Distinguishing Between Impact & Risk in Sustainable Finance

Michael Torrance:

Welcome to Sustainability Leaders. I'm Michael Torrance, Chief Sustainability Officer with BMO Financial Group. On this show, we will talk with leading sustainability practitioners from the corporate, investor, academic, and NGO communities, to explore how this rapidly evolving field of sustainability is impacting global investment business practices and our world.

Speaker 2:

The views expressed here are those of the participants and not those of Bank of Montreal, its affiliates, or subsidiaries.

Michael Torrance:

At BMO's most recent Global Reserve and Asset Managers Conference, my co-host Jonathan Hackett, moderated a panel on risk versus impact within the sustainable finance umbrella. Jonathan was joined by Katherin Forest, Vice President for Capital Ground and Dan Novak, Senior Portfolio Manager and ESG Initiatives for Bank of Canada. Let's listen to what these experts had to say.

Jonathan Hackett:

Really, our goal is to talk about the distinction between impact and risk. As we think about ESG, the different goals that people have when it comes to ESG integration and sustainable finance products, to really understand from the perspective of both investors and an issuer involved in the Bank of Canada's program and the recent federal Green Bond, the trade-off that we see. So I'll start by asking Katherin and then Dan, to just give an introduction of yourself and then particularly, how your role incorporates ESG and sustainable finance. Katherin?

Kathrin Forrest:

Great. Thank you, Jonathan. Thank you for having me here. It's great to see you all in person. What a fantastic event and what an inspiring session we just listened to. So we'll try to step up and move to par with that, but just don't hold us to it.

Kathrin Forrest:

In my role, I act as a bridge at Capital Group between our equity investment team, which is about 250 investment professionals located across the globe and our Canadian clients. So my perspective to ESG, and it is ESG integration, is with regard to corporates, although as a firm, we also look at ESG integration with regard to sovereigns.

Kathrin Forrest:

If I take a step back and think about ESG integration for equity investment process, I think what's important there to note is how do we think about investing? Because it is integration. It's not an add-on piece. It's not something separate.

Kathrin Forrest:

So as equity investors, we think about companies, fundamentally, bottom up with a long term investment time horizon. That's the starting point. That's all you need to know. How does ESG integration fit into that? Well, if we have a long term investment time horizon, we need to understand how the environment around us and the companies that we invest in are changing. And ESG issues, technological advancement, customer preference changes, climate change, all those issues have, in our view, material impact on the companies that we invest in, with a long term investment time horizon. So we look at ESG integration as part of our fiduciary duty.

Jonathan Hackett:

Okay.

Dan Novak:

Yeah. So my main job is as a Portfolio Manager for the Foreign Reserves. And I guess my introduction to ESG was probably about 2016. It came in a very narrow file, where the suggestion from the manager was that when we have some of these labeled bonds on the books and just kind of have a look at it. Do they trade a little different? What's the liquidity like? What's the performance like? And quite a narrow focus to begin with, just the assessment of a few different parts of the portfolio.

Dan Novak:

And then the market, but then the file, and then the focus, just has grown and grown and grown, to the point where the Bank of Canada is part of the NGFS. We're part of the G20 Sustainable Finance Working Group.

Dan Novak:

These issues come up at the G7. And really, bank-wide, the bank has a climate change initiative, and it touches all areas, the bank, the markets department, which we look at, but also the research department. In conjunction with OSFI, we've done a pilot project to assess transition risks in Canadian financial institutions, all down to questions of corporate travel and premises and things like this.

Dan Novak:

So it really touches all areas of banking. It's kind of grown and grown and grown. And now we have a lot of people at the bank looking at this, in all their various departments. So that's kind of how I got into it and kind of the way I look at it now.

Jonathan Hackett:

Okay. And Kathrin, maybe just talk about ESG integration. I feel like that ranges in people's perspectives from, "Hey, I get a score from MSCI and if it's bad, I just don't invest," all the way through to, "I tear apart things and I'm using satellite data around methane emissions, around facilities, versus disclosures in order to get an edge." What's your approach to ESG integration and how does it really work in practice?

