Joe Cass   00:00:00

Hello, and welcome back. My name is Joe Cass. I'm a Senior Director here at S&P Global Ratings, and I'm the host and the creator of the FI15 podcast. So on this episode, we have Andrew Howard, Global Head of Sustainable Investment at Schroders; and Christa Clapp, Managing Director in Sustainable Finance at S&P Global Ratings. As always, a very quick reminder that the views of the external guests are their views alone, and they do not represent the views of S&P Global Ratings. Andrew let's start with you. Would you be able to share with us your career path thus far and how you ended up managing sustainable investments at Schroders?

Andrew Howard   00:00:36

Sure. Well, I can certainly try and piece this together. So, I started about 25 years ago. I started my career in investments out of university as a mining analyst, about the time of the Asian crisis. It's still not entirely clear to me why I was given the job of being a mining analyst, but such was the way of the world back then. One of the things that struck me was that every time I would go and visit mining companies, the management teams would insist on talking to me about health and safety, what they were doing with local communities for 15-20 minutes at the beginning of every presentation. And as an analyst, I'm sitting there thinking, I don't know what to do with this. I've got my financial model. This doesn't seem like a cost, but I should be treating it as a cost line. I don't know how this connects with what I'm doing as an analyst trying to value the business. And it struck me that there was a bit of a disconnect between the outputs—the financial numbers that we were looking at as financial analysts—and the way that management teams were running those companies. In many ways, the following few years were really a journey in trying to figure out how to bridge that gap. I did an MBA for a while. I worked as a management consultant for a while. Frankly, neither of them entirely solved that problem. And then I went to work at Goldman, where I stayed for about 6 or 7 years when Goldman was just starting a research team focused very much on long-term investing and really trying to understand the long-term health of companies, which started to connect those two things. Really, in a way, that subsequently led to my joining Schroders in 2016. And that basic principle of how do we connect what's happening in the real world, the stuff you read about on the front pages of newspapers, to an understanding of how we're assessing investments, the implications for businesses, and ultimately, the implications for the value of those investments and the value of those portfolios, in a way that really tries to connect what we're seeing in the real world with the way that we analyze investments and build portfolios.

Joe Cass   00:02:29

Great. Thanks, Andy. And Christa, similar kind of question for you. Can you give us an introduction to yourself and also your career thus far?

Christa Clapp   00:02:38

Yes. So I'm a co-founder of Shades of Green, which was acquired by S&P Global about a year ago. But my career journey has been more focused in climate policy research and economic analysis. And the thing that motivates me the most is to understand how climate research can connect to financial decision makers. So I've been trying to work in the nexus of climate research and finance for a number of years. And I used to lead the climate finance research team at CICERO, which is a International Climate Research Institute based in Oslo. And that's where we developed the Shades of Green methodology that we're using today to assess green bonds.

Joe Cass   00:03:19

Great. Thanks, Christa. Andy, can you provide an overview of how Schroders approaches sustainable finance and how you look to integrate ESG factors into your investment strategies?

Andrew Howard   00:03:32

Well, I mean, first and foremost, sustainable finance is a component of finance. Ultimately, for us, this is an investment problem. And to me, it's probably one of the most important and one of the biggest opportunities within our industry in terms of how we think about connecting what will be extremely disruptive changes, climate change, inequality, social unrest, nature loss. If you sort of think about the magnitude of impact that those trends can have on industries, on economies, on the value of individual companies, the potential disruption is going to be significant. We're already starting to see that playing out in some areas. And there aren't that many areas of our industry where you can see something that can be as significant and disruptive as social and environmental change are already proving to be, where the knowledge and the understanding of how to tackle those questions is not in a textbook, there's no definitive approach as to how you do this and where the opportunities, therefore, to come up with better answers and better ways of solving those problems is, therefore, particularly, I think, important and particularly compelling. So for us, the starting point really in the context of an individual investment strategy in the context of different asset classes, understanding what are the ESG factors that matter to what will drive the future performance and understand the valuations and the business models of companies in different sectors and assets in different areas of the market. And then to ensure that we are creating the tools, the analysis to understand those trends and their implications as effectively as we can. I hesitate to call this a data-driven process. Data in the ESG space is not like data in some other areas. There is a lot more data available than there was ten or fifteen years ago, but still judgment is a really important part of this. This is not an exercise in simply plugging some numbers into a computer and seeing what comes out. And embedding that sort of knowledge and those sorts of questions into the way that we make investment decisions across different parts of the business has been really critical, ensuring that that's then reflected in how we build portfolios, how we select individual investments. And then equally importantly, how we go about monitoring those investments and engaging with investing companies, engaging with the assets that we've invested in to help them to transition and adapt over time is a really important part of that exercise. So it's very much about thinking about sustainability or ESG factors throughout the life cycle of the investment process rather than simply thinking about it as a compliance exercise. It's not a screen. It's not a filter. It's not a rule that you apply. It's about trying to recognize and incorporate social and environmental change into each step of the investment process.

