Morgan Stanley (MS) Earnings Call Transcript & Summary

Thanks, Debbie. Hi, everybody. My name is Rian Pressman, and I'm a senior analyst on the U.S. Bank team at S&P Global Ratings. Environmental, Social and Governance, or ESG factors, have become a topic of growing importance to the investing community. Today, we are joined by 2 industry experts that will guide us through a discussion of ESG management and investing. Before we start the panel discussion, I would like to take a few minutes to discuss ESG initiatives at S&P and how we are working to better communicate to the marketplace how we incorporate ESG factors into our credit ratings. On the first slide are the major components of our brand criteria in which we embed ESG factors into our analysis. For example, quality of governance throughout a banking system would be factored into our BICRA assessment. Business concentrations in geographies that are more prone to natural disasters or exposure to lending activities that may be socially sensitive are factored into our business position assessment. Future losses because of the impact of climate change on loan or investment portfolios is factored into our risk position assessment. On the next slide, looking at our portfolio of 105 rated banks in the U.S. and Canada, we believe about 10% of institutions have a greater sensitivity to ESG factors. We conducted this analysis concurrent with the release of our first U.S. and Canada ESG report card, which was published earlier this year. Unsurprisingly, we determined that governance factors play an outsized role in driving credit ratings. Social and environmental factors tend to be less relevant and come into play with higher risk consumer lending or concentration in energy lending. On the next slide, I would like to turn away from credit ratings and introduce a new non-ratings product at S&P. ESG evaluations were rolled out in the corporate and infrastructure group last year and are currently being introduced in FI. The goal of the ESG evaluation is to provide an independent opinion as to how ESG factors impact all stakeholders in terms of ultimate financial impact. Here, we show the building blocks of our ESG evaluations, the risk atlas which calibrates both the ESG factors by industry and is a starting point for the scoring on these 2 factors. Note that banks are lower on the spectrum, which implies lower risk, while natural resource companies are the highest. We also calibrate the G factor, but by domicile of the company rather than industry. On the next slide, we show a graphical depiction of our ESG approach, which is pictured on the right. The approach combines an analysis of the ESG profile with something we call preparedness. For the ESG profile, we assess an institution's exposure to observable ESG risks and opportunities, and its ability to mitigate and manage those risks. For the preparedness scoring, we can adjust the profile score upwards or downwards based on our evaluation of an institution's ability to anticipate and adapt to a variety of long-term disruptions such as those posed by the risk of climate change. On the next slide, we show the scoring of ESG evaluations completed up to midyear 2020. Note the variety of industries and we expect to add a number of banks to this in the near future. Now I would like to introduce our panelists. Andre Bertolotti is the Head of Global Sustainable Research and Data at BlackRock. He is responsible for establishing and providing leadership in creating a platform ESG research capability and supporting sustainable investment solutions across the firm. Audrey Choi is Morgan Stanley's Chief Marketing Officer and Chief Sustainability Officer. As Chief Sustainability Officer, Audrey oversees Morgan Stanley's global efforts to promote sustainability through the capital markets. Welcome to you both. Before we kick off, we have a poll question for the audience. So here is the poll question. How do you expect the COVID-19 pandemic to impact the pace of adoption of ESG principles at U.S. financial institutions over the long term? Choice A, the pace of adoption will increase; Choice B, the pace of adoption will decrease; Choice C, COVID does not impact the pace of adoption; or Choice D, COVID will temporarily increase the pace of adoption, but not for the long term. Okay. Great. Well, thank you, once again, everyone, for joining us. And we're going to go ahead and go to the first question.

So we'll go first to Audrey. Why has ESG become so important? And what have been the factors driving increased focus from both banks and investors?

