Speaker 1:

From the library of the New York Stock Exchange at the corner of Wall and Broad streets in New York City, you're Inside the ICE House, our podcast from Intercontinental Exchange on markets, leadership and vision in global business. The dream drivers that have made the NYSE an indispensable institution of global growth for over 225 years. Each week, we feature stories of those who hatch plans, create jobs and harness the engine of capitalism. Right here, right now at the NYSE and at ICE's exchanges and clearing houses around the world. And now welcome Inside the ICE House. Here's your host, Josh King of Intercontinental Exchange.

Josh King:

Regular listeners of Inside the ICE House will note the several times we've used episodes of our show to bring you inside special events happening around the global universe of Intercontinental Exchange. Over the summer several of those special events centered around the fascinating work related to environmental, social, and governance or ESG issues. We've seen companies face far greater scrutiny in how they manage social issues such as human capital during the COVID 19 pandemic. In addition, environmental issues such as climate change remain a priority for investors while the pandemic has temporarily lowered emissions as a result of decreased manufacturing and travel, there are concerns about whether climate related projects will face resource challenges as businesses and governments recover from the economic fallout.

Josh King:

Earlier in the summer, we were joined by ICE Data Services president Lynn Martin, back in episode 176 with risQ's Chris Hartshorn for a talk on how our two companies combine cutting edge climate science, catastrophe modeling, and geospatial machine learning technology, along with pricing and reference data to quantitatively measure climate risk. Lynn is back now for another episode this time sliding over to the host's chair for a conversation with Savita Subramanian, Head of ESG Research and US Equity and Quant Strategy at Bank of America. They sat down to put COVID 19 investor trends and how companies make decisions under the ESG microscope. The next voice you hear will be our own Lynn Martin introducing Savita. Take it away, Lynn.

Lynn Martin:

I'm privileged today to be joined by Savita Subramanian. Savita wears many hats at Bank of America. She is the Global Head of ESG research, Head of US Equity and Quantitative Strategy at Bank of America. Member of their Global Research Division since 2001, Savita is responsible for recommending US sector allocations for equities and determining forecasts for the S&P 500 and other major US indices. I had the privilege of speaking with Savita via an Q&A in April of this year. So I'm really looking forward to today's discussion around ESG to continue that conversation, and also get an update on progress in the short five months since we last got together, so let's get to our Q&A. Savita, thank you so much for joining us today.

Savita Subramanian:

Oh, the pleasure is mine, Lynn. It's really great to be here.

Lynn Martin:

Last week, there was an announcement out of Europe that they would be raising carbon reduction target to 55% by 2030. What else are you seeing from a policy perspective? And in your opinion, do policy measures really help move the needle here or does it really need to be more industry driven?

Savita Subramanian:

Yeah, it's a great question. And I think you're seeing a few different examples of policy versus encouragement. And let's talk about the EU. So the EU is trying to manage climate change through really ambitious policies. Basically the EU aims to become the world's first climate neutral continent by 2050. So, Lynn, our kids are going to experience what life was like before the industrial revolution, at least in Europe, if they go to Europe. So I think in this case, the policies and the regulations like the EU taxonomy, the Green Deal have actually moved the needle pretty significantly. And we're seeing corporations really follow suit. Just in addition to the announcement last week, there's also a proposal in the works for a carbon border adjustment mechanism. So essentially kind of a tax that the EU would levy on companies importing goods like steel or cement, or goods that are high emissions associations.

Savita Subramanian:

So really the idea is to disincent companies to import high emitters or to use companies as suppliers that have not such strong emissions profiles or use less offensive materials, et cetera. So there are a lot of subtle ways of encouraging corporations to get with the program that can actually hit the bottom line. So now in the US, we don't necessarily have federal policies on carbon reduction. We don't have a coordinated Washington DC effort, but we have seen a lot of investors and corporations really step up and take action. And I think where the pressure is coming from is really investor demand. So if you look at the S&P 500, which is what I focus on primarily, half of S&P 500 companies have set carbon emission targets as of, I think, maybe a few months ago, and this is a very different environment from last year during Climate Week.

