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Why CFOs should embrace geopolitics and sustainability in strategy
In this episode of the Better Finance: CFO Insights podcast, Brian Tomlinson speaks with Aniket Shah, Head of Sustainability at Jefferies, about how policy and materiality are reshaping strategy for CFOs.
In this episode, Brian Tomlinson, Managing Director, ESG, Financial Accounting Advisory Services, Ernst & Young LLP, speaks with Aniket Shah, Managing Director and Global Head of the Sustainability and Transition Strategy team at Jefferies. They discuss how finance leaders can navigate the growing complexity of environmental, social and governance (ESG) as it becomes increasingly integrated into strategic decision-making.
Aniket explains how ESG has evolved beyond just disclosure to encompass investor expectations, business resilience and regulatory pressures. He highlights the importance of materiality, urging CFOs to focus on ESG factors that align closely with their sector, strategy and value drivers.
The conversation delves into how public policy developments are influencing ESG implementation in real time, requiring finance leaders to balance long-term vision with short-term catalysts. They also explore the role of CFOs in integrating ESG into capital allocation, regulatory alignment and strategic planning, as well as how evolving stakeholder expectations are influencing decision-making.
Key takeaways:
Understand how ESG has evolved into a strategic business priority beyond compliance and disclosure.
Discover the key material ESG factors that can influence sector-specific business performance.
Learn about the impact of public policy developments on ESG strategy and implementation.
Understand how to effectively integrate ESG efforts with both long-term goals and short-term business actions.
For your convenience, full text transcript of this podcast is also available.
Myles Corson
You’re listening to the EY Better Finance: CFO Insights podcast — a series that explores the changing dynamics of the business world and what it means for finance leaders of today and tomorrow. I’m your regular host, Myles Corson, from EY. And for this episode, I’m excited to pass the mic to my colleague Brian Tomlinson, an EY Managing Director focused on ESG [environmental, social and governance], for a conversation with Aniket Shah, Managing Director and Global Head of the Sustainability and Transition Strategy team at Jefferies. So let’s hear from Brian and Aniket now.
Brian Tomlinson
Thanks, Myles. Very excited to be here today with Aniket Shah. So, we're going to talk about some of the ways in which the ESG landscape is changing. And I want to highlight a couple of elements of that changing landscape to set up the conversation.
So, let's start by saying that ESG themes have become a critical business consideration. As companies think about value, resilience, competitiveness, innovation, brand perception, consumer preferences, etc., ESG issues are increasingly part of those considerations. And we see this evidenced in surveys of executives, earnings call transcripts and corporate disclosures among a range of other data points.
Alongside this, companies are navigating significant ESG regulatory initiatives, with many major markets mandating ESG disclosure. As ESG becomes regulated, companies are inevitably considering the extent of their claims around sustainability, the rigor of those claims and their strategic significance.
So Aniket, with that sort of opening up, I wanted to ask if you were to talk to a CFO [chief financial officer] about the way in which Jefferies thinks about ESG and why you're so deeply engaged about ESG, what would you say to a CFO to give them the thumbnail sketch of why this is so important?
Aniket Shah
I would make three very clear points. The first point I would make is that, in many ways, the ESG community has won over the past 10 years. ESG is now part of a quote, strategic broadening of itself, where this is no longer a box-ticking exercise about disclosures but rather core to how a company navigates the changing priorities of governments and investors.
Governments are now taking sustainability, energy transition, climate resilience, reshoring into their decision-making and in fact are making them amongst the highest priorities of what they are trying to achieve. Just last year, US$2.1t globally was invested in low-carbon technology. That number, by the way, was US$350b the year the Paris Agreement [Paris Agreement under the United Nations Framework Convention on Climate Change] was signed in 2015, and US$160b the year I started my career in 2009.
So, this is just a big part of how the world is evolving. And any company that wants to be involved and engaged with the big topics of our time needs to be engaged on ESG and sustainability. But again, it has to be done at a strategic level as opposed to a box-ticking level. And I think that is the first thing that I would explain to the CFO, that this is just a huge part of how the world is evolving at the investor level or at the government level.
