Integrating IR & ESG IR to Maximize Value: Setting Priorities

 

On May 27, 2020, InspIR Group hosted the first of its InspIR Insights webinar series.  Ivan Peill, InspIR Senior Director and member of the Firm’s ESG Integration team moderated the panel including Edward Vallejo, Vice President of Investor Relations, American Water, $22 billion market cap utility which is S&P’s highest ESG rated company in the US and the second highest globally, Chad Spitler, CEO of Third Economy and former Managing Director of BlackRock who established the firm’s Investment Stewardship and Sustainable Investing Teams and Fabiane Goldstein, an InspIR Founding Partner, Brazil CEO and head of the Firm’s ESG Integration practice.  Monique Skruzny, CEO and Founding Partner of InspIR Group introduced the panel.

 

Monique Skruzny

Hello, I am Monique Skruzny, Founder and CEO of InspIR Group.  Welcome to the first of our Insight series of webinars: Integrating Investor Relations and ESG to Maximize Value: Setting Priorities.

Today’s webinar features two of the world’s foremost experts on this subject. We are honored to have Edward Vallejo, head of investor relations at American Water, which recently received from Standard & Poors; the highest ESG rating in the United States and the second highest rating globally. Ed is also the architect of the company’s ESG program.

We are also privileged to have with us Chad Spitler, the former COO of BlackRock’s Corporate Governance and Responsible Investment Team and founder of Third Economy, which provides sustainable investment research and advisory services to investors and corporations.

Additionally, sharing her expertise on today’s webinar is my partner Fabiane Goldstein, who leads our Brazil and ESG integration practices. InspIR is headquartered in New York with offices in São Paulo and San Francisco and with a presence in Buenos Aires. For information about our investor relations and corporate communications advisory services, I encourage you to visit our website at inspirgroup.com and reach out to us to discuss your IR and ESG communications goals, particularly in this highly volatile environment.

The format of today’s webinar is a fireside chat, moderated by my colleague Ivan Peill who is a member of the firm’s ESG Integration practice. The webinar will last approximately 45 minutes, and will be followed by a question and answer session which we will run for up to 20 minutes. We have already received some questions and ask you to submit your questions in writing on the site. I will be collecting them and asking our panelists to respond during the Q&A session. And, with that, I want to turn the webinar over to Ivan.

 

Ivan Peill

Thank you, Monique. Good day everyone. Ed let’s start with you. You are the Head of the Investor Relations at American Water. You spearheaded the creation of the ESG Program at your company. What motivated you to do this? What is your overall approach to ESG? How is the program structured? And what are its main goals? Sorry, these are lots of questions to begin.

 

Edward Vallejo

That’s ok. Good afternoon, everybody. Let me start by commenting that the ESG effort at American Water was an initiative that started approximately five years ago, by listening to our clients and our stakeholders: what they were asking for. Let me expand on that just a little bit. I would like to share a story. Approximately five years ago, we were in Germany visiting some accounts and one of the portfolio managers brought in their ESG analyst who said, “I did a key word search on your financial statements, on your access card, on your investor deck, and nowhere could I see information on Corporate Social Responsibility, nowhere could I see information on your ESG, how can you tell me that you actually have focus on ESG?” We went home, we thought about it, and we came back with the fact we thought we could do a better job explaining what we do to ESG investors, doing a better job “talking ESG”. So, we started putting all our ESG principles into our financial deck, into our financial reports, and investor deck as well. And, as we started doing that, and started educating employees on ESG, etc., we saw ESG weave itself into how we do things on a daily basis. Let me give you an example. We set out explaining to employees what ESG was; why, for example, if you keep the O&M (Operation and Maintenance) ratio flat it actually helps the consumer, and the “S” side of things, while at the same time it helps us have more CAPEX, and therefore a stronger rate base, and therefore grow earnings. And speaks to the fact that we mean what we say about safety. At American Water, we start every meeting with a safety message. All of us carry on our ID tag for work a stop-work order, which I can flash at any work site at American Water and I can stop the construction if I see that something is not right, without repercussions. I think when you do that, the summation of all that activity, ESG becomes a reality of how you do business daily.

Another important development was that we decided ESG should report to Investor Relations. I always scratch my head when I hear Investor Relations reporting up to Legal or reporting up to Corporate Communications, etc. It doesn’t make sense to me. My manager of ESG is an integral part of the Investor Relations efforts. She is on all our calls with investors, and we weave ESG into the Investor thesis that we communicate.

We are happy we received the attention that we received, but to us it’s a direct result of the significant time, attention and effort we gave ESG – in filling out the questionnaires and completing a Sustainability report in the proper manner. The investors see that, and that’s how you got the results.

 

Ivan Peill

Ed, you just touched upon on the next question we have for you that concerns investment. ESG is a significant investment, in terms of budget and time commitments. How did you convince your CEO and CFO to make the investments? What about the getting buy-in from the American Water board of directors?

 

Edward Vallejo

Well, if you think about it, it’s what I just said: this all started with visiting investor accounts. The CFO and the CEO were there, and when we were back home, we were saying “you know, there could be added demand for our shares if we tap into the ESG investors.” And at the time, I remember, this was happening at a time when American Water was becoming valued more like a typical electric company, typical gas company, and higher than the S&P 500. So, in some investors’ eyes, we were getting a little bit expensive. For a typical utility investor looking for a dividend yield, even though we were growing the dividend at a 10% clip every year, the dividend yield was actually yielding less than the 10% treasury yield because of the strength of the share price. So, we were getting fewer and fewer of those investors. So we said: ok, we need to do this because there is untapped investor demand. For the rest, we went to the board and said, “this is the expected demand that we think we could get by having these expected costs.” We were able to show them that the net effect was a value-added proposition, and once we have that, then you get to go ahead.

 

Ivan Peill

Ed, if I understood you correctly, ESG investors are willing to pay higher multiples and receive lower yields on dividends?

