MSCI Inc. (MSCI) Earnings Call Transcript & Summary

All right. Good morning, everybody. Thank you for joining us here. We're very pleased to have with us MSCI's CEO, Henry Fernandez. And obviously, the topic of the hour is everything climate especially after the COP26 meetings. For those of you who don't know me, my name is Manav Patnaik. I'm Barclays' business and information services analyst. I obviously cover MSCI, but we've been doing a lot of work around ESG and climate as well, so it's a real pleasure to have this opportunity to host Henry. So Henry, thank you so much for being here, firstly.

Thanks for having me.

Yes. So just for the audience, I have some questions obviously that I'm going to run through. If you do happen to have anything pressing, you can send questions to my e-mail address that should be listed on your screen there, and I'll try and read it in. Otherwise, I'm happy to get back to you after the call. So Henry, just to start off with, obviously, COP26 has been all over the press. I know you were there. You spent a whole week there probably doing meetings nonstop. Maybe we can just start there in terms of your reaction on the success of COP26 and then maybe even more specific to MSCI.

Well, thank you for having me and for this opportunity to speak about what we see in this area of the investment industry and what MSCI is doing. Maybe we have provided a little bit of background, the way we see all of this, and then we can go into what came out of COP26 and what we're doing about it. At MSCI, we believe that the -- climate change not only is an existential threat to the world, as we all know, but it is the largest reconstruction of the global economy in human kind, in human history. And we know how large that economy is. It's $100 trillion. It's very complex, as we have seen with all the issues of supply chains and the like. It's highly interdependent, highly interconnected and the like. So that global economy needs to go from primary reliance on fossil fuel energy to renewable energy. That will create a major transformation in everything we do, whether individuals and households or businesses or governments or municipalities. We -- when you really examine what we do every day and the dependence that we have in fossil fuels and petrochemicals, plastics and all of that, it's just incredible. And clearly, that has been one of the engines of growth -- economic growth in the last 150, 200 years since the Industrial Revolution. So this transition is not voluntary. It is imposed on us by this threat. And the benefit of the Paris Agreement, it was that in putting a 2050 time frame, the curse of the Paris Agreement is that it put a 2050 time frame because we don't have 3 decades to get going in a major way. So we believe that this is going to lead to a gradual but massive reallocation of capital in the world and repricing of assets in the world. It has already started, and we believe that it will accelerate in the next few years of this decade, not in the next 2 to 3 decades. We believe that capital, which is in our world of the finance, the investment and finance industry, investment is asset owners, asset managers of all types; and the finance industry being the banks and broker dealers and the like. We believe that, that industry will be at the forefront. It will be at the beginning of this transformation. Because when you look back at any economic transformation in the history of our civilization, whether it's the Greek or Roman civilization, whether it's the Renaissance, whether it's the Industrial Revolution, it was all financed. It was all based on capital. It was all based on savings one way or another. So therefore, this transformation cannot happen with a major role of capital, and that role will be at the forefront, at the beginning, not at the end or in the middle because that allocation of capital from -- away from carbonizing companies into less carbonizing companies and into the solutions to renewable energy. The other thing that is important is a lot of people think of this problem as an energy and power problem and that the solutions are simply technology solutions. Every industry, where we have analyzed, at MSCI, the carbon emissions of every industry, every industry has large amounts of participants that are carbonizing entities. And if you look at clearly the transportation industry, the production of cement and steel, the food production, the agricultural industry and industrials and all of that is a major area of carbon emissions. These are all areas. So what we are -- what came out of COP26 was a major commitment by a large number of finance players -- finance, I'm not talking about the political route or the autos or the energies and all of that. I'm talking about the finance industry. There was a crack with the finance industry. What came out was a commitment from asset owners, asset managers, insurance companies, banks, other providers of capital, aggregating $130 trillion, all forming these alliances. The umbrella alliance is GFANZ, which is the Glasgow Financial Alliance for Net Zero. And within that, there are 6 other alliances for asset owners, for managers, insurance companies, banks, et cetera. And there was a sense of optimism that these alliances and the -- within commitment, the signed pledges of every participant of those alliances is going to help us get in the way. So think of the finance day in COP26 as the organizational meeting of all of this. Now the next step is the measurement. What are we going to do to measure progress? And that's where MSCI comes in. This is a big measurement problem in addition to our execution one. The data that comes out; the carbonizing data; the models that are going to help you understand the trajectory of that carbonization; the models that are going to help you understand the value of assets in your portfolios and their impact; the physical risk models; the transition risk models and all of that; so -- and all the analytics associated with that and all the technology that goes with that. So this is a perfect type of opportunity for MSCI because we already are a large provider of tools for the investment industry. And a lot of what we do is data models and technology. And therefore, this is exactly in our [ value weight ].