Kathrin Forrest:

Yeah. Thank you for that. And you're hitting a very important point. It's not uniform. I can define... If I were to define ESG integration, I would say it's the explicit inclusion and systematic inclusion of material, environmental, social, and governance considerations into the investment process and decision-making.

Kathrin Forrest:

What you said is absolutely right. There's no one way to implement ESG. I think the definition we can probably agree to it, but if we think about it in terms of into investment analysis and decision, I just poke on that, we all invest with different objectives, with different time horizons, with different processes, different ways to add alpha. If that is the starting point, then absolutely. The way we integrate ESG into our process is probably going to be different as well. So I think that's maybe a helpful starting point.

Kathrin Forrest:

One quick number, though. And I think it encompasses all those various approaches that you were touching on. Last time I checked, which I think is data from 2020, investment strategies that follow ESG integration amounted to something around 25 trillion US. So it's a big number. It's not uniform, so let's not get too excited about it, but I think there's tremendous potential there to harness into something useful.

Kathrin Forrest:

How do we integrate ESG? Just to actually get to your question, let me pull out two pieces again, from that definition.

Kathrin Forrest:

The first one is material ESG factors. What that means for us, is that we're not imposing a constraint. We're not putting on a secondary investment objective. This goes right to the core of the primary investment objective itself.

Kathrin Forrest:

The second part into investment analysis and decision, it needs to be owned by everybody. The entire investment team owns ESG integration. This is not an add-on, an after the fact consideration. Everybody owns it. It applies across the entire platform. And it goes right back to what I said before. It's not something where we think we're going to do something useful and good here. This is part of our fiduciary duty. It belongs to everybody, into everything.

Kathrin Forrest:

How do we do it? There are, within our process, three main pillars, all of them are led or lean heavily on our investment team. None of these pieces are add-ons by some sort of top down function. In a way, it's how we organize ourselves. There are different ways to organize it. It's part of how we invest. It's part of how we operate as a company.

Kathrin Forrest:

The first component to it is these ESG frameworks, and they apply at an industry level. Our investment team identified 32 different industries and then for each industry, they defined the E, S, and G considerations that tend to be most material, in those specific industries.

Kathrin Forrest:

And those frameworks, they don't live on a spreadsheet somewhere or filed away in a cabinet. They live directly in our investment research system and they're populated with real live data on an ongoing basis. So I think that's important.

Kathrin Forrest:

And the second piece to that is that the consideration here is not just to highlight risk to the investment team. This is meant to find the best companies within those industries.

Kathrin Forrest:

So it's two ways to look at it. And we certainly do look at it from both perspectives.

Kathrin Forrest:

There's a second part to the process where we pull in external data, really to get a reality check. So we have our way to think about the world, to think about companies. How does the industry think about these companies? And if there's material deviation, we do do the extra work and there's a formal governance process around it.

Kathrin Forrest:

And then the third pillar is proxy voting and engagement. I'm not going to go into details here, but I think what's important is that two pieces, I alluded to the first one, you need to enable the investment team to actually implement this. You can't just say, "Go off and do it." So if you give them systems data, tools, I think you're much more likely to be successful.

Kathrin Forrest:

The second consideration that I think is important for us is that we do think that ESG is dynamic. ESG considerations change. Technology changes. Resource constraints change. Human capital considerations change. Customer preferences change. As the environment changes, we need to make sure that we update our frameworks accordingly, and keep our process dynamic through time. So I hope that gets to your question and I'll pass it over to you.

Jonathan Hackett:

No, it doesn't. Dan [inaudible 00:10:41].

Dan Novak:

Kathrin, in many ways, I envy the level of engagement that you're able to have with some of these names and so on, when it gets to proxy, but it's going to make what I'm going to describe about reserves management to sound very, very boring, which by comparison, it is.

Dan Novak:

So we also have three pillars. I'm giving you the quick and dirty on how the foreign reserves works, of which capital preservation, liquidity, and return are the main pillars and return is the junior pillar out of that. And this is where I do meet with some... And we invest in sort of SSAs and very high rated sovereigns and the agencies and such, many of which have been here over the past few days.

Dan Novak:

So I do get met with some skepticism when we hear, "Well, okay. We've got..." I mean, it's one thing when we talk about like there are certain organizations, certain multilateral development banks that only issues sustainable, and we definitely like those names. And so when we add those, we will be adding sustainable paper. That's fine.