Joe Cass   00:06:14

Great. Thanks, Andy. Christa, can you tell us kind of the story, I guess, of how you initially developed Shades of Green, how the methodology works and how it now integrates into S&P Global Ratings sustainability practice?

Christa Clapp   00:06:31

Yes. So, something that Andy just said really resonates with the story of how we developed the Shades of Green methodology. It's not a data-driven process. The data isn't good enough for us to make it a data-driven process—maybe in the future. But right now, it involves a lot of trade-offs, focused more on climate but across environmental factors, ESG factors, scenario planning, and risk management. All of these things can, I think, be informed a lot by qualitative and opinion-based analysis, which is what we’re doing with the Shades of Green methodology. But the start of it was, as I mentioned, back at this research institute, the Climate Research Institute, a nonprofit group in Oslo. We set up an advisory board of investors to understand what they wanted climate research to help inform. It was a real learning exercise for everyone because this was back in about 2014. We just brought climate scientists and different types of investors together, put them in a room, and thought, "Let’s see what happens." The climate scientists said, "What do you want to know from us?" And the investors said, "I don’t know, what can you tell us?" That was really it. The starting point was a bit awkward. And, of course, it was learning. Over time, it became much more refined. What can we actually say from the climate science? There are a number of different modeling platforms and scenarios, and it can be quite confusing. We don’t have a crystal ball. There's a lot of different metrics we’re looking across and a lot of trade-offs. But we can say something. We can actually look across all the scenarios used for the Intergovernmental Panel on Climate Change (IPCC), the UN Climate Assessment report that comes out every five years or so, and we can say that across all those scenarios, to be aligned with the Paris Agreement targets, you need transformation in every single economic sector to hit zero greenhouse gas emissions by mid-century. That’s a very rough rule of thumb, but we use it as a basis to talk about the shades of green. Then we thought about how we could compare different investments, how well-positioned they are for the zero-emission future and the future where we're also facing more physical impacts of climate change. We're facing more economic impacts from flooding, heat stress, hurricanes, and all the things we read about in the news today. What we knew was that we didn’t have enough precision or enough data to score on a zero-to-hundred-point scale— that would be false precision. What we could do was say, let’s put them into three buckets. We started with a simple three: light, medium, and dark green. We can communicate that about a particular investment, and then an investor can make their own decisions based on whether it factors into their sustainability strategy, or if it may complement or supplement their own internal analysis. Then they can decide what level of green they’re comfortable with. For us, the dark green end of the scale—that’s our top shading—means it’s essentially zero emissions by mid-century. It’s essentially Paris Agreement aligned. It includes things like renewable energy, which is common, but of course, we’re also paying attention to environmental impacts throughout the supply chain. So, it’s a complete value chain perspective. But a lot of renewable energy falls into that green space. At the other end of the scale is light green. Light green is quite interesting because it can represent very significant emission reductions but, at the same time, has not fully transformed away from fossil fuel use. These are important starting steps toward climate transition, but they may have very different starting points depending on the region you're looking at or even the sector or technology you're considering. So, it gives us a bit of flexibility. As you can probably guess from the way I’m describing the methodology, it is not data driven. It’s not taxonomy based. It’s actually principles based. So, we’re able to take into account the context of a particular investment, a particular company, and situate it within our three shades. Joe, you also asked about how we're using it at S&P today. It is now an integrated S&P Ratings methodology, and we spent the first six months after our acquisition focusing on that. A couple of months ago, we came out with it, and we now use it to assess both green and sustainable bonds. The green projects within those bonds are assessed according to the Shades of Green methodology, and we've integrated our team—originally from the Research Institute—into S&P Ratings as well.

