March 6, 2024 • 31 mins
Founded in 1998, Impax Asset Management is a pioneer in investing in the transition to a more sustainable economy. On this episode of the ESG Currents podcast, Ian Simm, Impax’s Founder and CEO, joins Eric Kane, Bloomberg Intelligence’s director of ESG research, to discuss the evolution of the ESG space, single vs. double materiality, net zero vs. net-zero aligned, the complexity of biodiversity, why “green is not black and white” and much more.
This episode was recorded on Feb. 12.
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Speaker 1 (00:09):
ESG has become established as a key business theme as
companies and investors seek to navigate the climate crisis, energy transition,
social mega trends, mounting regulatory attention and pressure from other stakeholders.
The rapidly evolving landscape has become inundated with acronyms, buzzwords,
(00:30):
and lingo, and we aim to break these down with
industry experts. Welcome to ESG Currents, brought to you by
Bloomberg Intelligence, your guide to navigating the evolving ESG space,
one topic at a time. I'm Eric Kane, director of
ESG Research for Bloomberg Intelligence, and i'm your host for
today's episode. Today we're talking with Ian sim who is
(00:53):
the founder and CEO of IMPACT's Asset Management. We'll talk
about how ESG has evolved in the two and a
half decades since Impacts was founded, net zero versus net zero,
aligned materiality, verse double materiality, and much more. Ian, thank
you so much for taking the time to join the program.
Speaker 2 (01:12):
Great to be here, Eric, Thank you.
Speaker 1 (01:14):
So for our listeners who may be less familiar with Impacts.
Can you tell us a little bit about your company's
work and ultimately what you were trying to solve for
back in nineteen ninety eight when you founded it.
Speaker 2 (01:26):
So Impacts Asset Management is a business working for ASID
owners around the world, and what we're doing essentially is
giving them an opportunity to beat the market, to make
great risk adjusted returns by investing in what we call
the transition to a more sustainable economy. So back in
nineteen ninety eight when I founded the business, I was
passionate about the companies that were, for example, in the
(01:49):
wind energy sector, or cleaning up water supply or recycling.
I had a personal interest in the environmental issues. I
had a science background, but I'd also tried to set
up a business in South Africa and the sole energy sector,
so I was quite sort of passionate about entrepreneurship. And
in those days these industries were quite quite tiny, but
(02:09):
the companies were making some quite interesting profits and great
return on investing capital. So it's quite a sort of
interesting gem of an idea back in the late nineties.
Speaker 1 (02:18):
Absolutely, So we were talking a little bit before we
started recording, and you mentioned, of course that ESG as
a term hadn't even really been invented yet in nineteen
ninety eight, so maybe you know tell us a little
bit about how the term came to be, and then
you know how you think the space has evolved since
(02:39):
ninety eight or since the term was developed, and ultimately
what you think some of the big successes have been
and where you see continued room for improvement.
Speaker 2 (02:48):
Yeah, that's absolutely right. So back in ninety eight ninety
nine when we were getting going, our second client was
actually a Danish bank, and the Danish bank saw that
in the context of the internet sector, the TMT revolution
that was underway at the time, that what they called
environmental technology was going to be a big opportunity, and
so our very first funds were focused on this idea
(03:11):
of environmental markets or making money from solving environmental problems.
Now ESG as an acronym only came along in two
thousand and four when some clever consultants were preparing for
a UN conference and in the wake of the Enron
and Welcome governance scandals, they thought would be really interesting
to debate whether there was some overlap between governance issues
(03:33):
and the ethical issues that were kicking around at the
time around polluting the planet, and so they put environment, social,
and governance three words together in this acronym, and frankly,
up until two thousand and nine, ESG was a very
low key topic concept, if you like. But after the
financial crisis in two thousand and eight, people were looking
(03:54):
around for some kind of simple way of explaining what
had gone wrong, and our observation was that ESG became
an easy that we had a financial crisis because it
wasn't enough ESG, and frankly, ESG has sort of taken
off from there, but it's quite an unhelpful or slippery
idea because quite deliberately in the eyes of those who
(04:14):
created it, it conflates capitalism on the one hand and
ethics or values on the other, and that's just a
recipe for confusion.
Speaker 1 (04:23):
Very interesting. So, I think, following up on the last
you know part of part of your answer there, I
think one of the debates that has really started to
surface or has has been around for a while now,
which I think is trying to get at, you know,
the difference between ESG and impact investing and how we
(04:45):
can ultimately kind of define these terms and have the
biggest impact if that's ultimately you know, the objective. So
that debate has really centered around this idea of materiality
versus double materiality, and I know Impacts for example, has
advocated for a double materiality approach in regulation and standard setting.
(05:05):
Can you tell us a little bit about your reasoning
for that.
Speaker 2 (05:09):
Sure? Yes, Look, double materiality itself is a piece of
jargon which needs explaining. The starting point with materiality in
this industry, of course, is the financial materiality. What are
the potential impacts on profit and loss account, cash flow
and balance sheet. And the second element in double materiality
is what some people refer to as impact or the
(05:30):
effect of business activity on environmental topics and maybe social topics.
But from our perspective as capitalists who are trying to
steer our clients towards great risk adjusted returns over the
medium to long term, the second element of materiality is
actually a very strong indicator of risk and potential medium
(05:51):
to long term opportunity and does have a nice feedback
into the first element are either financial materiality. So we're
very much looking at the second element of materiality as
an enhancement to the first. Now, it's not to throw
the baby out with the bathwater, because we are also
interested in the impact of our investment work on the
(06:12):
environments and on social issues, but that as an output
an outcome, rather than a particular objective x ante. So
capitalism first and let's see what happens to the environments
and social factors as an outcome.