So Henry, maybe just to unpack that $130 trillion number, the commitments out there, who are the main constituents in there? And then somewhat tied to that, I guess, what is the opportunity that MSCI has with these constituents?

So the $130 trillion is made up of about 450 institutions in some 45 countries. The $130 trillion also has some level of overlap because if an asset owner, a pension fund commits to this is counted. And if an asset manager that manages money for the same asset owner is also counted in that $130 trillion, so it's not a huge overlap, but we got to bear that, and we've got to keep that into account. Now it's not bad to double count because those would -- those may end up being interdependent but separate decision. The decision by the asset owner as to which [ direction ] to pay and the decision by the asset manager. So it's not bad to double count. So these alliances that were created and growing, clearly created and led by Mark Carney and the GFANZ organization, which is now being made permanent. GFANZ has been made permanent. It was a temporary organization just for Glasgow. It's been made permanent, with a permanent secretariat and all of that and is now reporting to the Financial Stability Board. So -- and it's, therefore, a sister entity to TCFD, which is the one that is setting up a lot of the standards and all of that. The other clue, so to speak, that GFANZ did was the ability to broker a transaction between the IFRS, which, as you know, is the other accounting system in the world besides GAAP, to be able to take over some of the sustainability standards organizations that have been created in the U.S. and the U.K. And now those are going to be all part of our IFRS, and IFRS is going to come out with accounting standards of disclosure about -- everything about having to do with climate change. And that is likely to be probably at the end of this coming year, '22, or the beginning of '23. So I think, therefore, what you see here is that all of the GFANZ and the FSB and some of these accounting organizational are going to become the global governance of all of these that -- in trying to determine what the standards are and what the disclosures are, the recommendations with the regulators, et cetera. So that's very important to follow for the audience here. You've got to follow this governance, its global governance because they're going to come out with pronouncements about disclosures and things like that. I think the area that is going to have the keenest pressure point at the front of this is going to be the regulated banks. The bank is regulated by the central banks of the world. The Bank of England is already asking its regulated banks to provide a very detailed action plan and targets of decarbonization of their entire loan portfolio by 2025, meaning they have to have targets of high levels of decarbonization of their loan portfolio 4 years from now. And that report, that detailed report has to be submitted in the first quarter of this coming year. So a lot of the banks are now scrambling to figure out how they are going to put together a lot of these things. So the European Central Bank is not far behind. At some point, the Bank of Japan, the banks in the U.S., this is going to be a tsunami in the next year or 1.5 years for the banks. And as you know, shifting the allocation of capital in a loan portfolio is not an easy task. I mean you've got 1,000 -- maybe hundreds of thousands of loans, in some cases, millions of loans, right, that are on the books of these banks. And the question to come is, how do you turn over that portfolio from lending to carbonizing -- high-carbonizing companies to low-carbonizing companies to start measuring or making -- to start declining your Scope 3 emissions in your portfolio? So that's coming pretty soon. So behind that are some of the insurance companies and the regulators of the insurance companies. Clearly, they're very focused on the physical risk of what they do, fires and earthquakes and monsoon and hurricanes and all that, all these events that have [ quintupled ] in the last 50 years. If you look back at 1970 and you look back at today, the number of climate-related and water-related events in the world have quintupled. Same planet, same number of -- a lot more people but same planet, same river, some oceans, but the events have quintupled. So there is physical risk associated with property on that, so therefore, mortgage securities are very focused. That will be another area of upfront focus. The municipal bonds, if you have a city or a county that gets flooded or heat waves and it affects the revenues of those municipalities, those municipal bonds are going to have a negative effect on them. So I think that even though climate change started as a long-term equity risk, long term mostly in equity portfolios, since the climate risk is being front-loaded and moving forward particularly because of the physical risk that I just mentioned, then it's within the maturity spectrum of a lot of loans and a lot of fixed income instruments. So we believe that while a lot of the pressure point is going to begin on fixed income probably even much more than equities in the world. So anyway, what MSCI is doing is we are frantically -- we have been investing on this. As you know, we're the leader in ESG. And climate was always a part of ESG, and we've been at it for 15, 20 years. But a few years ago -- quite a few years ago, we began to identify climate as a separate pillar to ESG, meaning as a separate business. And we began investing in people and data models and technology and all of that, which we can talk in a minute about. And -- but we're now accelerating that investment. So my take away from Glasgow was not only a confirmation of what we were doing, but also we have to accelerate dramatically what we're doing at MSCI to ensure that we provide the tools that our clients are crying for, to understand what is in my portfolio, how many carbon automations, what do I know, how do I transition, how I do this, how do I build models and all of that. So we are dramatically accelerating our investment in this area. Thankfully, our revenues and our run rate, as we described -- as we normally call it, our run rate is increasing more than 150% per year. That's what happened from '20 to '21. And that's what we're anticipating from '21 to '22 as well, from a smaller base, somewhere right now in the -- between $35 million and $40 million of run rate, somewhere in there. And it's accelerating at more than 100%. This is pure climate tools, not ESG, pure climate tools. So we believe that this is an incredible opportunity for us. It's a great opportunity for the asset management industry, the investment industry, but it's also a big risk.