 

Edward Vallejo

No, they actually view things through a different prism.  If you think about it, you could be valued a little bit higher than on a historical basis, but if you really believe in ESG, and   think of ESG as a balance score card, if you have a high ESG score, you are probably not going to encounter the same headaches you would have in the future compared to a company that doesn’t have an ESG score. And which is probably valued a couple of turns on a P/E basis.

 

Ivan Peill

Got it. I am going to ask Chad a question in a just moment but while we are still on the subject of senior management and board of directors: what role does the board play with respect to ESG at American Water?

 

Edward Vallejo

Like any other typical company, the board does oversee the overall strategy and leaves it to management to implement that strategy. For ESG, it’s really the same thing. Funny, right now, we are working through the ESG goals both for 2021,  and for 2021 to 2025, which is the five-year outlook we give to the market on a yearly basis. We use our ESG materiality assessment- and for people who have not done a sustainability report, a materiality assessment is a required first step that is needed under the global reporting initiative in order to do a proper sustainability report.

A materiality assessment is a road map of sorts. When you interview different stakeholders – in our case customers, regulators, employees, the executive leadership team – out of this process you will define the goals that you need to look at; the current goals. On a yearly basis, you will need to see which goals you need to update and consider new goals that you will need to include in order to stay current with the ever-changing ESG change landscape.

 

Ivan Peill

Ok. Let’s go to Chad who comes from the investment world. Chad, how in-depth should a company’s ESG program be?  Fully compliant with GRI, for example? Scopes one through three for GHG emissions? And what about independent audits, which are an additional expense?

 

Chad Spitler

Thanks Ivan and thanks InspIR for having me, and to all the participants for joining us. In terms of the language “ESG compliant”, I would challenge that language. I wouldn’t discuss it as being compliant. What investors are looking for are companies that, to Edward’s point, use ESG as a prism or a view toward corporate strategy. There is no compliance manual. This is about each company coming up with their own understanding of how ESG factors contribute to long-term financial performance, and then communicating that to the market and to investors. There are no right or wrong answers. There are standards, frameworks, but it’s really the company that has the best insight into this. So, one of the things I encourage our corporate clients to do is to develop a level of confidence with regards to how you think about ESG as it relates to your long-term strategy- to this prism that Edward mentioned- and get comfortable communicating that.

Ivan, you mentioned GRI. So GRI is a very popular sustainability reporting framework. It is probably the most comprehensive, and probably one of the most popular. But one of the things that I have come to conclude in building ESG ratings, where I assess the quality of ESG programs at companies for investment purposes, is that sometimes less is more. I would rather have a few really good quality data points that I can rely on and can compare across companies than I necessarily would want every single possible data on it. I really see GRI as a comprehensive set of considerations that companies can evaluate with respect to their own view on which of those line items might drive financial performance.

You didn’t mention SASB, the Sustainability Accounting Standard’s Board. That is a framework that I think is very complementary to GRI, the Global Reporting Initiative (GRI). The reason why I think so many US investors favor SASB is because it takes that financial relevance into account. So it’s not necessarily thinking about each possible factor, but it’s really saying, by sector, what are the top considerations, what ESG factors may have the most financial relevance for an investor, and let’s take a look at those as a starting point. So I think for companies that are thinking about getting started, SASB is a more manageable set of factors to consider, while GRI really gives you that comprehensive view into everything you might want to take into account.

Lastly, you mentioned GHG emissions. I think that varies by sector. So clearly if you are in a highly emitting sector- like oil and gas, transportation, utilities- then having a really good understanding of your carbon footprint is critical, and your investors will expect that you have that understanding. For other sectors, it will depend where you are at, relative to your peers, and how it relates to your company’s risks and opportunities with regard to your corporate strategy. So again, the idea here is that a company needs to take charge, tell your own story, and decide, from an ESG perspective, which of the factors are the most relevant to your business.

 

Ivan Peill

And presumably a good tool for doing that would be materiality analysis that Ed had mentioned earlier.

 

Chad Spitler

That’s right. That’s an excellent starting point. I would say in addition to thinking of materiality analysis you might also want to do a peer benchmarking, to get a sense of where you are at, relative to others in your industry. Another great starting point would be looking at ESG rating reports on your company from some of the providers out there, and how they are assessing your company. Those reports are sold to investors, so if you take a look at how you are being rated by the rating agencies then you can see exactly what the investors will be subscribing to.

 

Ivan Peill

And one more question on the subject: Task Force on Climate-related Financial Disclosure. Any thoughts there?

 

Chad Spitler

That task force really gained prominence in a short period of time. If you think about how long it takes to develop standards and position a framework within the market, TCFD rapidly rose to the top of the investors’ minds. And the reason is, first of all, climate is probably one of the biggest concerns for long-term investors. So, if you are a hedge fund or you are managing on a one- to three-year timeframe, maybe climate change is not top of mind for you. But if you are the large universal owners who are essentially holding the market for perpetuity, more and more so via index funds, then you want to have an understanding, as a fiduciary, as to how climate has potential risk or opportunity with regard to your investment portfolio. TCFD essentially brought together – again Task Force on Climate-related Financial Disclosure – the leading minds as it relates to climate and investment risk and opportunity and came up with a reporting framework that I think is very helpful, especially for companies who are in high-emitting areas or high-risk sectors.

 

Ivan Peill

And, just one final question. Everything you are talking here is quite objective. What about science-based targets and measures like RE100 and their importance to investors?

 

Chad Spitler

RE100 is an interesting one. For those of you that are not familiar with it, it’s essentially a commitment to renewable energy. Renewable energy commitment comes from a couple of different perspectives. One thing to reflect on when you are engaging to investors is: are they engaging around ESG or sustainability for a Values perspective or a Value perspective.

A Value perspective is from a financial value perspective. So, how would a commitment to something like renewable energy lead to cost savings or to lower utility costs, for example. While an investor coming at an investment for a ‘Values’ perspective might be approaching the question more for an environmental consideration, in a sense that maybe the company is an environmental manager and they have investment products that are Clean Tech or are oriented to those types of objectives. So, one of the things to always know about your investors going in is ‘Values’ versus ‘Value’, and make sure that, if you are committing to renewable energy objectives like RE100, you are able to discuss your reasons and basis relative to both of those perspectives.

