Moody's Corporation (MCO) Earnings Call Transcript & Summary

Thank you very much, and appreciate the invitation to speak with you today. Take care.

Take care.

Good afternoon, everyone. My name is Judah Sokel. I'm from the Business and Information Services team, and I'd like to welcome everyone to the Ultimate Services Investor Conference. This is the last session of the day. Hopefully, it's been a productive day for anybody who's been with us the whole day or anybody who's joining us just for this panel. It's an exciting panel. It's an addition to the conference this year, getting to speak to really accomplished professionals from different avenues of Wall Street, really, of the financial services profession, all who are really experts in ESG and ESG integration specifically. So I'm excited for the opportunity. And I think that I'm going to start off by giving each of the 3 of the panelists an opportunity to introduce themselves, explain where they work, what they do, what their role is within the broader ESG ecosystem. So why don't we kick it off with Martina, please?

Sure. With great pleasure. Thanks a lot, Judah. My name is Martina Macpherson. I'm the Senior Vice President for Strategic ESG Engagement in the ESG Solutions Group at Moody's. And it's a newly formed group that sits side-by-side with the credit ratings agency. And we are actually aiming to establish new ways to integrate ESG information assessments, ratings, generally insights via and with the affiliates. You might have heard and know that we have acquired major stakes in Vigeo Eiris and Four Twenty Seven over the course of last year. And together, we are working on actually establishing new solutions for ESG.

Okay. Terrific. Martin, why don't you kick it off next?

Thanks for having me Judah. Martin Jarzebowski, Director of ESG and Responsible Investing for Federated Hermes. In that capacity, I lead the Responsible Investing office, which is in charge of ESG integration across all 30 global investment teams across all asset classes, equities, fixed income, money markets, privates, alternatives and also being able to integrate our active engagement and stewardship division. So we have over $600 billion in global assets under management and also $1.2 trillion in assets under stewardship.

Okay. Great. Hugo, please?

Thank you. Hi, everyone. I'm the Head of ESG and Sustainability Research within JPMorgan EMEA Equity Research. The role in the ESG and sustainability research team is actually a new team within JPMorgan. It has been created when we arrived with my colleague, Jean-Xavier Hecker at the beginning of the year, and we have a double role, which is, on the one hand, to drive specific dedicated ESG research. But also to drive the ESG integration process within the equity research department.

Okay, great. And might I add that certainly, since your arrival along with your team, the ESG has definitely risen in terms of the consciousness of equity research here at JPMorgan. So appreciate the partnership.

I'm going to start off with a question that is really for all 3 of you. And that is really maybe about the role of ESG in general. In terms of investment decisions, how has the role of ESG coalesce over the past 5 years? How do you envision the area continuing to evolve over the next 5 years? I know it's a broad, big picture question, but you can take it in any direction you want and give the audience your sort of a little bit of your vision into how ESG fits into the ecosystem? Maybe we'll go in reverse order from the introduction. We'll kick it off with Hugo and give you a chance to speak.

Sure. Thanks. Let's take concrete examples. So let's take this conference. There's now an ESG panel. It's brand new. And basically, at every single conference you can join, there will be an ESG panel today, which was definitely not the case just 5 years ago. Another concrete example is the global ESG conference we organized at JPMorgan in March. This year, the size of the conference will significantly increase. And in fact, it will be one of the largest conferences outside of the U.S. for the firm. So it's definitely something very high of the agenda. Finally, as I mentioned, the newly created ESG and sustainability research team is also a sign of this drive within the firm. And I think it's not limited to our role, but across the firm. So what was just 5 years ago, a niche market is definitely mainstream today. And it's also something that you can acknowledge when discussing with PMs, with CIOs or Head of ESG. Interestingly, the health crisis, the COVID crisis has not impacted this, let's say, importance of the ESG integration agenda, and it's still a top priority for firms. Now regarding the question of where we will be in 5 years, I think from something that is mainstream, it is actually the mainstream that will be ESG. What I mean by that is that a majority of firm houses and actually firms, will, in my view, be actually, to some extent, integrating ESG criteria. That will be the result of regulatory changes, especially in Europe, but also market forces of the U.S. It is not surprising. Let's take a step back and acknowledge that as a global society, we are facing existing [shore] threats in terms of sustainability, climate change, but also biodiversity losses. And this is -- will have direct impacts on the financial system. So obviously, this will be increasingly integrated into -- by market participants, and that's basically the way forward.

