Citigroup Inc. (C) Earnings Call Transcript & Summary

Good afternoon, and welcome to our panel presentation. I'd like to thank my fellow panelists who are all ESG experts for joining me today for this discussion. We're going to talk about how ESG and the emergence of climate-aligned finance are changing, the investment landscape with respect to power and utility assets. My name is Martin Toulouse. I'm a partner at the law firm of Baker Botts in New York. I'm a debt finance partner. So I'm involved in leading the transactions in the energy and power space on the debt side. As was the case with the prior panels, we hope that discussion will be interactive, and we do welcome audience questions. So I would encourage you to raise questions. [Operator Instructions] We will leave time at the end to tackle the questions. So joining me today are, first, Michael Ferguson. Michael is Senior Director, Sustainable Finance, at S&P Global Ratings. Michael has been involved on a variety of projects, including developing specific ESG evaluation tools at S&P, and he's also responsible for incorporating ESG risks and factors in credit ratings. So his comments on -- in that respect will be interesting. We also have Dr. Richard Mattison, who is CEO of S&P Global Trucost and also Chief Product Officer of ESG at S&P Global. Dr. Mattison is an expert in sustainable finance. He's been consulting on the topic for years for governments, NGOs and companies. And he's done really pioneering work with respect to carbon risk assessment and the development of indices and, more generally, how to integrate climate change and natural resource capital analysis in investment decisions. Our third panelist is Elree Winnett Seelig. Elree is Head of Environmental, Social and Governance for Markets and Securities Services at Citi. She's had a long tenure in financial services. And in her current role at Citi, she sits above various product and industry lines. So she'll be able to provide holistic comments on ESG topics. Our final panelist is Dr. Uday Varadarajan. Uday is Principal of the Rocky Mountain Institute, and he's also affiliated with Stanford University, the Sustainable Finance Initiative at Stanford. His main focus has been on how to use cutting-edge data and financial policy and regulatory analysis to help drive the energy transition. And in addition to his work in academia and consulting, he spent time in government, having been at OMB and also at the DOE. So he's -- he will be able to provide some insight from that perspective as well.

So to start our discussion, we -- with respect to sustainable finance and climate-aligned finance, one interesting aspect of recent developments seems to be that a lot of the pullout of the demand seems to be coming from the investor side of the equation, the demand side of the equation. There's increasing awareness amongst the investor base with respect to ESG topics and all across the investor base, debt and equity and various levels in the capital structure. So to start our discussion, I thought I would ask, first Elree and then the other panelists as well to chime in if they have any thoughts, as to how they've seen the investor landscape evolve in recent months in light of the stronger focus on ESG matters.

Yes. Thanks so much, Martin, for asking me to join the panel. Really excited to hear what the others have to say as well. So we really think that 2020 was a tipping point for ESG in our markets. The reality is that COVID and the pandemic really -- and Black Lives Matter really highlighted systemic risk that exists in the market that probably pales in comparison to climate risk that is embedded. Also, ESG strategies performed well on a risk-adjusted basis granted we were in a risk-off environment, but the reality is they performed very well. And the level of sophistication that investors have in terms of how they think about ESG, what they want to achieve with their ESG strategies and how they use data is -- has really grown dramatically in the last 18 months. So we really feel that in our more mature markets, we're probably moving out of ESG 1.0 into ESG 2.0. ESG assets under management are growing by leaps and bounds. They're projected to grow 3x as fast as conventional formats. Bloomberg -- if you say that ESG assets under management are probably, I don't know, $36 trillion, $38 trillion right now -- that's self-disclosed, not necessarily truly labeled. It could be ESG-integrated. Bloomberg guesstimates -- or estimates that those assets will reach $53 trillion by 2025. That's 1/3 of total AUM in the market. So it's huge. Importantly, it's moving well beyond equities. So a lot of our audience is familiar with these niche strategies in equities. But what we see in ESG 2.0 is it's really moving squarely into fixed income. So not just sustainable debt but CLOs, ABSs and a lot of those tools that we use to recycle risk that our clients use to raise capital. Certainly, private placements globally, ESG or green private placements, are growing quite dramatically as well. The reality is it's not a mature market though. What investors mean by ESG varies by client, what they want to achieve with that strategy. At its core though, ESG represents risk. So many of our clients are looking through that risk lens, what might be a stranded asset, what are they thinking about in terms of their brand or their franchise risk being associated potentially with thermal coal, tar sands. But at the same time, our clients are also looking to align with their values. That's probably slightly more still on the retail side. And so a lot of our clients, a lot of the asset managers are developing products that help us reflect who we are, just like consumers buy things that reflect who they are, and they choose to buy renewable power versus conventional power. The third thing though that I think has really shifted in the last, I would say, 6 to 8 months -- and we see this a lot more on the institutional side. We saw it maybe a year ago, 9 months ago, not from hedge funds but we're really seeing it from the real money accounts, is really that shift to ESG and climate as opportunity. So it's no longer just about risk. They're wanting to participate. And of course, we saw great performance by renewables, funds, ETFs assets last year, and there's still an enormous interest in that but they're getting a lot more sophisticated about it.

