Listen: IR in Focus | Episode 2: Sustainability and Governance Regulations Deep Dive

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Carmen Lilly

Hey, everyone. Welcome to our podcast, IR in Focus. I'm your host, Carmen Lilly, and in the next 20 minutes, we'll dive into a subject that you're either going to love or going to hate, environmental, social and governance, otherwise known as ESG. So exciting, I personally love this topic. And during this podcast, we'll also take a look at emerging sustainability trends in the regulatory environment within the U.S. and Europe. And joining me today for this discussion is Andreas Posavac. Welcome, Andreas.

Andreas Posavac

Hello, Carmen. Thank you so much for the invite. It's great to be here.

Carmen Lilly

And thank you for joining us. By way of an introduction for our listeners, Andreas is the Executive Director of Global ESG, M&A and Governance Advisory with S&P Global Market Intelligence. Andreas runs a global team that supports companies, their C-suite and investor relations teams as well as their banking and legal advisers with Market Intelligence, risk analytics and advisory services focused on institutional investors.

He and his team also work with companies to develop a coherent ESG and engagement strategy to follow legal and industry best practice standards as well as take advantage of the opportunities and sustainable investments and benefits from increased integration. Andreas, now I know you have a ton of experience in this field. But for our listeners, can you hit the highlights of your experience and knowledge within sustainability in ESG?

Andreas Posavac

Yes. Well, that's a good question. I mean, I've been in this field for more than a decade, right? And I've worked with Boards and executives, IR people, to really help them develop a strategy and really understand what ESG actually is. I mean, we'll probably get to this a little bit later in the session, but this has gotten a label. People think that ESG is a thing.

But in essence, I believe it's just a general part of the strategy and the business risk that you're supposed to be managing. And I've been doing this for more than a decade focused on the governance part in the very beginning. That's what some of the people might remember as CSR, corporate social responsibility, and then this term ESG and sustainability was coined. So ever since then, we operate under that name. But in essence, it's managing business risk with high management quality and also communicating it the right way.

Carmen Lilly

Yes. So you definitely have seen this ESG as a thing, like you said, kind of evolved over the years. But in reality, it just seems like this is just additional risk reporting and risk regulation, right? Is that what I'm hearing?

Andreas Posavac

Well, it's just quantifying some of the risk that always has existed, maybe in a little bit of a new way because -- and we'll see it also in regulation is pushing companies to just focus and zoom in on some of these nonfinancial components of risk. So I would argue that they've always been there. They just now got a name, and they now have a definition.

Carmen Lilly

Right. Right. Let's dive right in and start with the SEC. So last year, the SEC proposed a ruling that would require companies to provide certain climate-related information, both in the registration statements and their annual reports. This proposal is expected to be finalized here, possibly in April.

I read the proposal, and I read many of the comments. There are thousands of comments on this proposal, as well as the NIRI D.C. Chapter response, so that's the National Investor Relations Institute. And 2 of the main arguments against this proposal is that it's burdensome, whether that be operational issues, costs or difficulty to measure and report. And the other argument is the SEC is redefining materiality by using the 1% bright line threshold.

Okay. To set a stage on this threshold, what it means is that companies do not have to report is the aggregated impact of the severe weather events, transition activities and other identified climate-related risk is less than 1% of the total line item for the fiscal year. This is a departure from our collective understanding of materiality as defined by the Supreme Court and FASB and other entities. So my first question to you is like, what would you say to these people and entities voicing these concerns?

Andreas Posavac

I mean, you're right. It's a little bit of a new situation. But in respect to the materiality aspect, the 1% threshold for disclosure, like you said, is definitely it's quantitatively lower than what we usually know as material. I think generally a 5% benchmark is used to define materiality.

But on the other hand, it's not new, the SEC, I think, around excise taxes, has already used similar thresholds before. And in their arguments, they, I believe, want to draw the line in the sand on what actually is material and try to prevent underreporting, which if you look at the space, has been the case in numerous other regions and legislations and there's been quite some pushback recently.

And I think we're now in a situation where the SEC might ease actually some of these requirements again. It's not finalized yet, but I guess that's the direction that we can go. I mean one of the reasons for lowering thresholds, if you look at it, might be actually to cover any nonquantifiable risks, standard risk elements. Also as the major risks arise out of Scope 3, for example, whether this is -- if you're a bank or a financial insurance company, so be it in the financial sector via investments or also loans or in the real economy through a supply chain risk.