Well, good morning, Rian, and thanks so much for having us. It's great to be with you today. I would say there have been at least 3 major categories or reasons why ESG has grown so much. One has really been investor interest; two has been increasing awareness of the impact that it can have on both performance and risk management; and thirdly, with the societal expectations. If you think about the evolution that we've seen. So at Morgan Stanley, admittedly, we were very focused on the space quite early within large Wall Street firms. We actually started our global sustainable finance group back in 2009. Really premised on the conviction that although it was small at the time -- at the time, sustainable investing accounted for maybe 10% of the market. And it was predominantly face-based institutions, often looking at negative screening, we believe sustainable investing would really become mainstream over time. And what we've done over the years is really trying to take the pulse of investors. And what we've seen, Rian, over that period of time is a real evolution, where when we did our first poll, we actually saw that 70% of investors said they were either very or somewhat interested or at least intrigued in sustainable vesting. We've seen that really grow from 71% to 75% to 85%, and it is now 95% millennials are not only somewhat, but really passionately interested in sustainable investing. And they really -- millennials and women all along sort of led the way in terms of interest growing. What you've seen with that is an extraordinary increase in assets under management. Again, when we started at Morgan Stanley in 2009, there was about $3 trillion in the U.S. under sustainable investing mandates of some type. The newest numbers out from U.S. Fifth just earlier this week show it's now at $17 trillion. That's more than 1 of every $3 of professional management in the United States. And globally, it's well over $30 trillion. So you see this huge surge investor interest. I think, one of the reasons you've seen the incredible acceleration, especially recently, has been because the data has increasingly been there to show that thinking about environmental issues and social issues and governance issues, are not sort of extra financial issues as they want or believes to be, that were sort of lovely, but then really are core to earnings. And I think, frankly, the fact that S&P and other rating agencies have started ingraining sustainability factors into your ratings is critical to that movement, right? Because it really shows that it's material to earnings, could absolutely affect valuation, both positively and negatively. And along the studies that we've done at Morgan Stanley out of the Institute for Sustainable Investing, have focused on precisely that, where we've seen that over time, sustainable investing, integrating ESG into sustainability actually cannot only reduce beta, but also increase alpha, and happy to give you some of those in detail. And then lastly, I would say, the broad category that I'm sure we'll go into more around societal expectations, not just in this 2020 sort of moment, but really, as a result of many factors that we can talk more about in terms of technology and transparency and accountability and convergence of media, there is a much higher expectation from whether it's an individual consumer or the largest institutional investors in the world, to really understand what is the full impact across the value chain, across the community of a company's products and services. And so all those things, Rian, I think it really combined to have this large, growing, swelling interest by investors, increasing proof that it actually does pay and increasing interest to maintain even more insights and accountability around it.

Excellent. Audrey, thank you. Andre, what's your take on this? Why has ESG become so important? And how do you explain this increased focus we see from banks and investors?

Absolutely, Rian. Thank you for having me on the panel. To build up on what Audrey's points have been, from the investment side, from the asset management side, there's been an increasing awareness that sustainability is a key component of long-term investing. And that is a focus we see increasingly from our clients, the idea that you have to be accounting for future risks and opportunities that are beyond sort of the visibility that traditional accounting measures are giving. Investors are also asking for a better alignment of their investments and their portfolios with their long-term views. So this is creating a demand, a demand to have both risks and opportunities considered in portfolios across asset classes in equity, fixed income, alternatives, et cetera. And there's also an awareness that this is not a cyclical trend. So we're not in a sort of in a swing now from traditional to sustainable, and we're going to go back to traditional. But this is going to be part of a shift. There is a consumer shift and awareness from new investors. Everybody talks about the millennials coming up, looking for more green and sustainable investing. But there's also an awareness that there are some megatrends that are occurring that are really sort of a one-way street. We talked about climate change, and we'll have more on that later on the panel, and sort of changes in energy and technology and regulation, consumer preferences that are pushing us in the direction of thinking about long-term investing from the point of view of sustainability. And all of this is accelerating the trend that was a smaller part of an investor's sort of landscape for investing, but it's now becoming with the mainstream. And the numbers that Audrey mentioned are just going to increase, and it will become part of table stakes for future investing and future analysis of opportunities.

