Episode #78: Real Talk on ESG!

"Take Sounds Presents" The Conscious Capitalists Hello and welcome to The Conscious Capitalists, hosted by two of the co-founders of the Conscious Capitalism movement and co-authors of the Conscious Capitalism field guide from Harvard Business Press, Raj Sosodia and Timothy Henry. Each week, this podcast covers current events and business news and Raj and Timothy's latest thinking on what it takes to build a conscious business. For more information and notes from the show, go to www.theconsciouscapitalists.com and now Raj and Timothy. Hello everyone and welcome to this week's episode of The Conscious Capitalists, myself, Timothy Henry and my partner, making the world a better place through business, Raj Sosodia. Hey there Raj. Hey Timothy, good morning from Rainy Monterey. Rainy Monterey, a cloudy London and we've got our guest today, Ken Pucker, in Boston. Sonny Boston. Good. Let me introduce Ken. Ken is an operator of advisor and investor and an educator with a focus on sustainability and ESG. He's the presser of practice at the Buffs Fletcher School. Ken also serves at Berkshire Partners and Investment Group as an advisory director where he's a member of the firm's Responsible Investment Committee. He's the published author and periodical, such as the Stanford Social Innovation Review, Institutional Buster and the Harvard Business Review. He's the board member of King Arthur Baking, Reagan Bone, the Commonwealth School, Mighty Earth and the High Meadows Institute. One of the things I love about Ken is that he spent most of his professional career working at Timberland, one of the very early companies that was held up as being a socially responsible and a really good company. He served as the COO there from 2000 to 2007 and during his tenure, Timberland grew by 10 fold to over 1.6 billion in sales. So the value that Ken brings us is that he's thought about these things really hard, but he also comes from the perspective of having been in the driver's seat and having to practice it. Ken Pucker, welcome to our show. Thank you for having me. It's been great. So there's a lot of different things we can jump into and maybe I want to begin with your journey at Timberland. Particularly during that period when you were there and the knots when Timberland was really being held up as one of the great businesses and it certainly inspired me early on to be thinking, oh, this is what's possible. Tell us a little bit about that journey and how that came about for you personally and your experience of being COO of a great business. Well, the journey was one of good fortune for me. I don't know how many of your listeners know the story of Timberland, but it's instructive, I think. Timberland is a brand and a company whose story can be told generationally. It was its predecessor company was founded by Nathan Swartz, who is a Jew who fled Russia due to religious persecution with the fourth grade education and came to Roxbury, Massachusetts as a cobbler and started a shoe company called Abingdon shoe, which made low end women's private label shoes that were sold to low end department stores in the US at the time like Kmart Caldor Walmart equivalent. He ran that factory for many years and passed it on to his two sons, Herman and Sidney at the time it was still called Abingdon shoe. Herman was educated and an accountant and Sidney gambled away his tuition money. First week of college sophomore year at university of Maine, Hitchhike Tom and his father gave him a broom and so he became the manufacturing guy and the two of them ran the private label shoemaker for a number of years recognized that there was very little margin to be earned there and out of thin air created this brand called Timberland. They had a next door neighbor who's a graphic designer came up with the name and the logo and they placed it on a boot, which was innovative at the time, which created a unique waterproof seal between the midsole the mid portion of the boot and the upper and impregnated the leather of the upper was silicone so you had a waterproof seal for the first time. They made them yellow, which at the time wasn't a conventional color for a work boot, so got a lot of attention originally with working men and women and then ultimately students in the Northeast who were interested in the protection that a waterproof seal and gender. A deal of success in 1985, VF corporation came to the two brothers and offered $60 million to buy the company and the accountant Herman said 60 divided by two is 30. I'm done and Sidney said I want to keep doing this and but didn't have $30 million to pay out his brother so the company went public via Merrill Lynch in 1986. Merstlessly for the Swartz family, they had a very good lawyer who created a capital structure that enabled them to maintain control. They had class b shares with 10 to 1 voting rights and Sidney became the sole CEO at the time when he turned 60 he passed his keys on to his son Jeff, the third generation of the family to lead the company. And you're in about the year 2000 when Jeff became CEO I became COO and Sidney retired he became chairman and Jeff was different from his grandfather and father and that he was a polymath who was incredibly bright who's overeducated he was brown pre-med and then went to tuck for graduate school. And by the time he became CEO I think he was bored with the traditional part of running a shoe and boot company because we were so smart and introspective and he needed more to motivate I think himself to stay connected than just commerce. So he reoriented the mission of the company in the year 2000 which is a long time ago to this notion of commerce and justice and justice is a word that one doesn't often hear today 23 years later in a business context. But for Jeff justice had three components global human rights citizen service and environmental stewardship and on every one of those dimensions timberland funded efforts through the company not through a foundation to try to become