One of the most interesting findings of the one of my earlier blogs, the growth of ESG investments is playing out in different ways, depending on whether you’re on the buy side or the sell side.

And that’s the topic of the second episode of this season of Financial Futures, as Andrew Ciafardini, FIS’ Chief Sustainability Officer and Head of Global Public Policy, and I look at where ESG came from and where it’s going.

Click the button below to hear more about:

• How the rise of ESG has been influenced by changes in retirement planning
• The dilemmas facing investors as they try to evaluate companies’ ESG credentials
• How ESG is changing the role of both risk managers and fund managers
• The opportunities you can uncover if you embrace the principles of ESG

Start listening now – and let me know how you see ESG evolving capital markets and business as a whole.

Miss the last episode? Check out Never More Than Now: Data, Digitization and the CX.

Be sure to listen to the next episode: Frontrunners of Modernization: BPaaS and the Cloud.

FULL TRANSCRIPT:

ERIN DANGLER: TSR, NAV, ETF. The capital markets almost seem to have a monopoly on abbreviations and while total shareholder return and net asset value are still top of mind for many, there are three more letters that are proving to be just as important, ESG.

TONY WARREN: There are 26, ESG exchange, traded funds and mutual funds. They've got about 250 million in assets, under management. And, 19 of those funds, outperformed the S and P 500. They actually rose between 27 and a half and 55% And in comparison, the S & P was 27%.

ERIN DANGLER: But ESG, isn't just an indicator of a good investment. It's the mark of a sustainable, responsible and conscientious organization.

ANDREW CIAFARDINI: If companies don't address other stakeholders, they're not going to be a sustainable company. If you're a company that is manufacturing everything with single use plastics, if you don't have a plan to reduce single use plastics over time, that's not a sustainable business model for you because the societal expectations

Main Intro and Interview Set-up

ERIN DANGLER: This is financial futures, the podcast that charts, the frontiers of FinTech innovation. In this series, we'll be exploring the opportunities and challenges facing the capital markets and diving into the trends that are reshaping the way institutions operate in this rapidly evolving industry. I'm your host, Erin Dangler. And today, we're dissecting ESG with the help of executive vice president and head of strategy and solutions management at FIS, Tony Warren, and chief sustainability officer and head of global public policy at FIS Andrew Ciafardini.

We'll be exploring what ESG factors are and we'll discuss some of the challenges associated with determining and investments reading.

We'll also ask what is prompting this new focus on ESG among investors and investees, and we'll reveal the benefits for institutions with ESG offerings in their portfolio.

But first the basics. Okay. Here's Andrew to break down what exactly ESG is.

ANDREW CIAFARDINI: We'll start from the basics here, but there is so much going on. And what ESG is really, there's a lot of different ways to think about what it is. And when I think about and take a step back, it's really about how is a company or an organization thinking about the impact they have in society and on societal stakeholders, whether those be clients, employees, regulators, investors, and then society at large. And there's different factors –every company has an impact across the environment, across different social issues, across different governance factors that make you a sustainable company going forward. So, when I really think about what ESG really is…it's: How are you managing those impacts on society and what are you doing to make the most positive outcomes for these societal issues? And that's what really, this is about.

ERIN DANGLER: Great. So can you just break down, the acronym for us? The E the S the G.

ANDREW CIAFARDINI: Sure. The biggest one that you hear about on a regular basis is the environmental, right? And everybody no matter what kind of business you're in having an impact on the environment. And when we think of the climate issues facing the world right now, mostly showing up with extreme weather, but ultimately if our temperature of the earth continues to rise—is the expected negative impacts, whether that be droughts, temperature warming, coastal flooding, the ice caps, the acidification of the ocean, all kinds of things. And every company plays a part in addressing that because every company uses energy. Most of our energy created by fossil fuels really adds to that. And investors, globally are thinking about this and saying, ‘Hey, our shareholders expect us to, address and only invest in companies that are willing to tackle this.’ And then how do we really get and tease that out in our investment strategy, going forward.

