The financial services sector has long had trouble with trust.
As Edelman’s 2021 Trust Barometer found, financial services suffered the steepest loss in trust of any sector. While business overall experienced a trust boost, financial services did not, with the asset management and digital wealth management sub-sectors seeing the sharpest decline.
That said, some institutions are prioritizing the type of leadership and action needed to buck this trend. Among them —measured both by ambition and scale for impact — is State Street, the world’s largest custodian bank and one of the world’s largest asset managers, with over $4 trillion in assets under management.
As I reported earlier this year, State Street has been paving a promising path toward a more diverse and inclusive future. Last year, the firm launched its 10 Actions Against Racism and Inequality to build equity into the business.
2022 has already proven to be a seminal year for sustainable finance and ESG investing, and with so much progress (though we’ll see how enduring) it can be hard to keep up.
As such, I checked in with Eric Aboaf, State Street’s chief financial officer, and Rick Lacaille, its global head of ESG initiatives, to learn more about the view of Wall Street from State Street on. Among the topics we covered: the firm’s progress on its internal DEI goals; how State Street Global Advisors (SSGA), the firm's investment management business, is raising the bar on portfolio companies’ sustainability performance; and what the firm’s growing asset stewardship team is prioritizing this year.
Grant Harrison: Rick, you recently co-authored a piece on how net-zero finance may not be "the answer." One quote that stood out to me: " ... rather than procrastination, continuing ownership of brown assets can be part of a genuinely ambidextrous approach to net zero." What is an ambidextrous approach to net zero and why does it matter?
Rick Lacaille: An ambidextrous approach to net zero is a combination of investing heavily in renewable capacity, but also continuing to be responsible owners of existing hydrocarbon assets as they are wound back.
It’s important because divesting from brown assets and changing the ownership doesn’t move the world closer to net zero and could even make it more challenging. Staying invested in brown assets and ensuring the transition to green leads to more certainty about the reduction of emissions.
An ambidextrous approach to net zero is a combination of investing heavily in renewable capacity, but also continuing to be responsible owners of existing hydrocarbon assets as they are wound back.
Harrison: SSGA CEO Cyrus Taraporevala told company board members in his January letter covering the firm’s proxy voting agenda that all S&P 500 and FTSE 100 portfolio companies must meet several criteria to avoid SSGA’s voting action against responsible directors: They must have a person of color on their board, disclose the racial and ethnic diversity of their board; and for S&P 500 companies, disclose their EEO-1 reports, which capture demographic workforce data. How are boards responding?
Lacaille: Our asset stewardship team has long been focused on effective board oversight of ESG risks and opportunities. We’ve seen many boards increase their ESG competency, either through recruiting directors with relevant experience, devoting more of the board agenda to sustainability issues and inviting sustainability experts from within the organization to address the board more regularly. However, there are still directors with whom we engage that are unable to speak to the company’s approach to overseeing climate- or human-capital-related risks, for example, and that’s disconcerting to us. Every director needs to understand that ESG topics are an increasingly important part of their remit and we expect more fluency from them on these issues.
With regards to diversity, equity, and inclusion specifically, we have seen a marked increase in attention paid to this issue at the board level since June 2020. Many directors prioritize this topic in our engagements and are able to speak clearly about the company’s DEI strategy and progress toward relevant goals. We are also committed to supporting directors to strengthen their understanding of this topic and, as such, partnered with Russell Reynolds Associates to write a report on the effective board oversight of racial equity. We are also pleased to see more companies meeting the expectations outlined in our proxy voting policies and guidance.
Harrison: Turning to you, Eric, State Street has said that supporting Black-owned businesses as underwriters complements a number of ongoing DEI-related efforts. Can you tell us more about those broader efforts and what you and your team's involvement and support look like?
Eric Aboaf: We have committed to using systematic, measurable and broad-based efforts to bring about real change in our engagement with diverse businesses. We have challenged our business units and procurement team to be more rigorous in making sure minority suppliers have full access to bid on emerging business requirements, to add new diverse firms in key areas and to provide critical feedback to suppliers in hopes such feedback might help them win future business with State Street or another company.
As a result, in 2021, our spend across all diverse suppliers (women, minority, disabled and veteran-owned firms) in the United States and the U.K. significantly increased over 2020. What’s more, in 2021 our sustained focus on Black and Latinx suppliers resulted in measurable increases in diverse suppliers across the industry supply chain.
We have also endeavored to be a more visible champion of diversity and inclusion within our industry. State Street is pursuing certification as a Management Leader of Tomorrow Black Equity at Work employer. The certification is a framework approach for companies to make credible efforts to advance Black equity. Attaining certification requires a commitment by State Street to make comprehensive and sustained progress across five key pillars: Black representation at every level; compensation; inclusive, anti-racist work environment; racially just business practices; and racial justice contributions and investments.