Speaker 1 (06:25):
Very interesting. Yeah, So we were talking a little bit
earlier about a study that we did evaluating our ESG
scores universe here at Bloomberg, and our scores are based
on financial materiality. One of the things that we were
trying to understand is whether this distinction between double materiality
or single materiality financial materiality versus impact was really as
(06:49):
strong as a lot of you know, people in the
space might lead you to believe. And one of the
things that we did was just looked at greenhouse gas
emissions as an example, and we looked again at our
universe of fifteen thousand companies, and we found for the
industries and companies where we ultimately believed greenhouse gas emissions
management was the most financially material of the e issues.
(07:13):
We saw that there were about twenty two hundred companies
representing more than eighty percent of the index's total emissions.
And this is compared on the other side to about
almost eight thousand companies for which we don't assess greenhouse
gas emissions because we don't believe it to be financially material.
And that group of companies again eight thousand out of
(07:35):
fifteen thousand, so basically half was responsible for only three
percent of total emissions. So in our mind, this was
some interesting research that really suggested that these these concepts
were not as mutually exclusive as people might lead you
to believe, because ultimately, if you're looking to understand the
companies that have financial exposure to greenhouse gas emissions, it's
(07:59):
the same that will ultimately have the biggest impact on
the planet. So just maybe curious to hear your thoughts
on that analysis.
Speaker 2 (08:09):
Yeah, look, I think greenhouse gas emissions is a very
good example in the context of the second element of materiality,
and you need to be careful in doing the analysis
because greenhouse gas emissions may be a proxy for financial
risk if the company is not able to pass on
carbon taxes or some other restrictions on burning fossil fuels
(08:31):
to its customers. But if the company is able to
pass on those costs, if it's got pricing power, then
it's not indicator of financial risk. So this is part
of the skill of being a financial analyst with a
deep expertise in this space, and I think impacts with
eighty investment professionals and analysts in this area's got one
(08:52):
of the deepest benches in this space is really understanding
that that kind of economic analysis as to whether the
environmental social factor is a good for financial risk.
Speaker 1 (09:01):
Or not very very interesting. So in keeping with the
idea of greenhouse gas emissions. Of course, another topic that
has become very discussed in recent years is the idea
of net zero right in particular for financial institutions. And
you've written about the concept and kind of advocated for
(09:23):
this idea of net zero alignment versus net zero financial institutions.
Can you explain what the distinction is there and why
you ultimately think the use of the term alignment is
more appropriate.
Speaker 2 (09:36):
Yes. So, if the problem that we're trying to solve
at a global scale is to reduce greenhouse gas emissions,
and the best way to achieve a global target is
to break that down at the country level, which is
what the CULP process and the UN process is trying
to achieve. If individual countries have net zero targets, that's fine,
(10:00):
but that doesn't it doesn't make sense to then disaggregate
that sort of target to a whole set of corporate targets.
And the reason for that is that the cost of
abatement cost of emissions reduction at one company is not
the same as the cost of abatement or reduction the company.
And a good illustration of that is to contrast, say,
the consulting sector, which has god emissions linked traveling around
(10:22):
which can be replaced by people doing for example, teams
or zoom calls, with the steel industry, where the marginal
cost of switching is enormous. So reducing the emissions in
consulting is much more efficient way of reduction than to
reduce them in steel. So in simple terms, what we
need in the economy of the future is more consulting
(10:43):
and less steel. So in that context, it really doesn't
make sense to aim for portfolio of today's companies that
are all net zero because to achieve that net zero
picture ignoring the problems with net which we can give
back to If you like ignoring those problems, then it's
going to be much more cost effective in some companies
(11:04):
than another's. So what we've introduced at Impacts is a
different idea, which is net zero alignment, which is where
we want to see that companies that we're investing in
have business models that are resilient to the net zero
plans of nation states, which, in simple terms, using more jargon,
is this sort of transition plan alignment. Does the company
(11:25):
in question that we want to invest in have a
robust transition strategy to migrade it's business model to something
which is going to work in an economy where carbon
emissions or greeness gas emission are appropriately priced.
Speaker 1 (11:38):
Absolutely, so, you offered the option to come back to
the term net so I will take you up on that.
Here's to hear your thoughts on the term net zero.
Speaker 2 (11:46):
I guess then yes, Look, I mean this is quite
a well rehearsed issue. But just as there's a problem
with corporate net zero, there's also a problem with companies
who feel that they can carry on emitting or be
fairly limited in their reductions of emissions because they can
buy these indulgences or these offsets in some other part
(12:07):
of the system, be it in the economy or outside
the economy, and they're the problems are well rehearsed around
the robustness of carbon markets. The additionality of such offsetting
if you like standards and the impact on communities, particularly
in less developed countries. So there's a whole host of
(12:29):
problems with that offsetting, and we really should try and
move away from it.
Speaker 1 (12:32):
Absolutely. Yeah, So, in keeping with the theme of climate
and carbon in December, IMPACTS updated its fossil fuel policy
to indicate that it will not invest in companies that
derive any revenues from fossil fuel exploration or production, or
deriving more than five percent of revenues or profits from
(12:53):
fossil fuel refining, processing, storage, transportation, and distribution, as well
as utility power generation. So was wondering if you could
walk us through the evolution of this policy and why
you've ultimately kind of landed on that statement at this point.
Speaker 2 (13:11):
Yes. So in the US, in particular, due to the
legacy position of the packswall management business that we bought
in twenty eighteen, we have until recently been using the
phrase fossil fuel free to label some of our US
mutual funds. But that caused two problems. Firstly, there was
a clarity problem, so some of our clients didn't fully
(13:33):
understand or didn't agree with the definition of fossil fuel free.
That's probably for obvious reasons, so we dropped the word free.
The second problem that we faced was that we were
actually losing some of our potential investments because there were
businesses that maybe had great skills and assets suitable for
(13:54):
the emerging hydrogen economy, but because they had two three
four percent of their rev new coming from supplying parts
of the fossil fuel industry, we had to exclude them
on the basis of a fossil fuel free portfolio. And
so this slight window of eligibility, if you like, up
to five percent of revenue from the fossil fuel sector,
(14:18):
provided that we are therefore getting a much bigger potential
revenue or balance sheet commitment in the transition to the
more sustainable economy. That opens up the ability to invest
in some really interesting companies.