“Social” varies widely depending on what kind of industry you're in. But a number of issues that really fall into the social category are: How are you managing your workforce? Are you treating employees fairly? Are you making sure that they're safe in the workplace? Are you contributing to training and education beyond what's mandatory for the job to really talk about societal benefit? Are your employees engaged? What's the kinds of diversity and inclusion levels in your company? Those are big issues. And then some of them link back to what's your purpose as a company. So, for a company like FIS, our purpose really is about empowering the digital economy. And one of the things that we have a societal obligation to do as a company is make sure nobody's left behind as the economy becomes more digital. So, we think about things like financial inclusion.

And then finally in governance. Governance issues vary depending on the type. but for someone like FIS, governance issues could be around data, privacy, data usage, operational resiliency. And so we spend a lot of time thinking about those things, because we know our investors are concerned about how are you addressing those topics?

ERIN DANGLER: Absolutely. And it almost seems a little bit counterintuitive in a financial industry where usually you think of finance was about amassing wealth. And this trend has kind of taken off, where do you think it's rooted in? Is it the movement in the sixties and seventies for more philanthropic and socially conscious investment initiatives? Or was it even before that?

ANDREW CIAFARDINI: The shift is really gone from a broader look at stakeholder capitalism—when you really look at what's going on in the world, right? From the world economic forum saying, yeah shareholders, of course, table stakes, right? Investments don't really work if the financials aren't there, and the company isn't producing for his shareholders. No doubt about it. But, what we're finding is, if companies don't address these other stakeholders in stakeholder capitalism, they're not going to be a sustainable company. If you're a company that is manufacturing everything with single use plastics, if you don't have a plan to reduce single use plastics over time, that's not a sustainable business model for you because the societal expectations. And so, all the stakeholders have to be considered. And when you address the stakeholder needs in addition to the shareholder focus, that's what we're really seeing a shift across the world.

TONY WARREN: And I genuinely think, just to build on what Andrew has said, if you look at a couple of decades ago, many countries, retirement planning was more either handled both by the state, and by companies, who would give a gold-plated, defined benefit, retirement schemes. And that has completely shifted now for this generation. And s most mature economies now is all dependent on, defined contribution, whether it's a 401k plans, or different flavors of that around the world, for superannuation products and hand in hand with that, you've got education and you've got complete transparency of information. And so in a way, as younger people are growing up and they're becoming now the new middle class, they're the ones who will be driving a lot of the investments, it's hardly surprising really that they're saying, “okay, I can actually make a difference where my savings are going.”

ERIN DANGLER: I just find it such a fascinating concept. And for an industry that's so numbers oriented, how do firms measure ESG factors?

ANDREW CIAFARDINI: I think, we've seen this emergence of ESG as a core factor to the investment thesis going forward. I think the world is really trying to figure out how we do measure this appropriately. Because it will take time to evolve to what are the right standards? What are the right measurements going forward? And globally, we're really seeing that play out right now, investors are asking, how do I make the right comparisons going forward? And so there are a variety of ways that they're currently measuring things. One is, there's obviously a whole ESG rating agency industry out there. And there are a number of firms that are doing specific ratings of a company on their E S and G factors. Some weight climate and environmental issues, more important, some weight, social issues, more important. So even when you look at the scores between different agencies, it's not quite clear, which one is the best match up for you. But a lot of, the investment base does rely on some of those ratings out there. But again, how is this going to evolve and how do you get a really composite view of that going forward so that you can make a best judgment as a firm.

Secondly, some firms are building in-house. Their own analysts that either sit alongside their portfolio managers or, under a portfolio manager to look at their specific investment portfolio. And I spent a lot of time speaking to investors about these issues and trying to understand what they're trying to tease out and what's important to them versus another investment firm. And then, you have things like the Global sustainability reports that companies like ours put out, and, we try to align to metric frameworks, reporting the information. But I will say here is what you also see out there as there's industry specific ratings, every industry has the issues that are most material to them. And so that also presents another challenge, right? Because how do you compare a software and services company that has one set of material issues versus another that may have a different set of material issues. And how do you harmonize? So lots of interesting opportunities, for products and services to evolve, to meet these needs going forward.

ERIN DANGLER: It sounds like we're, laying down the track while the train is coming, like it's happening all very organically and in the moment.

TONY WARREN: We're good engineers though. We're fast!

ERIN DANGLER: Of course, but that's, how change happens really is, something is needed and you start chugging along. So Tony, tell us about these ESG scores. Could you give us an example of a good ESG score? And is that enough to allow investors and institutions to make financial decisions?