Savita Subramanian:

So we've seen huge progress just in the last 12 months. Two-thirds of these companies have completed the CDP questionnaire. So we have a lot more information around US companies. And I think that we're also seeing investors start to press these companies for more details, for more aggressive policy response. So I think one example of this is BlackRock voted against 53 companies for insufficient progress on climate action. So there's really a lot of investor pressure or support for some of these areas of change.

Lynn Martin:

That's an amazing stat on the S&P 500 and one that I hadn't fully appreciated. Is BlackRock and other similar investors driving some of those additional disclosures or do companies, corporations in your mind feel more of an obligation in that regard?

Savita Subramanian:

I think it's a little bit of each. So I think another big kind of important driver of disclosure is this entity called the TCFD. TCFD stands for the Task Force for Climate-Related Financial Disclosures. Big mouthful. But basically this organization, it was established about five years ago and its goal is developing a set of voluntary climate related financial risk disclosures. Now what's new this year, and I think the reason that we've seen such a hustle from US corporations is that mandatory TCFD disclosures kick in this year for any asset manager that is a UN Principles of Responsible Investment signatory. So there's now about a hundred trillion dollars worth of assets under management. 3000 firms that are UNPI signatories that are basically going to be essentially strongly encouraged to disclose the profile of their portfolio.

Savita Subramanian:

So in addition to us all looking at the performance of asset managers, we can now look at the emissions profile of their portfolio, which is a really interesting thought. When we're investing, we can actually invest according to that metric, which will now be available. So I think again, just thinking about companies that aren't disclosing, they will be cut off from a hundred trillion dollars worth of assets for the simple fact that they are not providing information. So I think that's another kind of subtle exertion of pressure from the investor community on corporations.

Lynn Martin:

I want to shift gears to one sector in particular. It's probably the one sector that comes under the most question when you're talking about environmental standards. And that's really the Energy Sector. So in your mind, what's the potential role in the Energy Sector, in the transition to a carbon-free economy?

Savita Subramanian:

There are a lot of different perspectives on this. I feel like I have a conversation every day with our energy analysts about this pressure from ESG assets. So, if you think about the Energy Sector from just a pure emissions profile, it's probably one of the biggest offenders. Utilities and energy have the largest share of global emissions. I think energy alone accounts for something like 40% of direct and indirect global emissions. So I think it's in the crosshairs of investor scrutiny around carbon neutrality. It's basically shrunk. So I think what's interesting is if you look at the Energy Sector within the S&P 500, it used to be 16% of the S&P. Today, it is now a little less than 5% of the S&P 500.

Savita Subramanian:

So it's really shrunk in terms of its market capitalization. It's one of the worst performing sectors this year. But now the risk with just choking off assets to the Energy Sector is that on the path towards becoming carbon neutral, we need to keep the lights on. We need to keep the factories running. And there's a major risk of supply disruption of these traditional commodities related energy sources in that path towards becoming a low carbon economy. And then that path as we've seen from Europe's goals could take decades to complete. So, that's the sort of interesting dynamic for the Energy Sector. And then on top of that, our analysts have also pointed out that energy companies have played a very strong role in innovation. So I think one of the examples that our energy team had was that Exxon was the first company to hold a lithium battery patent.

Savita Subramanian:

I didn't know this until he told me. So these companies aren't just sort of evil emitters of carbon emissions, but they're actually really investing in becoming carbon neutral. This morning we actually just published a research report on hydrogen economy. And some of these big energy companies are some of the biggest investors in that new technology, which could be salvific from a climate change perspective. So it's painted with a very negative brush by a lot of broad strokes CSG investors. But I think that there are definitely reasons to consider energy a little bit differently from not just looking at the emissions profile, but thinking about the path that these companies are on.