Got it. And so maybe a broader question before I ask specifically on MSCI's climate initiatives. And you're talking about all these standardized disclosures that people are working on. There's a lot of need for data, a lot of other players are getting involved in the space. So how does MSCI try and differentiate with maybe availability of more free data or tools out there?

So at MSCI, our biggest differentiator is at the downstream with respect to the mission-critical tools that we give people, whether it is a market cap index or whether it's, let's say, ESG index or thematic index or factor index, when there is a -- it's a risk model to understand the extent risk and return on your equity portfolio, fixed income portfolio, multi-asset portfolio, et cetera, et cetera. We always have tried hardest to be in the -- at the very end of the downstream with the tool that is mission critical for a very critical decision of an asset owner or an asset manager or a bank. Now in a lot of what we do, Manav, we don't have proprietary data. When you think about indices, they're not based on proprietary data. These are all publicly available prices and information about companies. A lot about what we're doing on risk models, it's the same thing. So therefore, in this area, we have been forced to not only hunt for data all over the world, particularly NGOs and dormant entities and all that, but also develop a lot of our old data. We will be -- I will be better off not having to do any of that and just keep focused on what we normally do, that is giving us a competitive advantage. So when we look at this problem of data and disclosure, we actually won a lot more public disclosure by companies and forced by government entities and regulators done less. So we don't view that as a competitive disadvantage. On the contrary, we view that as an advantage because then we can deploy our capital much more on the tools that people need to use rather than trying to come up with the data and clean the data and analyze the data, which is a massive amount of work.

Makes sense. So maybe just specifically on your climate initiatives then, $30 million to $40 million, obviously, it's been growing 100%, 150%. That's a good trend. But $30 million compared to, I guess, the challenge ahead seems like a very small number. So 2 questions. One, is that just a factor of people not taking climate seriously enough until now, which is why it's going to become a bigger number? And then the second question is, where do you need to invest? Does this mean you have to make a couple of acquisitions? Or how does MSCI fill the gap?

