With billions of dollars flowing into ESG investment products, changes are afoot for ESG disclosure best practices and reporting regulations. Maggie Peloso, partner at the law firm of Vinson & Elkins, shares her insights on numerous reporting challenges companies large and small are trying to tackle, including data management (10:20) and determining materiality (16:01). Maggie also outlines how companies can prepare to meet the evolving expectations of investors and changing demands of regulators (25:38).
We also have a bit of fun as Maggie, a proud Duke grad, shares stories from her days among the Cameron Crazies and names her 5 favorite Blue Devil players (43:30).
In this episode's PodBrief (49:30), the topic turns to a key piece of information that is missing from all the news about the greenhouse gas emissions reduction targets being touted by various countries -- including the US and the Biden administration.
More insights from Vinson & Elkins
Executive Order on Climate-Related Financial Risk: One Small Step for Climate, One Giant Leap for Federal Climate Policy
U.S. Climate Change Disclosure Regulation is Inevitable, Here’s What To Do About It Now
Maggie Peloso's book
Adapting to Rising Sea Levels: Legal Challenges and Opportunities
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Sean McMahon 00:08
Today's episode of the Renewable Energy SmartPod is brought to you exclusively by the innovative people at EDF Renewables. EDF Renewables is a market leading independent power producer and service provider with over 35 years of expertise in developing wind, solar, storage and electric vehicle charging systems. EDF Renewables - Energy your way.
Maggie Peloso 00:31
One of the really powerful things that good ESG practices can do for a company is to be a tool for imagination, right to help you think about like, what's the worst bad thing that could happen to us? And how would we survive it as a company? How do we think about improving our corporate resilience? And one of the things that we know is that we as people are really terrible at valuing the avoided bad outcome.
Sean McMahon 01:01
What's up everyone and welcome to the renewable energy smart pod. I'm your host, Sean McMahon. And that voice you just heard was Maggie Peloso. She's a partner at the law firm of Vinson and Elkins and an expert on ESG disclosure. With billions and billions of dollars flowing into ESG investment products. Maggie joins the show today to talk about what all that money and new regulations that are on the way mean for ESG disclosure best practices.
After our conversation, stick around for the latest PodBrief segment, where I'll talk about a key piece of information that's been missing amid all the talk about greenhouse gas emissions reduction targets.
Looking ahead, we've got a couple of great episodes coming up. Renewable energy certificates, or RECs, are a hot commodity right now. So I'll be talking trading trends for RECs was Steve McComb from IncubEx.
I'll also be joined by Greg Hopkins from RMI to discuss the growth potential for the green mortgage market. It's a relatively niche area right now. But a few tweaks to the housing finance and securitization markets could help green mortgages reshape the way homeowners pay to bring renewables and energy efficiency technologies into their homes. So be on the lookout for those episodes, because I think you're gonna like them a lot.
Joining me for today's conversation about ESG disclosures is Maggie Peloso, a partner at the law firm of Vinson and Elkins. Maggie, how you doing today?
Good. How are you, Sean?
Oh, I'm doing great doing great. Now, before we dive into the nitty gritty of ESG, I was doing some research for the show. And I saw you went to Duke University. That means I just got to ask you are those basketball games they're as wild and crazy as they look on TV.
Maggie Peloso 02:49
Oh, they are so fun. If you've never been in Cameron, it is a very old school basketball stadium and it is small and it is hot. And it is loud. And when the students jump up and down in the bleachers like the whole building just shakes and it has this this energy to it that is is really very special.
Sean McMahon 03:10
So were you ever in that crowd of Cameron crazies? And can I find some ESPN footage of you like with you know, your face paint all blue and white? Are you in the front row? That stuff? Were you mixed up in it?
Maggie Peloso 03:19
You can find me as a matter of fact, my first year at Duke I participated in the the tradition called tenting, which you've probably seen on ESPN where the students give up their perfectly lovely dorm rooms and sleep outside. They call that chef de Ville, right? They showed you and when you when I was when I was there, this will date me. When you went on the campus tour, one of the big things they wanted to tell you about was how they had just put Ethernet Jacks into all the light posts out there so that you could plug your computer in and still do your homework while you were sleeping in a tent. And I came home at the end of first semester and I told my parents I was going to do this and my mother said you're never gonna last out there. So of course then I did to prove to my mother that um, that I in fact, could sleep in a tent for basketball tickets.
Sean McMahon 04:00
Haha, that sounds amazing. Check it out a Duke North Carolina game at Cameron has been on my bucket list since I was a kid. So I got to find a way to make that happen. Okay, and now part of the basketball pun. But let's go ahead and tip off today's discussion about ESG. You are one of the experts in this in the legal world in this space. So I'd like to kind of set the table for our audience and just given the basics, like, What does ESG even stand for? You know, why is the world of ESG grown so fast recently? Just walk us through it real quick?
Maggie Peloso 04:30
Sure. So ESG is an acronym. It technically means environmental, social, and governance, which would lead you to ask well, what does that mean? In really broad brushstrokes. It is a catch all phrase that's used for a number of factors that are not traditionally considered to be financial, but that are areas that could be a risk to companies. Consideration of ESG factors has gained a lot of popularity recently for a couple of reasons. The first is that there has been a big movement in Europe in particular to regular ESG going back several years, and now here in the US context as well. There have been some considerations of ESG factors and some theories in the market that considering those factors can actually lead to better returns. So there's some question about, you know, is there a smart beta associated with ESG? ESG has really grown in response to investor demand, particularly here in the US. That's, that's been the big thing. Investors are asking companies questions about very particular kinds of ESG risks about diversity, about climate, about governance, and companies are responding to what they're seeing. But it's partly because of this thesis that better ESG practices can lead to better returns. And I think it's partly also because of changing societal expectations about the role of corporations, right, that we have really, as a society begun to expect that companies will be good citizens, and a lot of corporate value these days is tied up in brand. And so perceptions of corporate behavior can be really, really important to drive in corporate value.
