Listen: Private Markets 360° | Episode 2: ESG maturity in private markets (with Josh Green of Novata)

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Brandon Newland

Hi, everyone. Welcome back to the Private Markets 360 podcasts. My name is Brandon Newland. I lead our private markets product management team here at S&P Global Market Intelligence. I'm joined by my co-host, Jocelyn Lewis. Jocelyn, how are we doing today?

Jocelyn Lewis

Hey, Brandon. Doing great. Thanks. I'm Jocelyn Lewis, Managing Director at S&P Global Market Intelligence, where I'm Head of Private Debt Commercial Strategy across software and services.

Brandon Newland

All right. So we're going to jump into some exciting guests and focus on the leading industry trends for private markets here on the podcast. Jocelyn, should we jump right into it?

Jocelyn Lewis

Yes, for sure. So this podcast is dedicated to enlightening you to the world of private markets from different views. So yes, Brandon, let's go.

Today's guest knows how to roll up his sleeves, dig in the weeds and get his hands dirty as a serial entrepreneur, Josh Green. Today, we are delighted to have Josh as our guest. The two-time founder is Chief Operating Officer and Co-Founder of the leading ESG data management platform, Novata, working to make capitalism more sustainable and inclusive. And formally, he cofounded and served as Chief Executive Officer of Panjiva, a supply chain data startup acquired by S&P Global four years ago.

In this episode, we chat about ESG within private markets where it is in its life cycle, the politics associated with ESG, regional differences between North America and the European Union, the true believers versus those who look at ESG as a check-the-box exercise and of course, ESG frameworks. Hi, Josh, how are you doing today?

Josh Green

Great. Thanks so much for having me.

Brandon Newland

Welcome to the show.

Josh Green

Thank you. Excited to be here.

Jocelyn Lewis

Well, we're excited to have you, and thanks for joining Brandon and me. So to kick off our conversation, can you tell us where ESG is in its life cycle?

Josh Green

ESG is in a really interesting spot because on the one hand, I think some of your listeners probably heard so much about ESG, they're sick of it. And I think for those who have been working on ESG, many have been working on it for a very long time, have seen it evolve, have seen it improve and seen it really flow through the different aspects of the capital markets. And yet, most of the world has never heard of the acronym ESG or know what it means. So it's at this kind of interesting inflection point. And actually, you referenced politics, I know we'll get to that. But politics, I think, is responsible for introducing ESG to a much larger crowd as it makes its way into the political discourse.

But ESG, for those who don't know, environmental, social and governance considerations refers to taking these types of things into account when you're managing or investing in a business. And there's a long tradition here of things other than dollars and cents being measured inside a business and a long tradition of investors taking into account things beyond simple assessments of returns, ESG is what we call it today. But a few years ago, had a different acronym. And my hunches in a few years, it will have a different acronym. But what I do think is this notion that we need to measure things beyond dollars and cents to get a sense of a company's prospects, a company's impact on the world around it. I think that concept is here to stay.

Jocelyn Lewis

If it's changed acronyms even, but then you also have a whole host of people that don't even really know what ESG really is? Is it still nascent? Or is it more evolved? Is there a tipping point?

Josh Green

It certainly feels like we've reached a tipping point in different spaces of the economy. So I think we're past the tipping point in public markets. And so much so that we're seeing pushback and we're seeing political discourse focus on it. But all that really is about the public markets, publicly traded companies, which are obviously very important, but only make up a portion of the world's economic activity. And Novata is focused on the other piece of economic activity, private markets. And there are tens of thousands public companies. There are hundreds of millions of private companies.

And these companies collectively make up a huge portion of the world's economic activity, and therefore, really important, certainly, to the extent that you think ESG is best practice for managing risk, if you're more impact-oriented and think of ESG and related concepts as ways to bend capitalism in a more sustainable direction, you ought to be cheering for ESG to be going through the private markets. But it's not yet there. So Novata at this point is working primarily with private equity, private credit, the professional investors who are focused on investing in the world's biggest and best private companies. But that still is -- it's a small piece of private markets.

And even in that space, ESG is still kind of making its way through. So you take public markets, ESG is well past the tipping point. Private markets, it feels like we're approaching one right now. And then once you go to beyond the world of professional investors, I think the vast majority of businesses that are small and medium-sized private businesses have never heard about ESG and are probably a couple of years away from hearing about it.

Brandon Newland

So you mentioned that ESG is at this inflection point. It seems like now investment firms can be that conduit to introduce it to a broader set of companies in broader financial ecosystem. How effective is that today? And where is the opportunity around that?