The second thing I would say to the CFO around why they need to be engaged on these issues today is because there is a significant reevaluation happening to the ESG space. And so, if you want to be directly relevant to your customers or to your investors, you need to be aware of how this discussion is changing today versus two to three years ago. And Brian, what I would say is that I actually think the ESG conversation today is in a much healthier place than it was three years ago.
Three years ago, it was all about these massive European regulatory efforts, which is of course very much a part of the discussion today, but it is now being rightsized, I would say. Three years ago, it was all about net zero by 2050, which now we are now all appreciating a lot more pragmatism around the energy transition.
And so, in this reevaluation, a CFO needs to be aware that some of their biggest stakeholders, whether it's the investors in their equity and the equity of the business, the lenders into the company on the fixed income side, the customers to the business are all going through this rethink of what is going to be a trend that will be with all of us and our children throughout their lifetimes. And so, you want to be part of that discussion. That's number two.
And the number three reason, I would say, that a CFO needs to be involved around sustainability and ESG today is because all of these discussions, whether it's climate change, resilience, decarbonization, human capital, all of this is now being changed because of technology. And although it might be hard perhaps today to get a CFO to talk about ESG compared to three years ago, it's certainly not hard to get them to talk about AI [artificial intelligence].
And I would argue that the AI discussion is very much a quote ESG discussion. Why is that? Well, there are huge “E” implications of artificial intelligence (AI). This is the whole question around power demand, the energy costs, the efficiencies that can be gained from artificial intelligence.
The “S” around AI is of course very clear. You know, will this be productivity enhancing? Will this be labor substituting? How does it change who I hire? What skills am I looking for? The number of people I'm looking for, etc. And AI is very much a “G” conversation, which is how do I govern this new potentially world-changing technology, both at my individual company level and at the broader societal level.
And so, I would say, the third reason that a CFO should engage and how I would get them to engage is the biggest topic of our day, if it isn't climate change, it would be artificial intelligence. And that the right way to think about that is through the ESG lens. And hopefully, Brian, that would get me in the room with him or her and we could then have a broader discussion.
Tomlinson
Definitely gets you in the room, Aniket. And I think one of the things that you referenced, which I think is a key element to ESG, is that the relevance or materiality of an ESG issue varies systematically by sector. And so, the type of ESG issue that you would be talking to a CFO about in a tech company ought to be different than the type of ESG issues you'd be talking to at say an extractives company.
And one of the elements there that companies need to thoughtfully consider is the way in which an ESG issue is actually business-relevant is driven by the sector in which we do business. I think, one of the dangers potentially of the ESG discourse is that it has appeared to be of universal application, whereas actually it’s very kind of sector-company-, and business-model-specific. Did just want to pick up on your comment around the way in which the sort of discourse on ESG is tightening.
And that's, I think, related to that materiality conversation as well, which is to only talk about the real stuff that is really impacting your business and that really might impact the bottom line and to perhaps move away from some of the more hollow initiatives that there have been in the ESG space that aren't necessarily closely connected to underlying business value.
So, just on that point around materiality and companies focusing on what matters. Obviously, there's been a huge expansion of the type of ESG disclosure that companies are going to be required to make. A lot of that is somewhat materiality-focused. Will enhanced ESG disclosure make your job as an institutional investor evaluating long-term risks, easier or does that enhance your ability to evaluate the prospects of the companies that you and your clients follow?
Shah
It's a fantastic question, Brian. My bottom-line answer is that you better know what's the question you want to answer before you get all this data from companies, because the risk of all this disclosure is that it somehow confuses and obfuscates rather than clarifies. And I don't blame the company or the regulator for providing that data. They need to do what they need to do.
But if you're an investor or an equity analyst and you're looking at a company, you better understand what is that single material ESG factor that actually impacts this company's future performance so that I can then comb through all of the different disclosure and pinpoint the actual one data point that I'm looking for.