Sean McMahon 05:59
And now, there's been some growing pains associated with lately, because as you mentioned, that kind of gaining in popularity, what are some of those Growing Pains? standardization is one thing I hear a lot of, you know, buzz about and, and metrics and how to try it, you know, how do we actually kind of count or tabulate other things that go into ESG.
Maggie Peloso 06:15
So there is right now, a lot of heterogeneity in the ESG field, right, there has been a huge proliferation of ESG funds of third party metrics and scoring systems for ESG. And they all rely on different things. And in many cases, a lot of the scoring systems rely on their own secret sauce. And it's not even entirely apparent what they are scoring on. So some of them are doing things like they'll score on presence or absence of a disclosure, because it's really, really hard to rate the quality of a disclosure. So it can be really, really hard to create relationships that feel truly empirical between what companies are saying about ESG and what it might or might not be doing for their value.
Sean McMahon 07:00
And so what are the hardest things you're finding are the companies have to struggle the most with to tabulate or account, you know, that empirical data as there's some stuff that's easier to pull together than others?
Maggie Peloso 07:09
Yeah, I think really broadly, the things that are are easier to pull together as data you actually control, right? In the context of, for example, greenhouse gas emissions, it might not be so hard for a company to figure out what its own emissions are what we would call the scope one emissions. But then when you start to get to questions of, well, what are the emissions from things that your vendors are selling you for? Right, you bought power? What are the emissions from the power you bought? And then the scope three, what are the emissions from your consumers using your products, it gets much harder to figure out what those things are. I think a particularly tricky example of this is what's going on with the banks, right? The major US banks have all made commitments to reach net zero finance emissions. But if you look closely at those commitments, pretty much to a bank, they say, the first thing we're going to do is figure out what our financed emissions are, right? Because it requires some pretty sophisticated knowledge about what the dollars you're lending are being used for, and then what the emissions that result from those activities will be.
Sean McMahon 08:07
And one of the things I've seen, is the proposal to maybe separate out some of the E and the s and the G, um, what are your thoughts on that where companies might want to just kind of tabulate one of them and not focus on all three?
Maggie Peloso 08:18
I think it's really fraught. And I think it's really fraught for a couple of reasons. The first is, it's not clear to me that you can do just one of the three pillars well without doing the others. So for example, when you think about something like climate, right, companies are bombarded with all kinds of information every day about how climate is changing, and how markets are shifting in response to that, and how demand for their products might change and how physical risks might change. And they need to figure out how they're going to take that information in how they're going to evaluate it, how it might fit in their ordinary risk management processes, and when it might need to be elevated up because it might mean that the company needs to change its strategy, right? And once you start to talk about the strategy component, you're going well, how am I going to elevate this information to my CEO to my board, you know, to the right decision makers within the company. And so I find it really hard to think about how you would do climate risk management well, and seriously, without governance. The other reason I think it's really fraught, to pull these things apart, is because when we're talking about the broader suite, so going back to where we started, this is really a body of things that we're managing, partly because companies are trying to respond to the types of citizens that we expect them to be. There are often some real trade offs between what might be most risk minimizing for the company, and what the reputational impacts of some of those things might be. So I'll give you a very concrete example. And that's physical climate risk, right? If all I'm concerned about his Gosh, I don't want my facilities to be in places where there's a lot of sea level rise anymore. I as a corporation might move away from an area that is really exposed to fiscal climate risk. But in doing that you may be leaving a community behind that then doesn't have the benefits of the jobs that you create of the money you're injecting into the economy. Have you know any other things you might have done to reduce your physical risk, if you stayed that would have helped the community as well. And so I think it is really important to be considering all those factors together.
Sean McMahon 10:20
I like how you brought up the example of climate change and you know, kind of coastal areas, because I know you wrote the book on that topic, and I want to talk about that later. But for now, let's just kind of bring back to the data. Alright, so all these things, we're talking about those data points that have to be collected. Now, how are firms tackling that challenge? Is this something where they're building out? internal processes? Are there third party vendors or some kind of hybrid? How does that work?
Maggie Peloso 10:42
It's a little bit of both right? And I think it depends on the type of data you're looking at. You know, one of the things that we find when we work with companies in the ESG space is that the first question is always, what do you know about yourself? Right? Do you even have the baseline data to start to think about things like, what kinds of goals might I want to set? And how am I going to get there? for lots of companies, it does take quite a bit of time and effort to figure out, you know, is this data here is is there environmental data, climate data that's living in my EHS function and information about diversity that's living in my human resources function? And it's a matter of figuring out how to centralize that data and pull it together? Or is it data I don't have, and I'm going to have to go figure out how to collect it. I think the second challenge, once you figure out if you have data is figuring out if it's any good, right? that many of the purposes for which we might have collected, some of this data in the past are not the same as putting that data to use to do things like make disclosures to your investors that they're going to rely on and thinking about whether they want to be invested in your company or not. So there's a lot of work that many companies finally have to do around data quality, that is often an area where they will be bringing in third party auditors, people who can do data assurance, some of those kinds of things. And what's really interesting in the ESG space is that we do see some of the more traditional firms that do a lot of auditing getting into ESG auditing. But there are also some nuances around some of these things. Like for example, you know, if I want to audit my climate data, and one of my questions is, well, gosh, I use the EPA rules, and I create my greenhouse gas emissions data by counting how many compressors I have, and multiplying it by the number EPA gave me. And I don't know that that's right. And what I want to do is, figure out what my real emissions are, that's a very different kind of consultant that you need to help you go and answer those kinds of questions.