TONY WARREN: I think therein is the, is part of the problem that we have today. we are in catch-up mode, to be fair, on the data and let’s call it, the usability of the data in the capital markets industry. So, the Index Industry Association had a survey in 2021 and they spoke to asset managers. And they actually got back that they're continued really to be plagued by a lack of standardized data. And indeed 60% of asset managers consider the lack of data, the challenge to implementing very sound ESG investing principles. Again, another 60% said that the lack of agreed upon ratings among the data providers posed a challenge to them. And, again, another 60%, so all over half of those surveyed, that the companies themselves, that they're investing in, are not still transparent enough about their ESG activities. And I think it's a nut that is going to be relatively easy to start to crack with the advent of more openness to data, more, tools that we can synthesize data, scrub data, and then present it. Alongside the security or the debt instruments that are representing a company, that you can then start to rate portfolios. So, I don't think it's far away. And I think over the next year or so, we're actually going to start to see more and more product, which should start to meet the demand, which is just rising at such a pace for ESG style investing.

ERIN DANGLER: Even with the challenges presented by disparate scoring systems, non-standardized data, and a lack of transparency among some organizations, there's still a very clear demand from investors and institutions for investments with favorable ESG scores. And perhaps the reason for this lies in the resilience and profitability of ESG investments, especially during the pandemic.

TONY WARREN: So, according to S&P, between March the fifth, so the day and the month that the world health organization officially declared the COVID-19 pandemic, to March the fifth of 2021. So there are 26, ESG exchange traded funds or ETFs and mutual funds. They've got about 250 million in assets, under management. And, 19 of those funds outperformed the S & P 500. They actually rose between 27 and a half and 55% And in comparison, the S & P was 27%. And now hand in hand with that, other surveys, I've got tons of surveys for you. So there was a report that INVESCO did and it showed that 90% of respondents aged under 45—so to my earlier point—they now state it matters where their money is invested. And they want to see the money invested responsibly. And, in addition to that, three quarters of the older generation, so a little lower than 90% but I think it is a holistic phenomenon. And that also showed the 52% of those respondents who currently did not invest sustain sustainably, expect to be switching their investment strategy within the next 12 months. So, look at, it's really clear that the pendulum is swinging. and the industry and the platforms have to absolutely react to support this. And quite frankly, we need to support this, for our customers. And to put it into some more facts and figures for you. So by 2025 ESG assets they're on course to exceed 50 trillion. So that's more than a third of the projected, 140 trillion of total global assets under management in the world. So, this, isn't some pet project on the side anymore. This is absolutely mainstream and it's going to continue to balloon and grow.

ANDREW CIAFARDINI: Another hot of the press statistic I saw recently right in line with your trend of by 2025—and I actually think we'll get there maybe even earlier—43 trillion in assets today by nearly, almost half the asset management sector globally by institutional funds are already pledged to a net zero target right on the environmental side. So the expectation now for ESG performance is significant.

ERIN DANGLER: so it's here and it's growing and it's not going away. These investors really want the ESG label. So let's talk about that, they want to invest in companies that are governing with ESG principles. Do they want the label or do they want to know that they're actually meeting these ESG values?

TONY WARREN: I think it's both, but I think what we're going to see is investors are going to want proof that their investees are meeting ESG values. But I'll go back to that first point, the industry has got to crack that data issue to allow this to really then flow through. But there's a growing trend now for ESG data providers, to start to adopt a ESG reporting standards by external organizations, such as the sustainability accounting standards board, and the task force on climate related financial disclosures. But at the moment, they can't set a mandatory rules on data verification. So I think, you know that there is still a gap, but clearly if you think about this. And I'll just give you another couple of factoids, but millennials as a whole, they're gonna inherit some 68 trillion from us, the baby boomer parents by 2030. And these guys, they are making these deliberate choices in their investments around climate change around social justice. And they have a lot of a higher interest in investing that's aligned to their values and the future. And you see some of the younger, lobbyists today, on the news all the time. So it really sort of verifies that. But the point I want to make is when you're seeing such a fundamental shift the industry is going to have to show more transparency with the data to prove, that the investees are meeting ESG values. This is going to swiftly turn into a regulatory issue for the industry that you have to be validating and verifying the data in order then to be able to sell trade the, the collective product back to the investor.