Joe Cass   00:11:08

Excellent. Thanks, Christa. Andrew, shareholder engagement and proxy voting, they're very powerful tools in the world of sustainable finance. Would you be able to provide a couple of examples or instances where Schroders has engaged with companies to influence their ESG practices?

Andrew Howard   00:11:26

Absolutely and quite topical, I think, particularly in the context of this climate discussion. I mean, just to put things a little bit in context. So, at Schroders, we have an intention. We are transitioning our business, including the portfolios that we manage, towards a lower carbon world, and ultimately, we are targeting a net-zero world by around mid-century. We’ve had our targets validated by the SBTi, and we are a founding member of the Net Zero Asset Management initiative. I say all of that because that's the easy bit. In many ways, establishing targets is the straightforward part. The tricky bit is how do you get there? And our focus is very firmly on transition. I tend to say there’s really only two things you can do as a fund manager: you can pick the right assets or companies to put into a portfolio in the first place, or you can look to add value to those assets through the way in which you engage with them, the way you own them, and the influence you can apply. I think that latter component is becoming increasingly important, as more and more of the world’s companies, more of the world’s industries, will need to go through a transition to get us on the journey towards a decarbonizing world. So, for us, engagement, and transition—the active ownership, stewardship part of investment—is a really critical part of how we’re delivering that. So, to give you an indication, for the last few years, we’ve engaged with about 700 companies per year on climate-related topics. That’s a firm-wide effort, so our fund managers, our analysts across different investment teams are part of that exercise. What we have found is that the companies that we have engaged with have been about twice as likely to establish emission reduction targets as companies we haven’t engaged with. We found that they’ve cut their emissions more quickly. And, equally importantly, they’ve delivered better performance than companies that we didn’t engage with. So, you put all of it together, and I think the ability to engage and be part of that transition, which can unlock real value, not just in carbon emissions but also in shareholder value and shareholder returns, is going to be a really important part of how we see this journey—rather than just simply thinking about it as, “Let’s sell high-carbon companies, let’s buy more low-carbon companies.” Yes, your portfolio decarbonizes, but it’s a restrictive approach to transitioning rather than a dynamic one. So, I think that transition point is a really critical one, and in particular in the context of the conversation we’re having around data. There is a real challenge with, I think, in this industry, we’re going to get stuck waiting for perfect data. It’s going to take an awfully long time. The number of times that I’m handed charts that show me temperature alignment scores to three decimal points, and I have to scrub all the decimals out because it’s a false level of precision, given what we know the underlying data looks like. But even without that, we know that there are some relatively straightforward things that companies are going to need to do. They’re going to need to establish an intention to change their business. They’re going to need to deliver progress on that. They’re going to need to set themselves up to deliver that transition. And almost without the data, you can still really start to make a real difference, I think, in terms of how companies prepare for what will be a transition that is quite unlike anything we can look back at and say, “How did this play out before?” There is no sort of example from the last time. It’s not like when rates went up, and we can look at what happened last time rates went up and do a big quant analysis of it. It doesn’t work like that. It has to rely on logic, and it has to rely on common sense and knowledge, and at the end, company and industry understanding.

Joe Cass   00:15:01

Thanks, Andy. Christa, can you talk a bit about the climate financing gap? What is it? And why should investors be paying attention to it?