And by the way, that's something that a good investor is good at doing regardless, you know, they get disclosure from companies all the time and comments from CEOs [chief executive officers] and CFOs all the time. But a good investor has a clear understanding of what can actually drive the long-term value of the business and therefore; know how to analyze that issue.
And so, what we're focused on at Jefferies is getting our equity analysts here to be super, super, super focused on what are the one, maybe two, but ideally just one ESG factors that actually matter for the business. And if you understand that, then you'll understand what the data is that you're looking for. And then you can make ESG analysis an actual value add to your process.
And so that's what I hope people will spend their time doing over the next little while, is sharpening their focus sector by sector, subsector by subsector, and then company by company to figure out what is that one issue that you need to pay attention to. And then when the disclosure comes, you'll know what to pay attention to.
Tomlinson
That's incredibly helpful to understand the extent of focus in relation to ESG. One of the things that I did want to talk about there is whether or not by considering that narrow set of materiality-focused ESG issues that adjusts the time horizon on which you're considering those issues. Do you find that those material ESG issues tend to play out over a longer-term time horizon or do those sit more naturally in the kind of classic strategic horizon that many companies are considering?
Shah
That's a fantastic question. I'll tell you what my bias is on this, because I've changed my views on this over the last few years. I used to operate much more in the long-term strategic sort of mindset. What are the issues five years out, 10 years out that we all need to be thinking about?
Then I became a managing director at Jefferies and was asked to build and run a team that is basically talking to investors on a minute-by-minute basis. And Brian, what I realized is whether I like it or not, whether it's a good thing or a bad thing, who knows? But the reality is that you have to marry the long-term to short-term catalysts and to short-term decisions and news and policy changes that are happening month by month, quarter by quarter.
Because if you spend too much time in the long term, if you spend too much time focusing on five or 10 years out, you're sort of missing what's happening right now. And so, I think the real genius are people who can say, you know, the big question for company X, for let's just say a hydrocarbon-based company, is future policy on climate change. But over the next six weeks, over the next 12 weeks, this is the policy that I think will impact where that direction goes.
Or this is the technology release that I'm going to be focused on. Or this is the protest from an important industry group that I'm going to be tracking. Or this is the international meeting that will give me more insight into where that longer-term issue happens.
And Brian, what I would say is that many in our industry, I think, haven't made that link between a long-term strategic issue and short-term catalysts that can focus the mind and focus the attention. And as a result, I do feel like some of the ESG considerations get lost in the clouds. And that's a real challenge. And so that's what would be an evolution of my own thinking that I had to be in the market to fully appreciate and to understand.
Tomlinson
It makes an enormous amount of sense that ESG issues, they can sit on a longer-term time horizon. They can be connected to those broader systemic risks. But ultimately, if you only talk about them on those extended time horizons, you make them abstract. You make them hard to implement.
And ultimately, I think we can think of all sorts of very short-term examples of ESG issues crystallizing over the very, very short term. Unaddressed sources of ESG risk causing vast value destruction over the short term. Sound ESG analysis may have identified that that was an underappreciated risk over time, but ultimately the value destruction occurs in the short term.
So, I think tying it to the more frenetic time horizon of our capital markets is appropriate. And this is a topic that we've talked about before, which is that, if you only talk about ESG in the annual report, again, that limits its salience, whereas actually, it should be part of earnings call, quarterly conversations, and indeed, even shorter-term conversations, because it is so directly relevant to value, if you're focused on that narrow set of material issues.
Shah
You know, Brian, if I may, let me just make it even finer point to it, which is that I would be so brave to say that the actual most important ESG catalysts are 90 to 95% policy-related and that actually the link should just be around public policy and regulation, and these ESG factors that are happening over the long term. And I say this knowing full well that there are a whole host of ESG factors that are in fact non-policy related. I get that.
But you know, Brian, if I really pushed you hard and if you pushed me hard and we asked what were the big evolutions of the global economy last five to 10 years that really impacted the value and the strategy of businesses around sustainability. I think nine out of 10 points that you and I would highlight would be public policy, regulatory and government related.