Yes, the answer is, unfortunately, yes, quite a lot of the capital industry, meaning investment and finance, has been talking about this for a long time, but not a significant amount of action has taken place. And by action, I mean measuring the total carbon emissions of the companies in your portfolio and understanding the trajectory to get that portfolio to a 1.5-degree world. I would venture to say that if you look at your portfolio, it's probably a 3- or 4-degree world portfolio, which is not going to exist in 30, 50 years from now. So therefore, now based on what I just said, in the last 2 years, there has been an acceleration of this focus. A lot of it is because of the Financial Stability Board and TCFD. And a lot of it is the European regulators, right? A lot of it is the run up to Glasgow in which all these commitments were being made and people were very focused on. So I think that a turning point has been achieved here that will accelerate this trend that we're seeing. So the demand is going to explode. The demand for this is just simply going to explode. So for us, I think the issue is, in addition to all the incredible opportunities we have on investment thesis indices and direct indexing and a lot of what we're doing in ESG in general, a lot of the private asset classes that we're focused on and investing in and all of that, this has now come -- injected into us that of this acceleration that we can -- if we don't confront it, if we don't deal with it, it's going to leave behind as a leader in this area. So the areas that we're investing in -- let me first tell you what we're doing, and I'll tell you the area that we're investing in so to get a sense of the dimension in this. So first of all, we have now created carbon emission estimates of every single company in MSCI ACWI IMI. That's the world index and on the All Country World Index investable. That's about almost 10,000 publicly traded companies. Now a lot of these estimates are not because the company disclosed what their carbon emissions are. They're based on a lot of data, a lot of modeling, a lot of assumptions, but they're fairly good. They're fairly right. But they're one, not all. We have also created what are called implied temperature rise metrics, which is a measurement of whether that company will live in a 2-degree world or a 3 degree world or a 5 degree world for the same 10,000 companies. So we have all of that ready. So with those 2 things, you can look at a company in your portfolio and understand how much carbonizing you're doing and then when you look at the trajectory of where that company will be 10 years from now or 15 years from now. And you can then assess where your portfolio will be, what kind of temperature your portfolio will have on 10, 15 years from now, the trajectory. We've done the same on carbon emissions on 15,000 private companies using the Burgiss database. As you know, we own now 40% of Burgiss. Now those private companies are private equity or venture capital owned companies because that's part of the Burgiss equity database. So we've done the carbon emission, the estimates of those companies. That represents about 4,000 funds of equity and debt and the like. So we're doing the same for fixed income, as I said, because this is the area where the earthquake will take place in the early part, on munis and mortgage-backed securities, commercial, residential, corporate bonds, et cetera. We're going -- we're analyzing all of that. So we're doing quite a lot of that. And then we're building models, the ITR, the implied temperature rise metric is a modeling exercise. We also have built what we call climate value-add risk model, which takes your portfolio, and if you fix a degree in the world -- let's say the world would be 2.5 degree 10 years from now, then we can analyze the physical risk and the transition risk. Consumer taste is changing, policy changing, those are transition risks, and then present value, a lot of that and give you what the portfolio will look like today based on that future forecast. So we're doing a lot of that. We are -- so where is the investment coming into is, since there is no amount of data available, we need to gather a lot of data. We need to clean that data, normalize it, sometimes we don't gather it directly, sometimes we normalize and all that, especially in -- for fixed income instruments, especially for, as I was saying, what is the risk of a municipality being hit by the hurricane and the like or a heatwave or a wildfire, whatever. So we're focused on that. We're focused on the property risk, the underlying mortgage-backed securities. That's going to be big around the world. We're focused on collecting more carbon emission data clearly on all the companies. We are -- we want to expand what we're doing from private equities to private credit, right, private credit. Obviously, we're already doing some of this in private real estate in order to cover because a lot of the complaints in the world, Manav, is that all this is in the public market. But a lot of the carbonizing companies are going to delist and move to the private markets. So how do we ensure that we catch that, and that's why that effort on that. Another big initiative is clearly modeling. We need -- we're putting a lot more people. We have this climate risk center in Zurich, in which we have quite a few of those scientists there and modelers. And we're hiring more and more people. Another big challenge for us is the client demand. I mean we're getting calls all over, and we haven't had all the necessary trained people in our client coverage organization to go out and present what we're doing and allocate our client base and obviously generate sales and all of that. So that's another big, big step up on all of that. Now let me also say a view of mine. One last thing on this is we don't view climate just by itself, right? No. The reason why MSCI is extremely well positioned here is because we are taking climate and all -- what I said, and putting it into climate indices, climate fixed income indices, climate equity indices, right? We're putting it into our risk model. So we are pivoting a lot of our risk analytics to incorporate climate risk analytics. And for that, we just launched a great product called Climate Lab Enterprise or Climate Lab, which is basically a risk modeling exercise of climate for total portfolios for -- this is part of our analytics offering. So we're doing that. So it's going to cut across everything because this is not -- this is all across the entire investment portfolio of any banks.

