MSCI Inc. (MSCI) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you for joining us today. It is my distinct pleasure to host Henry Fernandez here for our keynote lunch session. Henry is the Chairman and CEO of MSCI, a company you have led for nearly three decades. MSCI is best known as a top global index provider. But importantly, it offers data, models, analytics and research for a range of investors, financial firms and increasingly, corporate clients. Headquartered here in New York, MSCI has employees in more than 25 countries, and it functions as a central connecting point for capital markets. In 2019 and in 2021, Henry was recognized by Barron's as one of the world's top 30 CEOs. And more recently, you may have seen the profile that both Henry and MSCI received in The Economist magazine. Earlier in his career, Henry was a Managing Director at Morgan Stanley. Outside of MSCI, Henry serves on a number of different Boards, where we have some good common interests, Henry: Royalty Pharma plc, Stanford University and of course, Memorial Sloan Kettering Cancer Center, which is a partner of RBC Capital Markets as well. Henry, thank you so much for joining us today.

Pleasure to be here.

So this keynote session is really around the intersectionality of emerging societal considerations on ESG and climate and the importance of the financial sector in providing the tooling, the data and the insights to tackle some of these long-term problems. So Henry, you have built one of the largest and most sophisticated global investment decisioning research and data providers in the world. What did you see in the external environments that led you to create this company, that we talked about as a compounding company yesterday, alongside your own capabilities? And how did ESG and climate fit into that consideration?

So some 30-plus years ago when I was at Morgan Stanley in various functions, I have begun to observe that the top-quartile talent in a society join investments and finance. And when they arrive, the tools of their trade, especially in investments, were really pretty primitive. They didn't have any tools to understand performance, understand risk, models to do asset allocation, pricing models, portfolio construction and all of that. So I said this is a good gap that we can fill, and I convinced the senior management of Morgan Stanley to help me lead an effort to build a third leg of Morgan Stanley. And those days, Morgan Stanley had the investment bank, meaning corporate and sales and trading. They had asset management. They didn't have wealth management at the time. And I was going to lead a third leg, which was investment tools for the investment industry, risk models, performance models, asset allocation models and all of that. And the starting point was this cost center that I found inside Morgan Stanley, which were market cap equity indices. So I said that's a good point. It's a good starting point. We can have some people, some clients and get going. So eventually, Morgan Stanley lost faith in the strategy. There were a lot of changes that took place, and therefore, we spun out of Morgan Stanley to create the company that we have today. They feel sorry because our market cap is 1/3 of their market cap today, and at the time, we're a tiny, tiny portion of their market cap. But we've got good friends there. So anyhow -- then in the late '90s, I had moved to Geneva, Switzerland, which is where the market company equity indices were created at the offices of The Capital Group. The CI in MSCI is The Capital Group of Los Angeles, historically. And a lot of our Scandinavian clients kept asking us for SRI indices, socially responsible investment indices. So they kept calling. And then I said to them, "Look, I don't know anything about that. If you're interested, come down here and we'll talk." So they came down there. They came -- they went down to Switzerland. And as an economist that I was by training, I began to understand that this SRI concept, which is now ESG and Climate, it was very much on the foundation of capitalism and economies and financial markets and all of that because a lot of these factors were not being priced in the securities around the world, and they were not being incorporated into the allocation of capital in a society. So I launched -- I went right into it, and I wanted to create ESG ratings. I went to the senior management of Morgan Stanley, and they said, "You must be kidding. You're going to take our corporate clients and create ratings for them? It's good for the ones that are AAA, but the ones that are not, they're going to fire us." So anyhow, so we had to wait until we got out of Morgan Stanley to develop the business in earnest. And that was the genesis of it. So the important thing about that is that this did not start as a social cause, as a political philosophy or some kind of governmental effort or NGO effort. We started this process pretty much at the heart of free markets, at the heart of capitalism, at the heart of pricing, at the heart of economic development and economic allocation of capital. And that's what we keep doing today. There are a lot of people that want to use it for different purposes, and we'll be more than happy to sell you everything for different purposes. But the mainstream of what we're doing is getting the majority of the assets of the world to incorporate ESG factors in their fiduciary duty of highest risk-adjusted returns so that they can price assets properly and they can allocate capital properly.