 

Ivan Peill

We have been digging a little deeper on the subject of setting priorities, so let’s go back to Ed to get his view. Ed, what kinds of external resources and advisors did you use to develop American Water’s ESG program, and that continue to be an integral part of it?

 

Edward Vallejo

Well, to develop the ESG program internally, we did that ourselves. What does that mean? Anytime we started embedding the ESG metrics into all financial documents, we did ourselves. We also then started a learning journey, where we picked the top 30 non-index investors and went to visit them. We requested that they have their ESG analyst join that meeting. And we brought in our own ESG manager and we started to have this dialogue of our new ESG effort.

Now, for the sustainability report itself, we used a consultant, and this is what I would recommend companies here to do as well for many, many reasons. One of them is the cost. A company issues a sustainability report every two years on average and it doesn’t make sense to carry the overhead for all that time. For American Water, it was a sustainability report with 65 pages, complete with graphics, pictures, database, etc. and I almost replicated the cost of the annual report. You also need to have somebody to advise you whether the GRI metrics have changed within the landscape, and an IRO doesn’t have the bandwidth for these things. You need a consultant to help you with it. When you finish the sustainability report, you will then probably have to utilize the same ESG consultant. You will have this nice, shiny sustainability report and need to market it , but you will not get a list of ESG investors from the Corporate Access team of the bulge-bracket firms because they just want you to talk to hedge funds, which are the firms’ trading ticket. So, we used a consultant in that regard as well.

 

Ivan Peill

Interesting. Let me go to my colleague Fabi. Fabi, you have done some perception studies around ESG that help clients set priorities, could you please talk about that?

 

Fabiane Goldstein

Thank you everyone for joining us today. Complementing what Edward and Chad said, what we are seeing, in terms of preparing sustainability reports within companies, as Ed said, it’s very challenging. The main question we get from clients in helping them prepare sustainability reports is what exactly investors want to see in these reports. Although standards like GRI are indeed very comprehensive, thinking of a sustainability report as a tool for all stakeholders, not only investors, and how to include the messages that the IR area wants to do deliver.

For our clients, in addition to the use of materiality metrics, we conduct a perception study specifically of ESG investors, to really understand, in-depth, what they expect from the sustainability report and that information should then be organized in a way that is easier for them to extract that information from the sustainability report. It has proven very effective for our clients as well as investors, who found it very interesting that we reached out to them to identify this more in-depth information in order to help companies prepare. The ESG investors have been consuming the information from the client previously and they knew exactly the areas where the companies needed to improve. So, it was really an effective process for our clients.

 

Ivan Peill

A lot of the role we have been talking about is largely quantitative. Fabi, what are your thoughts and views on the qualitative side of, for example, on the sustainability report that Ed had referenced earlier?

 

Fabiane Goldstein

I think it’s the most challenging aspect, because that is where you really integrate the message into your strategy. In terms of what we see investors expecting from a sustainability report, it’s not only looking into the past but especially looking into the future; looking into the commitment the company is making in terms of achieving its goals, and that would be the qualitative side of the report. The message from management, in terms of their goals in reducing, for example, GHG emissions, is a long-term goal, but they need to be very vocal and very clear on these commitments. What we see as the next challenge for IR is to treat this as guidance. You are giving long-term guidance and you should report on a more frequent basis: how you are getting there, how you are developing, in terms of reaching your goals and commitments. That is how we see all the challenges for the companies that are producing sustainability reports.

 

Ivan Peill

Going back to Ed and Chad, what is considered a reasonable pace of improvement and over what period of time for a commitment that a company makes? Presumably it varies by metric, but it would be interesting to understand what the expectations of the investors are as far as how quickly a company improves over time.

 

Edward Vallejo

I can start. That’s actually a great question, and something that all companies have to navigate. I had mentioned previously that the ESG target really has to come out of the materiality assessment that you start with. They have to be company specific. In our case, when we started looking at the metrics that MSCI or Sustainalytics use for our own corporate ratings, we saw that most of the metrics were geared toward gas and electric companies, not water companies. The only thing we have in common with gas and electric companies is the last name: “utilities,” but there is nothing else in common with these other companies. As a water company, we are not subject to the same regulations, in terms of environmental sustainability, that electrical and gas companies have. So, what we had to do was create a roadmap, a set of goals and metrics that should be applied to a US-based water company. They didn’t exist before, now they do. Further, the ESG metrics for a US- based water company are probably different for a water company in Latin America or one in Europe. This is because we have different things that we need to deal with, not on a macro scale, but on a micro scale we do. Once you finish, once you have the goals you need to measure, then again you have to rely on your consultant based on their market knowledge, and you have to know how far you want to stretch that goal. Do you want to just have a baseline-level goal for your first sustainability report and then add a couple of metrics to your goals to compete at a middle-ranking level in terms of disclosures, or a lead-level that would place your company in the first quartile. Or you might want to be what we call the game-changer level, where you are the absolute leader for that specific goal disclosure. All those decisions dictate what period of time and with what level of specificity you would set your goals. As you can see, there isn’t a clear-cut answer. You have to set which goals you want to achieve, how in-depth you want those goals to be, and then you see what time frame you can give yourself to achieve them. Chad mentioned greenhouse gasses. We actually established a 10-year greenhouse gas-to-revenue goal; not a three-year and not a five-year goal either. The time frame varies by goal.

 

Chad Spitler

I agree with Ed, when we were planning for the webinar, we joked about whether there were any controversial subjects that could surface, but I think the reason why American Water scores so high is because Ed has such a great understanding of the investment community and their expectations.

 

Edward Vallejo

Thank you.