Got it. So I mean maybe just to follow up on that, it sounds like a lot of the data still needs to be created almost with the disclosures and other aspects. So in your framework of MP&A that you talked about at MSCI, should -- especially on the climate front, should we be seeing more partnerships? Or do you think there's more M&A acquisitions to be done especially when you look at Moody's or RMS and other people that are trying to make some moves here. Just curious how you think -- what gaps you guys have.

All of the above, completely all of the above. In some cases, you're going to see us partnering up with somebody that have great proprietary data into strategic partnerships. In some other cases, you're going to see us buy out the whole company. These are small companies in general, buy out the whole company. In other cases, you're going to see us making a minority investment in the company to couple with a strategic partnership because the company may not want to sell itself, may want to remain independent but may need capital to expand. And we can provide some of that capital, and at the same time, this is very crucial, have a strategic relationship. So it's a way to secure the supply of data into that. And in other cases, you're going to see us building the data from scratch ourselves, obviously, hopefully, in emerging market centers, so we can keep the cost down.

And how would you describe the pipeline of opportunities there? Is it there's a lot of people doing good things, and so you just have to pick based on valuation? Or there's just not enough of what you're looking for?

Well, first of all, there is a lot of data regarding climate that is in universities, in nongovernmental entities, in NGOs, so we're also partnering up with those, with NGOs and with universities, with think tanks. There's -- once you enter this world, there are a lot of think tanks regarding climate change. I mean this is not a new phenomenon. It's been going on for decades now, the concern in the world about this. So there is a lot of data, so we'll partner up with them as well. We will create our own data. We will partner up with others and the like. So there is -- we're hunting the whole world trying to see who's got this data and all that. The difficulty here is that there is -- there are a lot of small firms that have -- that are product firms. They have a product, they are in sales, the product is not global, so it will be a patch work. I think a lot of what we'll do will be -- it's a patch work of initiatives to try to couple together a universal standardized set of data around the world. So the pipeline is good, but it's not something to write home about. I mean it's not like you're going to see us announcing something every month or every 6 months or anything like that. It's just that in the normal course of what we do -- but it's very important because without a lot of this data and the model and that goes on top, you can't get anything done.

Got it. And just to come back to the data question and more tied to this, there's been a lot of chat about more regulations trying to be imposed on the data providers like yourself. I think we alluded to earlier, kind of if data becomes widely disclosed, does that mean the data gets commoditized? So maybe if you could just address that again. And also, kind of in the context of -- I believe, you're one of the founding members of the Net Zero Financial Service Providers Alliance, so you're almost promoting those questions. So just curious on how we should all consider that.