at least a top core tile player in both commerce traditional measures and justice. And he did and led great things so in terms of global human rights timberland was the had the strictest code of conduct in our industry. We were one of the first brands in the footwear to parallel space to only abide by third party unannounced audits in terms of citizen service timberland was the first publicly traded company in the world to provide employees with 40 hours of paid community service. We hosted an urban youth court in our headquarters called city here and at every event globally instead of playing golf at sales meetings timberland would conduct service events. So if we were in Prague and there was a flood for a sales meeting we would do a service event and clean up for the flood if we were in a mockery Florida for sales meeting we would work with migrant farm workers. So it depended on where we were it was always bespoke to the location but that was all Jeff's vision and when it came to environment we did a lot of things timberland installed one of the largest solar raise in state of California at the time in our distribution center. By the way, this is when solar was uneconomic timberland powered its factories the renewable energy and did a whole bunch of other things that were wildly progressive for the time. We also became the first company to issue not just CSR reports Timberland's first CSR report was near 2001 I think the first one issued ever by a company was 1999 and I'll leave it to you to guess which company issued that but Timberland was early in terms of issuing CSR reports but then became the first public company to invite outside critics. To publish in our own CSR reports, unedited and also issued quarterly CSR reports in keeping with financial reporting and so I was more the commerce guy honestly than the justice guy. In order for Jeff to speak at Davos or thousand points of light and things like that and proselytized for this notion of commerce and justice we needed the commerce part to work because no one wants to hear from a CEO who's not delivering on traditional measures. And I'm over simplifying some but not a ton and so I was a beneficiary and a learner along this journey I was certainly not an architect but it aligned with my values and so I was very fortunate to spend time there and serve there. I love that perspective because I think that too often the commerce and social good discussion becomes more the social good discussion and I'm not the commerce so I'm curious you know some of the things you cited for example polar power at a time when it's not economic. How did you balance that idea of this purpose and profit because ultimately there were things you're doing on the purpose side that were significantly increasing some of your costs how in your CEO world did you balance it's a great question and I can best illustrate with a story. Jeff was many great things, one thing that was a bit frustrating was he typically would over book himself. So he would book two or three meetings often at the same time, even trips in different cities. And the way he compensated by this is by when he figured out he had a problem turning to me and say, "You go do this." So I was like the junior varsity and he was the varsity. And one time he double book and there was a meeting, a presentation he'd scheduled to give at Stern School in New York and they had a school focused on retail in their business program. And so he said, "I can't do it. You have to go." And I said, "Okay, what's the topic?" And he said, "We'll talk about commerce and justice. They want to hear about Timberlain's purpose agenda, why it works well." So I did my thing and the great thing about presenting at Business School is kids are, you know, full of piss and vinegar and not shy about asking anything. And so a one kid raised his hand in the back and he said, "Quick question. You are a member of the Swartz family, to me." He said, "No, no, I'm not." And he said, "Well, I think you should be fired." And I said, "Well, I'm glad you're not my boss, but tell me why." And he said, "Because you just said you spend a million dollars a year supporting this urban youth core called City Year. Is that right?" And I said, "Yeah, we outfit the core. There's four members across the country, these are core in South Africa." And he said, "But that's shareholders' money. Who are you to make a judgment about how to allocate shareholders' money? If they want to give to City Year, you can issue dividends and they can, you know, give that money to City Year. Who are you to make that judgment?" And I said, "It's a fair question." I said, "Tell me what did you do before you came to Business School?" And he said, "I worked at IBM in Italy." And I said, "Terrific." I said, "What did you do there?" And he said, "I was in the marketing function, which made my heart swell." And I said, "Okay, so tell me about marketing budget last year. What did you spend it on?" He said, "Well, we did a novel 10 million dollar TV campaign." And I said, "Terrific, tell me, how did you measure success?" He said, "Well, it's very difficult, you know, I mean, when you do TV, it's top of the funnel. It's not, you know, it's harder to make the numbers work on attributions, it's a longer term investment. But, you know, over time, we thought the metrics in terms of what we learned were very positive. Okay. Think about the investment in choice you're making and how you made that judgment versus the investment choice in judgment we're making around City Year. We're doing it because City Year actually orchestrates all of our service events globally the ones I was describing earlier. They wear Timberland boots and jackets in every city in which they appear. We house a core in our headquarters in New Hampshire and part of City Year's appeal to us is it's a manifestation of our values and action. And we believe that as a result of affiliations like the moon with City Year, we're able to recruit and retain a workforce that's three