A lower threshold might actually make sense. But I do also understand that when you're an early adopter or when you started at this stage with your ESG and sustainability strategy, this might look like a very hard line and hence, the pushback, like you also mentioned, from investors, that this is burdensome or can actually lead to inaccurate disclosures is something that really needs to be considered.

In my opinion, it's about the concept of materiality, where qualitative factors also have to count. So if maybe a comparatively small expense, as you mentioned, flips a line item from positive to negative, this is definitely something that investors will consider significant. And just for reference for that point to finish, the regulatory requirement, for example, in Europe already requires companies, especially financials, to quantify and consider disclosure and information on a single asset and loan level. So in that respect, maybe that 1% hurdle doesn't look as bad. There's definitely a direction where it's going to go.

Carmen Lilly

Right. There's definitely some like relative comparisons you can make with some of the other regulations happening abroad, which we'll get to a little bit later in this podcast. But can you talk a little bit more about how you believe transparency will play into the capital markets?

Andreas Posavac

Yes. Well, I mean, the 1% rule, right, might look like a hard line in the very beginning. But in essence, whether it's 1%, 5%, I generally believe that when you talk and when you witness this space from a sustainability perspective, that transparency is to be encouraged in the capital markets specifically.

I mean there is a lot of noise around ESG, but in essence, we need information. Anyone in this field needs information to properly kind of evaluate and assess and compare companies. And as we've also seen globally, relying on purely voluntary disclosure has not really worked. And hence, generally, I believe, transparency, whatever the threshold is, is a good thing and people will realize that it's a good thing.

But the other point is equally valid because whenever you introduce new measures and new regulation, you have to understand what that means for the market and all of the market participants. And that's actually not only true for the U.S. on the discussion that we just had, but also equally in Europe, et cetera. Not everyone has the resources to deal with these requirements. And these are huge complex regulations, the taxonomy, et cetera, and also what you see now in the U.S. So I'd rather prefer a little bit of a higher threshold that still gives us a base level at the baseline of transparency rather than a lower one that would then potentially result in not as much quality.

But this is a general phenomenon and, I mean, it's clear that there is some pushback on that. But technically speaking, especially disclosure and the concept around double materiality, namely the need to quantify the impact to which extent your business is resilient to external risks, I mean that is something that I believe, like I said in the very beginning, makes a lot of sense.

And specifically from a capital markets perspective, it shows investors or people that might help you finance on how much of where you are and how resilient you are as a company. And in that respect, the U.S. has been a little bit behind and has been catching up to the rest of the world from a transparency perspective and from a focus perspective.

But I think we witnessed it now in real time that the U.S. is going to catch up. And specifically, if we can get clarity around Scope 3, then a strong disadvantage for the U.S. companies or anyone on a global basis will be alleviated. So short answer would have been, I believe in transparency as a baseline indicator, this is important, and the scope will increase anyway over the next couple of years.

Carmen Lilly

Definitely. I mean, I didn't know this, but when I read through the proposal, there's mention that the SEC proposes first environmental regulations in the 1970s. Now those regulations eventually passed, but it took them like over a decade to do that. So we know this is not a new discussion or a balancing act that the SEC is facing. And this specific proposal may not be perfect, but we've seen broad support for climate-related standardized reporting. And like you mentioned, just transparency into that and some companies already do this voluntarily.

Now with these things in mind, it does make me think that the passing of some sort of climate disclosure requirements is inevitable for U.S. issuers and will only continue to grow in scope. So how would you advise companies to embrace changes in reporting and to prepare for what's next?

Andreas Posavac

Yes. I mean, like I said, and you just mentioned this, too, it's coming anyway. Question is, to what degree? But I think I very strongly believe it's a necessary requirement to really stay competitive internationally, whether this is from a company or whether this is from an investor, it's already something that, for example, largest banks and investors already demand anyway.

And you have to consider irrespective of what is going to happen in the U.S., the moment a company, for example, based in the U.S. is -- has an international operation. International regulation will also apply and will impact those companies that maybe have global operations, for example, through the supply chain directives internationally or also when it gets into financials, lending, et cetera, if you're part of an investment portfolio.

Actually, these stakeholders will already require this from you if you are a U.S. company anyway. So it's coming, whether you believe it or not, especially if you have a global and international operation. The question will be the granularity and the severity of it is a little bit unclear. But it's coming, scope will increase. And the good news is also that some of the previously not standardized or clear frameworks and standards are going to converge as well.

And one thing also, like from a risk perspective, you would assume that all risks are priced in from a capital markets perspective at any point in time, except on the ones that you're not aware of. And transparency around sustainability risks, I believe, will also allow a much, much, much easier transition and translation of ESG being viewed as a nonfinancial factor to what already a lot of investors call an extra financial factor.

