Keesa Schreane [00:00:00] Today, we're taking a deeper look at governance as a critical part of ESG, especially the role of governance 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 chief factor? Well, the treatment of employees is a huge part of that. Also, what are the best actual practices for companies around governance during crisis mode and beyond? Guillaume Mascotto, president and head of ESG investing at American Century, is sharing his insights on this today. Thank you for joining us.
Guillaume Mascotto [00:00:43] Thanks very much for having me. Glad to be here.
Keesa Schreane [00:00:46] Great. So we can look at governance in so many different ways in this environment. But let's start 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?
[00:01:01] That's a very good question. So as you know, within the ESG pillars, the S pillar, right, so the social pillar has always deemed a little bit of a soft variable. However, we think that this will gain more attention in the context of COVID-19. So, for example, public health, right, is definitely a key social issue. But over the past couple of years, you know, investors were kind of seeing this more as a systemic driven risk. Basically external to ESG characteristics of the companies. So, for example, for health, you know, negative externality.,to be considered something like a company-driven, investors would need to see that this issue has been triggered by a company's misconducts or process quality failures, for example. However, in the case of COVID-19, there's not really a lot of evidence that allows us to establish that there's a direct link between the cause of the pandemic and the company's own ESG risk management practices. 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 closes, the shutdowns and the firings will actually have an impact on the company's very ESG risk management practices. So in this case, we expect investors to consider those more qualitative indicators, right, as part of the social pillar. Examples include an emergency response mechanism, for example, supply chain controls and also employee benefits rates as a gage of company's long-term competitiveness, but also as a gage of their operational integrity. How can they maintain their business in the context of such crisis?
Guillaume Mascotto [00:02:48] So, you know, we think that all of that would be very important. And then last but not least, under the social pillar, there's also another indicator that's very hard to measure if everything that has to do with the whole data privacy and security issues. Right. As more and more business function in the digitalized space, where doesn't become much more visceral, right, the importance of cybersecurity, risk management will also be very elevated. And so, therefore, we think that's going to increase in terms of the attention that institutional investors pay to companies when they're looking to invest in them.
Keesa Schreane [00:03:19] Great. So is there an overlap between social metrics and governance metrics?
[00:03:26] Yeah. So they're somewhat related. So it's true that when it comes to having a strong social risk management program, that goes without saying that you need to have someone at the top of your organization looking to that. Right. So companies that have strong governance structures tend to also perform better than their peers under the social and environmental filters. That being said, there some instances where it's not exactly the same. You might have companies that have very strong social management programs, but at the corporate level, at the corporate governance level, they are, you know, subject to controversies. Sometimes their board members, you know, acting misconduct. And, this is a risk of 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 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 really look for this link between exactly how the disclosure of the corporate governance level is being transported into actual performance at the social and environmental levels.
[00:04:49] If we're talking about looking at how things may link or overlap in some cases, I'm wondering about compliance across culture. So what role does cultural compliance and even regional contextualization play. And also there are other variables like the sector matter or industry matter. And what about a firm's capitalization? How can we measure when there are so many contexts and variables that we're looking at?
Guillaume Mascotto [00:05:16] Yeah, that's part of the challenge, but also the beauty of EU investing is that, 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 that they need to be accounted for when one wants to apply EU loans to security.
[00:05:40] So that's why, for example, at American Century Investments, our integration framework 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, you know, given that not all sectors, as you said, are exposed to the same macro ESG issues, are ESG steam need to work with our in-house sector needs to isolate 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 heavily involved, let's say, in the energy sector, the mining sector - well, in that case, for this company, social issues may not be most relevant given the fact that the company has a very, you know, more like environmental intensive asset base. Right. However, for financials, because they're very asset-light focused, then social issues would matter a lot. So that's why it's important to have these proprietary sector weightings, if you will, applied across the S&G pillars in order to help you narrow down, if you will, this full set of available factors to the ones most relevant from a sector standpoint.
[00:06:54] But sometimes there are some issues like governance, that are a little bit sector agnostic, as we say. In other words, if you're looking at a bank or an energy company, well, governance matters in both cases. Right. You know, you might want to make sure that you focus on the same issues on governance, regardless of sectors. Right. But, maybe, focus more under the environmental pillar for the energy company, and the social pillar for the financial company. So what I'm trying to say here is the performance under governance is often subject to, you know, regional inducing crises, if you will, where the company is 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.
