Episode Transcript
Speaker 0 00:00:00 Today we're taking a deeper look at governance as a critical part of E S G, especially the role of governance in emerging from the Covid 19 environment. So the questions are, how can governance be measured and what are the specific things that investors should look for when making decisions based on the G factor? Well, treatment of employees is a huge part of that. Also, what are the best actionable practices for companies around governance during crisis mode and beyond? Giam Mascato, vice president and head of E S G A investing at American Century is sharing his insights on this today. Guim, thank you for joining us.
Speaker 1 00:00:42 Thanks very much for having me. Glad to be here.
Speaker 0 00:00:46 Great. So we can look at governance in so many different ways in this environment, but let's start at looking at it through an ethical labor lens. Is ethical labor considered financially material? And if so, could you unpack for us what that means?
Speaker 1 00:01:01 That's a very good question. So, as you know, within the E S g, uh, pillars, the S pillar, right? So the social pillar has always deemed a little bit of a soft variable. Um, however, we think that this will gain more attention in the context of, uh, covid 19. So for example, public health right, is definitely a key social issue. But, uh, over the past couple of years, uh, you know, investors were kind of seeing this more as a systemic driven risk, basically external to, um, E S G characteristics of the companies. So, for example, a health, uh, you know, negative externality to be considered something like, uh, company driven, uh, investors would need to see that this issue has been triggered by a company's misconduct or process quality failures, for example, right? However, in the case of Covid 19, um, there's not really a lot of evidence that allow us to establish that there's a direct link between the cause of the pandemic and the company's own e s G risk management practices.
Speaker 1 00:02:03 That being said, what's very interesting in this context is we believe that as a consequence, right, of the pandemic investors will actually be looking for how the reverberations of the virus and all the close the, the, the, the, the shutdowns and all of the firings, right, will actually have an impact on the company's very, uh, e s G risk management practices. So in this case, we expect investors to consider those more qualitative indicators, right? As part of the social pillar. Uh, examples include emergency response mechanism, for example, supply chain controls, and also employee benefits, right? As a gauge of companies long-term competitiveness, but also as a gauge of their operational integrity. How can they maintain their business in the context of such crisis? So, you know, we think that all of that will be very important. And then last, but not least, under the social pillar, there's also another indicator that's very hard to measure. It's everything that has to do with, um, the whole data privacy and security issues, right? As more and more business function, um, in the digitalized space, right? As we become much more virtual, right? The importance of cybersecurity risk management will also be very important. And so therefore, we think that's gonna increase in terms of the attention that institutional investors pay to companies when, uh, when they're looking to invest in them.
Speaker 0 00:03:19 Great. So is there overlap between social metrics and governance metrics?
Speaker 1 00:03:26 Yeah, so the, they're, they're, they're somewhat related. So it's true that when it comes to having a strong social risk management program, it goes without saying that you need to have someone at the top of the organization looking to that, right? So companies that that have strong governance structures tend to also perform better than their peers under the social and environmental pillar. That being said, there's some instances where, uh, it's not exactly the same, right? You might have companies that have very strong social management programs, but at the corporate level, at the corporate governance level, they are, uh, you know, subject to controversies, sometimes their board members, you know, <laugh> act and misconduct. And, um, you know, there's, this is a risk, what we call having a lot of disclosure, which is a function of governance, but there's not much of a link with how that disclosure is being translated into actionable programs, um, at the corporation level. So basically, if you're saying you're doing something for employees, but then you have a lot of strikes, you have a lot of lawsuits, you have a lot of complaints, then that means that you know what's on paper is not necessarily what you're implementing. So I would say they're linked, but at the same time, it's important to have someone, uh, really look for this, uh, link between exactly how the disclosure at the corporate governance level is being transported into actual performance at the social and environmental levels, if that makes sense.
Speaker 0 00:04:46 Absolutely. So, and, and that's a great segue. If we're talking about linking and how things may link our overlap, in some cases, I'm wondering about compliance across culture. So if, what role does cultural compliance and even regions regional contextualization play, and also there are other variables like the sector matter or industry matter, and what about firm's capitalization? How can we measure when there are so many contexts and variables that we're looking at?
