Our new FTSE Russell Convenes series brings together experts across finance, academia and government to discuss big trends like sustainable finance, digital assets and the evolution of investing. In this inaugural episode, FTSE Russell CEO Arne Staal explains what it will take for sustainable investing to matter at scale, why transparency is key, and his concerns about greenwashing.
Jamie McDonald: Arne, thank you so much for taking the time to chat with us this afternoon.
Arne Staal: Of course. Thanks for spending the time with me.
Jamie: The main issue I want to chat with you about is really around how the world of finance can affect the world of the environment and climate change. And with the rise of passive investing, are indices now playing the most important role when it comes to affecting ESG and issues in and around climate change?
Arne: There is so much that needs to happen through finance to support sustainability and climate goals in particular. Financial markets have a huge role to play there because this is all about reallocating capital to support a transition to a much lower carbon economy globally, not just for individual countries. And that requires capital flows to go to different projects, to different companies by funding new types of projects – climate technology, for example.
So some of the solutions that we don't even know about yet, they need to get funded, but also to help existing companies transition to lower their footprint, to modernize their processes, to re-engineer their business models entirely. And finance has a huge role to play there, both on the capital market side (raising capital for new projects and raising capital for companies), but also from a secondary market, from an investment perspective. So both from an active and passive stock market perspective, one market perspective there are huge opportunities to help capital flows drive the sustainability objectives, really and passive investing in particular.
It's often thought that you need active engagement with companies from a shareholder perspective to drive change. We actually believe that indices both because they underlie a very large capital flows, especially in equity markets, but increasingly fixed income markets as well. FTSE Russell has, by latest estimates, probably around 18 trillion dollars or so benchmarked against them. So huge capital tracking these indices.
And so indices have a key role to play because of that, just because capital flows are so tied to them, but also because they have a function to play as a as a clearing house for engagement. So if you imagine there's lots of individual active investors that all want to engage with the corporate, but there might be, saying slightly different things to the corporates. And the net result might be that you don't actually get the outcome that the overall economy needs. So through an index, there's a mechanism for collecting all those views and representing them at that scale – that 18 trillion dollar, huge economic scale. So yes, absolutely.
Jamie: So as demand has picked up for the use of indices, how has FTSE Russell tried to adjust their product offering to accommodate this new demand, but also a new demand for ESG?
Arne: So ESG used to be about scoring individual companies, so Tesla – is it high ESG or low ESG? And the question then is: What question are you answering really? Is it a good green company? A good social company?
Jamie: Well let me just ask you then. Do we need to have a better way of measuring ESG before we can start to score these companies on ESG? I mean, you mentioned Tesla, but Facebook and Amazon, like, I'm not an expert. It's like, I wouldn't know of a good ESG. Or are they bad? Because it's not just about carbon footprint, it's about diversity and the way they treat their employees and things.
Arne: The answer to that is transparency. The answer to that is standardization of data and methodologies, so people start speaking a common language. I think of it as a base of truth. Because currently people are saying similar things, but they might mean entirely different things because they're working with different data sets, different definitions, different methodologies. So yes, there will need to be much more standardization.
And our approach is very much what I call open architecture, which is to make the methodologies transparent, make the data transparent, but also allow people to bring in new components and new intellectual property. And that is important in ESG sustainable investing because, for this to matter, it has to matter at scale. And for it to matter at scale, people need to be able to work across the landscape and not just with one provider like FTSE Russell, for example.
Jamie: I mean, it sounds like the retail investor is trying to do their bit and the finance world, particularly FTSE Russell are doing their bit by allowing people a product which can allow them to be more specific about the companies they invest in. But how about at the top level, the political level? I know you've just been involved with COP26. I wonder if you could give some thoughts about what really needs to happen there?
Arne: Well, we're all somewhat skeptical in our own different ways, and sometimes I think, well, you know, it will outlast my time. But as soon as you have children, that perspective changes completely, right?
Jamie: I can concur. I have one myself.
Arne: I worry. I worry about climate change. And I worry that there is a lot of movement in the right direction. There's a lot of commitment and a lot of understanding growing. But if you look at the timescales that we're working on and what the science says – the consensus science, what I take as my guidelines because I don't have my own unique insights on top of the that – then time is running out.
So COP26 is hugely important because it brings together so many different interests at the government level, at a corporate level and NGO level, standard-setting levels. All these interests coming together and that's needed. But what's also needed is urgency. And you see the urgency from the individual contributions and the speeches and the commitments, et cetera. But the overall picture is not yet lining up with a path to a low-carbon economy that lines up with what the science think needs to happen.
So the 1.5 degree scenario that people often speak about from the Paris agreements, that is not achievable yet with the current commitments and the current net zero targets and the what are called the National Development Committees. Those are not lined up yet.