So the first thing to always keep in mind, Manav, that in addition to a selfish interest here of MSCI as a business, we have a much, much bigger mission in the world, which is how do we prevent that this world that we live in ceases to exist potentially for the latter part of our generation but for our children, our children's children, right? So therefore, we have taken that point of view to say we want to be the leader in all of this, but we don't want to be the leader in all of this in a shrinking planet or on a planet that is declining. We want to be the leader in all of this in an expanding universe, in an expanding planet, in a planet of incredible opportunities. And let us fight it out competitively in that universe. We don't have a problem. So therefore, we have call on the regulators repeatedly to enact regulation for much, much more disclosure and standardized disclosure of everything having to do with climate matters from any kind of organization, including private entities. We cannot afford the luxury of saying that regulators only regulate public companies, publicly-listed companies. That's great from our myopic point of view, but that's not going to solve this existential problem. We need to figure out ways that the regulators mandate carbon emissions of private companies even though that will be the only thing that they demand from those as opposed to their financial statements and things like that, right? So we don't have a problem if this data is large and commoditized. Just like I said at the beginning, actually, we welcome that because it will allow us to put more and more analytics and models and all of that. It would allow us to use our capital, our scarce capital or what we normally have done as opposed to devote a lot of capital, split the capital between collective data and creating the analytics and the models and the tools. Now the thing that we have also called the regulators to do is, I think, the issue of regulating ratings and metrics. When we call an ESG rating, it's actually a rating because we use that system on AAA, AA and all of that. But at the end of the day, it's truly not a rating, it's a metric. And it's a multivariable metric. So these ESG ratings are far from credit ratings, far. Credit ratings are almost unidimensional. It's about the cash flows of the company, the quality of the cash flow and the leverage of the company. In the case of ESG, it's about governments, about social issues, all sorts of environmental issues. And these are opinions in which people will have different ways. They will have different views of how much weight they put on governance issues, how much weight they put on their social issues. So it is normal, completely normal that there will be a major divergence of opinions. There will be some people that will have a company at a single B and other people have a company as single A because they may be waiting something very different than the other one. And it's going to be the same thing on climate. There will be some companies, some graders like us or metric providers like us that are going to do that. So if the regulators come in and try to impose a straitjacket on that, I think the world will be suboptimal. I think this fight to get to climate -- to conquer this existential problem is going to be a lot harder because there won't be a freedom of choice, there won't be freedom of understanding, there won't be innovation, there won't be creativity as with the various ways to look at this problem on one hand and the climate problem on the other hand. So letting various private entities come up with different opinions and different metrics. Let them be judged by their users, by their customers. What we did is the disclosure, the public disclosure for all of that to flourish.

That makes sense. Okay, Henry, we have a few minutes left here, so maybe let's just end with MSCI's own net zero commitments. And presumably, you're using all your MSCI tools to help you out there, too. But maybe if you can just talk about how you're kind of practicing what you're preaching.

Thank you for that question, Manav, because we go around at MSCI and saying, if we're going to be judging companies, we better judge ourselves in a much higher standard than what we judge others. And therefore, we have created within the corporate responsibility function of MSCI under Diana, we've created a whole apparatus and a whole infrastructure to look at what is it that we do. Quite a few years ago, we said we're an IP company. Well, IP company, how much carbonizing do we do? And then when we started applying our own tools. We said, well, we travel, we commute. We use energy for our buildings. We have products, think about Scope 3. We have a lot of indices. We have a lot of risk, and those are not net zero. So what do we need to do about that? So we pledged at the beginning -- towards the beginning of this year that we want to be net zero by 2040. That's an outside target with a fairly detailed plan. What we're now doing is saying we have to move that date forward, and we're going to move forward as far as we can. But it has to be on a very detailed, executable, fundable, finance plan to achieve that. Because everything else is just words, commitments that we make. So we are spending a great deal of time internally. For example, in the future of work, right, what do we do? And so we are pushing heavily our hybrid model. And one of the goals is not -- well, not only to give flexibility for our people, but it's also how do we get to net zero faster by providing a lot more options, that people don't have to commute, people don't have to travel. We're trying to work really hard with our own clients and say we don't have to go back to the past and having in personal meetings all the time. We can have the majority of our meetings virtually. And that will save us a lot of carbon emissions in the world. There are no electric planes yet, right? And if there is one, I'm not -- I'm getting in one right now. So getting around and flying all over the world is going to create a lot more carbon emission. So how do we -- before -- until there is an electric plane that can transport us relatively carbon efficient, we need to encourage the continuation of the virtual world. So that's another initiative that we have. We're working with our -- all of the suppliers of our -- we rent out our buildings, but the suppliers of energy of our buildings say, no, it's got to be based on renewable energy. We're shrinking the footprint of our real estate as well to be able to do that. So we have a lot of actions. We want to set ourselves up as a standard of corporate responsibility and climate change management just like we are asking others to do.

Got it. All right. Well, that's super helpful, Henry. We're just on time here. So really appreciate you spending the last 40, 45 minutes to talk through this. And hopefully, we'll hear more good news coming out of your end.

Thank you very much, and let's focus on this problem in the world, and we'll be better off, right?

Yes, absolutely agree. All right. Thank you, everybody, for attending. Bye.