Sean McMahon 12:33
So that sounds like something where there might be a little bit of a gap in terms of just the size or the budget, a company has to throw at this, if you're a huge company, we got, you know, dozens or hundreds of people can throw at it. But smaller companies might struggle Are you seeing any kind of you know, delta there, in terms of based on the size of the company, how these issues are being tackled?
Maggie Peloso 12:51
I think the gap is, is enormous. And I actually think it's really hard for midsize and small firms, because we see investors expecting many companies to approach this with equal levels of sophistication. And they're not all big giant corporations that have these resources, right, that there will be many big companies who already have very sophisticated internal environmental risk management or other kinds of risk management functions where they may have a lot of this data, and they may well already have processes in place where they can start to look at some of these risks in a more meaningful way. You know, but at the other end of the spectrum will work with a lot of companies where they're kind of going, you know, we have one person who does IR and one person who does, you know, all of our environmental health and safety work. And you know, they they don't have the bandwidth to go out and collect all this information if they don't already have it. And that is one of the places where we do see consultants doing a lot to fill the gap. But then you still have a resources question, right. And I think one of the really sort of interesting questions as we're thinking about where ESG is moving in, particularly in light of the potential for sec regulation of ESG disclosures is whether a one size fits all approach is really appropriate, right? Because the the level of resources you need to expand to really have good ESG data can be quite high if you're a smaller company. And because going back to where we were before, it's not so clear empirically, which of that data is really essential to understand to really get at corporate performance. I think it there can be some tricky questions there about how much of reporting version you want to place on smaller companies right now.
Sean McMahon 14:27
I'm glad you mentioned the SEC. And you know, some of the things on the regulatory front, because I want to segue to that real quick. And first of all, I did some research, you've written a few things on Vinson and Elkins website that are you and your colleagues, I think you've kind of CO written those and they're really excellent resources. So I'd recommend anyone can go check those out. So what do you see in the regulatory landscape now and where is it headed?
Maggie Peloso 14:47
So I think the most interesting things that are happening in climate these days in the Biden administration are really happening with the financial regulators. I the SEC right now has a comment period open that will close in June basically saying, you know what we think we need to make some new climate rules tell us about what we should do. And they've asked a series of 15 specific questions that range from things like, well, should we regulate this under regulation s k. So more sort of principles based? qualitative? Let's talk about what's material? Should we regulate under regulation as acts? So basically implying that this should all be covered in accounting kinds of rules? Or should we do something totally new all the way through to things like, how do you feel about international standardization? And should we have a cut off for company size? And should we have different standards for different industries? There's a whole lot of different things the SEC is thinking about there. You know, I expect they'll get a proposed rule out sometime this year, and then we'll see where that rulemaking goes. The Fed is in much earlier stages and exploring what they want to do. But they have created a supervision climate committee and are certainly starting to think very hard about the possibility of things like climate stress testing for systemically important financial institutions. So they may well do some interesting things also.
Sean McMahon 16:01
Okay, so you mentioned that part of what the SEC is trying to do is decide what information is material and what isn't. So can you take a minute for our listeners, and just walk us through what materiality is and why it matters so much in this conversation.
Maggie Peloso 16:14
So this is a very important to complicated concept in the world of ESG. When we talk about it internally, we talked about the difference between big M materiality and small and materiality. And when we use big materiality, we're talking about the legal definition under the securities law, right. So that would be information that a reasonable investor would want to know about you when they're making their decision. And materiality is defined in the sec context through a whole bunch of case law and some some regulation, but has has a pretty well bounded definition in terms of what kind of information would fall into that bucket. What's really interesting when you think about materiality in the ESG context, is that there are a lot of other ways that we use that term. Right. So in the EU, they use what's called a double lens of materiality. So it's sort of looking at definition similar to the SE C's, but also thinking about, you know, what's the impact of the company on the world. That's the definition that the global reporting initiative g ri, which is one of the most widely adopted voluntary sustainability reporting frameworks uses, they are looking at, essentially, it the externalities that a company is causing, you know, there are a number of other voluntary standards that don't use a materiality threshold at all things are material because they say they want to know them. And then you've got some voluntary thresholds like SAS B, that are trying to come back around to you like no, what we're trying to do is help you filter through to this sec definition of materiality. So you know, when you're really thinking about the ESG space, and someone's trying to talk to about materiality, the first question is, well, which materiality? Are you talking about? And I think one of the really interesting things that the SEC is going to have to grapple with as they move forward and making these rules is that they're going to have to think very hard about whether it is appropriate to stray from traditional securities law, conceptions of materiality, in the context of climate disclosures, I would submit to you that that's probably not a great idea, because one of the reasons that we use the materiality filter is to help to make sure that the disclosures that investors are getting are focused on the information they really need to know. And that's what that filter is for. And so more likely, I think, the place that it would make sense for them to end up and I'm not the SEC, so I don't know what they're going to do is to continue to apply that materiality lens to what's going into required reporting, so things like a form 10k, or a form 10 q filing, but then create other venues much like what companies do now. The standalone hire reports other places where you can provide more information for investors who are really interested in these topics.