ANDREW CIAFARDINI: Yeah. And I think we're going to see to Tony's point in, to your earlier question about how does this get validated? One is Tony's talking to us about the tools and technologies and those that you're working with to develop the products and services to do that assurance. But there is now going to be that compliance oversight from the government going forward. And we already know that the Securities and Exchange Commission, by this fall in the United States, is going to set out a number of, either principles or very prescriptive, rules and regulations around how some of this data is reported. And in particular, around the environmental side and the climate side and, potentially even around the diversity inclusion side. They've already had some voluntary disclosures over the last couple of years around human capital management and how you should be reporting some of those things, but you're going to see more of that, in line. So it won't be just become a voluntary thing anymore, they will now be required to be disclosed in a certain way, that is a regulated way. And that you have to make sure that you have that assurance. In many companies is, as Tony said, are also looking at—just like you get your financial results audited and validated by an independent auditor. I think that will be the trend as we've already seen by, third-party auditors to be monitoring the company's data as well.

ERIN DANGLER: So how are firms communicating this with their clients about their ESG investments?

TONY WARREN: I think in order to transform this into holistic ESG scores because it is going to complicate the investment process somewhat. So, I would say what we're already seeing is a mixture of human analysts, but leveraging new technologies—so artificial intelligence, machine learning, data science tools. And indeed, that's what we're doing here at FIS you know that's our plan in order to enrich the data. But this software via our APIs can then be used to analyze a firm's data set. And then we would use internal algorithms that can test and validate the various investment decisions and look at predictive insights into it.

ERIN DANGLER: Andrew, anything to add?

ANDREW CIAFARDINI: No, I would agree exactly with what Tony said. I mean, it is, especially when we think about our investment firm and capital markets clients, is how do you do this at scale? Because looking at a whole portfolio of investments, as we go forward and obviously most of the Fortune 500 companies have adopted some level of ESG reporting and sustainability reporting and across certain frameworks, but there's a much wider universe of investment than just the Fortune 500 companies. So, it really is about how are you defining those data elements? How are you making them visible in a way that then can be captured and consolidated and synthesized in a new way to provide those insights on a company? Just like financial data. And there may be a bit of a hybrid approach, but certainly we really need to be able to scale, with technology to be able to do this well long-term.

ERIN DANGLER: And as we can see, this is all good stuff. I mean, just to boil it down to very basic language. And yet it seems like it may be extra work to get it going, but the return on the investment will be very valuable to firms in the future. But it's affecting how firms are working. Can you talk a little bit Tony, about how this is changing the role of financial industries of risk managers of fund managers and working in this way.

TONY WARREN: Absolutely. So I think, firstly risk managers and fund managers, they need to educate confidentially their clients to ensure they understand, what they're investing in. And I think, if you look at the market today, perhaps it's more at the macro level, from what I can see the rebalancing into more ESG-style portfolio tends to happen on the wealth platforms. But I think that's going to start to shift into asset management itself. So, everything we've just spoken about the data and the ratings actually dropping that down to the individual security level so you can get full transparency into everyday funds, whether the 48 funds or UCITS etcetera, the process today. So I could almost foresee a rating that gets published within an AV so you can see that the fund is indeed sustainable. And then the investors are then freer to make that choice as are the wealth providers, but without it being a more, sort of, pure green fund, let's say. But, there was another, he had another survey, Invesco did one, and it showed that around 42% of advisors were pointing to a lack of knowledge being the biggest barrier, when allocating to sustainable strategies. And indeed hand-in-hand with that, feel that the terminology can be confusing a little too much jargon, and that there's not enough accessible literature today to be able to give more guidance. So I think education is still probably ongoing to help with the right language when talking to clients.

ERIN DANGLER: So in talking about buy and sell side firms, other than the positive impact on environment and society, can you tell them what other benefits they'll get from ESG offerings in their portfolio?