Christa Clapp   00:15:09

Yes, of course. So one of the hats that I wore the CICERO Climate Research Institute was as a lead author for the IPCC climate assessment report. And this is an assessment report that takes multiple years with multiple researchers around the world assessing the latest climate science. And so the headlines are rather depressing from this report. And the headline on the climate finance gap was that we are three to six times below and the magnitude of trillions depending on how you measure from where we need to be investing in clean energy and zero-emission technologies and resources in order to meet our climate agreement goals under the Paris Agreement. And that means when you take the balance of financing towards fossil fuel subsidies, for example, and you think about all the other green investments we're doing like in the green bond market, it's not adding up in the right direction for the climate. But beyond that, I think it’s more interesting even to dig into the details because it's kind of an obvious message. We aren't spending enough money in the right direction. It's actually hitting both developing countries and adaptation projects the hardest. So 90% of what we can measure is actually going towards mitigation. That's great, towards reducing emissions. The problem is that we've already locked greenhouse gas emissions into the atmosphere, and it reacts according to what emissions we already emitted in the last few years and are already in the atmosphere. And based on what we do today and tomorrow, ten years or so from now, the atmosphere can adjust. So we already locked into physical impacts of heat stress and flooding and hurricanes that are both planned to increase in magnitude and in frequency across many of the climate scenarios. So this means that, especially in developing countries, you have local populations that are extremely vulnerable to increased physical impacts in the next decade and aren't receiving the financial support. Now part of that is the type of capital markets we have and maybe lack of transparency and lack of maturity in some of the developing countries and emerging markets. But it also has to do with the financial paybacks and that type of structure. It's something that's a little bit less likely to fit well in a green bond as an infrastructure project that's going towards supporting renewable energy, for example. So there's a couple of complications there. And I think the result means that we have plenty of capital in the world is how do we redirect it towards both closing the transition financing and adaptation financing gap. And part of that is not just the responsibility of the financial sector. It is also that nexus with policy interaction and risk sharing mechanism. So it means a lot more cooperative work in the financial sector is a big role to play there.

Joe Cass   00:17:57

Thanks, Christa. Andrew, how do you see the role of sustainable finance evolving in the coming years? And what new strategies or approaches is Schroders considering to really kind of stay at the forefront in this sector?

Andrew Howard   00:18:11

Well, I think some of Christa's points really underscore the importance of finance in the investment industry. What is the point of finance? At the end of the day, it's about connecting surplus capital—capital available for investment—with areas of need in the real world that can generate an economic return on that investment. And there are few areas of greater need in the world than tackling climate change, mitigating its future impacts, addressing nature loss, and dealing with the full spectrum of sustainability, social, and environmental challenges that we’re all becoming increasingly familiar with. The finance industry, I believe, will ultimately have to evolve to reflect the way we connect capital to these areas of the world that need investment. Historically, there has been a tendency—though this is fading—to view climate investment or sustainable investment as something one chooses to get exposure to. I think, certainly, our starting point is that every investment is exposed to climate change, whether it's the physical impacts of climate change or the policy and social response to the threat of climate change. We're all exposed. The real question is whether you're taking that exposure consciously or whether you’re simply hoping for the best. Our approach has been to be proactive about it, trying to understand where those risks might emerge before they happen, rather than waiting for them to unfold. In the context of how we're evolving our thinking on these topics, particularly climate change, a lot of the discussion has focused on climate change or climate transition as a constraint, almost separate from the investment process. How do we reduce portfolio emissions? How do we set long-term targets and apply them as constraints to portfolios? I think this is the wrong approach. Ultimately, we should think about climate transition as a way of managing risk, finding opportunities, and making climate analysis part of the investment inputs—rather than merely a constraint on portfolio outputs. As we've seen over the last few years, valuations have fluctuated. If you look at the valuations of clean energy companies relative to traditional energy companies, we've been on quite a roller coaster ride. Valuations matter, fundamentals matter, and understanding how to incorporate climate risk into that process is crucial. This is about seeing climate risk as an opportunity rather than a limitation. That shift is something we’ve been trying to make, and while I won’t pretend we have all the answers, I do believe we’re asking the right questions. The goal is to use climate analysis as an input to the investment process, so that portfolios transition and decarbonize as a result of the investment process, rather than simply treating climate goals as constraints we must work within. Another area that's becoming increasingly important, and one we’re focused on as an industry, is how to ensure investments connect to real-world change. More and more of our clients are seeking ways to understand how their investments contribute to tangible outcomes. A few years ago, we invested in a company called Blue Orchard, a leading impact investment firm. We’ve been working to take the experience and DNA that Blue Orchard had built and apply it across the Schroders Group to build impact investment products, frameworks, and funds across different asset classes. The goal is to connect finance to real-world change in the same way that we’re integrating real-world change into our investment decisions.