Speaker 1 (14:32):
Absolutely, and certainly sounds like it, as you said, opens
up a lot of interesting opportunities to invest in different companies.
Are there any of your stakeholders who kind of pushed
back against that change in policy and we're advocating a
kind of stricter approach, if you will, not.
Speaker 2 (14:52):
To my knowledge, I think certainly from what I've heard,
everybody was supportive and sympathetic to the dropping of the
phrase fossil fuel free, and I've not heard any pushback
on the second point. What we are doing is being
very transparent about what where the boundary lies. And so
if we have a potential investor who is absolutely adamant
(15:14):
that they didn't want any exposure to the fossil fuel sector,
then either will invite them to go and find a
service provider somewhere else, or they're large enough, we might
be able to create a spoke portfolio that excludes the
one or two stocks that might have gotten in because
of the new policy structure.
Speaker 1 (15:31):
Very interesting, so in shifting to maybe a different environmental
topic or the one that's certainly very related to climate.
In twenty twenty two, you wrote a paper called just
Too Complex addressing biodiversity loss and the role of investors.
So twenty twenty two, this was of course before CUP
(15:51):
fifteen and the big announcement that came out in CUP fifteen.
In my mind, it was, you know, before biodiversity really
became part of the kind of mainstream ESG conversation. So
just curious to hear your thoughts on the activity that
has happened since twenty twenty two, so again cut fifteen.
But the release of the TNFD framework, for example, and
(16:15):
if these events have at all changed your view on
the complexity of the topic.
Speaker 2 (16:21):
So it's very interesting to compare and contrast by diversity
with climate change in the context of the financial sector's response.
So clearly climate change concerns have come first in the sequence,
and because of the commonality of the receptor. Would be
like the fact that a marginal unit of pollution anywhere
in the world has the same amount of marginal damage
(16:43):
to the climate that affects us all, it's relatively straightforward
to agree how to apportion the blame or the burden,
and hence the idea of disclosure of climate risk and
apportioning reduction targets, etc. Can follow a sort of natural
and logical arrangement or process. Biodiversity is not the same
(17:08):
because it's a multilocal problem, with many of the biodiversity
issues being confined to one particular locale, some of them
are multi local and connected, so it's therefore much more
complex to attribute cause and effects and to apportion blame
and the burden sharing, if you like. So in that sense,
it was sensible to do climate first and then to
(17:29):
think about biodiversity. Subsequently, we applaud the TNFD team and
the process that they've gone through to make a start
to put in a very sensible taxonomy, to categorize the
issues and the epics of their pyramid as they describe it,
to to get going to try and put some structure
around how we're going to protect biodiversity. Now when it
(17:53):
comes to assessing risk at the corporate level for biodiversity, again,
it's much more complex than inslimate for for reasons that
are pretty obvious. But what we did in twenty twenty
two was work with Imperial College London to try and
investigate and write up some case studies of companies that
had decided to act to preserve biodiversity in while acting
(18:17):
in their own self interest, but with some measurable benefits
down stream or upstream in the context of protecting nature.
And we didn't actually find one of these, but the
example that we went in with was the idea of
this paper mill that potentially would have an incentive to
invest to protect the water supply upstream from its plant
(18:41):
in order to improve or preserve the water quality going
through the plant, and the upstream investment could be the
preservation of a wetland or the reforestation of a particular
part of the hillside. So we went in with that example.
We actually found six really interesting examples in other areas,
which which can be seen if anyone wants to look
(19:03):
on our website in the report that we made. But
I think the conclusion that we in Imperial came to
was that there were not that many examples of corporates
acting in their self interest to preserve biodiversity, but there
were some quite interesting early early examples which could be
built on, and if they were showcased more effectively, then
(19:24):
other companies might be more creative in looking around to
see what they could do as well.
Speaker 1 (19:28):
Very interesting. So you mentioned the idea of self interest
and difficulty in finding companies that were acting in their
own self interests to protect biodiversity. I think, you know,
that's certainly a component of it. But I guess my
question here is how much of it is, you know,
(19:49):
companies not recognizing their self interests versus not necessarily having
the information necessary to kind of make these decisions around diversity.
Because as we've been discussing things like T ANDFD data
on biodiversity, it's you know, just starting to come to
fruition now. So again also a reason why it's you know,
(20:11):
quite different from climate is in my mind we as
investors researchers don't have the information and I also think
a lot of corporates still don't have that information.
Speaker 2 (20:22):
Yes, I think that's a really good point. And the
associated issue there is the horizon or timescale of the
financial markets. So in the listed equity world, and Impact
Asset Management is a listed company listed on the AIM
market in London, there is significant pressure from the analyst
community to make your next twelve months earnings. And if
(20:46):
you are faced with a choice between spending some money
now and maybe falling short on today's earnings in order
to invest in something that might might enhance value either
by reducing risk or improving returns over the medium term,
then you have a strong incentive to stick to the
next four months. So what that does, in the context
(21:08):
of bidiversity and actually climate change is the same is
skew investment decisions away from that logical medium term value
enhancement in climate change is a very good example around
adaptation to more severe weather, for example, to put in
physical protection against storm surges or increase the strength of
(21:32):
bridges and to stand up against stronger winds. So there,
I think we do have as a society a very
significant problem around creating the incentives for corporates to act
in that medium to long term self interest maybe on
an NPV basis to enhance value, but with the downside
(21:55):
that short term returns are going to get impaired. The
logical response to that, of course is for government to
be regulating. But your question, there is a major problem
around not just the availability of information and data, but
also the accuracy of the environmental models which the data
is then informing. And I think it's well understood, now
(22:17):
well rehearsed that climate weather models are massively inappropriate or
out of date given what's happening around climate.
Speaker 1 (22:26):
Change, absolutely makes sense. So we've been talking a lot about,
you know, climate and other environmental issues, in particular biodiversity impacts.
Products are of course not limited to environmentally related products.
