Prickett: I’m thrilled to be speaking today with Georg Kell, Chairman of Arabesque, longtime friend and member of the World Environment Center. Georg has a new book that he has co-edited with others on the topic of sustainable investing. Georg, welcome and thank you for joining us.
Kell: Thank you, Glenn.
Prickett: Tell us about the book. What is it about, and why should we read it?
Kell: The book tries to take stock of where ESG investing is today and what the prospects for the future are. We discovered two, three years ago that existing textbooks on finance are kind of outdated, not taking into consideration the changes that have actually happened already in the cooperate world, in regards to sustainability, and the many changes (incremental changes) that corporations have introduced over the past two decades or more. And at the same time, taking stock of the rapidly changing landscape in the world of finance, which has now started (probably in 2014, 2015) to take ESG Investing seriously. So the book really tells the story of a convergence between cooperate responsibility (and its drivers) and sustainable investing. We are convinced that this will open up new opportunities for market-led changes enabled by technology. It’s a big evolutionary step, so to speak, because in the past we looked at cooperate sustainability in isolation. We looked at impact investing, sustainable investing in isolation. We are bringing this together. We brought together leading voices, practitioners, executives from the cooperate world and from the world of finance, and of young thought leaders to tell that story with the attempt to also look a little bit ahead of where does this lead us to.
I think we have three big insights that ring through most of the chapters. One is that the pace of change in the framework conditions within which markets operate is accelerating. This is largely because of technology, but also because of planetary boundaries and the feedback loops we increasingly have to deal with as well as social changes, social movements, and governance changes. This insight should be helpful for executives and for students of finance.
The second big insight is that we have to look at finance in a systemic way now, from the technology angle, from the social angle, from the environmental angle, and even from the political angle. In today’s world, we need a horizontal, systemic understanding of change, in order to make sense out of it, and to adapt strategies and operations for a “future-fit” model.
And the third deep conclusion of the book, that is probably a bit more daring, is that much more work needs to be done, including on the theoretical foundations of finance, because some of the old assumptions just no longer hold. We are not in an equilibrium state of well-being; we are in a state of constant disruption. We are moving into uncharted waters. So, we need a new understanding of the forces That are disrupting the economy. This means sustainability has to become a part of leadership, no longer relegated to some communications department, or reporting department. It’s about strategy; it’s about the future; and that message is very clear. For finance, we also have very concrete contributions—how to bring this change about. Many financial institutions have started the journey, but they haven’t really embraced the sustainability agenda yet. They ask the question, “How do I change my institution to become future-fit?” The book gives some answers.
Prickett: Your point that the theoretical basis of markets and investing needs to be updated, I think 2020 shows how true that is. This is such a disruptive year in every way. To look at markets the way we have in the past is out of date. What kind of reaction do you get to that message? Do you get agreement? Do you get disagreement? Blank stares? How are people reacting to that more fundamental message in the book?
Kell: Well I’m just back from a trip, and I met a couple of top executives, and I’m actually quite confident that this message resonates very well. All executives now face the challenge of re-inventing themselves. Many are discovering only now that these slow moving changes add up to a huge momentum, and you better be prepared. COVID-19, as you hinted at, has clearly brought home the message that being prepared is essential for survival, and these slow moving risks and opportunities add up to enormous new landscapes. Our subtitle of the book is “A Path to a New Horizon,” and we are playing on Mark Carney’s famous quote “the tragedy of the horizon,” which speaks to the dilemma of the short-term versus the long-term. Basically, what it also means, is that as an executive, you have to survive in the day-to-day battle, yes, but you no longer can afford ignoring the long-term trends. Someone has to basically build up the ability to think in multi-time scales simultaneously, and prepare the ground for the future today already.
Prickett: Let’s talk a little bit about the underlying phenomenon—sustainable investing, or ESG Investing as it’s come to be known. You’ve been in this field of sustainability for a long time., How did this phenomenon arise so fast, ESG Investing? And for the cynics out there, is it real? Or is it just window-dressing? Is this a real change in investors’ attitudes or is it just green-washing?
