Charting the Future for Capital Markets - A survey of current progress and practices
KKS Advisors & High Meadows Institute / January 2016
Sakis Kotsantonis, George Serafeim, Chris Pinney
The High Meadows Institute and KKS Advisors have performed an extensive landscape analysis that provides a first of its kind overview of integration of nonfinancial data by major players of the capital markets value chain. Over the past ten years, major progress has been made in moving to a new investment paradigm where nonfinancial data are used to improve the capital allocation efficiency and therefore the functioning of global markets, with the goal being the private sector producing more sustainable and inclusive economic outcomes.
The report identifies a number of opportunities for further progress. First, although many worthwhile frameworks have been produced to date, we still lack convergence and standardization in measuring intangible assets and clarity in defining the ‘path to value’, i.e. how better management of intangible assets affects key financial parameters, namely return on capital, growth and cost of capital. Second, while certain asset owners have been the protagonists in ESG integration and incentivizing the rest of the capital market players, the analysis suggests that most of the largest asset owners do not have the governance and incentive systems that promote ESG integration. Relatedly, while most of the largest asset managers are now using nonfinancial data in their investment process, for many of them this involves screening techniques rather than ‘true’ ESG integration where nonfinancial data are formally embedded and accounted in valuation models. A critical element for true ESG integration is analysts and portfolio managers training in analyzing nonfinancial data. Third, the analysis identifies credit rating agencies as the institutions that lag in adopting ESG integration into business analysis models. This is somewhat counterintuitive since credit rating agencies are in the business of assessing downside risk and ESG factors have been thought of as providing an indication of business risks. We note that this is likely to change as investors are now asking credit rating agencies to adopt ESG integration as is evidenced by the shareholder resolution filed by Calvert Investments in the case of Moody’s. Finally, a significant number of stock exchanges have promoted sustainable investing by offering sustainability-related indices and providing training opportunities to companies and/or investors. However, still many of them have not adopted ESG disclosure requirements for listed companies. Industry self-regulation, where all stock exchanges agree to adopt a common set of disclosure regulations, might be a promising way forward. Given that a path to value will clearly illustrate how nonfinancial data can be used in business analysis and valuation, stock exchanges might find it useful when designing their future disclosure requirements.