For example, you have a social leader's fund and gender
funds as well. Even though there's difficulty, of course, as
(22:49):
we're just discussing, in measuring performance on environmental issues. For
me and I think for many in the space, environmental
issues have always been easier to measure performance against. There's
typically kind of a north star for performance that we
can all measure against, whether it's you know, the idea
of net zero or net zero aligned, or you know,
(23:13):
more more simply the elimination of a certain waste stream,
for example. So curious to hear your thoughts on whether
there are equivalents on the social side, and if so,
how do you ultimately evaluate progress towards these social issues,
given you know the fact that in my mind, the
social issues often are far more interconnected with policy. If
(23:36):
you think about something like health, you know, corporates can
only do so much, so much of it is dependent
on government policy. And then, of course, the other challenge
with the social side, similar to what we're describing with biodiversity,
is the data is often not as available, and if
it is, it's not as comparable.
Speaker 2 (23:57):
Yeah, So we first start looking at the possibility of
a social product in actively managed equities in twenty twenty two,
and the obvious place to start is where you were suggesting, Eric,
which is to look at markets linked for example, to
financial inclusion or healthcare that were demonstrably improving the quality
(24:17):
of people's lives and improving economic participation. And at first order,
it is possible in certain markets to look at, for example,
a number of people connected to the internet or healthcare
outcomes linked to private sector activity as measures of progress,
measures of market development. But actually we wanted to go
(24:38):
one step further, and it did take us about a
year to refine this. But where we've ended up is
to also look at the quality of a company through
social factors, particularly around staff retention rates and staff engagement schools,
which we've seen through quite significant analysis are good indicators
(24:59):
of the quality of management across the board. So the
Social Leaders Universe and the fund that we're running are
bringing these two factors together. So investing in companies that
are producing great investor returns return on investing capital by
investing in high growth markets with a skew towards healthcare,
(25:19):
financial inclusion, de materialization of infrastructure with a social angle,
for example, but then also wanting to ensure that the
companies that are leading the way and are in our
portfolio have got great management quality as evidenced by these
sort of social metrics.
Speaker 1 (25:37):
Very interesting, and something like retention rates, it's certainly, you know,
a metric that we try to evaluate for certain industries
in our issue spores for example, and the day to
day research that we do. But I would say that
is an example of a data point that is often
missing from public filings for example. So is that something
(25:58):
that you're able to ascertain by engaging with companies specifically,
or where are you, you know, essentially attaining those data
points for that analysis.
Speaker 2 (26:06):
Yeah, you're absolutely right. This is not a mandatory around
corporate reporting, and therefore, unless a company's got top notch
data in this space, it generally isn't going to be
publicizing it. But they generally the data are generally available
if you ask, and so yes, it's through the dialogue
that we get to get the information, and if a
company is completely refusing to comment, then that generally is
(26:28):
a bit of a black mark. So the companies know that.
Speaker 1 (26:32):
Very interesting. Yeah, So I think the final question that
I had, which is maybe a two parter, I think
we would all agree that these days it's hard to
have a conversation about ESG or whatever you ultimately want
to call the space that doesn't address regulation and the
pushback to ESG. So I wanted to hear your views
(26:56):
on how these two forces are ultimately impacting you know,
your business and the space out large.
Speaker 2 (27:02):
Yeah, it's quite interesting looking back over a couple of decades.
But up until twenty sixteen twenty seventeen then the world,
certainly Europe and North America had some quite interesting nonprofit
or private sector providers of labels for funds and green
taxonomies that were providing the consumer with choice and recognizing
(27:24):
that there's no definitive explanation for what this space is.
Green is not black and white, as a praise I
like to use, then it did make sense that, for example,
there was a climate index in Europe that included nuclear power,
but another one that excluded it, so consumers had a choice.
(27:45):
The European Union came along in twenty seventeen and mandated
the creation of a green taxonomy, which was like a
government directed definition for what green was, making it very
sensitive or critically where the boundary was. And as a
result of that sensitivity, it took them quite a long
time to work out the boundary, and out of that
(28:08):
came the SFDR regulations that everybody is familiar with, and
then the UK said, well, we don't want to do
it quite that way, so the UK came up with
its own definition of sustainability and the disclosure regulations that
were published in the four last year. The US is
going down a slightly different route with the SEC's regulations
(28:31):
coming out later in the spring, which are essentially around
transparency and clarity of definition. So going seven years ago
from a space in which there was a bit of
a free market for labels consumers had choice to one
in which governments are kind of competing with each other
to be the absolute definition of the space. I think
(28:56):
we're in a much more bureaucratic place than we were.
There's lots of green red tape, another one of my
common phrases, and that is expensive for companies to comply with.
So what is the way out? Well, I do like
the SEC's approach of really ensuring that there's transparency and
(29:18):
clarity with a minimal amount of imposed framework and structure
as something which is preferable to what the Europeans are doing,
and I'm hopeful that eventually that's where this industry or
the sector will settle down. I suppose my final suggestion
and plea would be could we please move away from ESG.
(29:40):
As I was saying earlier, it's deliberately designed to conflate
two things that don't really fit together capitalism more than
one hand, ethics on the other, and it's caused enormous
amount of confusion since it went mainstream. I don't blame anybody.
The designers had a different purpose in mind. They were
not trying to put in a new framework for sector,
(30:00):
but unfortunately we've picked up on it. So what I'd
like to see over the next three to five years
is that we wean ourselves off ESG completely and we
talk about the transition to a more sustainable economy.
Speaker 1 (30:11):
I'm not sure I agree on the idea of abandoning ESG. Rather,
i'd say the focus should be on doing ESG well
and with transparency. Either way, this is a great segue
into our next episode, which will feature Professor Alex Edmonds
from London Business School, and we'll focus on his belief
that we should move away from ESG in favor of
what he calls rational sustainability. I'd like to thank Ian
(30:35):
sim founder and chief executive of Impacts Asset Management, for
joining us today and for a great conversation. As always,
you can find more information on all things ESG by
going to the ESG team dashboard, bi Space, ESG go
on the Bloomberg terminal. If you have an ESG quandary
or burning question you would like to ask bi's expert analysts,
(30:57):
send us an email at ESG Currents at Bloomberg dot nex.