I would talk to you at length about the Paris Agreement. I would talk to you at length about the Inflation Reduction Act [Inflation Reduction Act of 2022]. You would talk to me at length about the EU [European Union], regulatory efforts, the SFDR [Sustainable Finance Disclosure Regulation], the CSRD [Corporate Sustainability Reporting Directive], the Omnibus, which are several of the many things that you are a global expert on. I would then push back and talk to you about the GX [Green Transformation] plan in Japan. You would then come and talk to me about the European emissions trading scheme and so on and so forth.
And are there other issues? Of course, there are other issues. Of course, there are, you know, DEI [diversity, equity and inclusion] issues and corporate culture issues, but things that are real, that are tangible, that are complicated, where the ESG community can actually add value and that we know that asset prices are impacted by are largely government-related. It's one of the main reasons that, as you know, my team at Jefferies is now not just our sustainability research team, but we are also Jefferies public policy research team.
I very intentionally made that evolution around 18 months ago. And it's been incredibly successful because no one ever questions our credibility on being policy analysts because if you're a good sustainability strategist like you are, like I am, we are following policy much more closely than maybe anyone else at our institutions. And so, I think that's one way to marry the long term with the shorter term is actually through the lens of government policy.
Tomlinson
This, I think, naturally allows us to talk about that strategic broadening of the ESG space that we were discussing earlier. Quite a lot of engagement on ESG over the last 10 years or so has been quite focused on disclosure. You'll see that in a lot of the regulations that are being adopted around the world, the intention of that is to essentially re-baseline corporate disclosure to give you a high and minimum baseline of quality disclosure in relation to material ESG issues.
Different reporting frameworks are doing that in different ways. You have the ISSB [International Sustainability Standards Board] adopted in various jurisdictions internationally, then have CSRD in the EU too. But one of the things that we've seen, is as the world moves away from a kind of free trade, free market paradigm, there's a broadening of the ESG toolkit beyond disclosure. And that naturally takes us into conversations around industrial strategy, which has been, I think, a key part of the way in which this conversation is emerging.
Just to contextualize that in the context of the EU, which have obviously been leading with that ESG disclosure toolkit, in response to the Draghi report [European Central Bank: Economic and Financial Policies Report by Mario Draghi, 2012], they're now saying, actually, there's a broader set of tools that we need to use to achieve our overall net-zero transition to a clean economy objectives.
And a lot of that is to do with industrial strategy. Now, of course, industrial strategy used to be a dirty word, right? Used to be associated with picking winners, always the suggestion that there's probably some rent-seeking involved, preferring national providers that may be more costly over actually providers external to your country who could probably provide the same goods more cheaply.
But ultimately, now countries are realizing they have certain strategic needs in key technologies, particularly often to facilitate the transition to a low-carbon economy. So just wanted to get your read on where we're at in terms of the overall mix of industrial strategy being considered, the way it's being done in different jurisdictions and how you present that when you talk to your clients.
Shah
This is the big story of our time. And to be honest, most market participants don't fully appreciate the size and extent of it. And it's wonderful of you to give a spotlight to it because this is something we all need to wrap our minds around.
The bottom line is that the reach and influence of government in the market, in the economy, is growing everywhere. Everything that we have seen over the past several years from the United States in terms of major economic policy, I would argue, should be seen through the lens of industrial policy.
Tariffs are a form of industrial policy. That's when the government actually comes in and is trying to protect certain industries, certain sectors, certain jobs from the free market doing its thing. But it is not a free-market-oriented way of looking at the world. This is a long ways away from the Washington consensus era of free markets, open trade, less state ownership of enterprise and so on and so forth. And this will have a fundamental impact on how investors do their jobs and how companies do their jobs.
I would argue that companies have a better understanding of industrial policy than investors do because they're dealing with governments all the time. They're trying to take advantage of subsidies and credits. They're also trying to make sure they're not on the wrong side of industrial policy. But investors largely, Brian, are still operating with their models that are trying to do a discounted cash flow of future earnings that have zero, absolutely zero modeling of what happens. Or when a company can get access to highly subsidized credit because of government support of the banking sector.