Lynn Martin:

That's really interesting, particularly the whole idea of Exxon being one of the ones that holds a patent. That is something I hadn't appreciated. Clearly a scenario that we have a lot of focus on at ICE given the fact that we've been in the carbon risk management business since we acquired the Chicago Climate Exchange back in 2010. And that market around carbon credits, things of that nature is one that's significantly grown for us. So we do start to see folks in their own energy transition from a risk management perspective. I know you've recently just launched a proprietary ESG scoring metric. Can you give us an overview of ESG Meter? How does it compare to other potential scoring metrics in market, and how does it assess the company based on climate related metrics in particular?

Savita Subramanian:

Yeah, absolutely. So we're very excited about ESG Meter as you know, and we're particularly excited because the data engine behind ESG Meter is your data. So thank you for that, Lynn. It's a fantastic-

Lynn Martin:

No, thank you. You're a great partner.

Savita Subramanian:

What I love about the data is that it is very granular. It's transparent. You know exactly what you're putting into your models and as a quant, that for me, particularly important in terms of thinking about assessing the risks of corporations. So what is ESG Meter? Well, we're really excited about it and, and Candace Browning, my boss, our director of research on a global basis had this idea maybe five or six years ago that in addition to providing by underperform and neutral ratings on our stocks. And in addition to telling the world our fundamental opinion, we should also take a look at this whole new set of metrics and data and codifying of environmental, social, and governance risks and opportunities at a company level.

Savita Subramanian:

So our goal is within research to have a read or a score if you will, on every stock and every credit instrument that we cover within Bank of America research. And we're really excited about it. We've got our pedal to the metal and we are launching sectors on a monthly or a weekly basis. So look for that to be built out more thoroughly by the end of the year. But really what we're trying to do is instead of taking a moral lens and saying, "This company is making the world a better place, this company isn't," because that's a tough call to make, that morality obviously differs across individuals. So what we did instead was we spent a little bit of time thinking about each sector in the market and what are the most important drivers for that sector?

Savita Subramanian:

So for example, if you look at a technology company, it's not necessarily going to be as important to look at the carbon emissions or the more environmental aspects of that corporation. But instead what we found that the most critical risk for a technology company, an asset light tech company like software or internet, is keeping their talented employees at their company as opposed to leaving for a competitor. So we found that these social factors like job satisfaction, training, retention, leave policies, especially during COVID. All of these different sort of employee related aspects of a corporation tend to be the strongest drivers. So for our scores for the tech sector, we have a big skew towards those material drivers of financial results.

Savita Subramanian:

And interestingly, what we found is that we're building this from a quantitative back testing perspective, but then we're also going to our analysts, our fundamental analysts who know these stocks, they fly around the country, they live and breathe everything that happens to these stocks. Our analysts are basically helping us to refine our quantitative work and come up with a forward looking perspective on what the risks and opportunities are at an individual company level.

Savita Subramanian:

So since it's Climate Week, let's talk about the environmental score and I just jotted down... The data that we're using, like I said, I'm very excited about it because I really think it's top class data. We're looking at things like not just carbon emissions, but other types of emissions. We're looking at GHG emissions reduction target rates. So for a company, they'll set a target. How ambitious is that target? Are they going to become carbon neutral over the next year, 5 years, 10 years? We also look at whether they're on the path to achieving their target. So each year, are they making that necessary progress towards achieving that target? We look at water usage. We look at waste metrics, hazardous and non-hazardous. Recycling versus discharge. Lots of really nitty gritty data elements go into these scores. So think it's really just a very rich read on a company's environmental footprint, as well as its goals for the future. So not just what's happening today, but what that company plans to be over the next decade.

Lynn Martin:

So in your analysis, is good climate disclosure rewarded and are companies that disclose bad information bound to be penalized in this scoring?