TONY WARREN: So on the sell side, certainly our experience to date, the focus is much more on climate risk and transitioning to renewable energies. Banks are focused on helping customers measure and optimize that their counterparts exposure by those advanced risks, solutions and services. From the buy side, as I think we've made quite plain here, it's more about investor sentiment is shifting at such a dramatic rate. So asset managers need to quickly act to support ESG requirements so their portfolio, as I alluded to before, will need to be broken down and scored accordingly. And in order to do that, they'll have to normalize the data with it.

Capital markets firms, I think will continue to publicize their commitment to providing ESG focused products. And there'll be a divergence between public facing trends and internal priorities of course. But, uh, we actually did our own survey and surprisingly few had this as a high priority. but I still think it's going to continue to grow at quite a surprising rate.

ERIN DANGLER: The challenges surrounding ESG ratings and the data that dictate them. Aren't just an issue of technology and standardization. They're also an issue of education. And institutions, risk managers, and fund managers need to evolve and equip themselves with the right tools and knowledge in order to navigate the various rating agencies in terminology.

So they can make the best decisions and give their clients the best advice.

And if they can do that, the benefits they'll reap will go well beyond positive environmental and societal impacts.

ANDREW CIAFARDINI: Tony earlier, talked about the outperformance of companies focused on ESG. And we tend to sometimes just focus on the risk, right? The risk to that transition to a low carbon economy. The risk of single use plastics, or other risks for energy companies that haven't made a shift to more renewable energy sources and part of their portfolio. But really I think the companies that are doing right, and that investors can also be looking for is when you think through this new ESG mindset, what are the opportunities that it creates? And that's something that I'm, even internally at FIS going, okay the de-carbonization risks. We know, these are things that we have to do to reduce societal impact. But what can we do as a company to seize the opportunities brought by these issues? And nine times out of 10, as a company starts to look at the societal expectations they find, wait a minute, here's a huge opportunity to go serve a market or develop a product that hasn't existed before. And that is the real upside opportunity, to look forward to and what our investors and capital markets can be thinking about.

ERIN DANGLER: Yeah, that was one of the things that I thought was so interesting when I was researching is that the financial industry is a risk averse industry and actually companies that are governing themselves with these ESG principles are reducing risk and it makes a better investment overall.

ANDREW CIAFARDINI: Certainly, and as I mentioned every company should be looking at it from a risk perspective first and, just like we were talking about and like single use plastics, right? If you're developing products or services or products in single use plastics, you really need to figure out how to transition to something that's more sustainable long-term. Same thing when you think about, how do you do your business model? You know the shift to renewable energy, for instance, I was just on with an energy outside counsel yesterday talking about energy projects and solar energy and, I said, typically what's a solar project on the roof of our large retailer produce? And, they said it could be upwards of 50% of the daily use of energy. Just think about that, you're not only eliminating your carbon transition risk, but now you're cutting your costs as a company going forward right now by self-generation, of that energy usage. And I think there's multiple examples like that. You know, when we think about data privacy issues, those are ones that all of tech is struggling with. How do you handle data privacy? But the groups that have really figured it out and come out and said, this is how we have the right balance around it. They've reduced their risk, but also become a more trusted partner in terms of that consumer facing benefit going forward. So I think there's dozens, if not hundreds or thousands of examples of that risk reduction plus that project and product and service opportunity.

ERIN DANGLER: Improving your brand image and companies again, that, that governed with these principles, did better during COVID the research shows.

TONY WARREN: Absolutely Erin. Look, there's a government side to it as well. I mean, as you can hear from the accent, I'm from the other side of the Atlantic and our government they're serious about this stuff. It's being accelerated rather than pushed out. I think it's changed from the top down. And I think people are sitting up in the taking note and, and it is changing behavior, without a shadow of a doubt from both the individual and corporation. But the good news here, you know, I represent the technology build for the financial services industry, which is driving the money, let's say in the investment through, and Andrew's at the other end, like driving what companies should be doing. and I think, if I look at our investments from a strategic point of view, where we're combining these clear macro trends, for what we need to be doing with then the latest and greatest technology. And that's why I think the picture is going to complete, over the next couple of years at quite a rapid pace. And the reason is, this is going to produce, and it has been produced so much more data and overhead. So firms are having to reconcile the quantitative data such as the ESG scores and the qualitative data, so the human analysts together. But what we're going to do now is we're going to use the new tools. So we're evolving our infrastructures. We're opening up the APIs. We're letting the data flow into these new data lakes and mega databases let's say, where we can then augment with the additional ESG data, but it's the artificial intelligence, which I think is now going to pivot everything because using AI tools, we can assist that static data score so we can synthesize it. We can structure it and take away that kind of overwhelming element that's there today. nd I think it will also start to address some of the gray areas and the numerous frameworks and lack of disclosures as well. And check against specifics as well. So have you heard of greenwashing?