At the end of the day, it's ultimately about the creation of long-term value and how you can look through the lens of opportunity and look through the lens of risk with data that may not necessarily be apparent through a traditional financial lens. Within your global business, MSCI, you look at 2 -- you look at climate and ESG distinctly. What solutions, what questions are your clients asking you to solve that led you to go down this path for ESG and Climate separately?

Yes. So what happened was we started with ESG some 15-plus years ago. And well, we started a long time ago, but in earnest, started rating companies when we got out of Morgan Stanley. And climate is one of the factors in the Environmental Pillar, just one. If you have a company or a municipality that pollutes a river, that's not climate change. See, it's just economic degradation, I mean, environmental degradation. So therefore, climate was one of the factors. But as time went by, we began to recognize that climate submerged on the ESG criteria eventually was going to be a problem. Because as climate change and climate risk develops, and you let it run in the context of ESG, it's going to swamp every other aspect of it. Then you're going to then ignore other environmental issues. You're going to ignore other social and corporate governance issues and the like. So we said it's fine to still keep it within that, but we need to break it out and make it its own pillar, its own product set, its own this because, over time, it's going to be the mother of all transformations in our generation and in future generations, right? So -- and it's going to happen a lot faster than we think it will be. So that's why one of the biggest problems we have, and I'm sure you have, is that when you engage in a conversation with somebody on "ESG," it takes you a few minutes to figure out what the person is talking about because the person may be talking 100% about climate, but he or she calls it ESG or the person can be talking about social issues and nothing to do with climate and the like. So it's a big problem. It's a nomenclature problem. We're trying to figure out how to solve it. ESG is not a good word anymore, so we're trying to figure out if there are alternatives to that. But importantly, we differentiate ESG and Climate within it to climate by itself. And that has worked really well because a lot of the discussions with our clients have been very centered around that, and there's no misunderstanding what is it that we're talking about.

Yes, and you're solving distinct needs for your clients, right? And it helps you provide direct tools for what they're looking to solve. It is a political environment right now, though. And as you mentioned, ESG has perhaps not become the most used terms. How are you guiding MSCI through political waters?

So the first thing that I tell people in our company, also on our clients, is that ESG and Climate are, and will continue to be, political issues. They have to be political issues. My own definition of politics is an organization of a society and the choices that society makes about how they treat their resources, how they treat their people, how they treat their environment and all that. Those are political choices. Now we, in the private sector, especially in the capital markets, defined as finance and investments, need to then say is that -- does that work well for us in terms of maximizing returns, right? So it is political. Now it is -- at times, it will get politicized because there are some people who want to use it as a weapon to -- for their political purposes, right? So in a lot of America right now, the sad part is that the retirement savings of citizens of States is being weaponized by political purposes because they're trying to force people not to look at ESG integration in their investment criteria, and those people are not going to do well in their investment allocations. So they're weaponizing at the expense of the retirement savings of people. So that's not good. So we look at the thing and we say, "No, we've got to speak the truth, regardless of the consequences. We got to call out how is being weaponized by the right or the left." Both sides weaponize it because the left wants to take ESG as a way to channel resources to their social causes. That's what the left is doing. And the right says, "No, I want to run a completely free market, and this stuff is woke." And you say, "Well, it's neither," right? This is not a way to mobilize resources for social causes. That's the government. Those are NGOs. Those are other people. But people like you all that have fiduciary duties to fulfill to the beneficiaries or to your clients that gave you the mandate to get the highest risk-adjusted return in their portfolio or if you're a bank and you have a balance sheet and you want to make sure you have enough capital and return on capital, you're not the government. You need to make decisions that are fiduciary decisions in the best interest of the capital providers that were given to you. So -- but there is going to be a politicization. There is going to be a polarization, and that's part and parcel of it. And I think all of us have an obligation to call it out and to say what is it that we're using it for and what is it that we're not using it for to make sure that there is no misunderstanding as to what our goals and objectives are. So we, at MSCI, are doing that. Obviously, sometimes we don't endear ourselves with either side, the left or the right, because of that. But we're a company that, as I said at the beginning, was created to provide transparency, to provide tools, to fully understand risk and performance and asset allocation around the world and obviously, to shed light into some of the factors that are not being incorporated, such as ESG and, obviously, climate, into people's portfolios and into people's balance sheets. And we're going to keep doing it until there is a law that bans us from doing it, right?