Dan Novak:

But then we're met with questions where we have an issuer where they issued both some kind of labeled thematic bond, but also a conventional bond, and trying to talk about, well, what's the advantage of buying a French green over a French conventional? And it's quite a good question, because in one sense, we talk about risk. We said, "Well, the French sovereign is the French sovereign." You're not getting any different risk profile by buying a French green than you would by getting a French conventional. I'm sorry. I'm not picking on France, specifically. I could be talking about any issuer.

Dan Novak:

So from a risk perspective, you're going, "Well, these are the same." And from an impact perspective, you're saying, "Well, the French state will do what it intends to do," unless the fungibility of money is such that there would have to be the majority of the funding to be in green in order to push policy in a particular direction. So in other words, the government is going to do what it wants to do.

Dan Novak:

So from an impact perspective, your effect can be seen as being limited as well. As it happens, as we manage the foreign reserves, we're much more concerned about... We don't worry that much about a basis point or so, where trade is relative to the rest of the curve in the greenium. We are often more concerned about the tender and where it comes and so on. So that's why we end up with a lot of labeled bonds on our portfolio. But it does raise that question.

Dan Novak:

So then we get to the Canada green. And I've been asked this question sometimes politely, sometimes a little more rudely, in saying what the purpose is of the Canada green. Did Canada need to issue a Green Bond in order to have the kinds of expenditures that we anticipate in there? With clean technology and clean power generation, electric vehicles, this sort of thing, that'll likely form the bulk of the expenditure. Did Canada need to issue a green here?

Dan Novak:

And the answer is, in an absolute sense, no. It would be entirely possible to issue a conventional bond and to fund these expenditures via conventional bond. Then why do it? The answer is not the slight greenium. The answer is we wanted to bring some attention to Canada's story and the fact that these are part of the government's plans to fund these kinds of expenditures. We also wanted to serve as a large Canadian benchmark size issue in the Canadian green market, which can then be compared to other issuers in Canada. So it has that effect.

Dan Novak:

It also has the auxiliary effect of focusing policy. And this is the only time I've ever actually done this. I've been in the public sector for a little over seven years, the first time I ever worked on a government project that actually started with something new and brought it to completion. Everything I've worked on before has been amendments or changes to existing programs.

Dan Novak:

And so it had the effect of focusing policy, because you had to talk with all sorts of the various government departments and get a stock take of what their green expenditures were going to be.

Dan Novak:

So absolute terms, was it necessary? Maybe not. But it did have all these benefits of issuing, in that way. And so that I can that, it's certainly true for us, I imagine it's very true for many other issuers. So there was a real positive impact to the issue and I believe that's going to continue.

Jonathan Hackett:

And can I probe on something, because Kathrin talked about how their frameworks` are dynamic. And obviously a Green Bond framework is a market-facing document. It isn't just something you can edit without anyone noticing, but do you think, similarly, that the Canadian definition of "green" is going to be dynamic in that regard?

Dan Novak:

Yeah. So the short answer is, yes. The framework that we've had, it will change over time. It's difficult to say, when you immediately release a framework, "This is going to change," because otherwise, why didn't you write it differently to begin with?

Dan Novak:

But I think there's an understanding that, over time, at the very least, that the technologies that we use to address this, if you want to call it a new technological revolution in green, the technologies themselves will develop. They will evolve. They will change.

Dan Novak:

But also on top of that, I think there's an idea of what's accepted by markets, and in that sense, what I really mean is accepted by broader society as being green.

Dan Novak:

And I just want to address this one, because it's come up and that's the role of nuclear in the transition. And nuclear was not part of the Green Bond framework, which many market participants took some note of. But we're very clear, and the government has been very clear about this, that we see nuclear as part of Canada's overall transition to net zero, even if it's not part of the Green Bond.

Dan Novak:

Why was it not part of the Green Bond? It wasn't so much because we had a view specifically about nuclear, as I said. That was part of the government's view. But because of the market standard, and there are investors out there that explicitly exclude nuclear from their frameworks, and if that's going to be part of your framework, well, then, they're going to exclude it from their investment list. And we didn't want that.

