UKSIF Scotland conference report: lively debates on ESG fund ratings and inequality

Edinburgh conference highlights distance between public and financial community.

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The dissonance on ESG issues and saving between the broader public and the financial community was among the themes running through the UK Sustainable Investment and Finance Association’s (UKSIF) third Edinburgh Conference.
Scott Murray, managing director of Virtuo Wealth Management in Edinburgh, invoked Jekyll and Hyde, the creation of Scottish writer Robert Louis Stevenson, to illustrate the disconnect. He pointed to the popularity of robo-advice engines, the alter egos of such banks as Lloyd’s, Barclays, and the Bank of Scotland, faulting them for having a high savings bar (£50,000 or £100,000) to receiving personal advice and for offering no investments focused on ESG themes: “If we are going to attract millennials, who mistrust banks and financial services, we need to do better,” he said.
Noting a nearby portrait of Scottish inventor James Watt, whose steam engine ignited modern global warming, Neil McIndoe, head of environmental finance at Trucost, also bemoaned the slow recognition of climate change risk among institutional investors, despite growing concern among the public. “I’m tempted to call it glacial but glaciers are moving quite quickly these days,” he quipped.
Chris Varco, senior investment director at Cambridge Associates, said it could be a costly realisation. Rating agencies, he said, that turned a blind eye as the mortgage bubble inflated are making the same mistake on climate change. He described a $600m bond for a Miami convention center with an underground car park that is to be funded partly by a $200m tax on oceanfront businesses that are ineligible for flood insurance. He said bond investors and rating agencies are not focused on flooding, making municipal bonds the equivalent of mortgage-backed securities in 2008.
One of the livelier debates at the conference came during a session on new ESG fund ratings from MSCI and Morningstar; a development which some claim could start to bridge the ESG/finance gap.
Naomi English, head of ESG products EMEA and APAC, MSCI, said millennials will inherit $30 trillion in assets in coming decades. She said the fund ratings will provide the transparency and control they demand. San Lie, head of research for Morningstar Benelux, said Morningstar’s offering, in partnership with Sustainalytics, is a logical next step after 30 years of providing portfolio transparency.However, intended users of the systems expressed concern regarding data bias and misuse of the ratings. Julian Parrott, a partner in Edinburgh financial planning firm Ethical Futures, said he has been surprised by some of the ratings. For example, a well-known deep-value fund with 40% exposure to tobacco and armaments scored the same as a labeled sustainable fund. * Clare Wood, global head of investment assurance at First State Investments, said the fund manager had itself looked internally at creating a portfolio level fund rating based on the ESG data it buys, but shied away from doing so because of concerns that portfolio managers would not take the ratings seriously because they were based on only 50% or 65% of the portfolio, weighted by capitalization. She said this could also be an issue for the Morningstar/MSCI ratings. She said large-cap funds seem to fare better than smaller funds, where more climate innovation is happening. She also said a point-in-time number does not capture the quality of the engagement process.
English replied that there is no capitalisation bias: “Ratings aren’t disclosure driven or affected by capitalization. It’s risk exposure: what risks do you face based on your operation or geography, for example, and how do you manage those risks,” she said. The long-term nature of engagement, she said, makes it a difficult practice to measure.
A second panel discussed issues around compensation. Alan Brett, head of corporate governance ratings research at MSCI, shared results of a recent paper titled: Income Inequality and the Intra-corporate Pay Gap. The paper found that, between 2009 and 2014, total compensation for the highest earners in the 1,240-company sample grew on average by a 20% compound annual growth rate (CAGR) compared to a 2% CAGR for the average worker. Other findings:

• Companies with lower pay gaps had higher profit margins in all sectors bar materials.
• Consumer staples and consumer discretionary companies saw the largest and fastest growing pay gaps.
• Countries with the lowest corporate pay gap also had the most equal distribution of national income (as measured by Gini coefficient), such as Nordic countries.
• The highest corporate pay gaps were in countries with the most severe income inequality (Hong Kong, South Africa, Singapore, China, U.S., Malaysia).

Boards of directors, though, appear tone-deaf to the issue based on their executive compensation practices. Ashley Hamilton Claxton, corporate governance manager

of Royal London Asset Management, said boards were once cowed by a vote of 20% against an executive pay package. Now they argue that 80% in ‘favour’ shows ‘support’ for pay levels, despite the fact that most investors are not paying attention to AGM votes. She said her firm gets 30 to 50 letters each year from companies explaining why they feel their CEO is underpaid. She blames both remuneration consultants and the trend toward a global benchmarking system that is inflated by U.S. pay levels. She said the recent 60% vote against BP is a sign of things to come: “Boards are in for a shock if they are not paying attention to inequality issues,” she said.
Employment lawyer Sarah Gilzean, an associate with HBJ Gateley, said the U.K. is hoping to begin addressing a wide gap in pay between men and women in financial services. A 2009 enquiry found a 55% gender gap in pay among full-time workers in the industry versus 28% in the broader economy, a gap which widened to 80% when bonuses are included. A 2014 update found little improvement, leading the government to issue a draft Gender Pay Gap Reporting proposal in February. The first report will be due in April 2018 and must show the mean and median gender pay gap, the percentage of men vs. women eligible for bonuses, and the distribution of earners by gender and quartile.
The opening panel, which covered hot topics, offered repeated references to inequality and poverty. Sudip Hazra, senior analyst, sustainability research, at Kepler Cheuvreux, said the BP pay controversy, the Panama Papers, excessive labour cost cutting by retailers such as Sports Direct, the impact of climate change, modern slavery—all share inequality as a subtext. “Society and regulators are moving toward a thematic umbrella” as they address myriad problems, he said.The final panel gave candidates for the Scottish Parliament an opportunity to burnish their ESG credentials – or not. Murdo Fraser of the Scottish Conservative Party said he opposed efforts to lobby local government pension schemes to exit sectors such as defense. “Trustees have a responsibility to produce the best return. As a beneficiary, that’s my interest,” he said. Many of his constituents work in the defense industry in Fife. “I take a negative view of lobbying that we should pull out of certain industries because they aren’t the flavour of the month.” Sarah Boyack of the Scottish Labour Party countered that the scheme should focus on renewables and affordable housing, addressing long-term needs.
Fraser also took a swipe at the Scottish National Party for proposing reduced airline passenger duties and cutting funding for energy efficiency, which the conservatives seek to treble, he said. Ben MacPherson of the SNP said his party drove passage of the Climate Change Act and will pass a new bill with a 50% emissions reduction by 2020 if re-elected.
Asked whether Scotland can play a role in combatting tax avoidance, Fraser said the country should be less generous with incentives. He questioned a £10m incentive paid to Amazon to come to his district. He also said a subsidy cut to onshore wind farms was appropriate because the subsidies were too high. Scottish Green Party candidate Andy Wightman said Scotland can do more to promote transparency, noting that ownership of Scottish land was revealed by satirical magazine Private Eye, not the government. The Green Party seeks to shift tax from income – which is easily manipulated – to wealth and land, he said. Labour’s Boyack agreed, adding that vacant land should be taxed.