‘Green Is Not Black and White’

Published Mar 6, 2024, 12:45 PM

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.

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, 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 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.

Great to be here, Eric, Thank you.

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.

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 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 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.

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 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.

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 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 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 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 created it, it conflates capitalism on the one hand and ethics or values on the other, and that's just a recipe for confusion.

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 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. Can you tell us a little bit about your reasoning for that.

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 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 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 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.

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 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. 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 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 the same that will ultimately have the biggest impact on the planet. So just maybe curious to hear your thoughts on that analysis.

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 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 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.

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 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.

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, 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 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 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 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 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.

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.

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 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 problems with that offsetting, and we really should try and move away from it.

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 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.

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 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 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, 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.

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.

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 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.

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 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 if these events have at all changed your view on the complexity of the topic.

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 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 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 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 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 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 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 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 other companies might be more creative in looking around to see what they could do as well.

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, 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, 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.

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 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 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 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 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 well rehearsed that climate weather models are massively inappropriate or out of date given what's happening around climate.

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 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, 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 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.

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 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 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 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, 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.

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 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.

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 a bit of a black mark. So the companies know that.

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 on how these two forces are ultimately impacting you know, your business and the space out large.

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 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. 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 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 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 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 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. 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, 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.

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 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, 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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