So the financial impact on your company and regulation, voluntary efforts and the pressure will help companies not only see this as a risk, but also an opportunity. This is a huge opportunity for companies in the U.S. that proactively do this. So I would strongly advise to not wait, but start step by step and manage the market with your information.

Carmen Lilly

Yes. So let's change gears for a moment and let's talk about some of the changes happening abroad, specifically the Corporate Sustainability Reporting Directive, so CSRD. That was put into place on January 5 of this year. And essentially, the CSRD expands the scope and content of current EU nonfinancial reporting obligations and now covers a much wider range of entities. I think the number I read was around 50,000 and would require reporting on a broad range of ESG topics in much more detail. It would also be subject to a mandatory audit, and I thought this was interesting, all of this information would feed into a publicly accessible website. So first off, what are your comments around the CSRD?

Andreas Posavac

I mean, if you're dialing in from the U.S., then I can say be happy that you're not based in Europe because CSRD and the EU taxonomy, the Green Deal, SFDR on the buy side, obviously, it's even more complex. But to answer your question, I mean, CSRD, European taxonomy, there's a lot of ambition.

Europe has been on the forefront when it comes to sustainability over the last couple of years, a lot of ambition also now packed into regulation that, frankly, is extremely complex. So everybody is figuring it out in real time. And -- but it's a quite cumbersome exercise in a way. At the same time, it's really interesting. We are shaping the future, I guess, together, and we can witness where this is going. It's definitely not going to stop.

Now CSRD, EU taxonomy, like I said, it's touching all stakeholders. It has increased the scope significantly. That's extremely important also in the context of U.S. or Asia because it now covers -- in Europe, it covers 50,000 companies, including small and even private companies if you have more than 250 employees or a turnover of 40 million and I think 20 million in assets or something like that. It's quite granular, and as you can imagine, a huge challenge if you haven't dealt with this. For a lot of the companies, it's new, challenging with resources, it's big. And it will take a while to get there.

But at the same time, kind of the expansion, I think it was from 15,000 or so companies to now almost 50,000 was necessary for a couple of other reasons because like I said before, it's required -- disclosure is required on a corporate level already anyway because it serves as an input factor for banks who have to evaluate their investment portfolios or also we have to evaluate and assess their lending books. And as we all know, these are private individuals. These are small companies as well and also some large ones. So it's coming through various angles, including also, I mentioned it before, supply chain directives.

So if you are a Volkswagen or General Electric, you are being asked to assess your entire supply chain and their carbon footprint and their ESG profile, their sustainability risks. So no matter what, it's already there and it's there at a granular level. So we'll see where that goes. That's why I also believe that the U.S., with usually a much more pragmatic approach, will bypass what Europe does in the next couple of years.

Carmen Lilly

No, I think that's really interesting. And you touched a little bit on how this might impact some of the U.S. markets, specifically what you mentioned, the pragmatic approach being taken by the SEC, so incremental. But other than that, what else do you foresee how this will impact U.S. markets?

Andreas Posavac

It already does impact U.S. companies, the U.S. market. At the moment, specifically, you have an operation or you sell a product or you sell a fund if you're an asset manager, if you offer a fund in Europe, you're affected by that regulation. If you're a company that has supply chain into Europe or the U.S., you are already affected. So the impact is big.

And hence, I mentioned it, pragmatic. I do believe while the U.S. is maybe a little bit behind right now or it was, it will catch up quite quickly, but enhanced in order to remain competitive, in order to remain transparent so that you can assess and compare also U.S. companies. You'll be well advised to participate in. And again, to drive your story, the investment story, your sustainability profile with proactive disclosure and communication.

Carmen Lilly

Right. Right. So in your experience, what sort of trends or process improvements that you've seen abroad with all of this new taxonomy regulations coming out that IR teams in the U.S. can leverage?

Andreas Posavac

The reason why we talk so much about sustainability in ESG is driven by the investors, by the institutional investors in the capital market, which is quite interesting, right? So what improvements, what trends do we see that potentially can or should be leveraged?

Number one, I think generally what has happened is that there is this whole new ecosystem, ESG sustainability ecosystem that has been built over the last couple of years by demand that now enables you as a company maybe to access a lot more tools help companies help you understand, if you are, for example, very early in the cycle to understand what does the market think are the material drivers for your industry, your sector. There's a lot to lean on, and hence, a lot more guidance about minimum market requirements.

