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ESG Making Its Move in a COVID-19 World

Our aim is to create an ESG Alternative Debt Community to advance the SDG: What does “good” look like in a post-COVID world?

As economies move into recovery mode, finance leaders are exploring this question and debating the role of ESG – Environmental, Social, and Corporate Governance – in the post-pandemic marketplace. While the concept of responsible investment has taken a bit longer to embed in alternative debt, it is now at the forefront with many finance leaders thinking through how to mold the ESG alternatives universe.

For many in the ESG industry, COVID-19 has created an opportunity. As investors and economies find their way forward in recovery, many are asking new questions about the moral underpinnings of investments, not just as a way to create a better world, or even to polish a public reputation. ESG, professionals say, is emerging from COVID as a risk filter and more and more, it is inserting itself into the larger conversations around mainstream investment. What was once considered an outskirt topic is emerging as top-of-mind need.

ESG factors are the translation into the finance world of the 17 U.N. Sustainable Development Goals (SDG). And the SDGs can only be realized with a strong commitment to global partnership and cooperation. With those ESG Leadership Talks in Alternative Debt, Egon Zehnder is building a community gathering asset managers, in US and Europe, from alternative funds to big integrated organizations, bringing together leaders from around world and through different asset classes to shape the ESG Alts universe.

In this context, over the last few months, Egon Zehnder gathered experts in the ESG field over a series of virtual meetings to discuss the topic of ESG leadership in the area of alternative debt. In addition to Egon Zehnder experts, we invited leaders in the Alternatives space to share their experiences and their vision for the ESG future.

Many who joined the discussions said COVID has changed the way ESG fits into their industry. “Pre-COVID, we were in a capital-abundant world,” said one attendee. “Our issuers had a lot of places to go. Now we are at an inflection point. We can build this into the issuance of new securities. As ESG investors, we can make it not just about the provision of capital.”

The advent of COVID-19 has opened a door to making ESG a larger presence in investing, said some professionals. While it has always been part of the larger conversation, some see an opportunity to make ESG thinking a more central theme in the post-pandemic world. Political leaders have seized the moment.

“In Europe, there is strong political will for ESG regulation and standardization,” an attendee noted. “They want to use ESG to aid in the recovery and to accelerate transformation. It’s part of what many are calling a “green recovery,” she said.

There are many forces propelling ESG forward. “The No. 1 driver is client and investor demand. ESG is becoming a differentiator,” one attendee said. What’s more, the market is embracing ESG risk as important to the pricing of debt and bonds. And finally, regulators are scrutinizing ESG issues, including around pension funds. “We are seeing more incidents that are becoming more tangible, and visible and real.”

Still, injecting ESG values into global financial market faces hurdles. The standards around ESG may vary in different parts of the world or even between different sectors. There are still misconceptions and disagreements around the terms applied to ESG, such as “sustainable.” And not all regions of the globe are on the same page.

“The U.S. is behind,” explained an attendee. “We have no regulatory ESG framework in progress. Investors want ESG standards and frameworks, especially in alternatives. We have to tell them what it looks like, but there’s no agreed-upon metrics. We are at risk of being accused of ‘Green Washing.’ We have to prove it constantly.”

The demand for proof is a major hurdle for ESG supporters since good data is hard to find.

“The challenge in fixed income is that there are few long track records to demonstrate results. Everyone has their own strategies, their own ideologies, their own flavor. There are few data points,” said an attendee.

Yet the momentum, from COVID and other forces, is gaining strength. And just paying lip service to ESG issues is not good enough. It is evolving into a tool for better financial outcomes.

“Putting a company through those filters will add more value,” one guest noted. “Public market credit investors have done this a bit previously. But now it’s more prevalent as awareness of ESG has improved.” ESG has become a tool for assessing risk, he said. “If they treat people badly, that’s a risk. I have to price the debt higher, or just not invest. Pension funds bring this up at every meeting. It will eventually start to lower the cost of debt for companies ticking those boxes.”

The need to put companies through ESG filters is fueling the push for a more detailed screening methodology. Increasingly, this is more than just a sentiment to do good in the world, explained an attendee. “Some investors have contractual obligations to increase ESG. We’re trying to meet this.”

While better data and clarified regulations are called for, many in the industry say another shift will be needed to see ESG fully embraced: corporate culture. ESG is both a skill set and a mindset, they say, and one that must be supported by the framework of the companies in the space.

“We need to train people to think more holistically – to think about new risks and different risks,” said one of the guests. “It needs to be supported by senior management and the culture of the company. The world is changing and this needs to be the tipping point.”

Creating teams that embrace an ESG culture is the key to moving the process forward, said one attendee. “It comes down to the originators, the credit underwriters. They have to truly believe this will make them better investors. That
will determine long term success.” 

The key for ESG professionals is to understand why ESG is attracting attention right now. For many years there was a question mark about whether ESG and sustainability was merely a fad, noted a guest. It has come out now through COVID that it is definitely not a fad and is here to stay. “COVID made me think: how is sustainability going to withstand this test? COVID answered the question of – is it a fad? The answer is no,” she said.

But investors won’t wait for a long-term solution. While ESG may have taken some time to become lodged in the investor consciousness, now that it’s there, it will have to be addressed in the near term. “Interest has sky rocketed in the debt community,” an attendee explained. “The question has shifted from why to how.”

The answer to that question is, to a great extent, one of leadership, according to one attendee. A move toward ESG behavior demands a strong, charismatic leader – one who communicates strong views, courage and a visionary outlook. Companies with that type of leader in place are the ones that make the most progress in ESG, he said. Strong leadership, he said “is a shared component of an organization with strong ESG.”

“The leader has to create cultural alignment on social issues, otherwise there is a discrepancy among people within the company,” he said. “The younger/newer employees have real passion and interest. The midlevel, middle-aged employees have less interest. Even if the top has real interest, middle management can be the main obstacle.”

The mandate for leaders is to demonstrate a business rationale for ESG. “Altruism has to intersect with business priorities. The notion of ‘long-term greedy’ where the moral and philosophical intersects with business goals needs to be taught to middle management,” he said.

Another attendee underlined that we should expect an acceleration of the regulation in the next four years, with the COP26 being a key milestone. With President Biden declaring that the USA will re-join the Paris agreement, it is likely that the U.S. regulators will catch-up with European ESG policies and coordinate globally to build consistent approaches.

We see the topic of ESG as closely related to the larger Egon Zehnder mission of promoting leadership for a better world. By creating and animating this community of professionals in Alternative Debt, Egon Zehnder is actively participating on the achieving of the SDG 17 (Partnerships).

As the world seeks to recover from crisis, leaders across industries will be faced with choices and opportunities. ESG is already emerging a powerful theme in that process.

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