Yes. So it's great that the discussion is shifting towards the size of the opportunity because clearly, the opportunity is huge if all the goals are going to be met. So as the investor demand is growing and awareness is increasing, on the ratings side, which, of course, is one of the tools that investors are looking at, not the only one, Michael, would you care to comment as to how rating agencies generally have been dealing with ESG considerations and trying to incorporate them in their analysis both at the corporate level and also with respect to specific issuance, ratings.

Gladly. So I would first echo Elree's point. I think that investors have been increasingly demanding more disclosure around ESG. And certainly, we're happy to provide that. And I think the form in which we do that is evolving. And we're trying to provide more transparency. I think that there's a lot that has not changed. So we have captured ESG in our credit ratings even before ESG was considered to be kind of a separate risk category. A lot of these things have been influential and material to credit quality for many years, have been impactful and have effectively changed ratings. In fact, we've done look-back studies that substantiate that. But the world has obviously changed in the last 1.5 years or so. I think before 2020, largely what we saw was that ratings actions. The ESG space were driven by transition risk, more or less. I mean there's a smattering of other issues. Obviously, governance issues are always popping up, but it was largely related to the energy transition. Last year, it was almost exclusively S-related, so the S around COVID being safety and health and the management of those risks having significant impacts on credit quality. Now going forward, I think it's fair to say that with the energy transition hastening in certain parts of the world -- we're certainly seeing it now just in the first few months of the Biden administration here in the United States, we can see a pivot back to more ratings action that's driven by the energy transition, but it's a little hard to say who that is and how quickly it impacts them. But certainly, we anticipate it's going to be impactful. But what I would also say is this. I think that the level of disclosure we're seeing from the companies that we interact with is substantially higher and it's making our job, in terms of doing comparative analysis around credit quality, a little bit easier. I think a few years ago, we didn't necessarily have management teams that were uniformly able to articulate what their strategies were around ESG, how they were allocating capital on the basis of environmental and social risks they saw as being disruptive to their respective sectors. We also didn't get a good sense of how -- what the comparative data points were. I think it's fair to say that the data disclosure were kind of inconsistent. And now we have better access, which makes comparative analysis quite a bit easier. And so I think that going forward, we're going to try to make that connection a little bit more explicit. We've already started doing that. And I think those analysts who read our credit ratings reports can kind of see that front and center now. I would also say that one of the things that we are doing is looking at other sustainability-related products in part because, as Elree said, investors are demanding that. We recently produced what we call an ESG evaluation, which is more of a holistic analysis of how a company deals with the sustainability risks confronting its business model in the near term and in the long term. Now as with credit ratings, we engage with the companies, but again, it sort of behooves us to understand what is material in each sector with regards to ESG risks. That's a challenge, of course, because I think what is material is evolving. It's changing. We try to be transparent about what we consider to be relevant for each sector and then what KPIs we're using to make judgments about which companies are better or worse in that respect within sectors. And again, it's a big effort to make sure that we're being transparent on that. But certainly, I think that the -- we're making an effort to show the link between ESG and credit quality in part because that link has become very palpable in recent years and likely is only going to become more so going forward.

Yes. Thanks, Michael. So picking up on something you raised, which is the data. There's more data. There's more disclosure, most often voluntarily provided by companies, issuers, borrowers. But the sense I get at least is that there's still -- we still -- there's still a lack of uniformity. The standards, the factors being considered, the metrics are not uniform across the board, which makes comparison more difficult. So Richard, I was hoping you could comment on this generally from your perspective in terms of what's currently available and what could be improved. And all from the perspective of linking the performance of companies on the financial side and also to their performance on ESG, how can we more clearly create a link between the 2 to facilitate investments?