 

Chad Spitler

One of the words that Ed mentioned is “goals”. In my mind, when I think about where a company is on the ESG journey and on the path that it needs to take, it tends to start with the qualitative statements. Policies, written words that describe where you are today and how you are thinking. From there, the words tend to evolve into metrics. So how are you measuring the kinds of things that you’ve mentioned in your policies, and then, when you are really advanced, that’s when you set goals that you are tracking metrics against and you are reporting your progress. It’s this qualitative statement to metrics versus goals that investors are looking for companies to establish over time. There isn’t a one-year timeframe or three-year timeframe, per se, as much as it is that each company explains where they are; where they are relative to each particular factor. If you think about ESG with regards to ‘E’, maybe you are at the qualitative statement phase, within ‘S’, maybe you have goals that you are tracking metrics against. So as long as you understand where you are on that progression and within each of the main content areas for your sector, within the acronym ESG, and that you can talk about how you intend to advance those over time, that’s how you can satisfy your investors that you are progressing forward.

 

Ivan Peill

What’s a good timeline for developing an ESG or sustainability report that will get a company noticed by the investment community?

 

Chad Spitler

Generally speaking, the best practice would be to update a sustainability report on an annual basis. I think if you go longer than two years, you’re probably going to start looking outdated. I would recommend annual updates. And to get your first sustainability report going, I would probably plan a three- to six-month process, depending on the size and complexity of the organization.

 

Edward Vallejo

If I may add to what Chad was saying: I agree. For American Water, we publish a sustainability report every two years and in the interim period, when we don’t publish a sustainability report, we do a soft refresh on some of the goals we have. We update the goals in the intervening year and we do a full sustainability report the year after. That’s how we pace it.

 

Ivan Peill

Thank you. What about compensation, linking ESG to compensation? How common is that? How should a company approach building ESG into incentive-based compensation? A question for both of you, please.

 

Chad Spitler

Sure, I will start and please, Ed, join in. The practice of tying ESG metrics to compensation is two-fold. One is kind of new, maybe a little bit different rather than new. I don’t know if company management necessarily thinks about some of the metrics as being ESG. If you take Ed’s comment about safety at American Water, which falls within the “S”, the social part of ESG, tying safety records to executive bonuses, for example, or some sort of compensation program, is not necessarily so new. However, thinking about safety as ESG has been sort of a new approach. Really the idea here is that compensation aligns with your shareholders’ priorities. If you are saying safety is a priority for your company, but you are not compensating your executives for achieving safety goals, then your compensation program doesn’t support your statement that safety is a priority. The idea is that by aligning ESG with compensation it reinforces that these are the priorities and part of the company’s strategy. What investors are worried about is companies that are saying there are ESG priorities but then not actually implementing into practice. The compensation and the proxy disclosures around compensation really provide insights for investors to understand that if they heard during a meeting with management that safety is one of management’s top priorities but they don’t see management getting compensated for its amazing safety records, how does it work out in terms of practice?

 

Edward Vallejo

At American Water, we don’t have the ESG metrics – either our annual or long-term goals for the company – as part of compensation. But the ESG metrics and goals are company-specific goals that we know will enable us to reach the goals that, as a company, we have included and used to guide the market are tied to employee compensation. One of our ESG goals is to lower American Water’s greenhouse gases per revenue. One way to achieve that goal is to continue to replace water pipes buried under the ground. Across the United States, we lose close to two trillion gallons of treated water that never makes it to customers’ homes. This water gets lost due to a large amount of leakage and thus wastes a large amount of water throughout the United States. Remember what I said: it’s probably different between states; it’s not the same issue in California that it is in New Jersey. It might be the same issue as an old city in Europe versus Latin America, etc. What we do to address this problem is go in and invest approximately the 30% of our close to our two billion dollars of market cap on an annual basis. We invest in replacing pipes that should have lasted only a 100 years and lasted around 200 years, on a nationwide basis. When we do that, we have to convince the regulators that the cost of this capital that we invested was useful. And remember that regulators are one of the stakeholders that you should have interviewed to do an ESG materiality assessment. As a result, the regulator kind of knows where your company is going. If we are successful in getting those costs approved and rate-based, then it becomes part of Earnings, and Earning is part of the guidance that we give the Market and that is itself part of the incentive that we have.

So, you can see how ESG is woven into how we do things and allows us to reach metrics as a company as a whole. That’s what I recommend to other companies: weave ESG into what you currently do and guide the Market with this. You are right, Chad. For example, on the safety matter: at American Water we had to report a near-miss, but that is not counted against us because we think that if we report a near miss and we can actually see what occurred and what made it become a near-miss, then you learn and you end up having a better safety record. That is an ESG goal and it’s not what you want to incentivize people with money on.

 

Fabiane Goldstein

What has been happening the past few months with regard to the pandemic has shown a lot of what Ed and Chad are referencing. We heard from ESG investors that they were, in some sense, surprised positively but on the other side surprised negatively with what they saw some management do in terms of company’s relations with employees during the pandemic. This really demonstrates that investors are watching to see if companies “walk and the talk.” Things can have meaningful consequences, so investors really need to know not only the commitments written in sustainability reports, but what actions management actually took when needed.

 

Ivan Peill

Ed explained that the ESG program flows into a company’s financials. Chad, presumably that is a way to measure ROI for an ESG program at a company or perhaps not?

 

Chad Spitler

I think it’s hard to quantify the return on investment of ESG programs, but many companies are working on doing exactly that. The question is: how do you do this, and do you try to do this across multiple data points or, as I said earlier regarding ‘less is more’, do you try to pick a few that you can try to identify through statistically significant data.

As it relates to ROI broadly for ESG, we are looking at longer-term horizons than you would traditionally look at. That is one of the complicating factors. These factors don’t tend to show themselves as being statistically significant in the short term – it’s only over the mid and long-term that you would start to see that. If you look at ESG indices, for example, compared to their core non-ESG indices, they do start to outperform over time, as investors have hypothesized. A couple of the leaders, in terms of what aspects of ESG tend to have been identified in research as providing a better return on investment are more in the “S” and the “G” categories. There is a lot of good research out there on the value of diverse boards and diverse leadership teams, and diversity throughout companies. We are starting to see that companies that are proactive in developing diverse boards, leaders, and employee populations tend to perform better over longer-term horizons. Hence, that is one reason why diversity is such a hot topic for investors to discuss with companies. It’s not a social objective they have, it’s because research shows that diversity leads to better financial performance. Again, can you talk to your investors about Value versus Values, as it relates to diversity?

