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ESG: A NEW CHALLENGE FOR CFOS

Author: Francisco Matthews

Date: February 8th, 2021

I have spent all the 30 years of my professional life in the financial world; several years as a trader of FX derivatives and the last 20 years as an entrepreneur at NetGO. In both areas, some of the important aspects to be successful has been the early identification of new emerging trends and adequate management of the risks that are inherent to the business field.

COVID-19 has made us physically experience the impact that unexpected global crises can have and has taught us valuable lessons on risk mitigation. One of the most important lessons I have learnt is that the environment variable is an important factor in a company’s risk matrix, with great financial and operational implications. I have always considered ESG variables as variables from an area different from the financial area. I used to believe they were topics for activists like Greta Thunberg and that, in the company, sustainability management considered them as a way of carrying out green marketing, since it was in fashion. (Greenwashing).

Post COVID-19, my perception has changed. I believe ESG criteria should be considered an essential discipline of risk management. (ESG means Environmental, Social and Governance)

Even though environmental, social and government issues are old, I believe that the novelty today consists in that they are rapidly becoming stronger.

As an example, the following diagram shows the number of times the abbreviation ESG was mentioned by CFOs of 8000 companies around the world in quarterly earnings calls.

Additionally, when the CEO of Blackrock, the largest asset management company of the world, sends letters to the CEOs of the companies they invest in and to their clients, and reiterates the importance of ESG criteria in their investment policies, I believe this confirms that a change has come here to stay.

One of the letters was addressed to the CEO of the companies Blackrock invests in and is called “A fundamental reshaping of finance”. Another letter addressed to clients bears the title “Sustainability, the new Blackrock standard for investing”.

In the letter to the CEOs, Fink asks them the following questions:  What will happen to the 30-year mortgage – a key building block of finance – if lenders can’t estimate the impact of climate risk over such a long timeline, and if there is no viable market for flood or fire insurance in impacted areas? What happens to inflation, and, in turn, interest rates, if the cost of food climbs from drought and flooding? How can we model economic growth if emerging markets see their productivity decline due to extreme heat and other climate impacts? The changes Blackrock proposes are to exit investments that present a high sustainability-related risk; Fink adds that they will launch new investment products that do not invest in companies related to fossil fuels and gives thermal carbon, used mainly by thermal-power companies, as an example.

“Over time, companies and countries that do not respond to their stakeholders in situations of sustainability-related risks, will meet with growing market skepticism and, at the same time, with a higher capital cost”.

On the other hand, banks are considering extra-financial risks that may affect the credit profile of borrowers or of funding projects, and that could endanger paying back the contracted debt, like climate risk.

At the same time, bonds have been issued whose rate is linked to compliance with sustainability indicators, such as those issued by Enel in 2020.

When Blackrock, Banks and Greta Thunberg are on the same side with respect to ESG variables, this is a sign to consider and should make us aware of the fact that we are facing a structural change in finance.

It is true there is a road to advance on, mainly in looking for objective metrics in meeting the ESG criteria, but evidence is overwhelming in the sense that they should definitely be included in the agendas of the CFOs.

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