Okay. Excellent. Thank you very much, Andre. Before we go to the next question, let's show that answer to our poll, our audience poll. Okay. So it looks like the winner is the pace of adoption will increase. A distinct minority believes it will decrease. It looks like the second most popular answer was there would be no impact. So Audrey, I'll pose a similar question to you. How do you expect the pandemic to impact the pace of adoption of ESG principles? And how has the pandemic, as well as the death of George Floyd and racial justice protests, change the way companies are managing social risk?

Yes. So look, I have to say I would tend to agree with the respondents who said -- answered A there, for a number of reasons. I mean, first of all, as we said, this is not just a 2020 phenomenon, right? The growth that we have seen and sustainable investing in ESG has been steady. It has really been accelerating. So really, we really are in this hockey stick moment. What's interesting about this year, in particular, when the pandemic and the shutdowns first started happening, I've got a lot of initial comments from people saying, "Ah, I agree." Everyone's just focused on the disease, the sustainability stuff has got to get put on ice place for a while. And it only took about 2 or 3 weeks before people start to realize, oh, wait, this actually is a sustainability issue. This is like -- this is kind of what you guys have all been talking about for this whole time, haven't you? And then when you start having the racial awakening and [indiscernible] now on George Floyd's murder, I think people understood with an even greater sense of seriousness and real rolled up emotion some of the social impacts, right? And then when you look at this, when you step back, what we are seeing is the 2020 is not just a cascade of a lot of bad things happening all at once. It really is a confluence. We're seeing the confluence of the toll of climate change, of systemic inequality and how all of these things are coming together, right? It is absolutely no accident that we are seeing that the communities hardest hit by COVID are predominantly poor communities and predominantly communities of color who already have access to more challenging health care, education and living conditions. It is also no accident that we're seeing that globally, in terms of impactful climate change, that again, the severest impacts are felt by communities of color. But it's also no accident that we're starting to see in this era of climate change that we're also seeing -- effectively, we -- with climate change, when you've got population growth, warming temperatures, increased density of people living -- people living closer with wildlife, all of those things make for an incredibly hospitable global atmosphere for infectious disease, right? And if you look at -- actually Morgan Stanley Research did studies around climate change. And if we continue with business as usual, by 2050, we will see an increase of an additional 1 billion people on the planet exposed to tropical diseases like Yellow Fever, Malaria, Zika, all these tropical diseases that these -- that populations are currently not supposed to be, will be another 1 billion people exposed to those. Even if we do pretty Herculean efforts and align as a globe to the Paris Agreement and limit temperature changes to 2 or even 1.5 degrees, we are still -- we are going to be able to limit that exposure to additional infectious tropical disease to only 500 million more people that are exposed to those of disease today. And those people are going to be predominantly in Europe and North America. And so I cite that just as 1 example to say, what we're seeing right now is this incredible confluence where climate change is affecting our environment. It is making it a more, unfortunately, hospitable place for infectious disease. And those diseases are touching down and having more dramatic and more fatal impacts on communities that have already been suffering from economic inequality and systemic social injustice. So I think the -- with that kind of reckoning and awareness, I think it's very -- that is something that we are not going to be putting back in the bottle. I think that it has very much been an accelerant to people understanding the S behind ESG as well as the E as well as the interconnections. And I think we've seen it really also in the increase that we've seen in the ability and the interest of investors to apply their investments to align with the social goals. I'll give you just 1 quick example as 1 of the things we were able to do in April, is to work with an Italian institution. And of course, they were very early on in being affected by COVID. We were able to do the first ever COVID response by EUR 1 billion focused on COVID relief. Since then, we've been able to work with other leading organizations like the Ford Foundation, tapping the capital markets for the first time ever, [ for $1 billion ] also for COVID and social justice relief. So I think that these are very much trends that are secular. In terms of the investor interest that are not going to be diminishing, and if anything, we'll just continue to be accelerating because, unfortunately, the underlying drivers of climate change and social equity issues that we have to address, unfortunately, those drivers are just increasing and actually getting more significant as those issues converge.