Kell: Let me give a brief historical review of this issue. In 2005, I had the privilege of convincing Kofi Annan and convening a working group with asset owners, called “Who Cares Wins” and they coined the term ESG. We then launched PRI the next year at the New York Stock Exchange, and the issue didn’t really take off, frankly. Yes, some big asset owners, pension funds understood intuitively that negative externalities anywhere affect their portfolios. But it wasn’t really translated into strategies for new investment. Then came the financial crisis; the big story was overregulation, survival, easy money . . . not much happened either. It wasn’t until 2014 that the issue really started to take off with the first meta-studies confirming there is a correlation between good ESG integration at the cooperate level and long-term valuation. At Oxford University one of the meta-studies, was called “From the stockholder to the stakeholder.” Now many more studies have come out now, from Harvard, Singapore, and all over the world, hinting at the relationship. And the debate is still ongoing—Is ESG Investing just a fig leaf or not? I’m convinced now with one-third of global available investment, over thirty trillion dollars, using some kind of ESG filter or selection criteria already—it’s unstoppable.
And what’s behind it is something very basic our current price signals do not reflect the full extent of both risks and opportunities, because they’re short-term in design, and they behave in a herd movement. ESG, basically, is looking a little bit around the corner, trying to put valuation on non-traditional financial issues, which we know have relevance financially, over time, but are not yet fully reflected in the price signal. So, it’s like a bridge into the future, not a guarantee, but a bridge, a soft bridge. We do not argue that you should do away with the efficient market hypothesis. No, the price-signaling system is the most effective resource allocator ever invented by humanity. What’s needed is that the price signals more fully reflect the real threats and opportunities around the corner. And that’s what ESG delivers, and that’s what financial institutions increasingly understand. And all over the world now, from Asia to the U.S., from Finland to South Africa, financial institutions are developing capabilities to better integrate ESG into decision-making and allocations. Yes, the landscape is still very fuzzy out there; there’s a data challenge, there’s an alphabet soup of standards and protocols, but they’re important building blocks: the materiality notion, the SASB definitions in the U.S., integrated reporting in Europe as it’s called, the TCFD framework for financial institutions, the science-based target initiative for the cooperate world (with almost one thousand companies already in it).
We are talking here of big systemic movements, both in the world of finance and in the world of business, which are now taking shape. We also expect that the European taxonomy will be a major boost for this movement, because it will probably bring about a bit more coherence in that field. And yes, there is still a lot of inconsistency, incoherence, benchmarks can be really unclear. . . MIT talks about the aggregate confusion in one of their beautiful review articles, but the whole field is moving in the same direction. And with big data analytics and smart analytics, in particular A.I., increasingly it is possible to identify materially relevant information. Both, from what companies themselves disclose but also from unstructured data reliable elsewhere. And that’s clearly here to stay, because the world will increasingly be dependent on the natural environment and social changes. The pace of change is not slowing down, technological change is irreversible, the planetary boundary feedback loops will increasingly manifest themselves, and force a reaction—ready or not. Also the big social changes that are happening, social movements will not stop, if anything, they will accelerate. So, the drivers behind this agenda are not standing still; therefore, ESG Investing will become the new normal, until price signals better or more fully reflect externalities, opportunities, and cost. And then at some point, you can argue, it is just part of the pricing system. But in this transition period, where we are moving towards more sustainable, decarbonized, cleaner environment, ESG plays an important role.
Prickett: So I think a lot of us are believers in the underlying theory. One of the challenges, as you say, is if you’re looking around the corner, you’re looking ahead of where traditional financial accounting allows us to make objective decisions. And you touched in your previous answer on the thicket of different standards, and the fuzziness that’s out there now in terms of analytics. How should we be thinking about that? How long will it takefor there to be generally accepted accounting metrics for this? How will that turn out if I’m an executive at a public company, riding this wave, given that we don’t know exactly where it’s going to break?