Dan Novak:

So that's one I'm not prognosticating of our view about that particular industry, but this is one area where the acceptance of the markets, the approach of markets, and the approach of society, I guess, in a broader sense, could change over time.

Dan Novak:

Now, are we going to be changing the framework every few months, updating it? Of course not. That would be confusing. But I think there's an idea that when standards and market best practices have shifted materially, that the Canadian Green Bond framework will reflect that.

Jonathan Hackett:

So I'm going to digress us, just for a minute, because for those that don't know me, nuclear is definitely a passion topic for me. Would you say that having precedence like the Bruce Power nuclear green bond makes inclusion in the future framework easier?

Dan Novak:

Yeah. I believe that the Bruce Power bond was a very important step. The fact that they could issue it with the green label, that it was accepted by the market, and the market participants felt that it was green and could be included. I thought that was a very important issue. And we were very happy to see that succeed.

Dan Novak:

Other important steps, I think, will be as other sovereigns, or potentially agencies, depending on the structure, begin to include it and then that begins to see some acceptance. We're seeing attitudes change a little bit in Europe with the taxonomy here. And so I think there's a couple of steps to the Bruce Power. One was very important and I think there will be a couple others.

Jonathan Hackett:

Fair. And Kathrin, going back to the equity side, we've talked a lot about the technologies that will be there in the future and the opportunity, I think, for people to be rewarded for solving problems, like the energy transition. How do thematic topics like that fit into your approach of ESG integration and things that will cut across different sectors, like the energy transition? How do you approach that?

Kathrin Forrest:

Short answer is fundamental, bottom up, long term time horizon. It's a great question though, because we think about it as a multidimensional problem. It's something that it's not just the energy industry, it's really a cross industry issue. It's a global issue, a multilateral issue. So we need to think about that and the environment around it, when we look at companies that we look to invest in.

Kathrin Forrest:

And again, I would want to highlight that it goes back to both the risk and the opportunity. There's a risk of stranded assets, obviously. There's a risk for new market opportunities and new areas of growth for companies. And just to touch on some of the obvious, but I want to caveat by saying upfront that this is a long term journey for all of us. We don't have all the answers. I think we're reasonably clear on where we want to go, but the path is not completely clear.

Kathrin Forrest:

Dan talked earlier about a bump in the road and there will be other bumps in the road. And I think we need to be open-minded and reflect that and grab those opportunities and understand the risk as they come along.

Kathrin Forrest:

So some of the more obvious ones that we see today, I mean, obviously within oil and gas, it's LNG and how that is increasingly seen as an opportunity to support the transition, in particular, over the past three months. It was always there, but I think just the urgency is completely different.

Kathrin Forrest:

So then how do we look at companies? It's the mix of their oil and gas assets, gas versus oil, the CapEx required. Scope 1 and 2 emissions. All of that we need to think about.

Kathrin Forrest:

So again, looking across all standard financial analysis, including E, S, and G considerations, and that includes workforce engagement and all of those other issues that we don't really touch on in this panel today, but I just want to highlight it's not one-dimensional.

Kathrin Forrest:

Within materials, we need to understand electrification. What that means for copper. What it means for potential substitute materials like aluminum. It's not maybe the obvious target, but if we need more copper for certain users, what does that mean for other metals as well?

Kathrin Forrest:

Within industrials, we talked about nuclear briefly, but just broad applications into HVAC, building, heating and cooling technology. Industrial gas producers and the opportunities that are opening up for those types of companies. And then, of course, the crossover into utilities and what that means for industrials and the upgrade of electricity grids.

Kathrin Forrest:

So there are tons of opportunities. These are the obvious ones, the ones we know today. But if we have this conversation in five years from now, I suspect we will see other opportunities, that we will talk about at that point in time.

Kathrin Forrest:

So key point, again, it's a multi-dimensional problem. We think about it in a multi-dimensional way, and we want to reflect how the environment is changing around it. And some of the more recent examples are we have tight labor markets. How do companies engage their workforces? We need to think about that, when we invest for the long term in these types of companies, because they do rely on skilled labor.

Kathrin Forrest:

How about water stress? We need to think about that. And then, of course, how about security and energy security, in particular. We need to think about that.