Harrison: The emphasis on effective stewardship is an integral piece of the engagement approach. Karen Wong, SSGA’s head of ESG and sustainable investing, mentioned in a recent interview that SSGA views "divestment as the last resort." Could you share more detail on how SSGA’s stewardship efforts are growing and taking shape in 2022?
Lacaille: First, it’s important to note that divestment may not be an option. As index managers we cannot divest due to the investment mandate to track an index. While divestment may work well for clients or as a way to reduce certain exposures, we rely on proxy voting and engagement, and they are integral tools for us.
The 2022 asset stewardship priorities are: climate change; diversity, equity and inclusion; human capital management; and effective board leadership. Our stewardship approach this year follows the same practice we have followed for years: We clearly lay out expectations for companies and then take voting actions if the expectations are not met. This has proven to be successful in driving outcomes.
This year, we are setting expectations for companies in major indices in developed markets to align with climate-related disclosures requested by the Task Force on Climate-Related Financial Disclosures (TCFD). We lay out our specific disclosure requirements, including board oversight of climate-related risks and opportunities, total direct and indirect GHG [greenhouse gas] emissions and targets for reducing GHG emissions. If companies are not meeting our requirements, we will vote against responsible directors.
We are also launching a targeted campaign with the most significant emitters in our portfolio to encourage disclosure in line with our expectations for climate transition plans.
We continue to advocate for board diversity this year. We expect all of our holdings to have at least one woman on their board and, beginning in the 2023 proxy season, we will expect boards to be comprised of at least 30 percent women directors for companies in major indices in the U.S., Canada, U.K., Europe and Australia.
We are also focused on racial and ethnic diversity. We will take voting action against responsible directors at companies in the S&P 500 and FTSE 100 that do not have at least one person of color on the board. We will also take voting action against responsible directors if companies in these indices do not disclose the diversity of the board, and if companies in the S&P 500 do not disclose their EEO-1 workforce diversity data.
Harrison: Finally, Rick, what do you see as the most exciting opportunity and the most difficult challenge for the ESG investing space in the coming year?
Lacaille: One challenge for ESG investors, which has been brought to the forefront from the crisis in Ukraine, is that the scope of sustainability is changing, and defining the "S" in ESG is becoming more difficult. For example, what are the conditions necessary for holding defense stocks within an ESG portfolio? Should the shift from oil and gas be accelerated or leeway be given to high-emitting forms of energy as a mechanism to restrain Russian exports? ESG initiatives have coalesced around climate change, diversity and corporate governance, but now risks such as war, energy security and humanitarian concerns are broadening the sphere of sustainability.
One challenge for ESG investors, which has been brought to the forefront from the crisis in Ukraine, is that the scope of sustainability is changing, and defining the 'S' in ESG is becoming more difficult.
There could be a related opportunity coming out of this challenge, in the form of new ESG frameworks that introduce measures to address risks arising from infringement of human rights, energy security, economic sanctions and military conflicts. There might also be some degree of convergence between the approach of banks to sovereign risk, and that of ESG investors. Typically, assessment of environmental, social and governance risk is done at the security or industry level with little linkage to national and regional concerns. The next step will be to understand how to best calibrate the link between the country-level ESG risk (for example, a country with very poor human rights and corruption scores) with security-level risks.
Another opportunity in the coming year may be an acceleration in renewable energy programs. While the short-term focus will be on energy security, and there will naturally be a reliance on legacy energy sources like fossil fuels to meet that need, eventually net-energy importers will dedicate more resources to their renewables programs to become more independent more quickly. In turn, we should see accelerated investments in renewables.
As ESG professionals, we need to continue to challenge ourselves by ensuring that there are strong principles that drive our research and frameworks, but that the specific approach we take can adapt over time and not become a rigid orthodoxy.
Harrison: If firms want the strongest outcomes, diverse advisors must be involved in critical decisions. State Street recently underwrote $1.5 billion of senior unsecured debt and partnered with Black-owned businesses to do so. Tell us more about the genesis of this issuance and any key insights to highlight?
Aboaf: This was our second major debt issuance led by Black-owned investment banks. We started one year ago and we wanted to make sure they were driving the underwriting process, reaching investors and determining the final deal pricing and investor allocations.
These firms have evolved over the last decade and now have the advanced capabilities and capital base to lead. We're hoping to inspire other issuers to turn to Black-owned banks.
Harrison: As I recently highlighted, Edelman research found that the financial services industry is consistently seen as the least trustworthy in addressing racism and racial inequality. Do you think the industry is doing enough to change this? If not, what actions aren't firms taking that they should be?
Aboaf: Every industry has work to do. And each firm within an industry plays an important role in addressing racism and inequality. At State Street, it aligns with our values to foster diversity, equity and inclusion.