Yes. Well, it's a courageous decision. And I know it's one probably many of the organizations' representatives continue to wrestle with, but it's staying with that transparency and that authenticity, I think.

Not only that. Let me add, it's actually an obligation of ours. We can't let parts of society hijack what is best for what we do and what is best for the allocation of capital that leads to economic growth in an economy and society. So we have to take the high road. And the high road is to say, "This is what we intend to do." Now if we don't, then it's going to continue to get weaponized and politicized, which is fine. But it will then begin to distort the narrative and the education of citizens, and they're not going to understand what we're trying to do. And importantly, it will be socialized instead of being privatized, right? It'd be socialized, and it's going to be taken away from us. And people are going to dictate what we do, whether we like it or not, and I think most of us will not like that.

Yes, that's not a good outcome either. So investment decision-making is predicated on good data and proper transparent data that can be integrated into the decisions we all make, and sustainability is no stranger to that. We're still off from having -- far ways off from having perfect ESG and Climate data, but we have come a long way. How are you thinking about the next evolution of data from MSCI's standpoint? How are you utilizing big data? How are you utilizing AI to take you up to that next level of transparency for your customers?

So first of all, MSCI, in terms of our own function, is a modeling company. We model risk, we model performance, we model asset allocation, we model pricing, we model everything. Like a good econometrician that I used to study, my professor at the time at Princeton always told me and said, "I'm going to teach you how to put models, econometric models. But you got to understand that there are 3 requirements for you to do a good job." And I said, "Great. What are they?" Data, data and data, right? No model can do anything. You're going to have a bad model, but if you have a great model, you cannot do anything without data. Actually, I use the example of Google. Everyone gets mesmerized by the Google search engine, right? You search to see what's going on. That's the model. That's the equivalent of the econometric model. That model will be completely useless without the underlying data, meaning where are the Vietnamese restaurants that you're looking for? And what time do they open? And where are they located? That's the data, right? Or you said, "I'd go to London. I need a haircut," so haircut near me. They have to know the data is where all the haircut places are, and then the search engines have to gather it and serve it to you on a platter. So data, data, data is the new oil, right, in the world. So therefore, MSCI, we started as a modeling company, and therefore, we will take our models. We will get third-party data, process it in our models and give it to clients in terms of their portfolio, their risk return, the equity indices, the Barra factors, et cetera. But in the last 10, 15 years, we have gone into -- we are in a journey of becoming a very large, giant data-gathering, data-building company. And it started with flow data on equity indices, then it moved to ESG, then it moved to climate, then into private assets where we have the largest databases of private asset classes in the world. It's about $15 trillion of underlying values in those databases of private assets and counting. And according to our estimates, in a few years' time, even though we have an incredible amount of data today, we're going to have 1,000x more data inside MSCI than we have today.

1,000x.