Kell: It’s very hard to predict. It took financial accounting a hundred years to get established, right? A friend of mine always says ESG measurement is currently where financial accounting was in 1925, a few years before the big crash. But maybe the world is turning faster, so the evolution will most likely be faster. A lot depends obviously on the regulatory context, and currently we are on a pathway of fragmentation, but that may change. So, once politics aims at more coherence again and comparability, it may fast track almost overnight. It’s very hard to predict now. We are in a very unique space in human history, where Europe seems go its own way, the U.S. seems to go its own way, China goes its own way, and many other countries are forced to align themselves somewhere in between. We are no longer in a multilateral world where global standard by definition is to decide an outcome politically; on the contrary, political power now is driving fragmentation rather than harmonization. But the market forces won’t stop . . . they are a-political. The market itself will drive the issue forward. If regulators then come together and give it a boost, it will happen much faster. But even in the absence of regulatory pushes, I’m quite optimistic that market forces themselves will bring about practical coherence pretty soon.
Prickett: Let’s shift gears to your journey. Let’s talk about Georg Kell. You’re sort of voting with your feet on that theory that if governments can’t come together and set the course then markets will. You’ve moved from a role at the U.N., a very important role, founding and leading the Global Compact, and now you’re the chairman of a very interesting company called Arabesque. Tell us about Arabesque, what it’s trying to do, and how did Georg Kell end up chairing this really innovative company.
Kell: Well, I used to be very skeptical about finance, as an engineer, I must confess. For me, finance was always the necessary evil as Keynes put it. But when I retired from the U.N., I came across Arabesque, and I was totally impressed. It’s run by investment bankers, former senior bankers from Barclays, who’s brought it out from there. The idea of jumpstarting finance as a cutlass to me was very attractive. I also had a weak spot for technology itself as the fundamental driver of human progress. So it wasn’t a difficult choice for me. And I like the startup business too, you know, building something is fun. And that’s how I ended up with Arabesque, and I have no regrets whatsoever, because Arabesque has three complimentary business models, all of them related to each other.
One is classic ESG Investing, deep integration of ESG data into investment strategies. The second one is big data, we call it S-Ray, the equivalent to the X-Ray on the human is the S-Ray for the corporate. Big data for sustainability assessment of public listed companies. And the third one, which until recently, I didn’t really believe so much into, but now I’m totally convinced of, is A.I. We have one of Europe’s leading A.I. teams, and the machine they have been building just blows your mind. With my engineering background, I couldn’t quite wrap my mind around it anymore quite frankly. But I understand the power of the signals that it can produce and the enormous capacities for signal strength. It’s foreseeable that A.I. will disrupt finance very quickly in the area of portfolio construction management, for example. It will happen very soon, major disruption. To me, it’s a proof point that progress based on technology, together with the new valuation of ESG, is extremely powerful. And that’s what I like about Arabesque, is that this is their exclusive focus, technology and ESG data. It’s a wonderful playground, very exciting, very demanding. We feel confident for the future . . . but the race is on. It’s a good race.
Prickett: Like you, as an aging Gen Xer, I’m a little skeptical about all the claims of A.I. and how it’s going to change the world. But you’ve become convinced that it will revolutionize investing?
Kell: I actually started at the Fraunhofer Institute in Germany, and in those days I actually worked in A.I., in 1983. We had the old systems, the best you could produce was expert systems, and you know, diagnostic systems, with very long and complicated algorithms. I just spent two days, not so long ago, with Google, and I understood, for the first time in my life, the power of big data, and what it brings in additional insights, and the ease with which these insights can be generated. I also realized that the cloud business is revolutionary in so many classic business service functions. So, we are already in the new world, we just haven’t realized it yet. A lot of companies are already plowing ahead, full force; they’re doing it quietly. They don’t want to be too loud about it, because it could create regulatory reactions, and all sorts of political, social debates. But it’s unstoppable. The challenge now is to ensure that technological progress is used for good purposes, like any new invention we have. We also have the choice, how we apply it. We can use a hammer to build a house; we can use a hammer to kill somebody. The more powerful the technology, the greater the potential on both sides. So, I think A.I., for good, for ESG Investing is a wonderful purpose. I feel very good about that, but that battle is still ahead—the purpose of technology. And the various debates that are playing out already are just a precursor of that.