Kathrin Forrest:

So it's a broad, complex issue. We can't solve it all today. We need to build a framework that is flexible through time to make sure that we can reach the destination. I think the way Dan put it, there's a trade-off between speed and doing it the right way. I think that was his main point. And I think that's how we think about it as well.

Jonathan Hackett:

Can I probe on just one part, because you mentioned change your perspectives on LNG in the last three months and you touched on energy security. You have what I might describe as a distributed model, where this is... Everyone should think about this and should be incorporating ESG, but there are some topics like energy security that feel very fast moving, changing perspectives, changes in opportunities. How do you align against, rather than a thousand flowers blooming, a perspective on how some of these large trends that are rapidly evolving, are going to impact still ESG factors, within investment strategies?

Kathrin Forrest:

I mean, the first point is, just in terms of looking out on an investment process, collaboration. You're not going to solve that in one office with a three-person team, likely. So you need to bring in different perspectives. And we spend a lot of time on doing that, because none of us understands the world in its complexity on our own.

Kathrin Forrest:

And the other thing we do, and it doesn't answer your question directly, but I think it's an important feature as well. We don't drive for a consensus top down standard view. Our investors can invest wherever they feel they can find long term value. So in a world that is changing rapidly, with a lot of uncertainty around it, we're not going to say we're going to put all our chips on LNG. That's not how we operate as a firm, but you can see how that discourse and debate and discussion within the group is guiding individuals towards certain emerging segments of industries and LNG would be one of those.

Jonathan Hackett:

Perfect. So I'm going to flag for the audience, would love to have questions coming up. I'm going to ask each of you about your perspective on where ESG is going, but very much, please, whether it be in the app or if you just throw up your hand afterwards, we'd love to have your questions as well.

Jonathan Hackett:

Maybe Dan, starting with you, ESG ratings, green. I've recently been asked, are Green Bonds going to exist in 10 years? Or is everything going to be green? Where do you see these-

Dan Novak:

I'm going to make a projection here. It's a projection, it's not a promise, that in 10 years, we will no longer be talking about labeled bonds, green bonds, social bonds, or sustainability link. These will no longer be issued. The existing ones will still run and so on, but we're no longer going to be issuing that.

Dan Novak:

And before I get called out for being crazy about issuing bonds and then telling them they're not going to exist in 10 years, I think this is absolutely a necessary part of the development of this market, at this time. It's a necessary step before we move on. And I think that does serve a purpose, to have labeled bonds and sustainability linked at current.

Dan Novak:

But I think, eventually, what we're going to get to, 10 years, it's a round number, is a kind of integrated ESG, at the level of the issuer, at the level of the entity. And I know Kathrin's looking at me, going, "Look, on the equity side, we're already there." Or we're getting there, right? That's what we do every day. But definitely on the fixed income side, at the issuer level, certainly when it comes to sovereigns and so on, we're definitely not.

Dan Novak:

You take a chart of where different credit rating agencies have the credit on a particular name and just plot those over each other. And the correlation is very, very high. The difference between rating agencies, when it comes to a particular name, one notch, maybe two, and then they have slightly different methodologies, but it's not going to be, overall, that different because you're asking really a very simple question. Am I going to get my money back.

Dan Novak:

Plot the correlation or... Sorry. Yeah, just a map of where the ESG ratings are from some of the major ratings agencies, MSCI and Sustainalytics and so on, to the issuers. And they really are all over the place. The correlation on there is like very close to zero, because they're asking, not just because they have different methodologies, but they're also asking different questions.

Dan Novak:

So when I say this is going to be in 10 years, I really have to stress the Herculean nature of this task, to be able to do this in a way that's kind of accepted. The way I see it, we can go one of two ways.

Dan Novak:

One would be the credit rating agency approach, where the market converges around some methodologies and some standards that the market, overall, is very comfortable with. And then the major ESG ratings agencies will converge around those methodologies with maybe some slight differences, not unlike credit rating agencies do today.

