FTSE Russell Convenes | Episode 1, Season 1

FTSE Russell CEO on climate and sustainable investing: 'Time is running out'

December 7, 2021

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.

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FTSE Russell is an index provider and research houseunder the LSEG umbrella.They specialize in convening the best ideas on evolvingmarket trends and helping to developstrategies for global investors.In this series, we look at the evolutionof the biggest of today's trends.Over recent years, passive investing and the riseof indices have become increasinglyinfluential in allocating capital towards climate changeinitiatives.I spoke with FTSE Russell CEO, Arne Stahl, about the rolethat indices now play in affectingthat change.Arne, thank you so much for takingthe time to chat with us this afternoon.Of course, thanks for spending the time with me.The main issue I want to chat with you about is reallyaround how the world of finance can affect the worldof the environment and climate change.And with the rise of passive investing,our indices now playing the most important role when it comesto affecting ESG and issues in and around climate change.There is so much that needs to happen through financeto support sustainability and climate goals in particular.So financial markets have a huge role to play therebecause this is all about reallocating capitalto supporting a transition to a much lower carbon economyglobaly, not justfor individual countries.And that requires capital flows to go to different projects,to different companies, by funding new typesof 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,so to lower their footprint, to modernize their processes,to re-engineer their business models entirely.Finance has a huge role to play.They are both on the capital market side,so raising capital for new projects and raisingcapital for companies, but alsofrom a secondary market, from an investment perspective.So, both from anactive and passive stock market perspective, bond marketperspective, there are huge opportunitiesto help capital flows drive the sustainabilityobjectives really.And passive investing in particular, it's oftenthought that you need active engagementwith companies from a shareholder perspectiveto drive change.We actually believe that indices, bothbecause they underlie very large capital flows,especially in equity markets, but increasingly in fixed incomemarkets as well.Footsie Russell has, by our latest estimates,probably around $18 trillion or so benchmarked against it.Today, I'm going to talk a little bitabout how to engage with a corporate.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 asa clearinghouse for engagement.If you imagine, there's lots of individual active investorsthat all want to engage with a corporate,but they might be saying slightly different thingsto the corporate.The net result might be that you don't actually get the outcomethat the overall economy needs.Through an index, there's a mechanism for collecting allthose views and representing them at scale,at that $18 trillion, at that huge economic scale.Yes, absolutely.As demand has picked up for the use of indices,how have FTSE Russell tried to adjust their product offeringto try and accommodate this new demand,but also a new demand for ESG?So ESG used to be about scoring individual companies.I'm going to ask you a question, Tesla, are you high ESGor are you low ESG?And the question then is, what question are you answeringreally?Is it a good green company, is it a good social company?Well let me just ask you there then, I mean,do we need to have a better way of measuring ESG before wecan start to score these companies on an ESG?I mean, you mentioned Tesla, but like Facebook and Amazon,like I'm not an expert, I wouldn't know,are they good ESG or are they bad?Because it's not just about carbon footprint,it's about diversity and the way they treat their employeesand things.The answer to that is transparency.The answer to that is standardization of dataand methodologies.So people start speaking a common language,they have a common, I think of it as a baseof truth, right, because currently peopleare saying similar things but they might mean entirelydifferent things because they're working with different datasets, different definitions, different methodologies.So, yes, there will need to be much more standardizationand our approach is very much what Icall open architecture, which is to makethe methodologies transparent, make the data transparent,but also allow people to bring in new components,new intellectual property.And that is important in ESG and sustainable investingbecause for this to matter, it has to matter at skilland for it to matter at skill, people need to be able to workacross the landscape and not just with one providerlike FTSE Russell, for example.I mean, it sounds like the retail investor are tryingto do their bit and the finance world,particularly FTSE Russell, are doing their bit by allowingpeople a product which can allow them to be more specific aboutthe companies they invest in.But how about at the top level, the political level?I know you've just been involved with COP26, so I wonder if youcould give some thoughts about what really needsto happen there.We're all somewhat skeptical in our own differentways and sometimes I think, well, it will last my time,but as soon as you have children, that perspectivechanges completely, right?I can cook her.I have one myself.So I worry.Yes.Yes, you do.I worry.I worry about climate change.I worry that there is a lot of movement in the rightdirection.There is a lot of commitment and a lot of understandinggrowing.But if you look at the time skills that we're workingon and what the science says, so the consensus science,what I take as my guidelines, because I don't havemy own unique insights on top of that,then time is running out.So COP26 is hugely important because it bringstogether so many different interestsat a government level, at a corporate level, NGO level,standard setting levels, all these interestscoming together and that's needed.But what's also needed is urgency.And you see the urgency from the individualcontributions and the speeches and the commitments, etc.But the overall picture is not yet lining up with a pathto a low carbon economy that lines up with whatthe science think needs to happen.So the 1.5 degree scenario that peopleoften speak about from the Paris agreements,that is not achievable yet with the current commitmentsand the current net zero targets and what are calledthe national development competencies.Those are not lined up yet.So I know that Europe is probably a little bitahead of the U.S.in terms of having a price for carbon but do youforesee that America will be, you know,quick to follow