Jamie: So I know that Europe is probably a little bit ahead of the US in terms of having a price for carbon. But do you foresee that America will be, you know, quick to follow in terms of pricing carbon and finding a way of accelerating the corporate change?
Arne: So the pricing carbon question is a hugely interesting one because yes, there are mechanisms in place in different parts of the world to look at carbon prices. But there is not a global market for pricing carbon yet and to really start pricing carbon, we need a market for carbon like we have for global equities, like we have for other liquid instruments. And we're still quite a long way off that, and I think that would be an enormously important development, but we're not there yet.
Jamie: So as we look out over the next three or four years, particularly in the world of active and passive investing and perhaps the rising of interest rates being another trend that we're possibly going to see, how do you see the world of investing sort of play out on that playing field?
Arne: The big trends that I see are ESG and sustainable investing, driving change in investment styles, and that is both important to the passive investment world and the active investment world. I think short-term that means lots of people trying to adapt processes and get new data, but also re-engineer how systems work. For example, if you want to give a good picture of the carbon footprint of a multi-asset global portfolio that requires a lot of data, but also a lot of systems functionality. So that's a near-term requirement that is driving a lot of changes.
On top of that, you have the other big global trends, technology and data, what I call data democratization, really driving a lot of consolidation of capabilities. So even 10 years ago, you could not do what you can today in terms of technology and trading and seamlessness and the low cost of doing a lot of things. That is changing how investing works. The bar in some ways has become lower for being able to provide access to markets. That's a big change.
And then you have the big demographic trends and interest rate trends and questions about inflation. And certainly, if rates start rising at a persistent pace again, that will completely change investing as you know it, as I've known it. There are not a lot of people around that have seen other environments than what we're used to in terms of low rates.
Jamie: And am I right in thinking that at FTSE Russell, you also publish research yourself to try and highlight these issues? Can you perhaps talk about that?
Arne: Yeah, we're very active, especially in climate, because ESG sustainable is a very broad topic and there are a lot of very important dimensions to that. But we touched upon climate and the urgency of that – I see that as one of the main focus areas there, and we publish a lot of research on that.
We've recently published the Net Zero World Atlas, and it basically gives at a country level what the implied temperature rise is, that is implied by the policies and commitments that individual countries have in place. So the net zero targets the nationally determined contributions, the current law that they have in place, how that impacts what we think the impact of a country on climate will be. And that's the type of awareness and the type of transparency that I think investors need, financial markets need, but more broadly, we need as well, because there's so much confusion around this topic that we need clarity, we need insights.
Jamie: So it sounds like the more conferences there are, the more research reports that get pushed out there that just raise awareness, hopefully, that's going to start to trigger and can continue the momentum.
Arne: Yes, very much so. There's one thing that I worry about that might be a brake on the speed at which we move, and that is the risk of greenwashing.
Jamie: What do you mean by greenwashing?
Arne As sustainable investing, ESG, and climate have become so important, there are lots of commercial opportunities that come with that. So being the first to market with a new climate solution, a new climate fund or climate index, a new climate analytics platform, whatever it might be. There’s commercial value in that, and what we need to guard against is that we have things that are being sold under a green label or a sustainable label, or an ESG label that don't quite line up with the impact that people think it might have. That is a risk that I see.
And if I could just take a little bit more time on that, we know that historically ESG investing has been very profitable in equity markets, so ESG investments have done well. And that makes it easy for people to invest in ESG because there are financial incentives line up with their principles and their objectives. But at some point, maybe when rates start rising, maybe ESG investments do not have that outperformance effect anymore. And then there will be a tradeoff between, well, what is my principle and what is my financial incentive; what is my climate target and belief, and what is my financial incentive? So we need to be very clear that those are two different things, and it's great if they match. But we should also be ready that we need to stick by our principles even when it's not necessarily a financial consideration.
Jamie: It's interesting because, you know, I think there are still some very large funds out there that don't have an ESG mandate. And the more that happens, the more you may get this virtuous circle of companies feeling that they need to be much more ESG aware and that will lead to better performance. So hopefully we can get in that groove and it will be self-fulfilling, so to speak.
Arne: Yeah. And this is a bit technical, but forgive me. So we get a lot of people asking us, we run some of the largest benchmark families in the world. So markets that capture the overall investment opportunity in the UK, in the US and China. Different countries, different sectors, etc. And the benchmark families tend to be market cap weighted. So they just represent an overall investment opportunity out there in a liquid and transparent way. Increasingly, we're getting the question why are not all your benchmark indices ESG indices? But then there wouldn’t be market cap weighted indices anymore, because currently the companies that are the greenest are not the biggest and put them in very simple terms. So we'll come full circle when the market cap weighted indices are the ESG indices.
Jamie: That’s interesting. Well, listen Arne, thank you so much for chatting with me this afternoon. It has been really interesting.
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