Dan Novak:

The other possibility, and Kathrin, I think you're going to help me out here because I'm not really an equity person, but is the way we often do equity analysis in the sense of we present a bunch of data and a bunch of facts about various kinds of equities, but there's no standard methodology for determining where should an equity be in there? What's a buy? What's a sell? We present a bunch of data, hopefully comparable and interoperable, so that the equity analyst can use this usefully.

Dan Novak:

And then it's up to the analyst to say, "Well, this is what we think matters," or "These are the ESG indicators that suit our investment strategy and our objectives," and so on, in which case, it will be a question of presenting a lot of the ESG data and the indicators in a way that can be understood legibly by the market, but allowing the individual players to decide for themselves what they feel is important and relevant for their objectives.

Dan Novak:

So, again, this is much medium to longer term, but I do think that it's starting with the equity side, more than the fixed income side. I don't know if you agree with me on that, but what do you think?

Kathrin Forrest:

I love how you put this, and it strikes me as incredibly circular, because the way I see it, the way ESG ratings started, anyway... They tend to, at least in my mind, I'm not a credit person, so I might be speaking out of turn here, but they resemble how we think about credit risk. I think we start with all the risk factors and then we figure out how those risks might be mitigated. And then we are left with some residual risk, which then drives the ESG score.

Kathrin Forrest:

It doesn't strike me as awfully different from maybe how we think about credit risk. And to me, that is actually one of the key areas that is an opportunity for the industry to do much better. And this might be speaking more for myself, as a professional in the industry, as opposed to some corporation that might be associated with my name here. I'd need to clear that with my colleagues.

Kathrin Forrest:

But if I think about where the industry is going, why are we highlighting so much the things that are wrong with the companies that we're investing in? If we flip the reporting around and turn it to, "Here are the things that have been impacted. Here's the progress that's been made. And here are how these companies, in terms of their business line revenue, for example, support you and social, sustainable development goals," or something along those lines. Some common standard that actually helps us understand how various products, investment opportunities, projects, whatever we're looking at, how do these align with the goals that we're trying to achieve?

Kathrin Forrest:

So really just changing the conversation, I think that would be a really interesting way to think about ESG integration and sustainable investing. And I can leave it at that and just open it up for maybe some comments from you, Jonathan, or questions.

Jonathan Hackett:

I'll start by saying, Dan, I don't know if I should be worried that your belief is that most of my team will be out of a job in 10 years. But I actually-

Dan Novak:

The job changes a little bit.

Jonathan Hackett:

... Fair. But Kathrin, something you just touched on that I find really interesting, because absolutely, when I'm explaining an ESG rating to a corporate, my answer is this is somebody's attempt to calibrate a PD rating, without ever having done an actual regression. This is somebody creating a score that when I built large corp default models, would've been something that somebody tried to calibrate, but it would never actually have been a way we would think about an equity investment. You're not looking at a binary outcome on this and saying, "Okay, Coca Cola good," because it's not how you're doing ESG integration for them.

Jonathan Hackett:

And so maybe Dan, I'm going to put you on the spot and ask the World Bank creates ESG ratings for sovereigns. If we think about what an ESG rating is, and this idea of a PD, are you ever looking as an investor and saying, "I should incorporate this information." There is risk not currently captured in credit ratings, that is ESG risk. And obviously, you're still focused on, a lot of these are not still likely to default, you're talking about things at the margin, but are you thinking about that information when you make decisions?

Dan Novak:

Yeah. I mean, at the sovereign level, the risk... Questions of sovereign risk as relates to climate... It does-

Jonathan Hackett:

Well, I'll say governance is a risk and you could say-

Dan Novak:

Yeah, governance-

Jonathan Hackett:

... Is a president for life structure a good governance structure?

Dan Novak:

My view on that is governance... Governance was always a risk. That should have been incorporated. If it wasn't incorporated into sovereign risk before we started talking about ESG, then the risk department hasn't been doing the job correctly. So I absolutely think that that's part of it.

Dan Novak:

Now, as pertains to the E and the S side, especially the climate E. There is a question there about which countries are most exposed to climate change. And then which countries are doing the most to mitigate. And there's an adaptation. One of the paradoxes of the risk to climate change is that you look at a map of who is most vulnerable and there's a little bit to do with geography. It may be 10%, but 90% of it correlates with wealth.