in terms of pricing carbon and findinga way of, you know, accelerating the corporate change?So the pricing carbon question is a hugely interesting onebecause, yes, there are mechanisms in placein 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 marketfor carbon like we have for global equities,like we have for other liquids instruments,and we're still quite a long way off that and I think thatwould be an enormously important development,but we're not there yet.So as we look out over the next three or fouryears, particularly in the worldof active and passive investing and perhaps the risingof interest rates being another trend that we're possibly goingto see, how do you see the world of investing sort of playout on that playing field?The big trends that I see are ESGand sustainable investing driving change in investmentstyles.And that is both important to the passiveinvestment world and the active investment world.I think short-term that means lots of people trying to adaptprocesses and get new data but also re-engineer how systemswork for example.If you want to give a good picture of the carbon footprintof a multi-asset global portfolio that requires a lotof data but also a lot of systems functionality.So that's a near-term requirementthat is driving a lot of changes.On top of that you have the other big globaltrends, technology and data, what I call datademocratization, really driving a lotof consolidation of capabilities.So even ten years ago you could not do what you can todayin terms of technology and trading and seamlessnessand the low cost of doing a lot of things.So that is changing how investing works.The bar in some ways has become lower for being able to provideaccess to markets.That's a big change.And then you have the big demographic trends and interestrate trends and questions about inflationand certainly if rates start risingat a persistent pace again, that will completely changeinvesting as you know it, as I've known it.There's not a lot of people around that have seenother environments than what we're used to in termsof low rates.And am I right in thinking that, at FTSE Russell,you also publish research yourself to try and highlightthese issues.Can you perhaps talk about that?Yeah we're very active, especially in climate again,because ESG sustainable is a very broad topic and lotsof very important dimensions to that,but we touched upon climate and the urgency of that.So that's one of the main focus areas there and we publisheda lot of research on that.We've recently published what we call the net zero world atlasand it basically gives at a countrylevel what the implied temperaturerises that is implied by the policiesand the commitments that individual countrieshave in place.So the net zero targets, the nationally determinedcontributions, the current law that they have in place,how that impacts what we think the impact of a countryon climate will be.And that's the type of awareness and the type of transparencythat I think investors need, financial markets need,but more broadly we need as well because there's somuch confusion around this topic that we need clarity and weneed insights.So it sounds like the more conferences there are,the more research reports that get pushed out there thatjust raise awareness, hopefully that's going to startto trigger and continue the momentum.Yes, I think yes, very much so.There's one thing that I worry about that might bea break on the speed at which we move and that is the riskof greenwashing.So what do you mean by greenwashing?As sustainable investing, ESG climate has become soimportant that there are lots of commercial opportunitiesthat come with that.So being the first to market with a new climate solution,a new climate fund, a new 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 thingsthat are being sold under a green labelor a sustainable label or an ESG label that don't quite lineup with the impact that people think it might have.And that is a risk that I see.And if I can just take a little bit more on that,a little bit more time on that.We know that historically, ESG investing has been veryprofitable in equity markets.So ESG investments have done well.And that makes it easy for people to invest in ESGbecause their financial incentives lineup with their principles and their objectives.But at some point maybe when rates start rising,maybe ESG investments do not have that outperformance effectanymore.Yeah.And there will be a trade-off between what is my principle,what is my financial incentive, what is my climate targetand belief, and what is myfinancial incentive.So we need to be very clear that those are two different thingsand it's great if they match, but we should also beready that we need to stick by our principles even whenit's necessarily a financial consideration.It's interesting because I think there are still some verylarge funds out there that don't have an ESG mandateand the more that that happens, the more you may get thisvirtuous circle of companies feeling that they need to bemuch more ESG aware and that will leadto a better performance.So hopefully we can get in that groove and it will beself-fulfilling, so to speak.Yeah, and this is a bit technical, but forgive me.So we get a lot of people asking us, we run someof the largest benchmark families in the world.So markets that capture the overallinvestment opportunity in the UK, in the US, in China,different countries, different sectors, etc.And the benchmark families tend to be market cap waiters.So they just represent the overall investmentopportunity out there in a liquid and transparent way.Increasingly we are getting the question,why are not all your benchmark indices ESG indices?Interesting!But then, they wouldn't be market cab weighted indicesanymore because currently the companiesthat are the greenest are not the biggest, to put it in verysimple terms.So, we'll come full circle when the market cab weightedindices are the ESG indices.That's interesting.Well listen, Arno, thank you so much for chattingwith me this afternoon, it's been really interesting.No, thank you, it's been a pleasure.Thank you so much!Thank you.Sustainable investing and the role of ESGin corporate culture was something that was certainlytalked about for 10 years, but it didn't reallytranslate into investment opportunities.Now, due to the rise of indices allowing more direct investmentinto ESG and sustainable themes, capital allocationsare accelerating these trends, creating opportunitiesthat are only going to get bigger and more diversein the future.If you'd like to read more on this topic,please go to footsyrussell.com forward slash researchwhere you'll find much more information.

Video recorded on June 3, 2021 at FTSE World Investment Forum

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