Okay, great. Martin, how do you see the market having changed over the past 5 years? And where do you see things going?

Yes. I'll dovetail on what Hugo just elaborated on. And so if you go back historically, I think most people, especially in the U.S. markets, the associated ESG is this sort of all-encompassing acronym and label, but many people just assumed that it was very much exclusionary in nature, right? So most people were familiar with SRI or Socially Responsible Investing. Those are the early origins that have been around for decades. Then you're starting to see this transition towards other types of products being developed. So you'd see something that's a little bit more impact oriented. So instead of excluding particular sectors or industries, now you're seeking to generate a measurable environmental or social benefit. Then you're starting to also have this handoff into exactly what Hugo described as being a little bit more mainstream. So when you think of ESG integration, if they think of existing products that are now weaving environmental, social and governance considerations into the DNA of the investment process. It's starting to become a natural extension of that primary research that they're doing in order to mitigate risk. So where I think all of this is starting to head is that you're going to see, obviously, greater demand changing consumer preferences from all angles. There's certainly going to be more of a regulatory dimension that's not just occurring in other regions. That's also going to be coming over the pond, into the United States. And so you're going to see that convergence begin to occur, and people are going to start thinking about ESG also not just something that they're doing within a certain slice of their portfolio, meaning, right now I think most people default to ESG and they think about it as something associated with proxy voting and very equity or shareholder-centric. And I think that the demand, especially in the U.S. is now going to start to open up into the multiple asset classes. So the pendulum is going to naturally swing from just something that people associate with equities to all different asset classes, whether it's fixed income, credit, cash management, money markets, alternatives, hedge fund products, private equity, real estate, infrastructure, you name it. It's not going to be just a slice of everyone's portfolio. It's going to comprise holistically the entire portfolio for most consumers. And that's institutional investors, such as large pensions and endowments as well as high net worth retail investors as well.

Okay. Great. Then Martina?

Sure. Maybe I just can give you a trajectory here of the change by talking about my own story. I mean I've been in this market now for around 20 years on both buy side and sell side. And when it's literally started as socially responsible investing, we talked around USD 4 trillion committed towards the principles of responsible investment in 2006. And now ultimately, in 2020, we're talking about USD 80 trillion represented by 3,100 plus signatories. So that was the latest figure somewhere in Q3 of this year. And I think some of you might have seen the latest announcements by US SIF, the Sustainable Investment Forum in the U.S. The announcement came out just earlier this week, that sustainable investment assets are hitting something like USD 17 trillion and that's up 42% since 2018. So that number in itself, I think, speaks volumes. And that is, again, as Martin highlighted, not constrained to the equities side. I mean the European sustainable fund market generally has reached something like 882 billion of assets under management, again, against the backdrop of this COVID crisis. And generally in this context as well, this is not just something that we're seeing in active investing, but also in passive investing. We're seeing this across asset classes, equities, as I highlighted as well as fixed income. Again, we just recently came out with some research on the Moody's investor side, estimating that the sustainable bonds market might reach up to USD 425 billion this year. Again, giving you a reference benchmark roughly 10 years ago when the first climate awareness bonds were launched. We talked about a segment that was under $10 billion of issuances in that first year and the years to come. So generally momentum across asset classes and ultimately, a stronger focus on product innovation. And that brings me to my last point, what do we see in the next 5 years? So clearly, there will be more innovation around ESG products, active and passive, especially in the passive space, when we see ETPs, when we see listed futures contracts, there is this sort of shift that's happening, and ESG is at the core, together with hybrid and factored strategies. And then ultimately, we see the shift thematically from climate to social. And ultimately, as Martin highlighted towards impact. So there are multiple opportunities to explore. And I think it's going to be interesting to see when, how that's going to take us from a global perspective, given that not only the European and U.S. markets are focusing on this particular area. I just came off a conference in Asia Pacific this morning. I spoke at the [ IKMA ] Global Conference in Japan a week ago. And the focus on sustainable investment strategies and sustainable finance more broadly in APAC is enormous.

It's great, well, that was really great. So I'm going to start off with a question for Hugo. How do you use the ESG scoring and rating services that are out there? There's many and I'm curious, I'm trying to understand how you use it from your -- in your role whether there's a market leader in your eyes. And really, generally, how important is it for a company to have a "good" ESG score, good ESG rating?