We'll be right back.
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Sean McMahon 19:21
And now back to our conversation. So where does equity come in to all these decisions the SEC is trying to make if you look at the approach that by demonstration has taken on a whole host of issues, equity seems to be factored into all kinds of regulations and initiatives. Do you think that's something the SEC will keep in mind? Or will the commission just shy away from the equity conversation and try to maintain a broader approach?
Maggie Peloso 19:44
I think this is such an important question. And I think it's one that the Commission still really needs to grapple with. One of the last questions on the list that they're taking comment on right now is, should we do just climate or should we do ESG? You know, I think where you come out on that really will depend, or will be past determinative for how they're thinking about equity and how explicitly or not they're thinking about equity in the context of this current rulemaking, you know, I would argue that looking at ESG more broadly, is probably much harder from a regulatory perspective, because there's so many more things you would have to think about how to quantify or how you're going to put boundaries around what you should or shouldn't say. But it may provide a framework in which there is more room to really think about things like equity and talk about them in a way that is meaningful.
Sean McMahon 20:34
What's the timing and all this? You said, the SEC has got a comment period that ends in June. So what kind of timeframe? Do you see some of these rules coming down?
Maggie Peloso 20:43
I think it's gonna take a while the comment period that's out right now is before the SEC has even created a proposed rule. So they will take all these comments. And if the current pace of submitted comments and the number of companies that are thinking about this as any indication, they will be voluminous. And then they will think about all of that and do some more probably some more stakeholder engagement, and then come out with a proposed rule. So you know, if I were to guess I would say a proposed rule is probably going to be coming late summer or fall of this year. And then because of the way the administrative rulemaking process works, they'll have to take comment on that specific proposed rule, and then come out with a final rule. So you know, I know the SEC has ambitions for an aggressive timeline. But frankly, just thinking about the basic way that administrative law works, it's hard for me to envision that there will be a final rule much before late summer, early fall of 2022. And then, of course, when is that really going to impact companies? The question would be who's going to litigate over that rule? Will they be able to get a stay of the rule while the litigation is ongoing? And how long will that litigation take? So we may still be several years away from seeing rules about climate disclosure take meaningful effect.
Sean McMahon 21:57
Is there any concern out there about just the political pendulum swinging back and forth? I mean, I know a few weeks ago, we had the climate leader summit. And, you know, we're in Paris, and we're out of Paris. Now we're back in I mean, is there anyone thinking that like, okay, yeah, this is great. But if there's a change in administration, you know, the SEC for eight years from now is gonna roll these back.
Maggie Peloso 22:15
So I have not heard folks talking terribly explicitly about that yet. But one of one of the things that we are seeing that's interesting is that there are two bills in Congress right now, that would actually expressly legislate that the SEC needs to regulate climate disclosures and get pretty granular about the kinds of things that that at least the democrats and Congress would like to see things like, you know, you should require scenario analysis, you should require companies to say what their fossil fuel holdings are, you know, so it's possible that one of those two pieces of legislation could move one is actually in the clean future Act, which is the broader bill that the House Democrats have on climate. And that would certainly provide a backstop that would make it harder in a change of administration for the SEC to walk away from being as aggressive about climate. You know, I will tell you, from my perspective, one of the things that was really remarkable about the last four years was that, despite the fact that climate was not an area of priority for the SEC, it was an area of priority for investors. And we saw both the volume and the sophistication of climate disclosure increase a lot. And so, you know, I think there's some interesting questions there about, you know, in a hypothetical future world, we're four years from now we have a different kind of political leadership. Would it really change what companies are doing or investors pushing this so hard already that it would be hard for companies to say, hey, guess what, we found that really burdensome and we're just not going to do it anymore.
Sean McMahon 23:40
Our regulators around the world collaborating on ESG?
Maggie Peloso 23:44
They are they are so actually, just this week, the International Financial Reporting Standards foundation that are known as FRS announced that they're going to create a sustainability Standards Board that has a goal of establishing a single set of international standards for climate risk disclosures. The goal is to have those standards out by mid 2022. And they would initially be based on the framework of the taskforce for climate related financial disclosures. That sustainability Standards Board has been formed in response to requests from a number of governments and others and is really being looked at as a place for sort of centralized international collaboration on this. There's also a group called the network for greening the financial system, which is a network of central banks and supervisors who are sharing best practices. So that's one of the places where the central banks are getting together and talking about things like how do we think about climate as a systemic risk? How would you think about what is systemic shock to your financial system caused by climate change looks like what kind of stress testing might you want to do? And so they're doing a lot of really interesting work in terms of trading best practices and thinking about how their work should evolve.
Sean McMahon 24:51
So despite all that collaboration, is there any concern about what I would call ESG? arbitrage, meaning companies seek out The country or jurisdiction with the lightest touch regulatory regime, and then set up shop there. So they don't have to abide by stringent disclosure rules. You have any concerns about that?
Maggie Peloso 25:10
I have yet to see that happen. I would posit to you that consumers and investors might penalize companies very heavily if they were seen as trying to avoid making those disclosures, which is not to say that there are not a lot of companies that are in very different places on their ESG journey. But I think the the arc of ESG is towards more disclosure is towards more rigor and disclosure. And I think that's going to be hard to change.
Sean McMahon 25:38
Okay, what can companies do now to prepare for these roles that we've been talking about, you know, is there internal or external things they can do to get ready for these roles when they land?