Speaker 1 00:05:16 Yeah, that's, that's part of the challenge. But also the beauty of vsg investing is that as you, as you said, you know, it doesn't mean the same thing for everyone, and certainly not to all investors, right? They have their own preferences, some of them have their own objectives, and also in terms of regions, there are different regulatory contexts, right? That, uh, that need to be accounted for when one wants to, um, apply an e ESG lens to, um, to a security. So that, that's why, for example, at American Century investments are, our integration framework is, is composed of three layers, right? Macro, which is kind of global issues, or as we call sustainability mega trends sector, and then issuer. The reason we say that is that, uh, you know, given that not all sectors, as you said, are exposed to the same macro E s G issues, right?
Speaker 1 00:06:00 Our E S G team need to work with our in-house sector leads to, um, isolate, right? The issues that we consider as potentially altering long-term sector specific competitive forces. What does that mean? If you have a company that is, um, you know, heavily involved, let's say in the, um, energy sector, the mining sector, while in that case for this company, social issues may not be most relevant given the fact that, uh, the company has a, has a very, you know, more like environmental intensive asset base, right? Uh, however, for financials, because they're very asset light focused and social issues would matter a lot, right? So that's why it's important to have these proprietary sector waitings, if you will, applied across e, s and G pillars in order to help your, um, your analysts narrow down, if you will, the full set of available factors to the one's most relevant from a sector standpoint.
Speaker 1 00:06:54 But sometimes there's some issues like governance, right, that are a little bit sector agnostic, as we say, right? In other words, if, if you're looking at a bank or an energy company, well, governance matter are in both cases, right? You know, you might wanna make sure that you focus on the same issues on governance regardless of sectors, right? But maybe focus more under the, the environmental sec, uh, you know, pillar for the, uh, energy company and the social pillar for the, uh, financial company, right? So what I'm trying to say here is, uh, the performance under governance is often subject to, uh, you know, regional inducing crises, if you will, <laugh> where the company's operating. So it's necessary to compare a company's performance with its domestic and global peers separately, as well as to consider their performance over the last, let's say, three or five years to assess the path that the company is on.
Speaker 1 00:07:42 So a good example of that is board independence or something like board, uh, board, um, over boarding, right? So essentially someone that sits on, on many different boards and therefore may not have the ability to fully concentrate on, on his or her role, um, as, as a director on a given company in some countries in Asia in particular, um, that is kind of standard. We're not saying that it's the best approach, but it is standard. So you might have a company that does not really compare well to a UK base or a, let's say a Nordic space company, but, um, you know, in the context of its original peers, that company based in Asia may actually be operating quite well or in line with peers, right? So that's why contextualizing both by sector in terms of the dynamics to which the company's exposed to when it comes to E S G, but also when it comes to the regional context, which may really change, right? The perspective, uh, when one looks at a company. And so it's very important to have that distinction, both of the sector and the regional levels.
Speaker 0 00:08:41 So let's take that a step further. So say you have, um, these companies that have made the distinctions at the sector level, at the regional level, and you still find that they are not compliant with ethical employment or labor standards. What are the implications for corporates who, who don't comply? And let's look at this from an institutional investor standpoint. What are some of the considerations that we need to think about when corporates don't apply reputational damage? Is there some room for, um, a makeup, if you will, for compliance and initial reviews when they don't comply initially?
Speaker 1 00:09:18 Yeah, absolutely. So, you know, the first big consequence is, is that, uh, they can suffer, uh, fines and, and, and basically as we call, like, um, you know, e s G liabilities, right? So if, if they're, if there are basically treating their employees the wrong way, and this means that the employees are leaving, or the employees are, are, are striking, some of them might actually, um, be using, uh, whistleblowing, uh, mechanisms, right? To kind of, uh, shed light on, on corporate misconduct. We saw this in multiple cases in the financial sector. Um, while there can be some financial costs, right? Mostly in, in terms of, uh, regulatory liabilities. Um, but something else is important too, is, um, if you're basically not doing the proper due diligence across your, your, your supply chain, um, you might have some, uh, some disruptions in, in the event supply chain, uh, gets, uh, impacted because, um, you know, let's say the facilities that, uh, give you your raw materials are, are not on the par with the best safety standards, and then there's a terrible accident, and then people, you know, people lose their lives.