Joe Cass   00:21:54

Great. Thanks, Andy. And Andy, what view or opinion from the world of sustainability do you believe to be true that few others would agree with you on?

Andrew Howard   00:22:06

It’s tricky because there are so many people involved. When I first started, there were hardly any, so it was easier to know most of the people in sustainable investment. But now, finding something that’s still controversial is challenging. However, if I look at the numbers, the growth of passive investment strategies in this area suggests that a lot of people believe we can approach sustainable investments as a somewhat formulaic exercise—applying ratings, rules, and managing portfolios that way. I disagree with this approach. Sustainability is, in many ways, about a set of disruptive challenges that will impact different companies, industries, and economies in ways we can't perfectly model. We can't analyze it through a purely quantitative lens. The factors that made companies successful in the past won’t necessarily be the ones that make them successful in the future. There’s no shortcut here; we need to apply logic, brainpower, and deep understanding to assess how this change will play out, where the opportunities will arise, and where the risks will come from. I often think of it like driving on the road: If the road is straight, driving using the rearview mirror is fine. But when the road starts to bend, using the rearview mirror alone will lead to a crash. In some ways, whether we frame this in terms of passive versus active investment or not, the key insight is that the future will look different from the past. Looking at things without the safety net of quantitative data, back testing, and 30 years of history is the only real way to navigate the changes that are already beginning to come true. As Christa has outlined, we’re already seeing these changes play out in the climate space and many other areas.

Joe Cass   00:24:02

Thanks, Andy. So Christa, green or sustainable bonds now equate to 15% of all global bond issuance. How are investors comparing the relative greenness of bonds? And what challenges do they face when investing?

Christa Clapp   00:24:19

Well, every investor is different. They have different mandates and different ways that they assess their own risk and different ways that they look at sustainability. So hopefully, what we're doing as a second-opinion provider in the green and sustainable bond market is providing a way to compare. But it's not easy because every second-party opinion provider has their own methodology. On top of that, we also have a lot of regional differences. Andy, I think you talked about a road that's not quite straight. That’s definitely how I would characterize the green and sustainable bond market. If I look back from the beginning when, underneath the Sister Research Institute, we provided the first second-party opinion on the first green-labeled bond in 2008 to where we are today, one of the biggest changes is what’s happening in different regions around the world. We have both the EU regulatory space that’s advanced quite remarkably in the past few years. And now we also have regional taxonomies for what counts as green popping up basically everywhere. We have them everywhere from Singapore, Australia, Canada, the categorization in China, and many others. And I think that is maybe one of the biggest challenges today. Of course, I can’t speak from the investor angle, but it’s a challenge for us too. We have our own methodology that we can layer and supplement when we look at different taxonomies, and we find that useful because it is hard to map some of these taxonomies together. Some of them are a list of just green projects, which is the approach the EU has taken. Others are more of a traffic-light approach, where they’re looking at some of the earlier-stage transition, where we might be able to map to a light green or a little bit off the green scale in our shading spectrum. So we can use that as a common language to talk across different regional taxonomies. So that’s what we’re aiming to do. And I think we can expect this to be a bit of a messy space for a while. I don’t see a future where we have one global agreed taxonomy. I think every region needs to think about their own resource base, their own technology development, and what they’re comfortable with. But as an independent opinion provider, we can help try to provide some communication across those taxonomies.