Savita Subramanian:

It's a great question because I think that from a corporate perspective, it's really hard to tell the world you don't look great on certain metrics, but what we're finding Lynn, and this is really interesting. What we're finding is that companies, even if they say something bad, so even if you come out there and you tell the world, "Yeah, my emissions are well above average," companies that disclose emissions, even relatively high emissions trade at a premium, almost being equal to companies that say nothing. So it's really interesting to see. So investors are essentially penalizing companies for remaining mum, and that opacity is more detrimental to your market valuation than telling everyone, "Look, we're not doing great, but we're going to get to here in 10 years, we're going to get to here in 20 years." So there is this incentive, a really strong incentive for companies to actually disclose information.

Lynn Martin:

Interesting. It just comes back to transparency and the market rewarding transparency just of information. Even if it's not the best information, it's better than no information. The last time we spoke Savita, you gave us a stat, which I can't tell you how many times I've reused. Specifically that during the peak volatility of the COVID period, when things were really at their most crazy in markets, we saw a good chunk of money flow out of your traditional equity funds. But interestingly, during that peak volatility, we saw money flow into benchmarks driven off of ESG magic tricks. Has that trend continued over the last five months since we spoke?

Savita Subramanian:

I think this ESG story is very sticky and stable and it's not necessarily ruled by the vaguery of the markets obviously very volatile rollercoaster year that we're having. So even just as of today, if you look at... So every week we publish our data on various flows. And we noticed that there were just even today, like as of right now, or maybe last week, we've seen 20 straight weeks of inflows into ESG funds, which is very unusual. So there's another statistic you can use.

Lynn Martin:

I'm writing it down. I'm writing it down because I'm going to plagiarize that now for the next five months until we speak again, so that's great.

Savita Subramanian:

That's right. I think what's really interesting about ESG is it's an all weather theme that is not necessarily being dictated by volatility or expectations of recession or booming economy. It's really just a long term secular trend that we're seeing. And asset flows have been probably more stable and more aggressive towards ESG funds than most other themes that we're tracking. So I think what's also interesting is if you look at within the ETF market, ESG ETFs have been the fastest growing area within the thematic ETFs that we track. So lots of interest, steady interest. We've also continued to see highly ranked ESG stocks outperform the equal weighted S&P. I think we've seen anywhere between 5 and 10 percentage points of alpha this year. So I think where we are today has been a pretty telling story of how ESG is not a bull market phenomenon. It's not a bear market phenomenon. It's really just an all weather strategy.

Lynn Martin:

Okay. I know you mentioned when you're talking about ESG Meter, some of the impact of S on tech. How has E in particular performed the E aspects? How have those companies, where you're more heavily weighted towards greenhouse gas emissions, carbon emissions, those types of things, how have they performed over this period?

Savita Subramanian:

So it's interesting because if you look at just... And quickest way to see this is if you look at sector performance. Some of the sectors that rank the poorest on EMA, like for example, energy is the worst performing sector this year. So we've continued to see... And part of that is driven by the fact that we're just coming out of the worst global recession we've seen in the postwar era and energy is a very cyclical demand driven sector. So that's part of it is ESG and part of it is environmental risk and then the other component is demand. So it's hard to sort of disentangle the two. But if you just look at kind of highly ranked stocks on environmental components like disclosure, lower emissions versus higher emissions, et cetera, we have continued to see a strong differentiation between the so-called good and the so-called bad.

Savita Subramanian:

And then I think what's also interesting is if you look at green bond issuance, this year I think we're tracking another record year for green bond issuance across corporations. So the demand and the reward for environmentally focused investments has been very strong and has been relatively unshakened despite the fact that we've seen this sort of exogenous shock of COVID and a healthcare or social related crisis hit the markets.

Lynn Martin:

Okay. That's really helpful, especially to give the added color around supply and demand and how that factors in as well as these environmental scores. So one question that I just got from the audience as I'm monitoring the Q&A is you said money is flowing into ESG stocks. What qualifies a stock as an ESG stock? Is it one that discloses under SASB and or TCFD? And to your point, even if what they disclose might be seen as negative.