The other factor that starting to show in ESG is human capital management, in general. In a post COVID-19 world, as Fabi mentioned, we are starting to see companies that have built resilient business models that have taken care of employees throughout the epidemic. These are the kinds of companies that are retaining investment capital and they are shining the light on how ESG can be part of financial success. And that’s how you really want to position your ESG program. Again, this is a financial question, not to be confused by the acronym starting with “E”. It’s really about how ESG ties to financial strategy.

 

Ivan Peill

Ed started out talking about how companies can get incremental demand get from investors that are ESG oriented in one way or another, and both of you touched upon sustainability indexes. What can you tell us about inclusion in sustainability indexes, beyond the obvious?

 

Chad Spitler

First of all, it’s hard to get into a sustainability index. If your company is in the earlier stages or middle of the pack, you are probably not there yet. To get into the sustainability index, you have to be a leader. That’s the whole idea; that ESG indexes only include the best companies and that’s why they show they outperform. One of the hardest and most challenging questionnaires and surveys out there is the RobecoSAM ESG survey. It used to be that the RobecoSAM survey was the survey needed to get into the Dow Jones Sustainability Index. Companies did not necessarily realize that, and they were spending a lot of time trying to complete the RobecoSAM questionnaire but they were nowhere near being able to get into the Dow Jones Sustainability Index. However, that survey, because it’s so comprehensive, is a great resource for you. If you can answer everything positively in the survey, then you are far along the bell curve and you are a leader. Just make sure you understand when these surveys and questionnaires come in, what’s your return, what do you want to achieve in completing the surveys?

 

Edward Vallejo

Great points, Chad. I totally agree with you. RobecoSAM is a very large questionnaire, and you should get an A+ just to finish it. The first thing I thought about is, you have to realize and be comfortable with the fact that you are not going to be able to complete all the questionnaires that are out there because there are far too many. One of the things you don’t want to do is check a box on a questionnaire, because it’s going to come back and bite you. If you look at our carbon disclosure project questionnaire from three years ago versus last year, you see a huge increase, from D to B+. Why did we have a D? Because we didn’t bother answering some questions. But you can’t answer an N.A., because like any exam you don’t get a partial credit if you don’t answer. Those are the intricacies that you have in each of those questionnaires. What you end up doing, is you identify the questionnaires that you didn’t rank highly on and then you have to determine which are the most beneficial to you. You really have to ask your stakeholders which questionnaires or which indexes they look at and consider. In our experience, we found that not a lot of stakeholders follow the Dow Jones Sustainability Index, per se. We asked the Buyside which indexes they use and which goals they want us to set. Following the merger, now use S&P-SAM, the surveys of others as well, such as the Carbon Disclosure Project. We also do the ISS survey, because the results are included in our annual shareholders meeting. We complete the Bloomberg questionnaire because most investors have a Bloomberg terminal, and we do the Sustainalytics and MSCI surveys.

 

Ivan Peill

Thank you for that. Going back to Chad. This conversation leads us to the ESG rating firms. Which of the ESG ratings firms are the most respected and influential within the investment community? What is your advice for dealing with them? A question I should also ask Ed.

 

Chad Spitler

From a US market perspective, there are three ESG rating firms that should be top of mind for all companies. One is MSCI. My understanding is that they have the largest market share, actually one of the last contracts that I signed at BlackRock before I left the firm was the MSCI ESG contract, and that was because they had the broadest converge and they were able to provide that global perspective that we needed at BlackRock. MSCI is the biggest and the broadest geographically. So, you want to make sure you are communicating effectively that rater. To Ed’s point on ISS, that information also goes into your proxy analysis. So, it’s not just your ESG rating, but it’s linked to ISS’s proxy recommendations. As such, you definitely want to stay on the top of how ISS is rating your company. And the third I would say is Sustainalytics, which is similar model to ISS, in the sense that its ratings go into the Glass-Lewis recommendations. If you have to choose ratings firms, start with MSCI, ISS and Sustainalytics. Those would be the three that I recommend.

In terms of engagement, they each have their processes and approaches, and the experience varies by company. I would encourage you to develop a relationship between your company and the rating agency. See if you can connect directly with the person that writes your report. Develop an understanding as to whether the ratings firm will accept internal information, as Sustainanalytics will do, or if they only use public information. And then familiarize yourself with their ratings updates. What are their schedules and how do you position your information in front of them relative to their timelines? Those are some of the tips that I have on how to manage your relationship with the ratings agencies.

 

Edward Vallejo

If I may add what Chad said. These are great points. For example, on the timeline, you certainly don’t want to publish a bright and shiny sustainability report a month after they just finish analyzing your company and they won’t review your company again for another year. You will have stale data by the time they take a look at you.

You definitely need to have a relationship with the person who is analyzing your company, because, at least at American Water, when we didn’t have that contact it would take us weeks to find out who would be the analyst to talk to who had made some pension assumptions. Eventually, they told us that we had some aggressive pension policies and, if anybody knows American Water, we are not aggressive. We found out that they had used their internal policy. The analyst had to look at the entire database of all the U.S. companies: utilities, non-utilities, Tesla Wal-Mart, etc., all in one bucket. However, that universe is different if you are a monopoly like American Water, because we have a regularity return on investments. As such, we had to explain this to the analyst. But again, having that relationship and making people understand where their analysis is flawed is crucial, if they are analyzing your company through a different prism. We were able to explain this to them.

 

Ivan Peill

Just one more question from my side before we open the webinar for the Q&A session. I want to ask Chad: Bank of America, in a report they published not too long ago, quantified, so to speak, the benefit of ESG performance in terms of cost of capital. And, of course, optimizing the cost of capital is really the end game for investor relations. Bank of America calculates that the cost of debt for good versus bad company, in terms of ESG, can be two percentage points lower. Do you agree with that? And what calculations have you seen that would support a company’s investment in a robust ESG program?