[00:07:42] So a good example of that is board independence or something like overboarding. So essentially someone that sits on many different boards and therefore may not have the ability to fully concentrate on his or her role as a director on a given company. In some countries, in Asia in particular, that is kind of standard. We're not saying that it's the best approach, but the standard. So you might have a company that does not really compare well to a U.K. based or a, let's say, a Nordic space company. But, 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. So that's why contextualizing both by sector, in terms of the dynamics to which the company is exposed to when it comes to ESG, but also when it comes to the regional context, which may really change the perspective when one looks at a company. And so it's very important to have that distinction, both of the sector and the regional levels.
Keesa Schreane [00:08:41] So let's take that a step further. So say you have 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, labor standards. What are the implications for corporates 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 makeup, if you will, for compliance and initial reviews when they don't comply initially?
Guillaume Mascotto [00:09:18] Yeah, absolutely. So, you know, the first big consequence is that they can suffer fines. And that's, and basically, what we call the ESG liabilities. Right. So they're basically treating their employees the wrong way. And this means that the employees are leaving or the employees are striking. Some of them might actually be using whistleblowing mechanisms to kind of shed light on corporate misconduct. We saw this in multiple cases in the financial sector. While there can be some financial costs, mostly in terms of regulatory liabilities, something else is important to us. If you're basically not doing the proper due diligence across your supply chain, you might have some disruptions in the event supply chain gets impacted because, you know, let's say the facilities that give you your raw materials are not on a par with the best safety standards. And then there are terrible accidents and then people, you know, people lose their lives and then ultimately, that supply chain is is no longer able to function, therefore you will have some significant disruption there. Also, you might have NGOs and you might have investigative journalism that might look into what kind of labor practices your suppliers are using. So if you're being found to have direct links to forced labor, child labor, everything that's to do with modern slavery, you know, that could actually be really bad because then the other costs would be your market force.
[00:10:50] Your customers might say, sorry, we don't want to have a relationship with a supplier or with a company that does get supplies from this kind of gray sources somewhere in emerging markets. Well, we think that, you know, the labor standards are not being uphold correctly. And I would say that another cost, that's important, too is, when it comes to technological innovation, institutional investors really look to make sure that their portfolios are comfortably ahead of the curve. So if you have a lot of companies that operate in sectors that are established or as we kind of say, in terminal growth of value. So basically the sectors that are being disrupted by technological innovation. Sometimes investors would just say like, look, no matter how much we disclose on your supply chain, no matter how well you treat your employees, your business is not able to compete with the way the world is growing. And so in that case, the investors would just maybe leave those sectors and not even want to have an exposure to them. And so that is a significant cost on market valuation and therefore, for the survival of the company. Right. So I would say that those are examples of how companies can suffer if they don't apply the right risk management programs in order for them to attract equity, but also to continue to be competitive in their respective sectors.
Keesa Schreane [00:12:11] Great. So could you give us your top three components that investors should look at to ensure that whether they are in the current COVID environment or whether they've moved beyond almost beyond this to ensure a firm is in good standing from an employee relations, governance, labor practices perspective, what are the top three things that should look for?
Guillaume Mascotto [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. 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 gage of success for companies. Another one that's important we touched upon it is supply chain management, right? So quality safety management. The whole question of local versus global dependence. Right. So in the context of COVID-19 companies that have no dependence on global supply chains actually did better, which makes sense because if you're getting all of your supplies from global networks and everything is shut down, then, you know, you're ultimately going to suffer some supply chain disruptions here; The same way on quality and safety: if someone finds out that you're mistreating your employees indirectly as a result of your lack of supply chain controls, then, you know, they might not want to buy from you anymore.
[00:13:36] And so therefore, that could actually hit you quite hard. And last but not least, it's everything that's to do with them, you know, asset integrity. Right. So if tomorrow there is a scandal, if tomorrow there's a disaster, whatever you want in terms of EU systemic risk, 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 communicating, distributing management. In other words, when COVID-19 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, that they entrust in the hands of the asset managers, will still being well taken care of in their interests, will still be best protected by the asset managers. I would say those are the three main categories that we would look for.
Keesa Schreane [00:14:28] So from employee benefits to supply chain management, specifically the local dependence part, to asset integrity, the top three things that should be at the top of the list there. Thank you so much for joining us. Great insight, of course.
Guillaume Mascotto [00:14:43] Thanks very much for having me. Appreciate it.