Maggie Peloso 25:47
There are so I have four that I think are are particularly important. The first is will talk give me all four, go for it. Alright, so the first one is, we've talked a bit about data already, right is organizing your data, you got to know what you have. Right? One of the really interesting trends that we have seen of late is, companies responding to ESG pressures they're facing from external stakeholders by setting big goals. And sometimes those goals are really well thought out. And sometimes it's like, Hey, we have a shareholder proposal and they say, we have to adopt net zero. And if we don't, it's going to go in our proxy statement, we're going to get voted against and that seems terrible reputational, so we're just going to say the words net zero. And I think, knowing that there is a push by investors towards more in the bucket of what we call metrics and targets, right, so measuring your progress and making real quantifiable targets on where you're going to get to, you've got to know where you're starting, right? So you have to know what data you have, you have to know what the quality of that data is. And you need to do that, in part to define the art of the possible for your company. Number two, is evaluating internal controls. Right? So understanding how your company is verifying information, how they're ensuring data robustness, are you having third party verification or auditing, and that I think is going to be particularly important because one of the really interesting things that we'll see as the SEC gets more involved in this space is that an awful lot of sustainability reporting and to some extent, climate reporting, has traditionally in companies lived more in a corporate social responsibility or a public relations kind of function. So it's come from a place where the messaging is more important than the data in some cases. And what we've seen as investors demand more sophistication in this area, is that the data really needs to lead. So coming back again to you need to know what's going on with your data.
Sean McMahon 27:46
So you're talking about kind of the greenwashing stuff, people are concerned about saying one thing, but not really delivering? Okay?
Maggie Peloso 27:51
Yes. And then third, I think, is speaking to your auditor, or your accounting department, I do not expect that we're going to be in a place where we're going to see regulations right out of the gate that require explicit accounting for climate change. But given the way that ESG risks are rising in prominence, it is more likely that some subset of them will be seen as material to financial reporting, at least for certain industries. And I think it's important to understand if you're equipped to deal with this, or what work you need to do to get there. And I'll give you a very concrete example of this many companies that are doing climate reporting right now, to the extent they look at their physical climate risks at all. They're trying to use climate modeling to think about, what are the physical risks of my operation going to be 20 or 30 or 40 years in the future? We generally don't treat that as material for two reasons. The first is that's a really long time away. And the second is, the uncertainty bounds on what we see are pretty high. However, if you have long lived physical assets, if you have a power plant, a port, you know, an airport, you might well be operating that facility 2030 4050 years from now, you might need to retire it and if you're going to need to retire it and you already have in your regulatory accounting, accounting for what it's going to cost you to retire that facility. You're making an assumption about the climate future, whether you're making climate assumptions or not, right, by just assuming that it will cost what it costs now, to retire that facility. The assumption you're making is that the climate 30 years from now, or 40 years from now, whenever you need to retire, retire, that facility is the same as today. And I think one of the really tricky questions as companies start to grapple with this is that I can't really tell you exactly what the climate future is going to be in 30 years pinpointed at your facility. But what I think you can say was a good degree of comfort is for most places, assuming it's going to be exactly like it is today is probably the wrong assumption.
Sean McMahon 30:01
What do you mean? Like the sunny day when I see outside my window, right has that going to be exactly like this 30 years from now,
Maggie Peloso 30:07
it might not be right, you might have much hotter days in the summer that impact the efficiency of how your plant runs, you might have more sunny day flooding that makes it such that you can't get workers to and from where they need to go. You might have more intense rain events, right there, there's a whole range of things, you might get more wildfire risk days, and your power gets shut off if you live somewhere like California. And those are all things that companies need to be grappling with. And then I think the last factor I would highlight in terms of preparation is find your team, right. We've talked a lot today about both internal stakeholders who are important to getting these processes off the ground, and some of the external folks who might come into play, you know, counsel, consultants, auditors, others. And I think that companies need to be thinking more broadly about what are the tools and resources I'm going to need to confront these problems? And do I have them?
Sean McMahon 30:59
Alright, now circling back to the massive wave of investments that's flowed into ESG products. We're talking billions and billions of dollars. The conventional wisdom is that companies that have strong ratings when it comes to ESG metrics, generally outperform others that don't. But I've seen new research that's come out lately, that suggests that might not necessarily be the case. What's your take on that? Do strong ESG metrics, make a company a better investment? Or is the conventional wisdom perhaps been wrong this whole time?
Maggie Peloso 31:32
I think that it's really hard to have the level of data, you would need to truly answer that question empirically. I think right now, what you see may be more a question of correlation than causation in many ways, right? That it doesn't seem like a stretch to think that a company that is managed well enough that they have created the time and the space to think about ESG and create a good ESG program is probably also really good at thinking about other kinds of risks and how they're going to manage them and building the sort of internal processes, they need to be agile and respond to the world as it changes. I think it probably also depends a lot on how ESG is being defined in any given study, right? If you look at how ESG funds are put together, right, you'll see some who are sort of saying, we're going to invest in best in class ESG performance, you'll see a bucket of funds that are exclusionary, right. So what we mean by being an ESG fund is we're not going to buy oil and gas or other things that we think are heavy emitters, you know, some funds that might you might call ESG, funds are probably better called renewables funds, right. And so each of those is going to perform in slightly different ways that have some correlation to the basket of things in which they're invested. Of course, that may or may not be because of the ESG factors explicitly, right. So for example, last year, at the beginning of the pandemic, when we also had the collapse of OPEC, plus, there was a whole lot of stuff coming out about how in the short term ESG funds were really outperforming their non ESG peers. And when you looked into what was going on there, at least some of it was that a lot of the ESG funds, were excluding oil and gas companies, and so they weren't hit by the price downturn at that time. I think fundamentally, it's just going to be really hard. And it's probably too early to tell for two reasons. And the first is, we're not consistent enough on measuring actual ESG practices, right, right. Now, the SEC issued a risk alert a couple of weeks ago that basically said, Hey, investment advisors, you need to walk the talk, if you're going to make claims about having an ESG fund, you need to be able to back up sort of what you're doing that makes it an ESG fund and where the money is going. That is still many, many steps away from can we measure the actual ESG performance of corporates and know whether that's making a difference in how they perform. The other reason I think it's going to be really hard to get to the bottom of this is that, in my mind, one of the really powerful things that good ESG practices can do for a company is to be a tool for imagination, right to help you think about like, what's the worst bad thing that could happen to us? And how would we survive it as a company? How do we think about improving our corporate resilience? And one of the things that we know is that we as people are really terrible at valuing the avoided bad outcome.
