Faced with the growing importance of ESG criteria for investors, Marie-Claire Daveu, Chief Sustainability Officer, and Jean-Marc Duplaix, Chief Financial Officer, look at the challenges and opportunities created by this trend, along with the work that will be required in the years ahead.
In your discussions with investors, has there been a growing interest in ESG subjects?
Jean-Marc Duplaix: Yes, ESG is now an essential part of the relationship between companies and investors and, more generally, it has become a key feature of modern capitalism. But that’s not always been the case. For the past ten years, we noticed an increasing awareness of the importance of economic issues linked to the environment. Sometimes, there was a lack of maturity in the action taken and the comments made by certain companies; in other words, there was a tendency for greenwashing. But over the last two years or so, we have truly reached a tipping point. Investors have seen for themselves that companies which operate in a ‘healthy’ way – by which I mean that they really do factor environmental, social and governance issues into their business strategy – are performing better, both operationally and financially. Views have changed. For investors, ESG has gone from being a ‘nice-to-have’ to a ‘must-have.’ And we’re very glad about that.
Marie-Claire Daveu: Certainly, this subject has been given far more exposure over the last two years. We particularly notice it in the growing number of requests we receive from investors. The information they seek, along with their questions, is also becoming more precise. And they are not just coming from the specialized funds, they are from every type of player in the finance industry, including the very largest ones.
It’s also worth noting that ESG issues have also become established as a result of being viewed from a risk management perspective. Some businesses realized that phenomena such as climate change and biodiversity loss had direct consequences on their activities, to the extent that doubts were being raised about their survival. The recent forest fires in California and Australia have almost certainly reinforced those views; the risks have already become a reality, and we cannot wait any longer to take action. What’s more, while environmental issues get most of the media attention, the social and governance aspects of ESG are not being marginalized either. The emergence of a new generation of customers, who pay more attention to the way brands behave, has led some companies to assess the risks posed by working conditions at their suppliers, which could, for example, be a direct threat to a brand’s reputation. All of this has helped to bring ESG requirements to the finance industry’s attention.
JMD: This trend is also being driven by asset managers’ clients – who no longer want to invest in problematic sectors of the economy, both for ethical reasons and pragmatic ones: the risk is simply too great.
So, there is no contradiction between profitability and ESG performance?
JMD: It’s not true to say that investors only think about very short-term returns or profitability at any price. Today, investors know all too well that a company investing in ESG will reap the benefits by attracting the most talented people, by winning the loyalty of customers who understand these issues, by improving their efficiency… and by protecting themselves from a certain number of risks. For many investors, governance is their number one interest. A company where governance isn’t in a healthy state is a company that isn’t worried about its ecosystem, which means its employees, suppliers and its environment – both in the more general sense of the word and also the ecological sense…
Of course, ESG investments need to be part of a virtuous strategy that doesn’t damage the company’s business performance. At Kering, we are convinced that environmental, social and governance issues should be part of the business model. It’s one of the reasons why we are working to improve the traceability of our activities, particularly to identify the operational impacts of our investments.
MCD: We are fortunate to have a CEO who is absolutely convinced about the importance of placing sustainability at the heart of our strategy – for two reasons: ethical ones, but also because it makes business sense. And the same arguments hold for issues of diversity and inclusion, working conditions at our suppliers and governance.
I would add that it’s also our role to explain to investors and our stakeholders that our action on ESG criteria have an overall benefit, beyond the sporadic impact on profitability. Let’s take a practical example: the Group is currently investing in artificial intelligence to make more detailed sales forecasts for its Houses, and therefore adjust its production to customer expectations. That will have a direct impact on our inventory, our logistics and therefore our profitability. But will also have an effect on our consumption of raw materials, our carbon footprint… Naturally, we cannot quantify every benefit yet, but the financial community is changing very fast and integrates very well the reasons and issues behind ESG in terms of value creation.
Can discussions with investors affect Kering’s strategic direction and action in terms of ESG?
MCD: Our commitment to these subjects is a historical one; it’s a fundamental part of our vision and strategy. It has also given us a lead: thanks to EP&L, for example, we quantify the environmental impact of our activities throughout the supply chain and convert it into monetary values. As a result, we have a much more detailed view of our impacts and we can optimize our progress. We have also been working on social issues for years, partly through our internal HR policy but also through our value chain, for example, by being vigilant in ensuring that our suppliers’ behavior is beyond reproach. We have been actively engaged in issues that are now of interest to investors for a while now! That engagement only adds to our motivation and our desire to act.
Kering aside, pressure from investors is a positive force, particularly for companies that do not benefit from having a senior management team with the same level of determination or belief in ESG issues. Every player in the economy is now progressively coming around to the same point of view in their dealings with investors, and that creates a virtuous circle.
Following on from that, it’s interesting to see how financial communication is changing, in bringing together two subjects that previously would have been quite separate – sustainability and finance. The emergence of the integrated report seems a very positive development to me. By giving investors a very accurate picture of how ESG criteria are incorporated into a company’s strategy, and their impact on performance, makes it very tangible just how ESG can create value for everyone.
For you, what’s top of the ‘to-do list’ in ESG?
JMD: The lack of common indicators for measuring companies’ ESG performance is a problem. Every country has its own regulations, and there’s a multitude of initiatives, rankings, indices, etc. … But without a standard that is shared by everyone, on what basis can a company report its performance? And therefore, how can you compare performances across different organizations?
In finance, there’s a set of rules that is recognized and understood by everyone. Those rules are limited in number and they enable everyone to speak the same language. However, the finance world has been able to turn its practices into a set of standards because it has a history that goes back several centuries. In the next four or five years, I think we will see ESG assessment criteria becoming uniform. When a company wants to issue a green bond, for example, it only makes sense to do so if it can set the analysis criteria and objectives, which will be reflected in the issue price.
MCD: On that point, we have to congratulate the European Commission for its work on green taxonomy – a system for classifying sustainable economic activities – which has provided a framework for every organization in the European Union. It’s a very interesting first step. Obviously, we hope it will rapidly make a real impact, and that the thinking behind it will spread worldwide. Finance has this ability to make profound changes, in an irreversible way and at a global level, through the use of its regulations and standards.
That said, we have to recognize that defining a set of common criteria that can be shared by everyone is a potentially complex task in certain areas, and some will take more time to be introduced. Whilst in terms of climate change, companies can use metric tons of CO2 equivalent for greenhouse gas emissions to measure their impacts and progress, it appears more difficult to define a common quantitative metric for measuring biodiversity, for example. It is therefore necessary to be pragmatic about this and accept that we are going to have to learn as we go along, and perhaps mix the qualitative and quantitative criteria together, at least initially, as these are urgent issues.