Thank you very much, and we'll see you next time.
ESG has become established as a key business theme as
companies and investors seek to navigate the climate crisis, energy transition,
social mega trends, mounting regulatory attention and pressure from other stakeholders.
The rapidly evolving landscape has become inundated with acronyms, buzzwords,
(00:30):
and lingo, and we aim to break these down with
industry experts. Welcome to ESG Currents, brought to you by
Bloomberg Intelligence, your guide to navigating the evolving ESG space,
one topic at a time. I'm Eric Kane, director of
ESG Research for Bloomberg Intelligence, and i'm your host for
today's episode. Today we're talking with Ian sim who is
(00:53):
the founder and CEO of IMPACT's Asset Management. We'll talk
about how ESG has evolved in the two and a
half decades since Impacts was founded, net zero versus net zero,
aligned materiality, verse double materiality, and much more. Ian, thank
you so much for taking the time to join the program.
Speaker 2 (01:12):
Great to be here, Eric, Thank you.
Speaker 1 (01:14):
So for our listeners who may be less familiar with Impacts.
Can you tell us a little bit about your company's
work and ultimately what you were trying to solve for
back in nineteen ninety eight when you founded it.
Speaker 2 (01:26):
So Impacts Asset Management is a business working for ASID
owners around the world, and what we're doing essentially is
giving them an opportunity to beat the market, to make
great risk adjusted returns by investing in what we call
the transition to a more sustainable economy. So back in
nineteen ninety eight when I founded the business, I was
passionate about the companies that were, for example, in the
(01:49):
wind energy sector, or cleaning up water supply or recycling.
I had a personal interest in the environmental issues. I
had a science background, but I'd also tried to set
up a business in South Africa and the sole energy sector,
so I was quite sort of passionate about entrepreneurship. And
in those days these industries were quite quite tiny, but
(02:09):
the companies were making some quite interesting profits and great
return on investing capital. So it's quite a sort of
interesting gem of an idea back in the late nineties.
Speaker 1 (02:18):
Absolutely, So we were talking a little bit before we
started recording, and you mentioned, of course that ESG as
a term hadn't even really been invented yet in nineteen
ninety eight, so maybe you know tell us a little
bit about how the term came to be, and then
you know how you think the space has evolved since
(02:39):
ninety eight or since the term was developed, and ultimately
what you think some of the big successes have been
and where you see continued room for improvement.
Speaker 2 (02:48):
Yeah, that's absolutely right. So back in ninety eight ninety
nine when we were getting going, our second client was
actually a Danish bank, and the Danish bank saw that
in the context of the internet sector, the TMT revolution
that was underway at the time, that what they called
environmental technology was going to be a big opportunity, and
so our very first funds were focused on this idea
(03:11):
of environmental markets or making money from solving environmental problems.
Now ESG as an acronym only came along in two
thousand and four when some clever consultants were preparing for
a UN conference and in the wake of the Enron
and Welcome governance scandals, they thought would be really interesting
to debate whether there was some overlap between governance issues
(03:33):
and the ethical issues that were kicking around at the
time around polluting the planet, and so they put environment, social,
and governance three words together in this acronym, and frankly,
up until two thousand and nine, ESG was a very
low key topic concept, if you like. But after the
financial crisis in two thousand and eight, people were looking
(03:54):
around for some kind of simple way of explaining what
had gone wrong, and our observation was that ESG became
an easy that we had a financial crisis because it
wasn't enough ESG, and frankly, ESG has sort of taken
off from there, but it's quite an unhelpful or slippery
idea because quite deliberately in the eyes of those who
(04:14):
created it, it conflates capitalism on the one hand and
ethics or values on the other, and that's just a
recipe for confusion.
Speaker 1 (04:23):
Very interesting. So, I think, following up on the last
you know part of part of your answer there, I
think one of the debates that has really started to
surface or has has been around for a while now,
which I think is trying to get at, you know,
the difference between ESG and impact investing and how we
(04:45):
can ultimately kind of define these terms and have the
biggest impact if that's ultimately you know, the objective. So
that debate has really centered around this idea of materiality
versus double materiality, and I know Impacts for example, has
advocated for a double materiality approach in regulation and standard setting.
(05:05):
Can you tell us a little bit about your reasoning
for that.
Speaker 2 (05:09):
Sure? Yes, Look, double materiality itself is a piece of
jargon which needs explaining. The starting point with materiality in
this industry, of course, is the financial materiality. What are
the potential impacts on profit and loss account, cash flow
and balance sheet. And the second element in double materiality
is what some people refer to as impact or the
(05:30):
effect of business activity on environmental topics and maybe social topics.
But from our perspective as capitalists who are trying to
steer our clients towards great risk adjusted returns over the
medium to long term, the second element of materiality is
actually a very strong indicator of risk and potential medium
(05:51):
to long term opportunity and does have a nice feedback
into the first element are either financial materiality. So we're
very much looking at the second element of materiality as
an enhancement to the first. Now, it's not to throw
the baby out with the bathwater, because we are also
interested in the impact of our investment work on the
(06:12):
environments and on social issues, but that as an output
an outcome, rather than a particular objective x ante. So
capitalism first and let's see what happens to the environments
and social factors as an outcome.
Speaker 1 (06:25):
Very interesting. Yeah, So we were talking a little bit
earlier about a study that we did evaluating our ESG
scores universe here at Bloomberg, and our scores are based
on financial materiality. One of the things that we were
trying to understand is whether this distinction between double materiality
or single materiality financial materiality versus impact was really as
(06:49):
strong as a lot of you know, people in the
space might lead you to believe. And one of the
things that we did was just looked at greenhouse gas
emissions as an example, and we looked again at our
universe of fifteen thousand companies, and we found for the
industries and companies where we ultimately believed greenhouse gas emissions
management was the most financially material of the e issues.