1,000x. So it's a major explosion, and therefore, how do you collect it? How do you store it? How do you cure it? How do you set it up in a way that you can retrieve it and make it useful to people? How do you put the models on top of it, whether it's the risk models, the performance models, the pricing models? How do you put all of that, and then how do you serve it out? So we've been doing that. We've been using AI for about 10 years, mostly predictive AI to have it because we don't want to throw tens of thousands of people to do this. We needed techniques to gather. And now we've been using gen AI, and that's going to be an incredible godsend because we'll be able to gather a lot more data, check the quality of it, store it properly, search it properly and all of that. So we're very excited about the new discoveries. And we have partnership with both Google and Microsoft on their gen AI efforts, especially Google. Because Google is one of the largest data companies in the world, as I was saying before. So a lot of what we do -- the other thing is a lot of what we do cannot be maybe it's right, maybe it's wrong and it's okay. No, no. A lot of what we do to serve it to all of you better be very right or close to right. So I think these neural models, like gen AI models and the like, large language models and the like, they work best when you give them a very large amount of data. But they cannot wander off looking for data in the moon or in Mars or whatever you -- so -- and therefore, they can give you very high levels of accuracy. And that's what we're very excited about so that we can -- our dream is to put our products and our services in front of clients, and then, at the same time, it's the equivalent of saying, "Not only we give you this, but we give you 100 PhDs from Stanford, MIT, Imperial College, Carnegie Mellon," whatever. And they're going to work for you at $0.20 an hour or so -- not an hour, $0.20 a year or something like that. And you can -- we're going to train them to do the work for you, to look into your portfolios, to understand insights, to correlate things. They're going to be there for you. They're going to be working for you all day, all night. They just happen to be artificial PhDs, not human PhDs, but it's okay.

It feels a little sci-fi almost, Henry, when you think about putting this into action. But exciting the opportunity, I think, that it's going to harness for humanity.

Well, it's very close. We -- yes. We're within a year of deploying that.

Yes. Exciting. Well, an area where we certainly need more data, more insights and more rigor is in the carbon markets. And you recently made an acquisition of Trove Research exactly for that purpose. Tell me a little bit about how MSCI is thinking about opportunities in carbon markets and channeling capital towards that area.

Yes. So a lot of people will come to us and talk to us about the voluntary carbon markets. And we realized that voluntary carbon markets must be part of the solution to the risk and decarbonize the world. Why is the case? As all of us know well, markets perform many functions, but 2 key functions of the market performance: they transfer value from one player to another, and they transfer risk from one entity to another. So if we have no mechanisms to transfer value and risk in the decarbonization and the derisking process of the world, it's going to be pretty limiting what we can do. So voluntary carbon markets are at the place where we're going to do that. By the way, I think the New York Stock Exchange is a voluntary market, too, right?

Yes, exactly.

So you can see the picture, right? As opposed to the compliance market, which are government mandated, here's what you need -- you could trade in terms of carbon credits and things like that. So therefore, we were looking for an entry point, and we found through this company called Trove Research, a London-based company. It's about 85 professionals in the company. And what we do there is that we analyze about 15,000 projects, carbon offset projects, in the world. And we understand what they do, how they do it. We rank them. We're about to launch our rating system, like an ESG rating system and those projects. And those projects then -- that information gets sold to corporates or anybody buying carbon credits, and therefore, we know what prices those entities are paying for in those projects. We know what they're using it for, et cetera. So then that gets us into the issuer that is looking to buy or a company or somebody, an organization, that is looking to buy the credits, and therefore, we learn about their own decarbonization processes, their own purchases of credit. We have about 3,000, 4,000 companies that we're following on the basis of that. And that information then, we sell that to investors. So investors can then have a transparent view of the total transition plan of a company between the credits that they use and the decarbonization efforts that they follow. So yes. One -- so that's what we do, and it's growing quite a lot. And so one important piece of research that they did, before we bought the company, is that they analyzed all of this. And they came to the conclusion that the companies that buy carbon credits decarbonize and derisk the rest of their operations, their internal operations, at a rate more than twice the companies that don't buy carbon credits, which flies in the face of all the naysayers and all the zealots that don't want anybody buying carbon credits. Because if they say, "If you buy carbon credits, it's a way -- it's an easy way out," right? It flies in their face. So we're going through the data. We're going to promote it. We're going to advertise these findings and the like. So hopefully, that will give a boost to the development of the voluntary carbon markets. It's a long way. There's a lot of other issues in these markets, but we're trying to do our part to get them live and going.