Sean McMahon 34:26
Yeah, like the crisis averted? You never get credit for that. Something like that? Yeah. Okay, so what kind of creative thinking, who's doing it best, you know, any firms that are kind of on the bleeding edge of that in terms of the guy outside the box and anticipating the worst case scenario?
Maggie Peloso 34:40
So we had only one client who had considered a pandemic scenario before the pandemic last year.
Sean McMahon 34:47
And I'm guessing that numbers gone up now.
Maggie Peloso 34:50
I would think it probably has, right but I think one of the things that we have seen when we think about some of the more conventional tools of scenario analysis, right is there's been a lot of push by investors to get companies to convert Because they want uniformity, right. And so I think a lot of companies are having a really hard time thinking about how to make the trade off between the delivering the uniformity that investors would like to have, because they want to be able to compare my scenario analysis to my pure company's scenario analyses with how do you think about being creative and thinking outside the box and doing some additional things? One thing we saw last year that I thought was really interesting was Citibank in their climate report last year, they actually tested essentially a price shock scenario for their oil and gas assets. Right? So they said, Look, you know, we've looked at how people think about these orderly transitions based on the International Energy Agency models of how demand for things like oil and gas is going to shift over time. But the other thing we want to really understand is, if there's a sudden imposition of like a very high carbon tax, or use that as a proxy to say there's a sudden drop in demand, because of change in policy, how's that going to impact our clients we're lending money to, and what's the impact going to be for us? So you know, I think it's more than sort of that diversifying the range of things that you're looking at, so that you can start to think about how to see around those corners.
Sean McMahon 36:08
So one of the things I wanted to kind of ask you about, I saw this recently that there's some concern, when it comes to the structuring of green bonds, companies will kind of position themselves to structure the bonds in that way. And then there's not a severe enough penalty, we'll say, if they just missed their goals, right? So they're looking at the marketplace or saying, Oh, my gosh, everyone wants ESG investments, let's just position ourselves to that. And then our bonds will fly off the shelf, everyone will come invest in us. And then later on, we pay a small fee to kind of miss our sustainability or environmental or governments goals. The only concern about that?
Maggie Peloso 36:41
I do, I don't think it's coming from a place of malfeasance. Right, I think it is coming from a place of this is a young market, and we're still trying to figure it out. I think that we have a lot to see and how it develops to see whether the KPIs are right. And the incentives are sufficient, right, a lot of sustainability links to instruments, your rate will go down, if you meet certain kinds of sustainability goals. And those and those are more or less rigorous, depending on the particular instrument. I think that there are many that are evolving in sophistication, right? And we're trying to get much more quantitatively rigorous about what are what are the KPIs you can achieve that we can really build in here, so that we can show that we're delivering performance? You know, the one thing that I think gives me some real comfort is that, I think when you look at sustainability, linked instruments, there are multiple people with skin in the game. They're right, the banks that are underwriting those, and the corporates, they are doing this because they have made sustainability commitments to the world, right. There are many trillions of dollars that are committed to green finance, sustainable finance, climate transition, financed by the major banks. And so for them, the risk of not doing this right, is the reputational risk that comes from not meeting that commitment. And so I think you have a lot of actors who have a lot of institutional investment in what they're doing and in making it go, right, because the reputational consequences of it not going right, could be severe. So I do think the market is still finding its footing, and we'll see it evolve. But I'm a little bit less worried about genuine greenwash in the sense of like, Oh, I'm just gonna mark this one is the sustainability note. And I might or might not do it. And if I don't think that'll be okay, I don't think we're seeing as much of that I think that what you really see in those sort of green financing markets is that companies are incredibly concerned about getting it wrong and are very concerned about being accused of greenwash because of the reputational risk associated with it. And that folks are trying really hard and making earnest efforts to do this in a serious way.
Sean McMahon 38:43
And one of the things coming from the world of finance, and when it comes to just standardization, I have caught your eye. I mean, I know you kind of took the first steps towards a taxonomy, you know, the strictly just define what is a green investment? and what isn't, how much you think things like that help? And where do you think they can be improved? Or do you think they're on the right track?