Yes. So I mean the point about data is critical. I think data remains one of the key challenges of this kind of entire agenda. I mean it's hard to ensure that capital is flowing towards sustainable outcomes if you can't agree on what a sustainable outcome is. And it's hard to do that when you don't have any disclosure about who is raising capital or what it's being used for. And so that's why we're seeing the emergence of more disclosure standards, more information about various different types of issuance, more information on entities. But it's still fairly early days. I mean we still really only have information reliably disclosed by the -- really the largest companies in the world. Other parts of the market and other types of assets are sort of fairly poorly understood from an ESG point of view. So that's why at S&P Global, we focus on disclosure but we also focus on engagement with companies and other issuers to make sure that we're gathering the right intelligence, getting the right information. And we also use a lot of modeling capabilities that we've developed and linkages. So at the moment, we have about 700 billion climate-related data points. And our focus is very much on making sure that, that information is relevant for financial decision-making. Otherwise, you just have data and not a lot of useful information. So really, the information is, by and large, forward-looking. It's focused on things like the physical impacts of climate risk, the transition pathways that companies are undergoing, translating net zero into action. Is that actually happening? Are companies on the right trajectory now and towards 2025 as well as towards 2050? So those are the kind of areas that our data sets really focus on. And as I said, not all of it comes from the companies. It comes from a combination of information that is disclosed, how we engage with companies, but also some of the models that we have. And we would say actually that 60% of the S&P 500, for example, own assets at very high risk of the physical impacts of climate change over the next decade or two. So there will be impacts on the valuation of those assets over that period of time, and we've already seen some damaging impact. On the flip side, on the transition side, under a very strong carbon pricing scenario where we would expect to see countries price carbon in alignment with a 1.5-degree trajectory, we could see as much as 13% of profitability, EBITDA affected by 2025 under a high pricing scenario, so fairly material impact actually in the bottom line of companies. And so really, what we do at S&P Global is we take all of that intelligence and we integrate it into the different products that we have, whether it's into the ratings intelligence that Michael was just talking about or into data and analytics that we have or indeed into indices. And so from the perspective of what happened last year in 2020, it was super interesting because we actually saw a lot of our indices outperforming the core benchmark. So for example, the Paris-Aligned & Climate Transition Index outperformed the S&P 500 by between 3% to 5%. And I think as investors start to see that, they were starting to witness the fact that certain types of index structures were actually outperforming. That attracted quite significant inflows. So watch this space. I would say that with better data, you get better investment decision-making. And we have a lot to learn, I think, but there's certainly a lot of push, I think, coming down the pipe from regulators. So we'll see what transparency does for guiding capital allocation towards sustainable outcomes.

Great. So yes, a work in progress. And before we switch to regulatory requirements that may be coming, I would like Uday to comment from his perspective because I know you and I have been spending time thinking about these issues specifically from the perspective of the U.S. utilities industry. So in terms of metrics and data, what are your thoughts on what's being done and what's available and how the reporting could be better?

I think the U.S. utilities industry, in many ways the power sector, writ large, is somewhat unique in already providing and disclosing, particularly in the United States, more data perhaps than any other sector on -- and particularly data that is actually relevant to assessing climate risk. The problem is that you're -- you have a situation where you have an overload of data, effectively quite a bit more of information but not necessarily information that's usable for investors in this space. And I think there is an opportunity -- one of the things that we've been working a fair bit on it is really starting to figure out how we take, I think as Richard was mentioning earlier, this extraordinary amount of disclosed data, in this case required disclosure, and turning it into meaningful forward-looking metrics that give investors and other stakeholders a clear understanding of the trajectory that these particularly important entities are moving towards when it comes to climate. And I do think there is an opportunity to really develop metrics that focuses on the confluence of factors that make the utility sector so interesting right now. And I should say the ESG, in particular as we reflect on where U.S. utilities are, the thing that makes the ESG scores with utility so interesting that -- is this confluence of -- as Elree said, this confluence of opportunity and need. We see demand from investors in the ESG space, and the utilities are uniquely positioned because the technology cost reductions that we've seen gives them an opportunity to transition in a way that few other sectors can, the electric vehicle sector perhaps being the tip of the spear, the next piece that might be seeing the same transition. And I think clarity in metrics that assess the extent to which individual companies and firms are really moving rapidly to both take advantage of the opportunities they have a monopoly right to and at the same time addressing the challenges and risks they face, which largely for the U.S. utility sector in particular are regulatory in nature, is the opportunity that we're trying to address. And so we're developing a tool that we call the utility transition hub that attempts to integrate this -- some of this information and provide this near forward-looking picture of this particularly important sector in greater detail and available to a broad set of stakeholders. I'm happy to talk about that more later.

Okay. Thank you. Well, turning quickly to what we might see on the regulatory front, you just alluded to that, Uday, and others have previously. I think in the U.S., we can expect some change as -- in light of the new administration and some of the statements that have been made by the SEC and others. But before we get to that, I thought it would be helpful for this audience to hear, just very briefly from Elree, about what's been going on in Europe. Many of us may not be completely familiar with them, but I think on the European side, there's been more work done in terms of trying to establish a common regulatory framework. So I was wondering whether you could just touch on that for a minute to see whether any of that experience could be applicable to the U.S.