Dan Novak:

And so you end up in a weird situation where, in mitigating sovereign climate risk, you are rewarding countries who are already rich, for being rich, which doesn't seem right.

Dan Novak:

But then if you go the other way and you say, "Well, okay. Now I want to reward countries that are taking actions to mitigate climate," okay, then you feel like you're rewarding the right thing, but you also run the risk of a little bit of, if you're purely worried about fiduciary duty, you run the risk of a little bit of job confusion at that point and going like, well, are you diverging from your mandate of fiduciary duty, to a mandate of impact investing?

Dan Novak:

And if your client has mandated you with impact, that's different, because it's the client's money and they want you to generate income. Sorry, impact. But if it's purely a question of fiduciary, then you may run a little bit, aside from that.

Dan Novak:

Now, if those two, if policy, either regional or global policy, were to converge on that by some sort of a... I'm not advocating for or against this, but it's been thrown about, but border-adjusted climate taxes and charges, I should say. But the questions, the coordination that rewards the mitigation level, then the risk converges there.

Dan Novak:

So that would be true, but right now, there is kind of a split between there. So that's where we are.

Jonathan Hackett:

I will follow up with one. You've talked a bit about the geographic differences, and that that's where there could be stark implications. Have you bought any long duration bonds from countries with high flood risk recently? And was that actually a part of the discussion?

Dan Novak:

Yeah. So one of the things about the foreign reserves is that we do have a tender limit of 10 and a half years. And so, much of the really catastrophic effects of climate change are towards the back end of that, where you do really start worrying about rising sea levels and the damage that would cause. I mean, if I said... Just a quick rule of thumb there, is to say, overall, if you want to mitigate against that risk, you prefer countries with a high ratio of area to coastline, I would say is probably what you like, which is a funny way of saying you don't want islands, unfortunately. Sorry.

Dan Novak:

But in the next 10 years, we probably won't see a lot of that. And next 10 years, most of the models I've seen, I think I've seen this one from the BMO Climate Institute as well, more of the risk comes from the exacerbation of catastrophic weather events. So I'm thinking like not so much rising sea levels, but floods. Or wildfires, or things of this variety, which are a little more dispersed and difficult to nail down where, exactly, they're going to happen.

Jonathan Hackett:

Okay. And Kathrin, maybe to similarly put you on the spot, Dan mentioned this idea of like maybe you're just rewarding wealthy countries.

Jonathan Hackett:

One of the arguments that I've seen against ESG integration is, "Oh, this is just a proxy for good management." You're rewarding large, well-functioning companies, that are disclosing the right information and penalizing companies that may just not be able to respond to these same data requests. Do you see a contradiction in the way we are getting our ESG data right now?

Kathrin Forrest:

I think it might be a fair point, if you invest based on ratings. And I don't want to completely discount ratings. They do have a place. There's good information in there, but you probably need to think beyond them.

Kathrin Forrest:

If you integrate ESG considerations in your investment process on a forward-looking basis, and you really think about the opportunity at the underlying company level, I think the argument goes away a little bit. And I can think of a couple of examples within the mining industry, in particular, where we are investors and the public ESG ratings for those companies are horrendous. And you can flag a whole range of different issues. I mean, it's a laundry list. Anything from poor relationships with the local communities, to human rights abuses, environmental damage. It's a very long list of very serious offenses.

Kathrin Forrest:

In many cases, those happened five, 10 years ago. So they need to take a step back and think about what's different now. Is there anything that's different now? What's the risk, on a forward-looking basis? What's the opportunity, on a forward-looking basis? How can we invest in this company with an understanding that they're on a path to actually solving problems for us, as opposed to extrapolating them?

Kathrin Forrest:

So I think it's a fair point, if you put too much emphasis on the historic data.

Jonathan Hackett:

Fair. Well, Dan, Kathrin, thank you so much for joining us today. I really appreciate the discussion.

Kathrin Forrest:

Thank you.

Dan Novak:

Thank you.

Michael Torrance:

Thanks for listening to Sustainability Leaders. This podcast is presented by BMO Financial Group.

Michael Torrance:

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Michael Torrance:

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Michael Torrance:

Until next time, I'm Michael Torrance. Have a great week.

Speaker 2:

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