Maggie Peloso 39:00
So the taxonomy approach is a really interesting one. And at a high level, I really see its intellectual appeal. I think one of the things that the EU taxonomy approach has shown us is that it's really hard, right? That they're they've really bogged down right now over debates about whether things like nuclear and natural gas can qualify as green and there's all this talk about like, what should really go brown taxonomy or a transition taxonomy? Right. And I think there's a little bit of a risk of losing the objective and kind of over categorizing things. I think that some of the other efforts that are going on that are that are really interesting in terms of thinking about standardization. Really go back to this question of how do you quantify things? Right so I'm watching very carefully the the P Caf the Partnership for carbon accounting financials, which is the body did many of the banks are part of this looking at thinking about, well, how do we make a consistent method for quantifying our financed emissions, right, because we've now made these commitments to net zero and we got to figure out how to move there. There's also a group called pacta it's the body that's helping governments and they have a pilot for banks in modeling, whether their economies are aligned with Paris, essentially, with the Paris Climate transition. And they do some really interesting stuff in thinking about weather, trying to drill down on the data to look at whether individual companies and sort of the the technology pathways, they are on our glide path that can be Paris consistent. And so I do think as some of those methodologies become better established or more widely used, they will get a lot more rigorous. And that that may be a way of getting out this.
Sean McMahon 40:34
So I want to take a step back right now, and talk about the way some of these disclosure rules might actually factor into some of the conversations we're hearing about various countries and their greenhouse gas emissions reductions targets. My concern is a lot of those targets are years and decades into the future, you know, 2030, and 2050. But there's no widely embraced a yardstick that measures how much progress a country is making towards its goals. You know, we have quarterly reports about GDP to to measure economic growth. But we don't have a quarterly report about environmental goals. So do you envision a future where the E portion of ESG the environmental portion might be so widely embraced and adopted by companies large and small, that we'll have a quarterly update on how much progress an individual country might be making towards its emissions reductions goals?
Maggie Peloso 41:27
You know, it's a really interesting idea, because that is probably what we actually need to understand if we're making meaningful progress toward Paris. I think I would break it down and sort of say, Okay, well, what are what are the baby steps you need to get there? And I think is I've been thinking a lot about all this stuff the SEC is thinking about doing and what what information is out there, and what information is knowable, and what information is really meaningful. I think that one of the biggest things to be thinking about is the gap between pledges and action. And I mean that very broadly, both right pledges that countries have made in their NDCs, under Paris, their nationally determined contributions. And also, you know, the net zero pledges that corporations are making. And I think that really, the the thing we want to see is we want to see that companies and countries are making investments, that will put us on the glide path we need to be on. And as I think about the SEC process in particular, one of the things that I've really spent a lot of time thinking through is whether the fundamental disclosures that we really want from corporates are, what's your climate target? And what what have you spent on it? And what are you going to spend on it over the next 257 quarters to get there, right, that the goal in 2050 isn't really all that meaningful, if you're not making the investments today to get towards that goal. And I think you could see if if you got to a reporting standard that looks like that, that maybe then you do have some ability to aggregate that up and sort of saying, look, here's here's what corporates are saying here is where they actually spent their money. Here is what that means in terms of where we are in the transition. But I think we're a long way from that right now.
Sean McMahon 43:11
I know that question is pretty pie in the sky. So I appreciate you trying to look into crystal ball, see if we'll get there. I hope we do. It just seems like that's something people need to, to kind of just know where we are. And it kind of just keeps things front of mind. Instead of an annual summit where decades long promises are made. It's a quarterly reminder, like you said of any progress. Okay, so now it's time to have a little bit of fun. But before we get into our world famous quiz about renewable energy project names, I just want to quiz you a little bit more about your time as a Cameron crazy, things look really wild down there at Duke. So what was the most memorable game you ever saw in person?
Maggie Peloso 43:44
Oh, man. So my first year was the year after Duke won the national championship. So it was the 2001 2002 season. So Jason Williams was still there, starting for Duke and Duke was number one and Maryland was ranked number three and it was the game that we'd like you know, tented all season for and Duke ended up winning, there was a big bonfire and that that was definitely my most memorable in person game.
Sean McMahon 44:08
Alright, I'm gonna put you on the spot now. So if you had to pick a starting five are your favorite Duke players? Give it to me.
Maggie Peloso 44:16
Okay, so I will caveat this by saying I chose players and when she's players who I remember watching play, I will tell you I'm a third generation Blue Devil. So these are not all people who were at Duke were not. So I would say Kyrie, Jay Williams, Grant Hill, Christian Laettner and Zion.
Sean McMahon 44:33
OK. No Bobby Hurley in there. No Shane Battier? All right, great. Well, it sounds like it's a good time. You know, you see it on TV every year. And yeah, it seems like a crazy place and a fun experience.
So one of the things we like to do on the show for a little bit of fun is is a little a bit we do. It's a quiz, actually. And it's called “Renewable energy project or NOT a renewable energy project.” And this is our light hearted way of making fun of all the magic have names I should say that renewable energy developers give their projects. So the way it works is producer Tom is gonna come on the line here and he's gonna rattle off the name of four projects. Three of these are real names. One of them is fake. And you and I get to try and guess which one is the fake name? I have no idea what he's got coming. So Tom, bring it on.
Producer Tom 45:28
Well, hello, everyone. The first potential renewable energies project is the Magic Valley Wind Farm. The second is the Fountain Valley Hydro. The third is Mountain Storm Wind Farm. And the fourth, Crescent Dunes Solar. One more time, number one Magic Valley Wind Farm. Number two, Fountain Valley Hydro. Number three, Mountain Storm Wind Farm. And number four, Crescent Dunes Solar. So Maggie, as our guest, you have the privilege of going first.
Maggie Peloso 46:08
These are all very convincing. Um, I will guess Mountain Storm Wind.
Producer Tom 46:14
Mountain Storm Wind Farm. All right. And Sean?