That's an excellent question because that's something that comes up every single time we discuss the ESG. Basically, it's an easy question to answer for us because as a sell-side research provider, we don't see any benefit to provide these ESG ratings to the buy side, which already have access to it. So basically, we don't use it as per se. What we do provide otherwise, is what we call ESG, too, which is our proprietary ESG scoring system, which was built by the JPMorgan quantitative team and which is based on for 1/3 on, let's say, standard ESG rating and 1/3 for the momentum of this rating and 1/3 of fast-moving data, which is [ wet risk and Arabesque]. So basically, the angle of this product is to provide investors who are interested in a purely quantitative approach to alpha generation with ESG data as a product ready to use. Now on the other hand, let's say, on the more fundamental side, what's the benefit of an ESG rating? An important point is that most investors have a proprietary ESG rating. So basically, they will buy the data from different data providers, such as MSCI and Sustainalytics, which are generally accepted or seen as the 2 largest players, but also from different data providers, and there's been a lot of consolidation over the last few years, and Moody's has been part of it. Most recently, Deutsche Börse which has been taken over just this week, ISS [ ACOM ], which is a historical player. And so it's really important to envision the diversity of methodologies and also the diversity of use by investors of this different ESG rating. An interesting point that has already been raised by Martina is passive. On the passive side, there is an important, let's say, impact of ESG rating because ESG rating providers are directly using these ratings to build ETFs or passive products. And so to some extent, you do have some kind of a threshold in terms of ESG rating to which, for certain providers, to be included in this type of products. And it's an important point because if you look at the detail of the ESG investment flows in the U.S., passive investing is actually a significant part of the market. I think the latest Q3 Morningstar numbers were stating 80% of the total flows were into passive products in the U.S., so it's significant. Final point on the overall correlation between ESG and, let's say, performance, there's multiple studies that show that and each data providers, obviously, has its own studies because it's a specific methodology, but there, overall, a clear correlation between the ESG rating and the long-term performance of the firm. So that's, let's say, the investment case for using these ratings.

Got it. The next question is for Martin. As being on the buy side, I'm curious, what are some best practices in terms of ESG integration that you see for an asset manager today? How has that evolved? And maybe what specific capabilities differentiate leaders in this ecosystem relative to the mainstream?

Yes, absolutely. I think there's actually a very clear-cut battleground that's happening in the marketplace today. And that's between proprietary versus outsourced. So what I mean by that is you're seeing market leaders on the buy side, who have proprietary in-house ESG capabilities versus the mainstream that Hugo alluded to, which are simply outsourcing all of their ESG research to third-party data providers. And so the reason why you're seeing that line in the sand sort of start to differentiate the leaders that are doing something, which I would characterize as being very much authentic in nature, it's because you're creating your own proprietary in-house data analytics. So you're looking at creating a framework where you have issuer-level tools, portfolio-level tools. You're able to really start to dissect all of the third-party data vendors, identify the ones that are most efficacious in different environmental, social or governance dimensions. And then this way, you're almost creating a multifactor model for all the quants that are listening because then it allows you to get a very nice profile of potentially where you're seeing ESG momentum, where you're seeing degradation. And in reality, at the end of the day, all of our fundamental investment teams, they're able to utilize that in a bit of a dashboard mechanism just to start the due diligence process. And the reason I say that is because most of the third-party data providers, you got to remember, they were designed for corporate disclosure aggregation and not alpha generation. So being on the buy side, you have to take that information and harness it somehow and then being able to identify mispriced ESG risks in the marketplace. So how do you do that? Well, now you start to think about creating your own in-house materiality assessments. When you see different investment houses, they're typically organized by sector and industry. They have teams. Whether it's centralized or kind of team by team specific, for the most part, you have portfolio managers and analysts that have great expertise in a sector, in an industry. You have to focus on what's relevant and financially material from an ESG risk and opportunity standpoint in those particular areas. And then the final piece, which I like to call ESG 3.0, I think this is definitely where the puck is headed, and that's active engagement. And so what I mean by that is a lot of people in the marketplace, they hear the word engagement or they hear stewardship, and they think of it, again, as very equity or shareholder-centric. It's something that most people equate with proxy voting season. And I always say, ESG is not seasonal. It's not a letter writing campaign. So the way that you see a lot of leaders in the space approach it is by having a dedicated in-house division of ESG subject matter experts who are also organized by sector and industry, and they are directly engaging with thousands of corporate issuers around the world, specifically working with the Board of Directors, with the C-suite in order to keep their finger on the ESG pulse of where that company is headed, right? So you want to see depth and breadth of in-house ESG subject matter expertise. You want to see proprietary analytics. You want to see databases that go back a long period of time so that you understand very concretely where these companies have been, where they're going. You got to go direct to the source in order to really have a comprehensive view. So at the end of the day, I think what you're going to see from responsible active managers is that there's this cross-pollination, meaning, you have huge insights that come from years of fundamental research. Now you're creating an in-house division of these ESG subject matter experts who are directly engaging to bring that ESG vantage point, right? So it's best of both worlds. At the end of the day, you have to answer the question of, are you able to identify mispriced ESG risk? And then number two, are you being fairly compensated for the ESG risk that you're taking in any one of the issuers that you're investing in? And I think that, that's what you're going to start to see or players that have those in-house proprietary resources just simply stand out. Because just like Hugo alluded to earlier, if you continue to have proliferation of passive products, and they're utilizing a very specific third-party ESG data provider, well, where is your comparative advantage if you're utilizing exactly the same information? It's MBA entry classes, you have to do something different and doing something proprietary is what's going to make you stand out from the crowd.