 

Chad Spitler

There is a lot of discussion around the qualification of the benefit of ESG, and cost of capital is one of the ways in which it’s been contemplated. I’ve seen situations where I think that is true, and I’ve seen situations where it’s hard to really tell. The ability to achieve a lower cost of capital is somewhat dependent on the provider of that capital. So, if Bank of America is incorporating ESG factors into their lending program, then you’ve got alignment there, where high-performing ESG companies can achieve a lower cost of capital. But if you are looking at a bank that doesn’t incorporate ESG into their lending program which, by the way, is one of the things that investors in the bank would be assessing in terms of its ESG program, then how would you get a lower cost of capital – you wouldn’t. It really comes down to the provider of the capital and their own ESG assessment of you as potential client or recipient of their loan.

 

Ivan Peill

Ed, Any thoughts on that?

 

Edward Vallejo

I actually agree with everything that Chad said. You saw me nodding all throughout.

 

Ivan Peill

Alright, very good. Before I start the question answer session, I just wanted to bring to everybody’s attention that on InspIR’s website, on the landing page are our blogs which Monique had highlighted earlier,  we have quite a number of blogs on ESG. So, if you’re looking for additional insights beyond today’s webinar, we encourage you to visit our website and read current and past blogs on the subject.

So, our first question comes from the United Kingdom. One of the key issues around ESG data is its accuracy and reliability. What are the implications of companies publishing inaccurate or estimated data to investors and other key stakeholders?

 

Chad Spitler

I’ll go ahead and get started, and then Ed please jump in. Poor data quality is a big issue for investors. It has gotten much better than when I first started. I built BlackRock’s first ESG rating methodology in 2009, a little over 11 years ago. At the time I concluded that less is more, because we incorporated a lot of data elements that we just couldn’t get comparable data on. That’s why you’ve seen firms like BlackRock get so behind reporting frameworks like SASB. The idea is that if we can get more uniform comparable disclosure across companies, then investors have better data with which to conduct analysis. As SASB has grown, as more companies have started to report, the data quality has gotten better. There is concern, or consideration is perhaps a better word, is that you get credit for disclosure versus actual performance. So, what you see happening is that as companies are improving their disclosure, the ratings methodologies or the assessments of ESG performance are also advancing. And as they are advancing, you get less credit for ESG disclosure and investors are focusing more on how you identify the actual implementation of that policy or the performance of the company. You have these two parallel tracks, where companies are getting better at disclosing, getting more comparable, and therefore ESG ratings are becoming more sophisticated and more accurate.

 

Edward Vallejo

I agree with what Chad is saying, about less being more. We are back to the point that we were making that there are too many questionnaires out there and you really need to see which ones you want to fill out with good quality data. Now, for a company like American Water, I shared with you how we use ESG metrics as almost a feeder into our market guidance. Since we actually go in and use those metrics for that market guidance, all these metrics are auditable by our internal audit team and are audited by an external audit team as well. We actually have a really regimented way developing ESG metrics and we have to send all that through our internal disclosure committee as well. We have a database that actually flows into who the subject matter experts are, and we have a SharePoint throughout the company and we can actually see who is feeding into that data and how that data is used. We spend a lot of time doing that. There are also other questionnaires that, because of the volume of information they ask for, are really not conducive to value-add. I’d rather spend time on a questionnaire that looks at American Water through something like an enterprise risk management prism, where they take a look at the water utility space in the United States, they examine what risks are involved, they take a look at the risks that are in our control, and they take a look at the risks that are outside of our control, and then they measure what is in my control and they see if the ESG goals that we have are included in that section, and if they are, then we can start laying out proper data.

 

Ivan Peill

Alright, another question from the audience: What ESG questions have investors asked, where they wanted to speak with the board versus the CEO? And in such cases, which committee or board member was speaking with that investor?

 

Edward Vallejo

Well, I guess I’ll start to answer that question. I really have not, in the last three or four years, have had questions for the board member. Typically, when talking to a board member, it becomes an area of the index investor that wants to talk during a proxy season, that wants to talk about ESG. They do want the board member, in our case the chairman of the board, to be fully conversive with ESG metrics, and that is one way for them to say, “Yes, I can see that the board is engaged because the board is understanding where the investor relations department and the senior management team are going with ESG.”

 

Chad Spitler

To pick up on Ed’s point about index investors, as indexing has grown in terms of market share, you’ve seen a parallel growth in what are now called Investment Stewardship teams. When I was in my former role at BlackRock, we called it the Corporate Governance and Responsible Investment team. They are basically the proxy departments and they are responsible for also engaging companies, because that’s really the tool that they have to protect their clients who are invested in your company. The managers are the intermediaries, their clients are the asset owners, they are the fiduciaries of their assets. When they are engaging and they are asking for a board member, it’s from this fiduciary perspective, that the board member is nominated and elected to represent the clients of the investment manager. If the investment management identifies a compensation concern, they are going to want to talk to the chair of the compensation committee. Because that’s the person that has the ultimate power over what happens with regard to compensation.

If they have a concern around board diversity, or succession planning, they are going to want to speak with the chair of the nominating and governance committee, because that’s the person that was elected and representing their client’s interests on that particular issue. One of the big differences between how investor relations engage with say, a sell side analyst, versus how investor relations engages with a corporate governance or investment stewardship team at a large index manager, is understanding that difference in perspective. With the investment stewardship teams, their tools are really voting and engaging. Different than investors that have the tools of buy/sell recommendations or who are actually executing trades. Again, different types of investments have different ways on how ESG is integrated.

 

Ivan Peill

Next question comes from someone who is both an Investor Relations Officer and a Sustainability Officer. Do you think investors or other stakeholders would view this positively or not, that the two roles are combined? Presumably it varies, but your thoughts, please.