Prickett: H I like your image of “We’re in the future, we’re just realizing it now.” The tremendous shocks we’re feeling this year, a global pandemic and its associated recession, the almost spontaneous global movement for racial and social justice and the frustration of how long that’s been denied, and of course, the climate crisis that’s upon us. All three of these things have been predicted for a long time. Now the world is waking up to them. How does this affect your thesis about where sustainable investing is headed? What do the shocks of 2020 mean for the ESG Investing movement?
Kell: A crisis always brings out both the good and the bad sides of human beings, of organizations, of collective responses. So we have seen the best and the worst at the same time, and the challenge now is to learn all of this, and to translate it into the good lessons learned. I’m a strong believer in human abilities to reinvent themselves under crisis and stress. I’ve seen it many times at the corporate level—when they hit the wall, when a crisis sets in, and the wakeup call is understood. Then when a new innovation from the inside is fairly easy to make in crisis situations; the barriers of resistance are much lower. So that’s why so many more companies, since COVID broke out, now have embraced climate road maps, for example, and are much more serious. It’s really impressive how the Science Based Target Initiative has welcomed record numbers of new companies, for example. To me, that is a signal that during crisis situations you can implement changes much easier. You can prepare for the future. Now, will the world learn the right lessons? The debate is on-going, how the recovery funds are used . . . Will they be invested for future-fit infrastructure? Or will they just be burned in the moment to continue business as usual? That’s one of the big open questions. Will the world come together again, recognize that there are probable threats which only can be tackled through cooperation? No country will be safe, so long as the virus is hiding out somewhere. We all should have, in our national interest, the willingness to collaborate. Climate changedoesn’t respect national boundaries. Even if we do our share, and the neighbors don’t, it doesn’t assure survival. So, we have every reason to rediscover collaboration. That’s the big bottom line, and I hope the world will ultimately arrive at the same conclusion.
Prickett: Collaboration is the modus operandi of the World Environment Center, which I have the privilege to lead, and you’re one of our valued members. What can WEC do to advance the cause of collaboration for sustainability,particularly in this arena of ESG Investing? How can we be most helpful to Arabesque and to others in your field who are trying to advance this mission?
Kell: Your great work is very important because sharing the best practices and stimulating learnings across sectors and industries is the key now. I’m convinced that old lines of divisions are breaking down. Innovation creates new business models across and between established industries. That’s exactly where you are active. So you play a critical role as a cutlass for best practices to spread wide and fast. And the more you can evolve the better, because the faster the learning, the faster the acceleration of change, the better our chance for having a soft landing in the future.
Prickett: For the W.E.C. members out there, you’ll be glad to know that Georg’s colleagues at Arabesque are working with us on a two-day roundtable on this topic of ESG Investing scheduled for January 27-28. We’ll dig deeper into all of these questions. So stay tuned for more on that. Georg, Is there anything else you’d like to share with our members and other viewers?
Kell: Well, the notion of leadership is always important, you know. It never goes away, at the corporate level, everywhere. The questionis how can you generate momentum for change in the absence of a crisis? A lot of executives now recognize that they have to move faster on these issues, but they have internal resistance. How can we support them in creating the momentum? That’s one area I suggest for your consideration, because you’re basically helping executives to be successful, and they want to create an internal momentum to advance the change faster. At a macro level, I’m concerned that strategically, we are falling into a trap, that we are abandoning international collaboration. So anything we can do to demonstrate that through working together we can accomplish more, is extremely precious and valuable. I believe that the Transatlantic Relationship will become stronger again. I think what we’ve just seen in the last two or three years will not reflect the future. So investing in that, I think, is also a good thing to do. Building a transatlantic understanding and making sure that the good historical lessons we’ll have learned won’t get lost but carry us into a safe future together.
Prickett: Well, let’s close on those points, and in particular the one about leadership, and what we all can do to generate momentum for change. At the World Environment Center, we can empower our members and partners to take these ideas forward. You’ve done your share with your new book. The book is Sustainable Investing: A Path to a New Horizon, edited by Georg Kell together with Herman Bril and Andrea Rasche. I commend it to everyone as important reading and hopefully it will encourage us all to push harder for more momentum on sustainability and collaboration. Georg, with that, we’ll draw this interview to a close. Thank you for being with us today.
Kell: Thank you, Glenn. All the best.