next to nil, depending on the electric grid that provides the charge. However, mining for the metals that go into production is environmentally intensive. It also often occurs on lands owned by Indigenous people, so there are human rights challenges. Furthermore, vendor estimation models are commonly black box models, so you can’t see the inputs.

For fiduciaries, plan sponsors, investors and asset owners, it can be hard to understand the metrics you’re applying. And every ESG rating has an inherent bias in the way data is collected, interpreted, rated and weighted. For plan sponsors, awareness is the critical piece. They need to understand what they’re buying when they buy the data, including the context, assumptions and data gaps.

I’d emphasize, too, that ESG strategies must be examined through the same risk lens, diversification models and performance lens as anything else. If ESG is negatively impairing your risk profile, diversification mix, or long-term performance, as a fiduciary you need to question why.

Priti: Measuring ESG impact is a can of worms. It really depends on what you are trying to measure. Is it the impact on companies from ESG issues or the impact of companies on society, stakeholders and the environment? Impact-based frameworks exist, but they can be distorted when companies that are not primarily impact-oriented force their business activities to fit into them.

Sudhir: Fundamentally, ESG is a plea for active stewardship — for managers to take the responsibility of owners. A very important part of what we do — of the data we look at, the engagement, the voting policies and all of these ownership responsibilities — is to improve the likelihood of an anticipated outcome being the actual outcome. It’s closing that gap. You also need to measure ESG relative to the term of impact the manager is aiming to achieve, since governance can change overnight, but impact on biodiversity or water security may take years.

 GIDEON SCANLON

How can plan sponsors best incorporate ESG in different asset classes?

Sudhir: There are two main ways to approach ESG investing in equities. Thematic ESG investing focuses on companies with revenues driven by selling services or products that lead to change. Integrated ESG investing identifies companies that are adjusting they way they and operate. Both matter, but thematic investing can become more speculative; just because a company is doing something interesting doesn’t mean that it’s a good company or that it’s got a winning product, a leading engineering edge or another advantage. What’s interesting for me is the transition of mainstream, large corporations to better practices. That’s what can move the needle across an economy and in the portfolios most people hold. In either case, it’s important for investors to have a relationship with company management teams that is built on trust and that encourages change.

Michael: ESG data doesn’t exist for every asset class. As a plan sponsor or a fiduciary, you can decide which variables and metrics are important to you, but data availability and accuracy may not be there, especially for smaller companies and companies in emerging markets. In private markets, real estate has one of the more developed data sets with acknowledged global standards. But in other areas, such as private equity, private debt and infrastructure, there can be issues getting solid data.

Priti: For every asset class, there are several layers of ESG analysis that depend on the asset class, time horizon, duration and issuer. And keep in mind that we have different controls in different asset classes. For example, as a shareholder of public companies, we control selling decisions on a more flexible basis. On the other hand, as an investor in a long-term infrastructure project, we’re tied in for 20 years or so. In that case, it’s essential to follow through with an ESG program by monitoring it continually over time and making sure we have targets and objectives to address in our regular engagement with property managers.

In equities, proxy voting is extremely important. It’s a proof point that shows our commitment to ESG. To use proxy voting to its best advantage, you need in-house resources to effectively vote on proxies, according to your fiducial responsibility and portfolio objectives, as well as a procedure to guide the portfolio manager towards consistent decisions on ESG issues.

 GIDEON SCANLON

Are there structural risks attached to ESG investments and could enthusiasm around them lead to bubbles?

Priti: I wouldn’t call it bubbles, but more unintended consequences. We’ve seen some already — for example, the implications for energy security if not enough investments go into energy development. We must keep our eye on the ball to solve for climate change, but we must also balance that against energy needs and a just transition. We need to have a much more thoughtful approach to ESG investments and the potential unintended consequences of divesting out of certain sectors too rapidly while some leading players in those sectors are positioning to provide solutions across their value chains and working with their clients on net zero by 2050 ambitions. That involves engaging and putting forward expectations on how we want those business models to evolve going forward and what their emissions reduction targets and climate action plans are. We don’t want people to be sitting in the cold and dark five, 10 years down the line because we did not invest enough in key areas that need to be built out for energy transition.

Glen: Nuclear power is another good example. Likely, for a zero-emission future, it does need to play a role in electricity generation. But it takes time to create a nuclear power plant and we probably need fossil fuel input to transition to that point. Also, we haven’t solved the nuclear waste issue and we have to acknowledge that will have a long-term, localized impact. One other challenge with nuclear power is that the media loves a great headline about a cracked nuclear reactor casing. That flavours perceptions of the industry by both the public and government officials.