(07:13):
We saw that there were about twenty two hundred companies
representing more than eighty percent of the index's total emissions.
And this is compared on the other side to about
almost eight thousand companies for which we don't assess greenhouse
gas emissions because we don't believe it to be financially material.
And that group of companies again eight thousand out of
(07:35):
fifteen thousand, so basically half was responsible for only three
percent of total emissions. So in our mind, this was
some interesting research that really suggested that these these concepts
were not as mutually exclusive as people might lead you
to believe, because ultimately, if you're looking to understand the
companies that have financial exposure to greenhouse gas emissions, it's
(07:59):
the same that will ultimately have the biggest impact on
the planet. So just maybe curious to hear your thoughts
on that analysis.
Speaker 2 (08:09):
Yeah, look, I think greenhouse gas emissions is a very
good example in the context of the second element of materiality,
and you need to be careful in doing the analysis
because greenhouse gas emissions may be a proxy for financial
risk if the company is not able to pass on
carbon taxes or some other restrictions on burning fossil fuels
(08:31):
to its customers. But if the company is able to
pass on those costs, if it's got pricing power, then
it's not indicator of financial risk. So this is part
of the skill of being a financial analyst with a
deep expertise in this space, and I think impacts with
eighty investment professionals and analysts in this area's got one
(08:52):
of the deepest benches in this space is really understanding
that that kind of economic analysis as to whether the
environmental social factor is a good for financial risk.
Speaker 1 (09:01):
Or not very very interesting. So in keeping with the
idea of greenhouse gas emissions. Of course, another topic that
has become very discussed in recent years is the idea
of net zero right in particular for financial institutions. And
you've written about the concept and kind of advocated for
(09:23):
this idea of net zero alignment versus net zero financial institutions.
Can you explain what the distinction is there and why
you ultimately think the use of the term alignment is
more appropriate.
Speaker 2 (09:36):
Yes. So, if the problem that we're trying to solve
at a global scale is to reduce greenhouse gas emissions,
and the best way to achieve a global target is
to break that down at the country level, which is
what the CULP process and the UN process is trying
to achieve. If individual countries have net zero targets, that's fine,
(10:00):
but that doesn't it doesn't make sense to then disaggregate
that sort of target to a whole set of corporate targets.
And the reason for that is that the cost of
abatement cost of emissions reduction at one company is not
the same as the cost of abatement or reduction the company.
And a good illustration of that is to contrast, say,
the consulting sector, which has god emissions linked traveling around
(10:22):
which can be replaced by people doing for example, teams
or zoom calls, with the steel industry, where the marginal
cost of switching is enormous. So reducing the emissions in
consulting is much more efficient way of reduction than to
reduce them in steel. So in simple terms, what we
need in the economy of the future is more consulting
(10:43):
and less steel. So in that context, it really doesn't
make sense to aim for portfolio of today's companies that
are all net zero because to achieve that net zero
picture ignoring the problems with net which we can give
back to If you like ignoring those problems, then it's
going to be much more cost effective in some companies
(11:04):
than another's. So what we've introduced at Impacts is a
different idea, which is net zero alignment, which is where
we want to see that companies that we're investing in
have business models that are resilient to the net zero
plans of nation states, which, in simple terms, using more jargon,
is this sort of transition plan alignment. Does the company
(11:25):
in question that we want to invest in have a
robust transition strategy to migrade it's business model to something
which is going to work in an economy where carbon
emissions or greeness gas emission are appropriately priced.
Speaker 1 (11:38):
Absolutely, so, you offered the option to come back to
the term net so I will take you up on that.
Here's to hear your thoughts on the term net zero.
Speaker 2 (11:46):
I guess then yes, Look, I mean this is quite
a well rehearsed issue. But just as there's a problem
with corporate net zero, there's also a problem with companies
who feel that they can carry on emitting or be
fairly limited in their reductions of emissions because they can
buy these indulgences or these offsets in some other part
(12:07):
of the system, be it in the economy or outside
the economy, and they're the problems are well rehearsed around
the robustness of carbon markets. The additionality of such offsetting
if you like standards and the impact on communities, particularly
in less developed countries. So there's a whole host of
(12:29):
problems with that offsetting, and we really should try and
move away from it.
Speaker 1 (12:32):
Absolutely. Yeah, So, in keeping with the theme of climate
and carbon in December, IMPACTS updated its fossil fuel policy
to indicate that it will not invest in companies that
derive any revenues from fossil fuel exploration or production, or
deriving more than five percent of revenues or profits from
(12:53):
fossil fuel refining, processing, storage, transportation, and distribution, as well
as utility power generation. So was wondering if you could
walk us through the evolution of this policy and why
you've ultimately kind of landed on that statement at this point.
Speaker 2 (13:11):
Yes. So in the US, in particular, due to the
legacy position of the packswall management business that we bought
in twenty eighteen, we have until recently been using the
phrase fossil fuel free to label some of our US
mutual funds. But that caused two problems. Firstly, there was
a clarity problem, so some of our clients didn't fully
(13:33):
understand or didn't agree with the definition of fossil fuel free.
That's probably for obvious reasons, so we dropped the word free.
The second problem that we faced was that we were
actually losing some of our potential investments because there were
businesses that maybe had great skills and assets suitable for
(13:54):
the emerging hydrogen economy, but because they had two three
four percent of their rev new coming from supplying parts
of the fossil fuel industry, we had to exclude them
on the basis of a fossil fuel free portfolio. And
so this slight window of eligibility, if you like, up
to five percent of revenue from the fossil fuel sector,
(14:18):
provided that we are therefore getting a much bigger potential
revenue or balance sheet commitment in the transition to the
more sustainable economy. That opens up the ability to invest
in some really interesting companies.
Speaker 1 (14:32):
Absolutely, and certainly sounds like it, as you said, opens
up a lot of interesting opportunities to invest in different companies.
Are there any of your stakeholders who kind of pushed
back against that change in policy and we're advocating a
kind of stricter approach, if you will, not.