Makes a lot of sense. Martina, a question for you. We often just joined together these 3 letters. ESG, they just click together, but they're actually quite distinct, obviously. So how do you see the unique role of each one of these 3 components in the ecosystem?

Very fair assumptions. I mean, absolutely, we started this discussion maybe around some of the fundamentals when and where management and governance are concerned. Also within, for instance, credit rating institutions, and that's obviously a G fundamental that runs across many of the current equity fundamental analysis points. In the ESG space, we started the journey on the E side, up and foremost with climate change mitigation and adaptation. Literally, the COVID context, but even before that, is slightly shifting this picture. And we just probably all saw the recent letters from Larry Fink at BlackRock, mandating for stakeholder capitalism. And this is no surprise. The business roundtable and other influential bodies and organizations over the last 18 months in particular, have started to shift from ultimately E to E plus S. I highlighted the trajectory is around sustainable bonds, where we see the shift within asset classes. In this case, green bonds or sustainable bonds with a large representation for the first time this year of social and sustainability bonds, but we are seeing that generally also when and where ESG criteria assessments, methodologies and ultimately, then decision-making is concerned. So the ever-increasing complex picture that we are looking at is now allowing us to move away from purely quantitative information around climate change, risk and data and to look into the more qualitative implications when and where S is concerned. And this is making the S dimension so complex because you could look at macro and macroeconomic and societal implications when you talk about S. You could talk about social externalities and the stakeholder management perspective when you talk about S and that ultimately could translate into multiple criteria when and where, for instance, human rights and labor rights are concerned, where human capital management and D&I practices sit and fit in, when you look at COVID in the context of health and safety, security and well-being or broadly as well, other areas, supply chain management oversight and/or community engagement and impact. So ultimately, one thing that is becoming clear, though, that you can look at these and you must look at the different pillars, E, S and G, but also identify areas of interconnectedness, especially where S and G are concerned, look at human governance. Virement, that's a convergence of the S and G pillar or pillars. And it's interesting, I highlighted the stakeholder capitalism work. There's also more work done by The World Economic Forum in this context. They actually came up earlier this year with SDGs, that's the sustainable development goals related to data and metrics. And they are actually focusing on people, prosperity and principles of governance. Again, the S and G dimensions as well as the planet. And just to highlight in that context very briefly, we also looked at bringing 2 of the 4 in the COVID context, the interconnectedness of S and G and SDG-related information. And we made this quite freely available at our end. You can look up our COVID-19 data set that tries to explain and express and assess when, how companies showcase an element of social resilience and future fitness. And I think these are all starting points. We have seen that multiple providers are shifting their efforts from ultimately E, to E plus S and G. And I think more of these fundamentals will become better understood also with the developments at the policy end. You might have heard or seen that the EU's technical expert group is expanding its current taxonomy and it's just calling together a group of experts to actually establish a social taxonomy. And again, these type of developments will be fundamental game changers.