Sean McMahon 46:20
I was gonna take that one Maggie, but I'm not gonna. I guess I got to go with a different one. What was the first one?
Producer Tom 46:26
Magic Valley Wind Farm.
Sean McMahon 46:29
Magic Valley. That's it sounds made up. I'm going with Magic Valley.
Producer Tom 46:35
So we'll go with one of the ones you didn't pick. Crescent Dunes Solar is in fact a project in Nevada. Sean, unfortunately, Magic Valley Wind Farm is in Texas.
Sean McMahon 46:49
Wait a second. Wait, wait, wait. Texas is so flat. How could they have a valley out there? It's magically created. It's their imagination.
Producer Tom 46:57
Exactly. Magic Valley.
Sean McMahon 47:01
All right. Well, did Maggie get it right?
Producer Tom 47:02
So we're down to Fountain Valley Hydro. And Maggie's choice of Mountain Storm Wind Farm. And I'm sorry to say Maggie, Mountain Storm Wind Farm is in West Virginia. Fountain Valley Hydro is the imposter today.
Sean McMahon 47:19
Gosh, one of the days I'm going to get that. Right. Maggie, thanks for playing. Before we get out of here, I do want to hear more about your book. I know you wrote about kind of the threat that climate change poses to coastal areas. So give our listeners a little taste of what they'll find if they pick up that book. And I don't want you to feel any pressure. But you know, there is such a thing as the renewable energy smart pot bump. So if you do a good job of hyping your book, it'll certainly just skyrocket up the list of The New York Times bestsellers. And if it does, of course, you know, you got to kick me back a little cash. But anyway, yeah, so tell us what it's all about.
Maggie Peloso 47:50
So, my book is about the legal challenges and opportunities that are associated with adapting to sea level rise. And really what I was trying to do in the book, is to break down some of the very esoteric and complicated rules around property law and constitutional law, that make it really hard for us here in the US to say, hey, guess what people, this area is going to go underwater, and you just shouldn't live here anymore. And to think a little bit about what that means for the kinds of cultural conversations that we need to be having to think about how we're going to respond to sea level rise. And that's particularly complicated in the US, because all those rules tend to vary state by state. And at the end of the day, politically, the thing that's most expedient to do is to protect as much as you can. But practically, that probably doesn't make a lot of sense. And so I was really trying to start some of the conversation around, what are the real legal rules? What are the imagined legal limitations? And what are the things that we need to do to build adaptive capacity as communities to think about what we're going to protect where we're going to retreat? And how we're going to do that in a way that makes sense?
Sean McMahon 48:54
Well, that sounds like a fascinating book, Maggie. For anyone who's interested picking up a copy, we're gonna put a link to that in the show notes. So Maggie, anything else you want to cover today or anything we kind of missed on ESG? And what's coming down the road for this sector?
Maggie Peloso 49:07
I think the only other message I would leave you with is that things are gonna change very dramatically and continue to change in this space for quite a long time. So it's an area I expect will keep us on our toes.
Sean McMahon 49:18
Okay, great. Well, I really appreciate your time today. Thank you for joining us. We'll keep an eye on all the stuff you're cranking out at Vinson and Elkins keep an eye on that blog, everybody. They have some awesome content and awesome information coming out of there. So, Maggie, thank you very much. Thanks for having me. Now it's time for a relatively new segment of the show we call the pod brief. The idea is that at the end of every episode, I'll circle back and highlight the key takeaways from the earlier conversation. Or maybe just riff on some of the headlines I see coming out of the renewables industry. Today, I want to do a little bit of both. Earlier you heard me and Maggie talking about various countries and their greenhouse gas emissions reduction targets. The reason I asked her if there would ever come a time when some of that ESG disclosure data, specifically, the ie the environmental, might one day be shaped into some kind of quarterly environmental data point is because I feel like that's a key thing that's been missing from all these conversations about emissions reduction targets. For example, the Biden administration has set a goal of reducing us greenhouse gas emissions by 50 to 52%, by 2030. And now that's based off of 2005 levels. But what I want to know, and what's been far, far under reported so far, is how much progress we've made up to now. You see, this is a marathon and not a sprint. It's a marathon, we've been running for 16 years, surely, we've made some progress. So I get it, the data around this can be kind of murky. And certainly the pandemic makes you want to take any data point from 2020 with a grain of salt, because it's just such an anomaly. But if we go back to 2019, the US EPA reported that the US had reduced its greenhouse gas emissions by 13%, relative to 2005, numbers 13%. That's a number we got to start talking about a little bit more. I get it, it's not totally impressive. But if you're just gunning for 50%, and you do the math, then you know, carry the one. That means you're 26% of the way to your goal. That's not nothing. And let's be honest, if we're going to get there, all the people talking about achieving that goal need to understand that we're gonna have to convert a lot of naysayers. Bring a lot of people on board. And it might be easier to bring them on board, if we let them know that we're not starting from zero. Right?
So maybe some of the folks out there crafting all these communication messages should start spending a little less time talking about how hard it's going to be and how far we have to go. And a little more time talking about the progress we've made so far.
Well, that's our show for today. Once again, I'd like to thank our exclusive sponsor, EDF Renewables. If you liked this podcast, please share it with your friends and colleagues. And be sure to follow us on Apple, Google, Spotify, or wherever you get your podcasts. You can also follow us on Twitter, or our handle is at renewables pod. And if you'd like a daily dose of renewable news delivered to your inbox, head to smartbrief.com and sign up for the renewable energy smartbrief. The Renewable Energy SmartPod is a production of SmartBrief - A Future company