Prioritise substance over form in your ESG work

Two people who have seen their field take off in recent years are Marco Kisic and Viktoria Voskressenskaia from ESG Research in Nordea Equities. In this interview from Nordea On Your Mind, they talk to Nordea Thematics' Johan Trocmé about the dramatic rise of ESG in investment decision-making, Nordea's own ESG ratings framework and what to expect in the years to come.

JT: Tell us about what you do at Nordea?

MK: We produce ESG Research on listed Nordic companies, working in close collaboration with our equity analysts. Over the years we have developed a number of research products, to cater for the different interests of investors. Initially our research was primarily focused on fundamental and company-specific research, but now the scope has expanded to include ESG ratings for the companies covered by Research, and ESG strategic work, developed with the help of our strategy and quant teams. We have seen an enormous increase in interest over the past three years, and we expect this to continue, so we want to continue to stay on top of latest trends and help to shape the ESG debate on the market.

JT: Sustainability has become mainstream for institutional investors over the past 10 years, but how would you say it is viewed by listed Nordic corporates at present? What are their key considerations and challenges? How to measure it? What level of transparency? Getting an ESG rating or not? Short-term costs versus long-term benefits?

VV: Nordic corporates have always shown a keen interest in sustainability, often leading the trend at the European and global level. Yet, over the past 12-24 months we have seen a further acceleration in this, with ESG now a core component of the narrative for most of the companies we talk to. This has created huge opportunities but also challenges for companies, with the latter ranging from the burden of reporting to multiple stakeholders and under different frameworks, to the challenges of companies that by nature don’t fit into any easily recognisable “green category”, and therefore feel misunderstood or left out from the ESG race. Quantification and measurability can be part of the problem, one that is likely to persist until we have more unified and standardised reporting standards. The EU Taxonomy can go some distance in plugging that gap, and it is a framework we really like and welcome, although sometimes it is difficult to fit the complexities of reality under one unique umbrella. It will be interesting to see how it will get integrated in ratings, which I expect will remain part of the landscape for the foreseeable future. Ultimately the recommendation I give is always to focus on the substance over the form of what a company does, and to keep the eyes on the genuine long-term benefit of society, even when these come at a short-term cost.

JT: How would you say the typical Nordic institutional equity investor considers ESG in their investment decisions today? How does it compare with, say, five years ago?

MK: The space has changed completely. Five years ago, for the majority of investors, ESG would be a secondary consideration in the investment process, taken care of by a separate team, and often in the form of a exclusion list or a tick-box exercise. Today, most investors integrate ESG in their assessment from the beginning: more and more responsibilities are being shared between the ESG team, which typically has gained in relevance and staffing, and the portfolio managers, who are increasingly developing ESG knowledge. It is hard today for the average Nordic investor to push the button on an investment without first having gone through a proper consideration of the sustainability profile of that company.

JT: You have developed a unique Nordea framework for corporate ESG ratings – could you briefly describe it, and how it differs from ESG ratings from other providers?

VV: Our ESG model has a number of unique features that distinguish it from most of the other and well-known ratings – we have designed it in a way that we think would fit the investment approach of a typical Nordic investor. First of all, it is purely a Nordic rating model, as we don’t score any non-Nordic company. This fact limits the scope for a peer-comparison type of exercise, which anyway often results in Nordic companies homogeneously scoring at the top of the peer group. We instead decided to build a more absolute type of assessment, which spans across sectors and compares a company to all the other companies in our universe. Despite this approach also having its own challenges, it is appreciated by investors, who tend to have similar constraints in their investible universe, and is a system that tends to reward companies focused on continuous improvement. A second peculiarity of our model is that we include a qualitative component in it, complementing the quantitative foundation. We do this by bringing our equity analysts' views into the assessment. Lastly, we are strongly focused on the future sustainability trajectory of the companies, so we have a whole section on strategic direction, targets and product impact.

JT: What do you think will happen in the ESG ratings landscape in the next five years? Concentration towards a common approach, differentiation into different niches, or something else?

MK: Hard to say, though in the mid-term it is likely to be a combination of both. I see it as likely that more and more sophisticated ratings will emerge, with a lot of investors developing their own rating models. On the other hand, however, we are likely to have common denominators that will stir those ratings, such as common frameworks (e.g. Taxonomy) and disclosure (TCFD). There is possibly also scope for some sort of “ESG consensus”, though the mechanics of this remain to be defined. At the end of the day, ESG is a very large, fluid and ever moving universe, thus hard to fit into a single box, though at least the parameters we use to talk about it can be unified.

JT: How should large corporates think about ESG reporting and ESG ratings? How big a difference can they make? What are the key priorities for corporates to be able to show a strong ESG performance?

MK: Transparency is paramount to allow the market to perform an assessment, and ratings can make a difference, particularly the ones which are most widely used. But what really matters is the underlying reality the ratings try to describe. In fact, as investors become more sophisticated, the focus may shift from single ratings to a “consensus” of ratings, thus something that is harder to optimise than a single rating system. So the best route for companies is to work on the basis of an expanded purpose, focusing on the genuine long-term interest of society, in a way that integrates that expanded mission in the traditional strategy of the company.