 

Chad Spitler

I think it would be a mixed bag. Some investors will have a preferred structure, others may not. The important thing is explaining why it makes sense for your particular company. There is no real right or wrong answer to this, as much as, in my view, you want to be able to explain. I thought that Ed did a great job at explaining why at American Water they have the structure they have. That is the key. Why does the structure make sense in terms of ESG performance and reporting? If you were outside the company and you were an investor in your company, help your investors understand why combining the two roles is the right structure and approach, based on where you your company is today and what it might look like in the future. Would you have a separate department? Is your company too small? As long as you can provide that rationale.

 

Edward Vallejo

Yes, I agree. Then you would have the confidence of the investor. If you relate to them the journey that got your company to where it is right now, you would get a lot of nodding saying, “I get it. I understand”.

 

Ivan Peill

Next question. We talked earlier about the rating firms and the indexes’ questionnaires. What is the perception of investors regarding questionnaires, like the Dow Jones sustainability index versus the ratings firms like MSCI? Are they largely treated the same? Which one provides more useful information when it comes to investment? Chad, do you have any thoughts on that? It’s a difficult question.

 

Chad Spitler

I am going to avoid giving a recommendation to any particular ratings firm over another. But I do think that investors use them in different ways. Some will use them to help inform voting, others it will be part of portfolio construction, integrated into how buy/sell decisions are made.

I’m actually moderating a panel tomorrow for another webinar, where we have a portfolio manager from Tudor Investment Corporation who is going to talk about how she actually uses the ratings as a proof of concept. She develops her own investment thesis and then uses the ratings as some sort of proof of concept post construction of the portfolio. Her portfolio has a really high ESG rating, but it’s not because she’s using them pre-construction; she’s been able to develop her own approach to that. The thing to take into account about the ratings is they have their own proprietary methodologies, they have their own strengths and weaknesses and they are selling their research to your investors, who are going to use them in different ways. You really need to conduct that research and diligence to get to know who your investors are and what research and ratings they are using, and how they are using it.

 

Fabiane Goldstein

In this sense can we kind of compare them to sell side analysts in terms of their role. I think they would bring their own perspective, right?

 

Edward Vallejo

Yes, you are absolutely right. For example, in our experience at least, we do not get a lot of investors who call and ask, “Why are you not in this index?” It is usually not the typical conversation that we have. But the conversation we do have, and you have to be ready for is, like Chad said, they are selling research to your stakeholders. If researchers have a flag that came last week, whatever it might be, then you need to be aware of this, that there is flag out there, because you are going to be asked about it by investors the following week, and what you don’t want is to be caught flat-footed and say, “Let me get back to you, I was not aware of that issue.” You have the research, they have the research, shame on you if you don’t know something has come up that investors will be asking about.

 

Ivan Peill

A follow-up question from the audience, who says that she is a bit overwhelmed with the number of questionnaires and how they vary in approach and criteria etc. Do you see them ever being harmonized or becoming less burdensome, let’s say?

 

Edward Vallejo

The first thing I’ll say is that I share your pain. I think eventually they may gravitate towards a little closer to each other that what we have today, and we have begun to see a little more harmonization. Two or three years ago, we would have questionnaires where we would get back the scoring and if my CEO was on four boards versus three boards we would lose one point, but if the CEO was on two boards and the chairman of one you would receive a point. It became very intricate. I don’t know if investors thought there was value add to this or not, but you see more and more ESG analysts coming in and taking a looking at our company through a prism of enterprise risk management. A part of why you see Moody’s entering the ESG ratings business as well S&P is they actually have a way to look at a company on a risk basis. I think that may be where the industry is heading right now.

 

Chad Spitler

Yes, I would agree with that. The reason why you have different approaches is that these different providers of the questionnaires or research are really trying to develop their own unique view of your company. To Fabi’s point on thinking about them like sell side analysts, while they are going to harmonize around big themes, as we talked about – diversity is a big theme, climate change is a big theme – but within those big themes, raters are going to differentiate themselves by coming up with unique insights. I wouldn’t expect all of them to become the same, because I think that’s how they compete, by being different. And that’s also what investors are looking for, they are looking for those unique insights. The solution to survey fatigue is to think about the source of the questionnaire or survey, and how relevant are they, and how important are they to your business. And where does that information go. Can you get away with sending them a standard set of Q&As, for example, or can you send your sustainability report in lieu of responding to each individual question. Often times, some of the smaller ones that are less important to your business, maybe that’s an approach to managing those. But if it is one of the big ones – Ed mentioned Moody’s and S&P, where a response is going to impact your company’s credit rating- you might want to spend a little more time customizing your response to those raters.

 

Ivan Peill

Thanks, a related question, and this one is coming from Brazil so I am sure Fabi will have an opinion too. For small companies, how can they add ESG programs that are financially viable for a small company and still be valuable to shareholders. We’re talking about budget here.

 

Fabiane Goldstein

It is always challenging, but going back to how both Ed and Chad have said, it’s all about how you prioritize it and how do you show your management that the cost of implementing ESG capabilities will be beneficial to the company in the medium- and long-term. For smaller companies, it will be a smaller budget and will take longer but definitely if you prove that it is worth it, and from what we have discussed here, we see that it is very important. We understand that a management team that has the long-term view will understand that.

 

Edward Vallejo

I think a sustainability program, if done correctly, is not going to cost you a lot in terms of incremental time and expense. The reason I say that is that is it again gets back to a sustainability report and gets back to materiality assessment, that ESG is particular to what you do – it’s how you integrate ESG on a daily basis. The things you do as a company on a daily basis, and you should be communicating that to investors anyway. You are almost halfway there, so you just have to say that we don’t need to have an army of ESG goals, but the ones you have, integrate these with the guidance that you give to the market and that will be very value-added to ESG investors.

 

Chad Spitler

I agree with both Fabi and Ed. I would add to that, if you had to prioritize, I would suggest starting with the “G” of ESG. The ESG acronym is a little misleading. How we used to describe it at BlackRock was that it’s a big “G” with a little “E” and “S”. And the idea being that the governance aspect of this is really critical and foundational. If you have a board committee with ownership of sustainability and you have sustainability expertise on your board, and you have a board member who can talk with investors about ESG and sustainability, right there you have a great foundation. And to Ed’s point about the materiality assessment, don’t try to be all things to all investors. Really focus on developing your own priorities. Once you have that governance piece in place, of all of the “E” and “S” aspects that you could consider, which have the most financial relevance to your business and then focus on those and communicating those as your priorities.