Yes. Thanks. It's really interesting because the EU has been at work at this for many years. And certainly, their marquee legislation is actually the sustainable finance action plan that they have used to anchor a lot of the other legislation that has come out. And they see themselves as leaders. They would love to see it exported. Most recently, we see their alignment with China. But the reality is people are interpreting and -- countries and jurisdictions are really interpreting it and trying to achieve different things. And I can talk about that in a moment. But the sustainable finance action plan really has 2 components. One is about transparency, first, to protect investors. So for many years and certainly in the last 3 years, we've seen this incredible wave of particularly retail money going into climate-aligned, particularly climate thematics, retail investments. Probably 80% of the money that we see going into the market right now is -- from the retail side is climate-aligned in Europe. So it's huge. So they want to foster that transparency, trying to protect against greenwashing. At the same time, they're actually trying to accelerate money going into this space. They have very aggressive net zero commitments, obviously, net zero by 2050 but a 55% target in -- by 2030. And so with that transparency, what they're trying to do is they're trying to give more clarity for investors so that they're not caught on the wrong side of a decision. They also are using the EU Green Deal to mobilize capital. So in terms of the finance action plan, it's about fostering transparency. Part of that is really underpinned by the EU taxonomy. Many of our clients or many of your -- the members of the audience will hear that because it's going to impact them if they have a bank that is underwriting some of their loans if they have an investor or a bondholder that sits in Europe. So that EU taxonomy is essentially a dictionary of activities and looking at the emissions level and whether it can be considered green or not. But there's additional legislation that's now starting to kick in. One of them is the SFDR, and that's what investors or asset managers have to disclose in terms of their own portfolios and how it aligns with Paris. They also have the NFRD. So both Uday and Richard mentioned this new disclosure that's coming out. We're trying to get -- across the board, we're all trying to get better harmonization in terms of disclosure. We need the same information, the same metrics at the same time in a format that's consumable. One of the things that markets hate is the opacity. I mean it helps in terms of [ arbing ] the market, but the reality is it can also kill a market. And so the -- you have information asymmetry if we don't have this harmonized data. So between some of the other legislation, they're trying to sort of harmonize that. They're also setting a lot of rules around what you can consider a Paris-aligned or a climate transition index or benchmark. And they're forcing additional disclosures. So that transparency is one core module of what they're trying to achieve. The second one is really about managing risk. So I sit in a bank. And so we see legislature, supervisors, regulators around the world starting to ask us to stress test our balance sheet and our markets' tradings books for embedded climate risk. That's certainly the interest that the FRB and the States and the SEC have but -- as well in Europe, they're starting to ask us to disclose under certain Pillar 3 -- or climate risk under Pillar 3 standards. The EBA is consulting on rules on climate disclosure as well. So first pillar is transparency. Second pillar is risk management. But the third pillar is where they're putting a lot of time right now as well, and that's really about facilitating capital. And it's about that opportunity. And so the EU Green Deal, EUR 750 billion of money that is being pushed into the market to help underwrite sustainable transition. And that's really important because it gives us the ability to structure transactions that derisk because right now, after last year, a lot of our clients are maybe less interested in the high-yield market. But that money is helping to derisk. It's helping to facilitate flows particularly into that renewables sector. I don't know that it's really coming to the States, I have to say. I think it's going to look very different in the States. It's a very different political environment. It's a very different legislative environment. The States seems to be approaching it more from a systemic risk perspective, although we'll see what comes out with the Biden administration's Build Back Better and that whole of government approach.

Thanks, Elree. Any thoughts from the other panelists on what might -- we might see on the U.S. side? I know it's maybe hard to predict, but any reaction to Elree's forecast? Maybe starting with you, Richard?