Yes. Us, too. We at RBC are also quite encouraged by what we see as the potential opportunity for carbon markets. We developed our own partnership with a company called ClearBlue. And I take great courage and confidence from the fact that you say leading companies are doing that because I think if you have an offset strategy, you acknowledge that you're not 100% net zero yet. You can take tactics and initiatives to get there. But offsetting your residual emissions is a really important mission of looking at your full portfolio.

Yes. Let me give you an example, I mean, to sort of try to nail this point, and that is, there's a whole industry called the reinsurance industry, right, in which if you run an insurance company and you think you have too much risk on your balance sheet and you want to take more, you lay off that risk with that reinsurer. That's a market, right? There is a market that is an over-the-counter market, so to speak, relationship-driven or whatever. But if you don't have a market like that and a lot of other assets like carbon is going to be very hard to -- so we are very bullish in the development of the voluntary carbon markets, but it won't be a straight line. It will be a zigzag and up and down and hopefully -- by the way, at the COP28 in Dubai, there was a group of people that I met, and I attended a lot of their meetings in which they're putting their full weight behind the voluntary carbon markets. Politically, John Kerry, his proposal was, there's no way we can transfer wealth from the developed north to the global south free. I mean, we're just going to give it to you because we're nice people. I mean, we have our own problems, too, right, and all the other countries. So therefore, he came up with a scheme, which is proposing that the way to transfer wealth from the north to the south to solve some of these climate problems is through the carbon offset markets because a lot that can happen in emerging markets can be -- can help this transition. And that's a way to channel funds and to channel money into these places. So -- but GFANZ, the Glasgow Financial Alliance for Net Zero, has thrown its weight behind the protocols and the structure. So they're doing a lot of work. I'm on the Board there. They're doing a lot of work in voluntary carbon markets. Mike Bloomberg has thrown the weight of Bloomberg LP and Bloomberg philanthropies behind that, and so is Mark Carney and with Brookfield and other places that he works at.

Yes. It's a fast-developing space and one that I think holds incredible potential for both of our organizations. Let's speak a little bit about the importance of convening partners. You're a convenor of asset managers and corporates. We're a similar -- play a similar convening role. But on sustainability, it is important to bring together different groups of people and to share areas where we can work together in advance, but also challenge some of the conventional norms. So you launched the MSCI Sustainability Institute at Climate Week here in New York last year. Tell us a little bit about why that was important for you and why we need some leadership on these societal issues.