Josh Green

Up until now, I think it's been kind of an interesting exchange between investors and investment managers where I think you have investors, individual investors, for instance, who in some ways are, and in some cases, are further along than the investment managers, right? They're going to the investment managers saying, "Hey, I want to invest my dollars in a way that takes into account long-term risks like climate or I want to invest my dollars in a way that aligns with my values." And the investment managers are then saying, "Oh, ESG. We can do that."

And then through that exchange, folks learn that there's this acronym called ESG. So I think that's an example of one of the ways that it's played out. But I think the challenge that investment managers have is that it's always been hard to invest in a way that aligns with your clients or your LPs priorities, even when you're just focused on total returns, getting that right in a way that reflects the priorities of the people who are entrusting you with money, that's hard.

Brandon Newland

When you're thinking about investors that are trying to divide between, hey, I do ESG, right? And when we say I do ESG, yes, like I'll have some thought around where they want to prove that out. But like how do you divide between working with folks that are putting the material first and foremost versus, okay, I'm working on ensuring that this is part of the strategy.

Josh Green

It's hard is the short answer. And I think if you look at conversations about fiduciary duty and where ESG fits into fiduciary duty, and there's a line of thinking, right, that if an investment manager is on their own investing in ways that are about more than total return or risk-adjusted returns that, that violates fiduciary duty. I think you see the arguments the other way, which suggests that there are investors who, if they really understood that their dollars are being invested in ways that were exposed to physical or transition risk with respect to climate, social risk or even going beyond that in terms of seeing their investment dollars go towards companies that are having a negative impact, right?

There's this argument that if people really knew how their money was being invested, they might be very frustrated with it. And I think the challenge is we haven't really yet, I think, cracked the code on the right communication tools to ensure that the folks that are allocating the capital can clearly articulate their mix of priorities. And the folks who are then investing the capital understand those priorities very clearly and then are in a position to act on that, which will be hard enough, right? But we haven't even really nailed that first piece, which is how do you get the communication flowing in a way that everybody understands.

Jocelyn Lewis

So could you comment a little bit, Josh, on some of the regional differences between the European Union's disclosure regime seemingly a little more, I don't know, it's systematic than North America, ESG standards that are seemingly maybe less stringent, a little more laissez-faire, is that a fair categorization?

Josh Green

Yes. Although I think we're seeing movement here in the U.S. just as we're seeing movement in the EU. I think there's a sense that the EU is frankly just a bit further along and that the U.S. is playing catch-up. But it does create similar challenges for investment managers who are working with LPs that are in both geographies because you have different expectations that are coming out of the EU and the U.S. So specifically in the EU, there's regulation that's much talked about right now, SFTR, regulation that basically is saying to investment managers, you need to clearly label your fund.

Your fund is either only in the business of making money, your fund is taking into account what they call principal adverse indicators that these are essentially measures of a company's exposure to or impact on the community, people on the planet. You need to either classify your fund as taking those things into account or you need to classify your fund to clarify that actually having a positive impact is the goal of the fund. And these different classifications are meant to help with the communication between those who are allocating the capital and the investment managers.

Brandon Newland

I guess when you think about this idea of polarization of ESG and communication of what are you ultimately serving with your fund. Is it fair that this is even coming to the picture, right? Because at the end of the day, should it really be politicized so that it's part of the equation?

Josh Green

I think part of the challenge of ESG, as it's discussed today, it's become kind of a holding tank for a lot of different concepts that really aren't the same thing. So to me, one of the best examples of this is ESG versus impact. So there are investors that take ESG considerations into account. And in that sense, ESG is set of flavors of risk. And they may represent the frontier in the state-of-the-art in terms of thinking about risk in a broader way, but it's fundamentally still a risk management tool. Impact is something different. Impact is saying, actually, we want to invest in ways that drive impacts, presumably positive, positive impacts on the community and the world. And that's a different thing than taking into account risks related to exposure to the possibility of a price being put on carbon.

It's different to look at the impact that these things have on a company versus the impact that the company can have on these things, the community and the planet. So those are different things, but they get lumped together. And I think, of course, in political discourse, things tend to get oversimplified and ESG becomes this thing that some folks are claiming is about putting an agenda in place via the capital markets that can't be put through the government. My personal hope is that it moves out of the political sphere and goes back to being something hits kind of an arcane financial markets thing that professional investors are worrying about and worrying about how to communicate to folks who don't want to spend all their time thinking about how their money is invested.

Jocelyn Lewis

And for those that really want to use ESG as a way to measure risk, particularly in the private markets, what do you see as some of the frameworks that they should look at because there's a few different frameworks that are out there. And it seems that different fund managers are capturing different data points. So what do you see in terms of frameworks that they're using?