Joe Cass   00:26:37

Great. Thanks, Christa. And Andy, as an investor in green bonds, what do you like about them? What don't you like about them? And what resources do you call upon to kind of refine your analysis before investing?

Andrew Howard   00:26:50

Well, I think I thought for a minute we’d managed to get through a whole discussion without talking about regulation, but foiled. I fully agree. I mean, I think your point, Christa, that there are ever more taxonomies being created. This whole area is becoming more and more challenging to distill nicely down into a little box. But I think, to your point, Joe, they have become an unavoidably large part of the market. And it’s not just the green bond funds or specific funds. Actually, they’re a large part of overall issuance. One of the benefits of that is that as the markets become bigger and more liquid, one of the historical challenges, which is around the ‘greenium’ or the idea that green bonds were priced at a less attractive rate generally for the investor, but more attractive for the issuer than other conventional bonds from similar issuers with similar credit profiles, that 'greenium' has, to a large degree, dissipated in most parts of the market. It’s slightly different in the sovereign space where it’s still a relatively small part of sovereign issuance, but it has become a much more liquid, much more conventionally and evenly priced area. I think very much to Christa’s point, it provides a much more focused way of investing. And I think for a lot of our funds and for a lot of our investors, that’s a very helpful feature where you're looking for – we’re creating funds with exposure to specific kinds of investments or specific kinds of projects. What I will say as well, perhaps tangentially, is that it's also really helpful in understanding the issuer and the company that we're investing in. So, oftentimes, the information that one gets through a green bond actually gives us a lot of information about what the company is doing in aggregate, what its strategy is, how it’s planning to deploy capital, how it’s planning to invest, and what sort of targets they’re setting across the firm. On the other hand, it’s challenging. We mentioned the sort of confusion issue. There is, notwithstanding the number of different taxonomies and everything else, the ability to populate those taxonomies with hard data is still often quite tricky. The ability to compare between different sets of information provided by different issuers is still often quite tricky. And there’s a long way to go before we really get that kind of transparency or comparability that we might like. On the other hand, we have analysts, we have credit analysts covering different sectors, different companies, being able to combine their knowledge of the industry, the context of the industry, and looking at the specifics of a particular issuer on a particular issuance is how we try to tackle that by really putting together, say, the company-specific knowledge with that perspective on the green bond itself.

Joe Cass   00:29:28

Fantastic. Andy, the very last question, and it goes to you. So I'm lucky enough to interview leaders and influential individuals like both of you to from the world of finance usually on this podcast. So thinking about everyone you've met, anyone you've worked with or just people you've kind of seen from afar who would you think could be an interesting potential guest I could ask to join a future episode of this show?

Andrew Howard   00:29:55

I'm probably about to annoy all of my previous colleagues in one fell swoop. But I actually think that in many ways, some of the most important figures for our industry won’t be of our industry. Now obviously, I’m looking at this to a large degree through a sustainability lens. But if I look at the last few years, and I’ll try and be impartial about this, but whether I think about people like Al Gore and what they did in terms of raising awareness around climate change, or if I look at people like Vivek Ramaswamy and what we’re seeing currently in the U.S. in terms of that debate, I actually suspect personally that a lot of the influences that will impact our industry most come from outside of our industry, whether that be social activists and social activist groups in this part of the world, organizations like Just Stop Oil. Whether that be pro-activists or the other end of the spectrum. And there are a growing number of organizations that are anti-ESG or anti-woke. But I think that discord, that discussion that’s happening beyond the edges of the finance industry is going to be a more important influence on our industry in many ways than many of the voices that are currently in our industry. And I think we often tend to look a little bit too narrowly when we look at this. So, not a very precise answer. I probably annoyed lots and lots of people that I work with and have worked with, but that’s my take.

Joe Cass   00:31:19

Perfect. That's great. Thank you Andy, appreciate it. So thank you, both. Thank you, Andrew. Thank you, Christa, and for your time today, fascinating. So for everyone listening, see you next time on fixed income in 15.