 

Ivan Peill

Alright, we are coming to the end of the home stretch, just a couple of more questions.

Two-part question from, I believe, Brazil. How will ESG shape our Real Estate investments post COVID-19 and how can alternative investors take into account ESG when they still can’t properly account for traditional risk, in a global portfolio? Tough question.

 

Chad Spitler

For the first one, I wish I knew how it’s going to affect commercial Real Estate. I actually just posted that on so many social media channels the other day. I had read an article about certain companies making all these commitments, including allowing their employees to work from home for the rest of the year and in some cases indefinitely, as a new employee engagement approach. I think there are a lot of questions around what that means for commercial Real Estate. It is going to be interesting to see how that pans out. I have been looking for research on that myself.

As it relates to the second part of the question, in terms of fundamental analysis, I think ESG tends to enter the models as a risk factor in a discounted cash flow model. I think that is where the rubber meets the road, in terms of the technical aspects. But the thing to remember again gets back to different kinds of investors. Really so much of the ESG motivation and market movement is around indexing and ESG as it relates to voting and engagement, less around portfolio construction. Then, when you think about portfolio construction, and how ESG comes into play, it really goes into either fundamental or scientific, are sort of the two different approaches to active management. I just touched upon the fundamental aspect. In terms of scientific, that is where investors are really looking at modelling. For example, one of the products that I really thought was fascinating was BlackRock’s Impact Fund, where they were looking at and trying to identify which companies were leaders in green patents and other kinds of innovations and technology. Can they quantify which companies are deriving more revenue from different kinds of leading technologies, and things like that. So, it takes form in many different ways and again it goes back to – for investors it was always “know your client “and for investor relations it’s “know your investor”.

 

Ivan Peill

Last question, before we wrap things up here, and perhaps a question for Ed. Your opinion on the best way to engage suppliers when it comes to ESG – now we are getting beyond scope one metrics – particularly when it’s a fragmented market, any thoughts on suppliers as it relates to ESG?

 

Edward Vallejo

It’s a great point. We actually have at American Water a diversity in ESG team, that engages with suppliers. You have to realize that for different kinds of suppliers, sometimes we are talking about a firm that has 10 people and they are not going to have a fully compliant ESG program. So, you have to go to what is a common denominator, you actually have to interview the folks, you have to see what their values are, we were talking about that before as well. We actually spend a great amount of time looking at diversity at suppliers, because we actually have to show the regulator which suppliers we are looking into and why, and we need to document all of that. American Water has separate people that are doing this selection process, and they are feeders to our ESG program as well.

 

Ivan Peill

Chad, any thoughts on that, yourself?

 

Chad Spitler

I think Ed is exactly right, to engage suppliers. If I was wearing my investor hat and I was assessing the corporate approach towards this question, I would want to understand first of all what’s the supplier’s policy, what kinds of things are included in that policy, and then explain how that policy is implemented in practice, and what are some of the things that are considered in selecting those suppliers in a way that it’s really about mitigating risks and identifying opportunities. Can you use ESG to find better suppliers that can give you new services at better price points, for example? Those are the kinds of things that these policies are intended to do, is to mitigate risk in the supply chain and find opportunities for cost savings and other benefits.

 

Ivan Peill

Before we turn the webinar over to Monique for some closing remarks, Ed, Chad Fabi, any passing or final comments you’d like to make, a word of advice perhaps at a high level?

 

Chad Spitler

Just remember governance within sustainability. If there is one piece of advice that I would give to every company it is to establish board oversight of your ESG/sustainability program and be able to communicate your own priorities proactively. Don’t wait for the investors to come to you, take the bull by the horns, get proactive and leverage the board to develop that strategy and proactivity.

 

Edward Vallejo

Yes, I would agree with what Chad said. Maintain communications with the board and senior management, as to the ever-changing landscape of what ESG is and how assets under management are changing, etc. And then also share your journey with your investors. It needs to make sense to them: where you were before, where you are now, and where you are heading. If you show them that journey and why you’re doing what you’re doing, that is going to instill confidence in your company and you’re halfway there.

 

Fabiane Goldstein

On our side, I would like to add that, count on us to help you on your ESG journey. We provide all these terrific insights, like those of Chad and Edward, and also from everything that we hear from investors and from the many companies we work with. We can help you a lot on the ESG journey.

 

Ivan Peill

Well thank you to our guest experts and now I’ll turn the call over to Monique for some closing remarks.

 

Monique Skruzny

I just wanted to thank, first of all, our panelists, our guests, and Fabi, Ivan, for a very informative conversation today. As I mentioned, it’s the first of more to come. All of you will be receiving a survey, two to five minutes at most. We really would appreciate your comments and, most importantly, this gives you an opportunity to follow up with any questions or areas of further interest that we can address- either through our blogs within the “Insights” section of our website, or through future seminars. Please do not hesitate to reach out to us, and again I thank very much our guests and were very lucky to have you guys on board. We hope to get you back again, because I’m sure there were a lot of questions, in fact there were a number of questions we couldn’t even get to. Thanks everyone and have a wonderful evening afternoon or morning, depending on where you are on this planet. Goodbye.

 

To learn more about ESG

InspIR Group regularly posts blogs on ESG, among other topical investor relations and capital markets issues. You can read our blogs here: https://inspirgroup.com/en/insights/

 

To learn about InspIR Group’s ESG practice: https://inspirgroup.com/en/esg-integration/

Please call or email us to if you would like to learn how InspIR Group can help on your journey to achieve best practices in ESG reporting and integration.

Ivan Peill, New York – ivan@inspirgroup.com, +1 212.710.9296 

Fabiane Goldstein, São Paulo – fabiane@inspirgroup.com, +55.11.98103.0201