Speaker 1 00:10:18 And then ultimately, uh, those, uh, that supply chain is, um, is no longer able to to, to function. Therefore, you will, you will have some significant disruptions there. Um, also you might have, uh, NGOs and you might have investigating journalism that might look into what kind of, uh, labor, uh, practices, uh, your, uh, suppliers are, are using. So if you're, if you're being found to have direct links to force labor, child labor, um, everything that has to do with modern slavery, you know, that that could actually be really bad because then the other cost would be your market force, right? Your customers might say, sorry, we don't want to have, um, a relationship with a supplier or with a company that does get supplies from, uh, from these kind of gray sources, uh, somewhere in the emerging markets. But we think that, um, you know, the lamber standards are not being uphold correctly.
Speaker 1 00:11:07 And I would say that another cost, um, that's, that's, that's important too, is, um, you know, when it comes to technological innovation, institutional investors really look to make sure that their portfolios are constantly ahead of the curve. So if you have a, you know, a lot of companies that operate in sectors that are established, or as we kind of say in terminal growth value <laugh>. So basically the sectors that are being disrupted by technological innovation, um, sometimes investors would just say like, look, no matter how much you disclose on your supply chain, no matter how well you treat your employees, your business is just unfortunately finite, right? Your business is not able to compete with the way the world is growing. Um, and so in that case, the investors would just maybe just shun those, those sectors and not even wanna have an exposure to it. And so that is a significant cost on market valuation, and therefore it's for the survival of the company, right? So I would say that those are examples of how companies can suffer if they don't, um, apply the right, uh, risk management programs in order for them to, um, to attract equity, but also to continue to be competitive in their respective sectors.
Speaker 0 00:12:10 Great. So gui, could you give us your top three components that investors should look at to ensure that whether they're in the current COVID environment or whether they've moved beyond, we've all moved beyond this to ensure a firm is in good standing from an employee relations, governance, labor practices perspective, what are the top three things they should look for?
Speaker 1 00:12:31 Definitely everything has to do with employee benefits. So paid sick leave, health and wellbeing programs, short time work, which is very important. The Germans have implemented that for years and they've shown some great success. Also, telemedicine, right? Uh, the costs have been proven to significantly reduce between going to the doctor and actually being able to tele communicate with the doctors. I would say those are very important benefits to be providing to employees. And we think that they are a gauge of success for companies. Another one that's, uh, important we touched upon it is supply chain management, right? So quality, safety management, uh, the whole question of local versus global dependence, right? So in the context of covid Covid, 19, companies that have no dependence on global supply chains actually did better, which makes sense cuz if you're getting all of your supplies from, uh, from global networks and everything is shut down, then you know, you're ultimately gonna suffer some supply chain disruptions here.
Speaker 1 00:13:25 The same way on quality and safety. If someone finds out that, um, you're mistreating your, your, your, your employees indirectly as a result of your lack of supply chain controls, then you know, they might not wanna buy from you anymore. And so therefore that that could actually hit you quite hard. And last but not least, it's everything has to do with, um, you know, asset integrity, right? So if tomorrow is a, there's a scandal, uh, if tomorrow there's a disaster, what, whatever you want in terms of e s g systemic risk, um, what can the investors see in you that allows them to be comfortable that your business will continue? Right? So that has to do with stuff like telecommunicating distributing management. In other words, when covid happened and everything shut down, a lot of institutional investors wanted to make sure their managers were able to continue to operate and have the right tools and process in place to make sure their money right, that they entrust in the hands of, uh, of the asset managers are still being well taken care of in their interests, will still be, uh, best, uh, uh, uh, you know, protected by the asset manager.
Speaker 1 00:14:23 So I would say those are the three main categories that, you know, we would look for.
Speaker 0 00:14:28 Hmm. So from employee benefits to supply chain management, specifically the local dependents part to asset integrity, the top three things that, um, should be at the top of the list there. Thank you so much Guim, for joining us. Great insight.
Speaker 1 00:14:42 Of course. Thanks very much for having me. Appreciate it.
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