Speaker 2 (14:52):
To my knowledge, I think certainly from what I've heard,
everybody was supportive and sympathetic to the dropping of the
phrase fossil fuel free, and I've not heard any pushback
on the second point. What we are doing is being
very transparent about what where the boundary lies. And so
if we have a potential investor who is absolutely adamant
(15:14):
that they didn't want any exposure to the fossil fuel sector,
then either will invite them to go and find a
service provider somewhere else, or they're large enough, we might
be able to create a spoke portfolio that excludes the
one or two stocks that might have gotten in because
of the new policy structure.
Speaker 1 (15:31):
Very interesting, so in shifting to maybe a different environmental
topic or the one that's certainly very related to climate.
In twenty twenty two, you wrote a paper called just
Too Complex addressing biodiversity loss and the role of investors.
So twenty twenty two, this was of course before CUP
(15:51):
fifteen and the big announcement that came out in CUP fifteen.
In my mind, it was, you know, before biodiversity really
became part of the kind of mainstream ESG conversation. So
just curious to hear your thoughts on the activity that
has happened since twenty twenty two, so again cut fifteen.
But the release of the TNFD framework, for example, and
(16:15):
if these events have at all changed your view on
the complexity of the topic.
Speaker 2 (16:21):
So it's very interesting to compare and contrast by diversity
with climate change in the context of the financial sector's response.
So clearly climate change concerns have come first in the sequence,
and because of the commonality of the receptor. Would be
like the fact that a marginal unit of pollution anywhere
in the world has the same amount of marginal damage
(16:43):
to the climate that affects us all, it's relatively straightforward
to agree how to apportion the blame or the burden,
and hence the idea of disclosure of climate risk and
apportioning reduction targets, etc. Can follow a sort of natural
and logical arrangement or process. Biodiversity is not the same
(17:08):
because it's a multilocal problem, with many of the biodiversity
issues being confined to one particular locale, some of them
are multi local and connected, so it's therefore much more
complex to attribute cause and effects and to apportion blame
and the burden sharing, if you like. So in that sense,
it was sensible to do climate first and then to
(17:29):
think about biodiversity. Subsequently, we applaud the TNFD team and
the process that they've gone through to make a start
to put in a very sensible taxonomy, to categorize the
issues and the epics of their pyramid as they describe it,
to to get going to try and put some structure
around how we're going to protect biodiversity. Now when it
(17:53):
comes to assessing risk at the corporate level for biodiversity, again,
it's much more complex than inslimate for for reasons that
are pretty obvious. But what we did in twenty twenty
two was work with Imperial College London to try and
investigate and write up some case studies of companies that
had decided to act to preserve biodiversity in while acting
(18:17):
in their own self interest, but with some measurable benefits
down stream or upstream in the context of protecting nature.
And we didn't actually find one of these, but the
example that we went in with was the idea of
this paper mill that potentially would have an incentive to
invest to protect the water supply upstream from its plant
(18:41):
in order to improve or preserve the water quality going
through the plant, and the upstream investment could be the
preservation of a wetland or the reforestation of a particular
part of the hillside. So we went in with that example.
We actually found six really interesting examples in other areas,
which which can be seen if anyone wants to look
(19:03):
on our website in the report that we made. But
I think the conclusion that we in Imperial came to
was that there were not that many examples of corporates
acting in their self interest to preserve biodiversity, but there
were some quite interesting early early examples which could be
built on, and if they were showcased more effectively, then
(19:24):
other companies might be more creative in looking around to
see what they could do as well.
Speaker 1 (19:28):
Very interesting. So you mentioned the idea of self interest
and difficulty in finding companies that were acting in their
own self interests to protect biodiversity. I think, you know,
that's certainly a component of it. But I guess my
question here is how much of it is, you know,
(19:49):
companies not recognizing their self interests versus not necessarily having
the information necessary to kind of make these decisions around diversity.
Because as we've been discussing things like T ANDFD data
on biodiversity, it's you know, just starting to come to
fruition now. So again also a reason why it's you know,
(20:11):
quite different from climate is in my mind we as
investors researchers don't have the information and I also think
a lot of corporates still don't have that information.
Speaker 2 (20:22):
Yes, I think that's a really good point. And the
associated issue there is the horizon or timescale of the
financial markets. So in the listed equity world, and Impact
Asset Management is a listed company listed on the AIM
market in London, there is significant pressure from the analyst
community to make your next twelve months earnings. And if
(20:46):
you are faced with a choice between spending some money
now and maybe falling short on today's earnings in order
to invest in something that might might enhance value either
by reducing risk or improving returns over the medium term,
then you have a strong incentive to stick to the
next four months. So what that does, in the context
(21:08):
of bidiversity and actually climate change is the same is
skew investment decisions away from that logical medium term value
enhancement in climate change is a very good example around
adaptation to more severe weather, for example, to put in
physical protection against storm surges or increase the strength of
(21:32):
bridges and to stand up against stronger winds. So there,
I think we do have as a society a very
significant problem around creating the incentives for corporates to act
in that medium to long term self interest maybe on
an NPV basis to enhance value, but with the downside
(21:55):
that short term returns are going to get impaired. The
logical response to that, of course is for government to
be regulating. But your question, there is a major problem
around not just the availability of information and data, but
also the accuracy of the environmental models which the data
is then informing. And I think it's well understood, now
(22:17):
well rehearsed that climate weather models are massively inappropriate or
out of date given what's happening around climate.
Speaker 1 (22:26):
Change, absolutely makes sense. So we've been talking a lot about,
you know, climate and other environmental issues, in particular biodiversity impacts.
Products are of course not limited to environmentally related products.