Excellent. Thank you, Audrey. And Andre, what would have been your answer to that poll question? In other words, how do you expect the pandemic to impact the pace of ESG principles throughout the banking and investment industry? And regarding social risk, social-to-social justice demonstrations, et cetera, what do you expect to be the evolution there?

Sure. I would also agree with the whole outcome that preexisting trends are accelerating. And what we saw with COVID is a number of components, all coming together from -- the investment point of view, what we saw is that companies that had a stronger sustainability focus pre-COVID showed more resilience in their stock price and in their valuations. Here is where investors were looking at the ability of the companies to weather the crisis, but also to come out of it stronger, stronger than competitors. And it was a host of components about the strategies, their alignment, the way they we're managing their business. And this resiliency that we've been speaking about for a while sort of was evidenced very strongly, and continues to be evidenced in this time. So the trends are continuing. Those trends of sort of economy shifting more to a service-based away from an industrial-based where actual employees and people, customers, the stakeholder community becomes more important. That trend sort of came to life. We saw a decline in economic activity that impacted demand for energy and how strong that impact was on the fossil fuel industry. We saw even the futures prices decline to unseen-before levels during the pandemic. And that is sort of a trend that was accelerating recovery. We're talking about the realignment of commerce, everything going online, the impacts to the transportation and the hospitality industries that may or may not fully recover if we have now a new model or some type of a new equillibrium that's going to get established. This is something that at the beginning, of course, in the heat of the crisis, late March, the focus, of course, was on the immediate need for infusion of cash and sort of remediation of that problem. But then long term, the realization came out that, look, we're still facing these issues that were before the pandemic that just got accelerated. The environmental component remains strong, and we've seen interest from central banks to keep their focus on the climate, climate disclosure and sort of requirements they're going to be asking their member banks. We've seen clients -- institutional investors maintain their focus on carbon emissions and the carbon component of the portfolios. And now, we've also seen an increasing awareness and sort of interest in the social component, particularly from the stakeholder. So the term stakeholder capitalism and stakeholder interest is now a more common term in our industry, that we understand that there is some broader community around a company that needs to thrive in order for the company to remain viable and remain competitive.

Okay. Thank you. One thing that I didn't hear as a focus of your answer to that question is the potential change of administration that is likely to occur in January of next year. Audrey, what do you see as being the impact of that change?

Well, look, I think that it is -- well, certainly, I don't have the policy crystal ball. But look, I think it's very good that the Biden administration will have a different view on climate change, right? The Biden administration is focused on the science of climate change, has really signaled that they -- I would expect that the U.S. will rejoin the Paris accords and will be we looking meaningfully at that climate science and how that needs to be affected in terms of both policies and regulations. I think though that -- I think that what we're seeing though is really that while, of course, it is extremely important what the U.S. does, this really is a global movement. And I think, as Andre was saying, among the reasons why I think the globe is just going to be adopting and investors already are focused on adopting a fundamentally, but word-meaning strategy around climate change and really how do we prevent the worst of it, how do we rightsize our processes and our businesses to really to deal with it, is that it is such an enormous global impact, right? So we are seeing through the NGFS, the Network for Greening the Financial System. I believe it's more than 75 central banks are already members of that, focusing on how to think about climate change as a central part of fiduciary risk management. I know that one of the S&P speakers earlier today also was talking about Department of Labor guidance. I think that what we will see, I think, is very much consistent with how the markets are acting and what investors, as they think about the future and as they think about risk management, how investors are looking at climate, which is that it is not a thing of the future. It is very much a thing of the present that is absolutely material to earnings. The SASB, the Sustainability Accounting Standards Board, that I've had the privilege of serving on the Board for a number of years now, did an analysis. And it shows that already today, something like 93% of the value of the U.S. equity markets is exposed to climate change risk that is not reflected in today's current financials. I think that we were increasingly, from the governments around the world, including the U.S., going to see an increased focus on making sure that as a part of prudent management, of businesses and of investments, the climate change risk among other risks is going to be materially reflected.

Thank you, Audrey. Andre, on the investing side, any change you would expect given the likely shift of administration?