Yes. So I mean, I think it's -- I think what's happening in Europe is super interesting. I think there's lots of debate but certainly lots of ambition. I think at last count, there are 17 or 18 different taxonomies under development across the world. And so we kind of sit in the midst of what some people call taxomania. Everyone is trying to develop their own green classification system. So I think the way that the U.S. is kind of contemplating this -- and there's a lot of engagement of the U.S. policymakers right now from other governments, frankly, that we're observing. There clearly needs to be some disclosure and transparency in order to guide capital allocation and capital flow both -- well, actually across all kind of aspects of the market, whether it's from companies but also from investors to avoid greenwashing from an investment standpoint as well. And so there -- I'm sure there are lots of discussions happening behind closed doors at the moment. Just some basic kind of views though is that the IFRS, the Accounting Standards Board, IFRS, is actually looking at how you might develop a consistent set of sustainability or ESG standards and metrics. So I think a lot of people are watching that. IOSCO, which is the kind of overarching body that is -- has membership from the SEC and various other groups across the world, is observing that very closely. In fact, the SEC is, along with the Monetary Authority of Singapore, are the co-chairs of that kind of group that is observing how those standards are emerging. So we can expect to see a lot of scrutiny on specific types of metrics that companies might have to disclose, I think, and perhaps where they disclose them as well. So when we look at the disclosures of companies in the S&P 500, about 90% of them actually already created sustainability report and published that quite transparently. Part of the challenge though is only 16% of them actually mentioned ESG or sustainability in their filings. So maybe there's a discussion about where information is presented, how material that information is, what is the definition materiality. And I'm sure there's an opportunity to align around definitions and what is green and sustainable from a taxonomy perspective as well.

Thank you, Richard. So unfortunately, we don't have much time left. I would encourage the audience again to submit questions, if you'd like, to the panel, and we'll be happy to raise them if we can. To -- just in the last few minutes we have, I'd like to switch gears and talk for -- briefly about products and product innovation. So we've seen -- of course, we've seen a lot of activity over the last 5, 10 years with respect to green bonds and green loans, which are products designed specifically to fund a specific, identified project or activity meeting certain requirements. More recently in the U.S., based on the European experience, we've seen some sustainability-linked instruments being more widely used. So those are instruments that are -- allow issuers, borrowers to raise capital and not tie the proceeds to any particular use, but to -- that includes a structural feature most often tied to pricing, so giving a pricing benefit to the issuer if certain targets are met. So I'd like to ask the panelists for their views as to what further innovation we might see on the product side or we would like to see, starting maybe with Uday because I know you've been thinking about this in the context of utilities. And I invite the others to chime in as well on that topic.

Yes. Very briefly, one of the challenges that you see in the real economy with the transition has to do with who bears the risk of transition. And in the case of coal in the U.S., roughly 80% of U.S. coal is compensated through regulated tariffs or long-term contractual structures that leave a ton of that risk with customers and often populations that are least able to bear on them. And what we're seeing is the emergence of financing tools, transition-focused financing tools like rate-payer-backed bond securitization to mitigate some of that risk associated with early plant closure in particular. We're starting to see that in states like Kansas that may not traditionally be moving on issues of climate but are starting to see this as a problem. And on the flip side for -- so I'll talk about transition risk and financing mechanisms to address real economy challenges. Same mechanism is also starting to be used to address physical climate risk in California and perhaps in Texas as well, again rate-payer-backed bond securitization dealing with the challenges associated with California wildfires, Texas, et cetera. And so these -- we anticipate that globally, something like this will need to happen if this transition is to be rampant. We -- our global plant database suggests that excess -- about 90% of coal globally is in a similar situation as utility-owned coal in the U.S. that, that stranding risk is going to fall on customers, and that transition risk needs to be managed. So that's a place where we're hoping to see quite a bit more innovation in the financial sector on a forward-looking basis.

Martin, maybe if I could -- sorry, go ahead.

No. Please -- I was going to ask you to provide -- or comment on the topic.

Okay.

Go ahead.

Yes. Absolutely. I think one of the things that we saw in 2020 was a sustainable debt market that diversified quite a bit, previously had been concentrated in green bonds. Last year, due to COVID, we saw about $140 billion of social bonds issued as well. But one thing I think we should keep an eye on going forward is we're seeing countries that are developing net zero carbon commitments by mid-century. I think it's fair to say it's going to be difficult to do that with green energy alone. And so I would look to the transition finance market, sustainability-linked instruments included, to see how it is we mitigate emissions from harder-to-abate sectors, metals, cement, agriculture, where traditional green financing isn't as practicable. I think that that's going to be an exciting market for us to follow going forward. But I think it's fair to say that the sustainable -- that market will continue to grow, but it will continue to broaden in terms of the scope of activities that are included within it and the scope of issuers that are issuing as well. And that will include governments, corporates, municipalities, securitizations, obviously, we've seen a lot of as well.

That's great, certainly room for growth and innovation. So that's an interesting market. So I think that's all the time we have, unfortunately. I would like to thank our -- each of our panelists for participating and providing their comments. I think it was a good discussion. And for now, I think the conference will transition into breakout sessions. So I would like to invite you to return to the auditorium and click on the breakout session you would like to join. Thank you again.

Great. Thank you.

Thank you so much.

Thanks.