So that's one thing. I think it's good. You have a benchmark in the U.S., in Europe, internationally. There's a lot there that companies, no matter where they are in the cycle, can lean on, can use, tools, data, information. I think that's a huge win and it should be leveraged.

Second thing, data collection, KPI definition, benchmarking is possible. So even if you're early or if you are in a developed stage already, this is important. You need to understand where you are in the market. So leveraging this information, how does the outside evaluate you, see you? Even if you start from scratch, allows you to, I think, understand a little bit on what you need to do in order to get there, right? Government reality framework. I mentioned it before. This is something that I can share. It is really well received, especially by the market participants around institutional investors. It's something that you should consider.

So if you -- many companies might have done a materiality exercise, but not in a double materiality framework way. So what's my impact in the current conditions into this world holistically and vice versa. -- example, climate change and its impact on my business model, right, and translating this into numbers, financial impact. So describing the sustainability information and its impact on corporate value and vice versa, that's something that is possible now that's also required, right, and best practice, you can leverage this.

And another thing is, don't forget, we would talk about companies and investor relations a lot, but your counterparts, investors, front managers, analysts, sell side, they're in a similar situation. I mean, for most of them, it's also new. They are also trying to figure out how to integrate ES&G into their workflow, into their decision-making process.

So leverage that ecosystem and many companies started doing this, go on proactive outreach, sustainability road shows, use information in an integrated form and basically use, for example, the institutional investor community as sparring partners to get the feedback on your ESG profile. You'll see that this will be highly -- not only possible, it will be highly successful, you'll get quicker to where you need to be because they also have an interest in collaborating and learning where your company, where your industry is going. So I think this new ecosystem and everybody wins in a way.

Carmen Lilly

Absolutely. Now when we talk about ESG, a lot of people are investors and a lot of like folks focusing on the E, but let's not forget about the S and G. I feel like those aren't talked about nearly enough. The S and G are usually viewed as ethical measurements. So things like making sure your supply chain doesn't participate in human rights violations and like treating your employees with care and respect. So to me, these are like the things to do, like you should be doing these things anyways. So why did these measurements get lumped in with sustainability concerns?

Andreas Posavac

Yes. I mean, you are right. But the reality is that not everybody sees it that way. And a lot of times, ESG gets simplified to climate and environmental concerns, right? Maybe understandably with some of the unprecedented sustainability challenges that we've seen globally, whether this is, I don't know, wildfires in the U.S. or droughts or avalanches, water scarcity, biodiversity loss.

And just in the last couple of years, the social and the corporate governance components of ESG have actually seen a lot of traction. So look at diversity equity inclusion which, by the way, for S&P also is one of the key focus areas. I mean, huge, human rights, supply chain, human capital, talent management. I mean, just think about that. These are initiatives. These are focus areas that have a direct impact on your valuation. I mean happy employees, less costs on people being sick, more innovation, less churn. I believe people sometimes underestimate that importance.

And the investment landscape, capital markets also have been changing in that regard. In a way, it's going away from this -- well, climate and environmental is still very much there and a key priority, but it's going away from this negative screaming focus to a much more integrated approach that also focuses on some of these social matters, depending on which industries you're in. Engagement and stewardship becomes more important. Thematic and impact strategies, all of that actually we see there as well.

Carmen Lilly

Absolutely. We're running kind of short on time, and I'd like to close out this podcast, which is a final word from you. The question is, what is one piece of advice you would give corporate issuers right now when it comes to ESG initiatives?

Andreas Posavac

Be proactive. Irrespective of your development stage as a company, really don't wait, be proactive and guide the market. And ESG and sustainability is a data play, so they're to data. You'll be able to solve many of the upcoming challenges with the right strategy and the underlying sustainability data, the material factors described in data KPI format. It sounds a little bit weird, but you drive and you guide the market quite a bit.

And maybe the last 2 quick step by step, don't boil the ocean, but have a forward-looking strategy. A lot of people report what has happened and focused on the past, but have a forward-looking strategy, give goals and the vision and step-by-step milestones that the market can evaluate it. And you don't have to do it alone. Get help, right? Preferably, of course, from us or with us, but you're not alone in this, and I think you really can leverage your peers, your industry, even your competitors that are in the same situation. So yes, I think that hopefully can help you out.

Carmen Lilly

Thank you, Andreas. It was a pleasure to have your insights and point of view today. I hope listeners gained actual insights on sustainability and reporting regulations, and please join us next month for a discussion on investor activism. I'm Carmen Lilly. Until next time. See you.