ANDREW CIAFARDINI: Absolutely.

TONY WARREN: So technology that's smart enough to sniff out greenwashing, where they're claiming that they are more responsible than they really are.

And having data in conjunction with the analysts. And then all of this at the end of the day will feed into the algorithms that will do the rebalancing for the ETFs the different styles of funds. So super exciting. And I'm delighted we've got people like Andrew who were giving us that guiding light and principle of the subject. And now we're putting that into action across our platforms.

ANDREW CIAFARDINI: When I think you hit it right on the head with greenwashing Tony, in the sense of, there's, a lot of companies can put out a flashy press release about this little thing or that little thing that they're doing, and that's great. But sometimes the underlying data, the underlying disclosures don’t really support that messaging or those sort of claims at the high level. And that's, to your point, essentially what that greenwashing is all about, look over here and not over here at the real thesis and the data going forward. And teasing that out and really making sure that, investors can do that going forward is of critical importance.

ERIN DANGLER: So as we're gaining momentum with this, what do institutions need to do to make sure their infrastructures are ready to handle this data?

TONY WARREN: this industry has typically been made up of different departments moving from front middle back office and, the siloed by functionality historically. Now what we've been working very hard. is really opening that up. So we're breaking down those siloed departments and we're breaking down the fragmented systems so we can create frictionless data flows through open APIs and then exposing that data. It will now allow us to incorporate the scrubbed and the synthesized ESG data, to then create all of the different outcomes we need. Whether it's risk assessment, for let's say climate change or whether it's, doing the ESG ratings and driving them through the granular level of the portfolio. So, as I said at the start, I think this is one of the most exciting things for us as a supplier, because this is an opportunity for us to both shape the industry and truly make a difference in the process. By providing the right platforms flip for the transition to occur on.

ANDREW CIAFARDINI: And I think what we're seeing too is, all of this is moving in parallel, right? When you think about what the companies are reporting, what the data flows could be, what we needed to do to enable sustainable finance, and more broadly, quite frankly, sustainable commerce. Right? When you think about the breadth and depth of what FIS does. And there's not a week that goes by that I haven't seen another data feed or how we're going to report this data. I do think what's going to be really exciting is, within this next, several months, at least for U.S. investors, there might be a real stake in the ground, which I think then will be a foundation for which at least U.S. reporting may build off of. And that will start to at least get a little bit more focus on what, our investors need, what capital markets companies need to be considering going forward in the disclosure regime. So I think there's some really exciting foundations being laid that are going to be really solid for the future. Everything's globally is not going to be harmonized anytime soon or maybe ever, I mean, even under our listed companies, regimes and different things in different parts of the world. There's no, harmonization and those kinds of things nor should we expect that to be.

ERIN DANGLER: As we wrap up the program. I'm heartened to hear this, just to think I grew up a child of the eighties, I'm a gen X or where, he who dies with the most toys wins. So it's nice to think about investing in a way that's, maybe not just helping me financially, but really is, if I can sound so cheesy, making the world a better place. So if you have any parting words, please share.

ANDREW CIAFARDINI: No. I just think, as Tony mentioned, we've got this sort of yang yang partnership, within the company and, what's most fun about it. And if you look at our sustainability, we talk about advancing the ways the world pays, banks and invest, but you also see in that sustainability report about how we're working on advancing sustainability. And that's both with our products and services, as Tony is leading up as well as becoming a sustainable company ourselves.

TONY WARREN: Exactly. I couldn't put it better. So I'll, I'll leave it at that.

ERIN DANGLER: Tony Warren is executive vice president and head of strategy and solutions management at FIS and Andrew Ciafardini is chief sustainability officer and head of global public policy at FIS. That's it for today's show. Thanks for joining us. We'll see you next time when we'll be exploring BPAS and cloud technology.

As we discuss the avenues to growth in the capital markets.