Great. We've got about 5 minutes and we have so much to touch on. So maybe we could run through some of these questions. Hugo, I have a question. The U.S. is playing catch-up to Europe in terms of just understanding the importance of ESG and integration. So what do you view as the best practices that should really gain traction in the U.S. quickly amongst corporates? Is it ahead of sustainability? Is it corporate sustainability reports? Is it ESG rating? I'll let you respond.

Okay. That's a fair point. Actually, all of the above. And I think it's a very interesting point that Martina just made. Increasingly, ESG is about being a holistically more resilient, but a sustainable company. And how do you manage that? You manage that by having a good social and environmental performance and to manage your governance to adopt and integrate these risks and opportunities. So again, I will stress the holistic nature of ESG performance and that's going to be increasingly true in the future as we look increasingly at social contribution to the SDGs but also at more specific topics in terms of cleantech opportunities, et cetera, that do also raise some kind of social transition questions to some extent. So what will the U.S. do? It's a very interesting point. So far, the most significant trend in the U.S. has been the massive adoption of SASB. Just over the last, I think, a couple of years, the number of company reporting according to SASB standards has increased by 400%. And the simple -- I mean, one of the key driver of this change has been BlackRock's decision to push SASB standards in its engagement with companies. So here, you can see that one of the most important driver of change in the U.S. has been investor engagement and involvement towards more ESG. And that's a fundamental difference because what's been driving the ESG market in Europe has been historically regulation. And that is something that also Martin has highlighted earlier, as it may come to the U.S. at some point. And actually, we recently commented on what would the ESG investing market could expect from the Biden-Harris administration. And we believe that the simple fact to have a more, let's say, broader approach to fiduciary duty in the U.S., which would allow U.S. investors to have a more impact-driven approach, that would be a revolution for the U.S. market. And that would, to some extent, bring it closer to what is going on in Europe with a notion of double materiality. So just to finish on that point, the SASB as a reporting framework is entirely focused on the financial materiality of ESG issues. It means that you limit the scope of your analysis to what is actually impacting or likely to impact the valuation and business model of companies. On the other hand, what the European Union and impact investing is doing is looking at the sustainable materiality of topics the sustainable materiality of topics is the actual environmental and social impacts, the real-world impacts of your investment. And that's a fundamental difference, and we are convinced that impact will be increasingly accounted for in the U.S.

Great. Got about 2 minutes. I want to try to sneak in a couple -- 2 more questions. So the first one is for Martin. Just in terms of ESG and the role of ESG in capital markets, it seems like IPOs are increasingly telling an ESG story these days that you sometimes find an ESG lens switching from risk mitigation to almost being a source of demand. I'm wondering what resonates the most in the buy side.

Yes, absolutely. There's certainly a proliferation of the messaging around ESG for IPOs. You're seeing the same thing for SPACs. So broadly on a capital market standpoint, I would lump that also in with sustainability-linked or green bonds that Martina brought up earlier, right? There's a huge proliferation there. So what I think is very interesting is any one of these new issuances, let's just call it that, they -- to be -- to have an ESG component within the narrative, then they're certainly on trend. But from the buy-side's perspective, I find it very interesting when you see a sustainably-linked bond or a green bond or an IPO come out with a very, very strong ESG message. But then at the same time, you look at the dichotomy between that message and maybe how that entity is actually rated, right? So there's a very interesting development in the sense of you see these new green bond issuances, whereas the parent, the sponsor, the obligor of that new insurance actually has a very, very poor ESG rating. So you got to be able to think about this in a 2-step function. It's not just the security, it's not just the label or the acronym that someone is painting on it. You want to see the authenticity behind it. You have to really understand the entity and the issuer, what kind of ESG trajectory are they on? Are they thinking about what's relevant and material? Are they disclosing it? Do they have a structure in order to be able to measure all of this information and to manage it effectively? Those are the types of things that we look for when we're directly engaging with thousands of corporates around the world, all based around that kind of an ecosystem.

Got it. There's so much more to talk about. I wanted to talk about reporting frameworks and maybe just the next frontier of excluded investments. But unfortunately, we are at the top of the hour, it definitely flew. And I want to thank each one of you, Martina, Martin, Hugo, for participating in this panel. And thank you to the audience for joining us well. I'm Judah Sokel, and thank you for attending the Ultimate Services Investor Conference. We'll see you in 2021, hopefully, in person.

Thanks for having us.