Josh Green

Yes. Yes, there's an alphabet soup of framework, standards, organizations that touch ESG and it's daunting. And in fact, Novata's customers, this is typically where the conversation starts. There are some folks who come to us and say, look, there's a set of things I want to measure. I know I need to measure, help me with the process of collecting this data. But I would say for every one of those, there are a few that come to us and say, hey, I know I need to be doing something here, but I'm not sure which metrics to track, which data to collect from the portfolio companies that I'm invested in. And I would say there's good news on this front. I think we are seeing some convergence.

There is an initiative actually called the Data Convergence Initiative that got some of the key folks involved in private markets together and identified a set of metrics that are a reasonable starting point. The regulation coming out of Europe, SFTR, I think, has identified a set of things that are reasonable starting points for folks. So I think they're starting to be kind of some things that you can grab on to if you're just getting started. And I think that's healthy for the market. And we're seeing people who have been on the sideline saying, "Look, of course, I want to do something here, but while there's total disarray in terms of people's beliefs about what should be tracked, it's not worth it to me to start collecting data."

I think folks who have been of that mindset who've been sitting on the sidelines, I think, are starting to come off the sidelines. And I think that's a good thing. And I think it speaks to kind of a level of maturity within ESG that I think is growing. Once upon a time, I think there were folks who were asked what are you doing about ESG? And if the answer was something that was sufficient. Now the question is asked, well, what data are you collecting with respect to ESG and people need to have an answer for that. And then at some point in the future, people are going to say, well, what are the trends looking like in the data that you're tracking on your portfolio companies? Is that heading in a positive direction. And we'll get there. But right now, I think we're still in kind of an interim phase, at least in the private markets where there's more focus on just kind of getting the ball rolling with data collection.

Jocelyn Lewis

And I'm just curious, when a customer kind of comes to you, a private fund manager, are they saying that they're looking for just ESG frameworks in general, just what metrics track? Or are they more targeting their approach saying, we want to improve our carbon footprint, become carbon neutral within the next 5, 10 years, something like that. We want to have better DEI scores. We want that to improve. So are they more targeted in their approach?

Josh Green

It's a mix. I think certainly, you see people who are hearing from their LP is, hey, you need to do more on ESG and they're coming and saying, "Hey, I need to do something on ESG. What should I do?" And then there are those who are coming with a point of view. So I'm thinking of one investor who came to us who said that gender and gender pay gap is an issue that's of real importance to them personally. It's one of the things that they want to focus intensively on in the years ahead. And so the measurement is focused on related issues.

And certainly on climate, you see people who say, look, I want to see my portfolio do the right thing on climate or be Paris-aligned on climate and are focusing there. So we see people who have kind of different approaches on this. My view is there are at least three different lenses that you can bring to bear as you think about what you focus on, what you do, what you don't do on ESG. One is what your stakeholders are asking or, in some cases, pressuring you to do, right? And this is a dynamic that I think is very real in private markets right now where LPs are putting pressure on GPs to track ESG data, and that is leading to action.

That's one lens, right? If your LP says, or your lender says, you need to track this data. Obviously, that's going to be a really important input. I think there's a second input, which is more tied to kind of the business you're in. So SASB did a bunch of work on this in terms of identifying which ESG factors are material in which industries. And I think there's an important recognition there, which is that different industries, different companies are facing different bundles of risk.

And it makes sense to be thoughtful and prioritize the areas where you perhaps given the focus of your investment fund, where you are likely facing significant risk, it makes sense to take into account the industries that you're in and focus your efforts in the areas that have been demonstrated through years of research to be materially impacted by these ESG factors. So that's a second lens, right? What has been demonstrated to be material to your business or the businesses that you're investing in.

And then there's a third lens, which is what matters to you personally. And some investors, particularly if they're investing their own money, this is something that they can act on directly by incorporating their points of view into their investment process. Others, it kind of circles back to the stakeholder perspective. So it's not so much your values, but your understanding of the LPs that are invested in you their values.

These are different lenses. And typically, if you just kind of think it through methodically, hopefully with folks who are knowledgeable about the different frameworks usually get to a pretty clear answer on what you should track and what you shouldn't track. And then comes the actual work, which is going and collecting the data. And that's where I think we're seeing more and more GPs doing the work and seeing interesting things in the data.

Jocelyn Lewis

And so with these different lenses, assume the data is collected, does that create arbitrage opportunities?