It's a combination of factors, but this is the big story of our time. It will fundamentally change how investors do their jobs. And we're just in the early stages of this right now. And we hope more analysts take this on board as they think about how industries will evolve.
Tomlinson
I feel like this connects into a conversation where very often disclosure requirements will meet these industrial strategy incentives.
So, for example, one of the elements that we look at very closely is the EU's sustainable taxonomy, because it's one of the ways in which the ESG space is making the financial statements speak sustainability. So, if you are in an industry in a geography which has significant decarbonization objectives, then something like the taxonomy will indicate the extent to which you have a transition plan. Is your business transitioning from, you know, business as usual, heavy GHG [greenhouse gas] emissions to a lower GHG footprint?
If you're in that sort of industry, you may find that that geography then has a set of incentives that change the economics of your transition story. Because it changes the tax regime; it may make grants or loans available to you as well to sort of make those transition investments.
So, I think there is like a connected story here between like disclosure and industrial strategy. So, I think some of the work that companies have put in on their disclosure story in relation to ESG can help prepare them to potentially navigate these other opportunities that are presented.
Shah
I actually never thought about it until you outlined it as such. But you're right. The disclosure regime in a way highlights what it is that government wants to encourage. And so, you as a company get a sense, a clue of what are the types of economic activities that governments would like to encourage. And that will give you a sense of where a lot of other partnership might happen. So, I like that. That's a novel way of thinking about it.
Tomlinson
I think in this conversation, Aniket, we've established that there's a core set of ESG issues that are gonna be material to companies. The issues that are material are gonna vary by sector. There's kind of a tightening of the ESG discourse right now with companies really focusing on what they need to talk about that is relevant to value.
And seeing that broader public policy picture, are there any kind of key takeaways for the corporate executive CFO audience to kind of think about how they can operationalize some of these ideas going forward?
Shah
I would say that the main ways to operationalize what we've discussed are the following. Number one is to have a very good understanding of how public policy is changing. I would be investing heavily in building either your own policy team, research team, lobbyist team, whatever, or getting the right partners in Washington and in Brussels and in Beijing and in New Delhi, because the world is big and complicated and it's not just the US and Europe. But because I fundamentally do believe that so many of these ESG issues become important via the policy route, appreciating that and putting that higher up the priority list, I think, is very important. So that's one.
The second very practical point I would make is that technology and the technological change that we are going through right now can be best understood through an ESG lens. And so, for whatever team that you have on your board or in your management team that's thinking through the impact of artificial intelligence and other such technologies on your business, even just breaking it down by E, by S and by G can help you get there in a simpler way.
The final thing I would just say to all of you is that it's always darkest before it's dawn. Market narratives change very quickly. It's very easy to say today, oh, ESG is dead. That was very 2020, 2021. And, either you could put together a lot of anecdotes to say, oh yeah, ESG is done and we can move on.
Be careful about that instinct because you should all know that this is a 100-year theme. This is not going to change. It's going to have a different color, of course, and a different flavor, but the theme is not going to go away. And so, don't dismiss it and ignore it because it doesn't sound cool anymore to say the letters ESG. This is very, very, very much still a part of how the world economy is evolving.
Tomlinson
That's terrific, Aniket. And that's, I think, the type of high-level strategic overview that we want to bring to this conversation. And I think it highlights maybe overall three things, which is the need to be aware of these large macro secular trends in the world economy. You need to be aware of the role of government in framing the scale, shape and size of markets, and what it wants those markets to do. And then at the level of the company, what are our in that broader expanded context, what actually are our material issues? What are actually our business drivers? What are the things that elevate our brand and cause our financial prospects over the long term to be enhanced?
So, great conversation today. Really appreciate the breadth of expertise that you always demonstrate and the level of insight that you can bring to this conversation, Aniket. Fantastic to have you with us today and really appreciate it.
Shah
I appreciate that very much. And again, Brian, thank you for all that you do.
Corson
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