Yes. So this is a fast-moving problem in the world. We may not feel, we may not think it's fast moving, we may think we have till the year 2050 to start working on it, but that's not going to happen given all the physical risks that we see happening in the world: droughts and fires. And we have the second largest fires going on in Texas, second largest, I guess, in the history of the U.S. going on. And so we -- 1/3 of Pakistan was under water last year, right? I mean -- so we don't pay attention to that. If anybody was in the Mediterranean last summer, you probably felt it too, right? So there are a lot of physical issues going on in the world, and we're not sometimes combining all those stories into one big story as to what is happening. So physical risk will continue to accelerate, and therefore, all of us don't have the luxury of waiting a very long time to come up with solutions. We need to convene. We need to talk. We need to debate what are the best ways and the accelerated ways that we can tackle these problems. So at MSCI, some of you who know us well, we're an extremely commercial organization, right? So a lot of our people didn't have any time to deal with academics or NGOs or think tanks, like policy entities or government officials and policymakers and all of that. And we felt that those people have -- they deserve a seat at the table as well, not just people in the private markets, in order to come up with solutions. So we created the MSCI Institute to precisely do that. We allocated resources. We allocated people. And what we're doing is trying to get people together from different walks of life and say, "How do we solve this problem together?" The world is too siloed. One example of that, speaking about climate, my first time at a COP was COP26 in Glasgow, right? COP26. COP means Conference of the Parties, UN Conference of the Parties, right? That's -- they meet -- all these parties meet to talk about climate in countries. I was shocked to know that 25 years have gone by, and it was not until the 26th year that they invited the capital industry, meaning investment and finance. They have never been invited. It was only these UN countries talking about policy, talking about that. And when I went there, I told somebody, last time I checked, the world runs on capital, not on policy only. The role of governments is to create the conditions for economic activity to take place. Not all governments, unless you're living in a socialist economy or a communist economy, the government is not the economic agent of the society. It is a facilitator of the economic activity in a society. And they have never invited the investment and finance industry. So we had our own Capital Day organized by Mark Carney, and we've achieved a lot. That's how GFANZ got created, et cetera, et cetera. So now that ability to convene, that desire to get people together is what prompted us to do this. And I encourage all of you to get involved, to get engaged in a lot of these discussions for your own business, for your own investment, for your own institutions, but also, it's your contribution to your kids and to your grandchildren. I'm not an environmentalist. I'm actually a conservative fellow in many respects. I grew up in a country that went communist, so I'd be the last person to talk about planned economies and things like that. I was actually a banker in the oil and gas industry in the '80s. So I've attacked this problem more from the economics of the problem, the pricing of the assets, the allocation of capital. And I'd recommend that -- everyone knows this is not a political call or an agenda or anything like that. It's a way to say to all of you, we need to get engaged here. We need to take matters in our own hands. Some of the things that I tell my fellow conservatives is that one of the tenets of conservatism is that we want a limited government. We don't want governments sort of infringing on every aspect of society. So I normally tell my conservative friends, I said, "If we don't take matters in our own hand and try to solve some of these problems, climate change is going to be the mother of all socializing factors in the world." Because as physical risk increases and society gets confronted by that problem, the citizens are going to demand their elected officials to do something about it and fast. And what they're going to do is they're going to come up with highly prescriptive policies that are going to tell us what to wear, don't wear that, anything made out of petrochemicals, right? They're going to tell us when to commute because we need to use fuel efficiently. They're going to tell us where to work. They're going to tell us a lot of things. So therefore, it is -- I mean, all of us, I normally say to you that, unfortunately, we've been the generation that has been stuck with this problem. And we wish we weren't. We don't deserve it. We wish we were doing something else. But we're stuck with the problem, and therefore, we need to sort of rise up to the responsibility and say, "There's no alternative." We need to deal with this problem and tackle it. And hopefully, people after us will say that we took our own responsibility for the problems that we had in the world, and we did something about it.

Yes. Terrific. And I think no better place than to have this discussion at our Financial Institutions Conference, where the allocation of capital and the role of the financial sector is so important. And like you, at RBC, we've created our own Climate Action Institute away from the core business to do exactly that: allow the core business to engage with these factors that continue to contribute the value that our stakeholders and our shareholders expect, but allow a venue and a mechanism for the dialogue to increase.

Yes, let me say one thing about that is that one of the real pleasures of us at MSCI has been working with RBC. Because think about this major bank in the world, major bank in Canada, Canada is an oil and gas producer, is a mining country, which could easily be said that nobody wants them to work on these issues, right? But they've taken the leadership. They said, "No, we got to be a leader in the world to do this." Other places in the U.S. haven't because they want to stay away from the pressures, right? But they have confronted the issue, and it's a real pleasure. And I was really looking forward to this event, not only because of what RBC represents to the world and to us, but also because they want to be in the leadership. You all want to be in the leadership of these issues.

Well, thank you very much, Henry. That's a great way, I think, to end the conversation. In my experience, it really is, and since leading the -- creating the Sustainable Finance Group at RBC Capital Markets and helping steward the enterprise, a key success factor to advance any of these agendas is committed leadership. And leadership that has the vision, it has that medium-term, longer-term plan. It sees the disruptive forces at play. And I want to thank you for your leadership of MSCI. I want to thank you for your stewardship of some -- what can be tricky issues at times. And I want to thank you for your partnership, for joining us here today. Ladies and gentlemen, please join me in thanking Henry Fernandez.

Thank you.