Josh Green

I would say, there are folks who view ESG and their approach to ESG as a competitive advantage, either in terms of their ability to attract capital or in terms of their ability to drive to great outcomes in the businesses that they're investing in. And then there's some that view it as a cost of doing business, something that they just kind of have to do. And then there are folks on the other end that are saying, look, all this capital is flowing towards things that look good from an ESG perspective, let me go the other way and invest in things that look bad from an ESG perspective, either because I think they're going to be more in need of capital, and therefore, I can get a greater return or because I can actually transform the business into a better ESG profile.

There are opportunities kind of across the board. And I think that's one of the fun things, I think, from an investment perspective. But of course, this is a serious stuff. I mean, when you get into ESG, you're talking about things that affect the employees at the companies, that affect the communities in which these companies operate, that affect the planet and the planet that we leave behind to our kids. So there's a fun side of this for sure, and intellectually interesting side to this for sure. But there's also a really important part of this, which can't get lost in the shuffle.

Brandon Newland

When you think about the different opportunities to drive ROI and ultimately change different businesses with those ESG lenses, is it easier to connect with investment managers that are looking to raise new funds? Or is there kind of a reckoning almost that has to come out of an analysis where, okay, here's where all of our investments sit across these different industries. You mentioned before, maybe some of them are high risk for ESG factors, some of them are low risk and then having to kind of go through that initial process could be an interesting journey for some folks versus others.

Josh Green

I do think there are a set of folks who have stayed away from ESG in part because they were a little worried about what they would find when they collected the data. And I think that was actually a viable strategy for a while. I think increasingly, it's not. I think the folks who have not yet kind of gotten into the data, I think, are realizing, boy, I better find out where the hotspots are, where the areas of significant risks are in my portfolio before somebody else forces me to do that. Because then if you're the one who spots it, you can take action on it.

I think we're seeing a shift in terms of behavior that is more in the direction of, yes, let's go and collect the data, even though we might be a little nervous about what we find. And I do think it's one of the things that I think is healthy about how ESG is unfolding, and it's almost cliche to say, but I think there is a sense that ESG is a journey, right? This is not you're good at ESG or you're bad at ESG. It's that this is a new and expanded way of thinking about how businesses should be managed and how investments should be managed.

And it's a process to get to a place where you can do this in a way that is efficient, that is cost-effective, that doesn't require huge amounts of effort on your team. And that's really the journey around the data collection process, then there's this whole journey about how you drive impact or drive progress on metrics that matter within your portfolio companies and there are some that are on that journey and most have that well ahead of them. I think that's okay. And I think as is often the case with things that are kind of on the cutting edge, you have some folks who are willing to take the risk, they leap in because they see the opportunity. You have others that hang back and wait to learn from the people who have leaned forward. That's okay, right? That's how innovation is diffused.

Brandon Newland

That's a great point. I guess being a serial entrepreneur and creating companies, do you think that the next generation of CEOs and folks that are formulating businesses are going to now put ESG at the forefront of how they think about a business and business risks in general?

Josh Green

I think it's already happening. I think it's already happening. I think you see the explosion in climate tech. You have entrepreneurs certainly that are in it for the money, I think a lot of them are in it because they want to have a positive impact on the world. And that's, again, beyond the scope of ESG from a risk management perspective, it's genuinely an impact orientation. But those folks are tracking metrics that would classically be considered ESG metrics from day one, because it helps them tell the story of the impact they're having.

I think you also see this, and I think this came about in the wake of Black Lives Matter, in particular, you have entrepreneurs who are looking at investors and saying, "Hey, I want to see investors, I want to see what your investment team looks like. Does it reflect the community in which it operates? And if it doesn't, I don't want to take your money." And I chuckle sometimes when I talk to investors who are a little kind of cautious, I don't want to impose it ESG on my portfolio companies. I chuckle because I think if they don't start the conversation about ESG, I think the companies in their portfolio are likely to start the conversation. So better to start it on the front foot than the back foot.

Brandon Newland

That's a fantastic point, Josh. Thanks for your time today. I think Jocelyn and I had an illuminating experience on where we're at with ESG, what's the right inflection point for both public and private markets and how to think about frameworks more broadly. So for those who have listened in, thanks a ton. You can find us wherever you get your podcast and tune in next time for the next episode of Private Markets 360.

Thanks to our wonderful guests. We had a lovely chat today. Really appreciate everyone for listening in. And if you're looking for more Private Markets content go to spglobal.com/research-insights, and you can stay tuned to find our next episode. Cheers everyone.

Jocelyn Lewis

Thank you so much. You can also connect with us on LinkedIn. Have a great day.