Savita Subramanian:

Yeah. It's a really good question. And I think it's... Right now, the world of ESG investing is a little bit of the wild west, if you think about it. So there's no strict definition of what a company should disclose. There are just encouragements from investors. There's no kind of example of good versus bad ESG. So some of it is a little bit subjective. In fact, two investors can look at the same company and one can think it has good characteristics because maybe today it doesn't look great, but it's probably going to be one of the biggest improvers from an ESG perspective. Whereas another investor can look at that same stock and say, I can't own this stock. The emissions profile is too negative for my portfolio or controversy stocks.

Savita Subramanian:

Some investors are ready and willing to buy a stock that has had a controversy because they see enough progress, changes in the management team and the culture, et cetera, to be able to step in and own that stock. Whereas another investor is the not going to touch a stock that has an E, S, or G related controversy. So it's really not a one size fits all type of exercise. But I do think to our listeners point, disclosure is an important part of it. So one of the things that we've looked at is if you take all the ESG funds in the world, and you look at their holdings, they tend to have a skew towards companies that disclose more rather than less information, which makes sense to all of us. We would rather know what we're getting than buy the unknown, but but I think that there is room for every company to have an ESG angle if they are interested in bonding that.

Savita Subramanian:

So the risk at a corporate level is even if you're a great company, if you're not telling your investor base what you're doing to to improve the world on an environmental basis or how great your social practices are in your community involvement, et cetera, nobody knows, and nobody's going to really reward those aspects of you. So I think disclosure is a really critical part of the equation.

Lynn Martin:

I have time for one more question it looks like. In your opinion, Savita, what is the potential impact GDP from climate change and why should not ESG investors care about climate risks to their portfolio?

Savita Subramanian:

We published a report last year during Climate Week on just the cost of climate change. And I think by our estimates, something like 60 trillion dollars of capital lost by 2100. But I think what's really kind of critical is that climate events already have cost the US something between 300 billion to half a trillion over the last five years. So this is a real cost. Inaction is really costly for the world's economy. And it's not even just the social cost and the global cost over a hundred year period. It's really what's happening right now. So if you think about, let's just stay that the governments around the world start to set carbon taxes and this is something you know more about than I do. That could be a costly phenomenon for corporations today.

Savita Subramanian:

So that's something where I think that the immediate hits of profits would be fairly shocking for certain sectors of the economy. And then if you think about just the impacts of climate change being felt in these extreme weather events that it feels like we have every season more and more frequently. The physical damage caused by extreme weather events. The cost, it's hard to quantify, but it's really broad and affects all of us in our portfolios and in our daily lives.

Lynn Martin:

Certainly extreme weathers. Potentially the most active hurricane season, as well as the wildfires that are ravaging California.

Savita Subramanian:

Yes, exactly.

Lynn Martin:

Thank you so much Savita for taking time join us again today. Hoping we can ask you to come back in a few months as well to give us an additional update. Thank you to everyone who joined us today. We look forward to continuing the conversation with you all on climate change, ESG, how these emerging risk factors can impact your portfolio and markets. So stay safe, stay healthy, and we look forward to seeing you again very, very soon.

Josh King:

Thank you again to Savita Subramanian, Head of ESG Research and US Equity and Quant Strategy at Bank of America, and ICE Data Services president Lynn Martin. If you like what you heard, please rate us on iTunes so other folks know where to find us. And if you've got a comment or a question you'd like one of our experts to tackle on a future show, email us at [email protected] were tweet us at ICEHousePodcast. Our show is produced by Pete Ash with production assistance from Ken Abel and Ian Wolf. I'm Josh King, your host signing off from the library of the New York Stock Exchange. Thanks for listening. Talk to you next week.

Speaker 1:

Information contained in this podcast was obtained in part from publicly available sources and not independently verified. Neither ICE, nor is affiliates make any representations or warranties express or implied as to the accuracy or completeness of the information and do not sponsor, approve, or endorse any of the content here in all of which is presented solely for informational and educational purposes. Nothing here in constitutes an offer to sell a solicitation of an offer to buy any security or a recommendation of any security or trading practice. Some portions of the proceeding conversation may have been edited for the purpose of length or clarity.