For example, you have a social leader's fund and gender
funds as well. Even though there's difficulty, of course, as
(22:49):
we're just discussing, in measuring performance on environmental issues. For
me and I think for many in the space, environmental
issues have always been easier to measure performance against. There's
typically kind of a north star for performance that we
can all measure against, whether it's you know, the idea
of net zero or net zero aligned, or you know,
(23:13):
more more simply the elimination of a certain waste stream,
for example. So curious to hear your thoughts on whether
there are equivalents on the social side, and if so,
how do you ultimately evaluate progress towards these social issues,
given you know the fact that in my mind, the
social issues often are far more interconnected with policy. If
(23:36):
you think about something like health, you know, corporates can
only do so much, so much of it is dependent
on government policy. And then, of course, the other challenge
with the social side, similar to what we're describing with biodiversity,
is the data is often not as available, and if
it is, it's not as comparable.
Speaker 2 (23:57):
Yeah, So we first start looking at the possibility of
a social product in actively managed equities in twenty twenty two,
and the obvious place to start is where you were suggesting, Eric,
which is to look at markets linked for example, to
financial inclusion or healthcare that were demonstrably improving the quality
(24:17):
of people's lives and improving economic participation. And at first order,
it is possible in certain markets to look at, for example,
a number of people connected to the internet or healthcare
outcomes linked to private sector activity as measures of progress,
measures of market development. But actually we wanted to go
(24:38):
one step further, and it did take us about a
year to refine this. But where we've ended up is
to also look at the quality of a company through
social factors, particularly around staff retention rates and staff engagement schools,
which we've seen through quite significant analysis are good indicators
(24:59):
of the quality of management across the board. So the
Social Leaders Universe and the fund that we're running are
bringing these two factors together. So investing in companies that
are producing great investor returns return on investing capital by
investing in high growth markets with a skew towards healthcare,
(25:19):
financial inclusion, de materialization of infrastructure with a social angle,
for example, but then also wanting to ensure that the
companies that are leading the way and are in our
portfolio have got great management quality as evidenced by these
sort of social metrics.
Speaker 1 (25:37):
Very interesting, and something like retention rates, it's certainly, you know,
a metric that we try to evaluate for certain industries
in our issue spores for example, and the day to
day research that we do. But I would say that
is an example of a data point that is often
missing from public filings for example. So is that something
(25:58):
that you're able to ascertain by engaging with companies specifically,
or where are you, you know, essentially attaining those data
points for that analysis.
Speaker 2 (26:06):
Yeah, you're absolutely right. This is not a mandatory around
corporate reporting, and therefore, unless a company's got top notch
data in this space, it generally isn't going to be
publicizing it. But they generally the data are generally available
if you ask, and so yes, it's through the dialogue
that we get to get the information, and if a
company is completely refusing to comment, then that generally is
(26:28):
a bit of a black mark. So the companies know that.
Speaker 1 (26:32):
Very interesting. Yeah, So I think the final question that
I had, which is maybe a two parter, I think
we would all agree that these days it's hard to
have a conversation about ESG or whatever you ultimately want
to call the space that doesn't address regulation and the
pushback to ESG. So I wanted to hear your views
(26:56):
on how these two forces are ultimately impacting you know,
your business and the space out large.
Speaker 2 (27:02):
Yeah, it's quite interesting looking back over a couple of decades.
But up until twenty sixteen twenty seventeen then the world,
certainly Europe and North America had some quite interesting nonprofit
or private sector providers of labels for funds and green
taxonomies that were providing the consumer with choice and recognizing
(27:24):
that there's no definitive explanation for what this space is.
Green is not black and white, as a praise I
like to use, then it did make sense that, for example,
there was a climate index in Europe that included nuclear power,
but another one that excluded it, so consumers had a choice.
(27:45):
The European Union came along in twenty seventeen and mandated
the creation of a green taxonomy, which was like a
government directed definition for what green was, making it very
sensitive or critically where the boundary was. And as a
result of that sensitivity, it took them quite a long
time to work out the boundary, and out of that
(28:08):
came the SFDR regulations that everybody is familiar with, and
then the UK said, well, we don't want to do
it quite that way, so the UK came up with
its own definition of sustainability and the disclosure regulations that
were published in the four last year. The US is
going down a slightly different route with the SEC's regulations
(28:31):
coming out later in the spring, which are essentially around
transparency and clarity of definition. So going seven years ago
from a space in which there was a bit of
a free market for labels consumers had choice to one
in which governments are kind of competing with each other
to be the absolute definition of the space. I think
(28:56):
we're in a much more bureaucratic place than we were.
There's lots of green red tape, another one of my
common phrases, and that is expensive for companies to comply with.
So what is the way out? Well, I do like
the SEC's approach of really ensuring that there's transparency and
(29:18):
clarity with a minimal amount of imposed framework and structure
as something which is preferable to what the Europeans are doing,
and I'm hopeful that eventually that's where this industry or
the sector will settle down. I suppose my final suggestion
and plea would be could we please move away from ESG.
(29:40):
As I was saying earlier, it's deliberately designed to conflate
two things that don't really fit together capitalism more than
one hand, ethics on the other, and it's caused enormous
amount of confusion since it went mainstream. I don't blame anybody.
The designers had a different purpose in mind. They were
not trying to put in a new framework for sector,
(30:00):
but unfortunately we've picked up on it. So what I'd
like to see over the next three to five years
is that we wean ourselves off ESG completely and we
talk about the transition to a more sustainable economy.
Speaker 1 (30:11):
I'm not sure I agree on the idea of abandoning ESG. Rather,
i'd say the focus should be on doing ESG well
and with transparency. Either way, this is a great segue
into our next episode, which will feature Professor Alex Edmonds
from London Business School, and we'll focus on his belief
that we should move away from ESG in favor of
what he calls rational sustainability. I'd like to thank Ian
(30:35):
sim founder and chief executive of Impacts Asset Management, for
joining us today and for a great conversation. As always,
you can find more information on all things ESG by
going to the ESG team dashboard, bi Space, ESG go
on the Bloomberg terminal. If you have an ESG quandary
or burning question you would like to ask bi's expert analysts,
(30:57):
send us an email at ESG Currents at Bloomberg dot nex.
Thank you very much, and we'll see you next time.
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