or four notches above what we should is a billion and a half dollar footwear and a parallel company. And I can't prove that to you. Any more than you can prove to me that your TV commercial generated a great ROI. And so we make in business aren't always, you know, reducible to a spreadsheet. You can try. I can put numbers in the spreadsheet if you'd like about retention and recruitment and brand value and that kind of thing made up. And just like yours are going to be. And so we make these judgments and you make judgments and ours are different from yours. But that doesn't mean I think that I should be fired because if you look at our metrics on a traditional basis, we're out performing our peers. I love that. The arrogance of that question and it will be the MBA mindset is just that's what struck me for a student to say that to somebody, you know, there's no respect there. There's no curiosity, right? And, but, you know, we've indoctrinated students in such a narrow way in business schools. I've been teaching councils in 1985 and yeah, we're a bit part of the problem. You're a great business school. I know you're, you're now affiliated with the top, right? Yes. At the Tufts Fletcher School, which is interesting because it's not just a traditional business school like HBS or Stanford, you know, it focuses on international affairs and diplomacy. And so I teach a business class, but the reach of the student body is different. You have diplomats, you have people from the military. You do have business people, you have social entrepreneurs, so it's a wider swath. And I think I'm impressed with how the school has begun to consider sustainability as part of their mandate and that I think in large part has to do with their leadership. But I think your point is right in general, in my experience, is that business schools still struggle even today to figure out the role of quote sustainability and curriculum. It should have been taught as a part of an accounting class and a part of a marketing class and a part of a finance class. Should it be its own vertical with certification or degree? Should it be a requirement or shouldn't it? How do we think? And so I think it's very messy and I think it's pretty diffuse how it's taught and I think it's reasonably disappointing. The way I focus on it is probably different than other places, and I don't know if you want me to get into that or not. But I'm happy to share how I try to approach it if you'd like. Well, I'd love to get into that in a moment. But I want to finish the chapter on Timberland, though it's the mid-2000s you're doing really well, you're outperforming industry standards and you're doing a great job on the purpose and sustainability front. So it's 2007, what happened towards the end of that time and tell us about catch us up with where Timberland has gone since then. So I'm going to challenge some of the good, the flowery language that you threw at Timberland. Yes, Timberland did outperform peers, both in terms of traditional financial metrics and in terms of its purpose agenda. And yet at the same time, after I left, I was able to reflect on how good we were relative to not just peers, but relative to need. And so I'll give you a concrete example. Timberland reported on its carbon emissions, which I view as an existential metric to track. And in the last seven years I was there when I served as chief operating officer, our revenue grew double digits every year and our carbon emissions came down double digits every year. So in an intensity basis, we did really well. And you could say, well, okay, that sounds terrific, what's the problem? Well, the problem is, and this gets a little wonky for listeners, but carbon is measured according to the greenhouse gas protocol across three scopes, scope one, two and three. And scope one of your direct emissions. So that's the emissions from driving cars and corporate travel and stuff like that, scope two is purchased electricity and scope three is everything else, 15 categories of upstream and downstream emissions. And in a footwear and a parallel company or retail company, about 95 plus percent of emissions are scope three during the value chain. They're mostly in the supply chain, upstream, and they're mostly for footwear companies in tier four and tier three manufacturers, leather manufacturer, for example, for us was a big source of emissions. In a parallel, it's different. It's more the die houses and the finishing houses, tier two and tier three, but what we reported on, where I told you we decreased our emissions by double digits each year, we're scope one and two emissions. So we were cutting our 4% of our profile, 96% percent, for us were scope three, 4% were scope one and two, we were cutting the 4% by 10 or 11% a year. And that's what we reported on. And we were heroes, by the way, for doing that. We did actually, we fully disclosed in our reports that we were only measuring scope one and two. Why weren't we measuring scope three? Well, because to measure scope three, we needed to track more than 50,000 data points every six months, for which there wasn't information nor was their software, transit points between tier two and tier three factories, emissions and tier one factories, for example, that had to be allocated to different brands because we shared factories and partners. It is a very complicated exercise. It's not mandated. So in the U.S., you can choose to report on what you want to report on. You don't have to have your reports audited. So some brands report on scope one, some report on scope one and two, some report across all three scopes. Back then, very few companies reported across all three scopes. And so here we were getting awarded. We got a presidential award for community engagement and environmental service. We won Business Athletics Award, Best Company in the U.S., or one of the top 10 companies in the U.S., for 10 straight years. We were a Fortune 500, Best Company to work for. And yet, I'm telling you, we were only measuring 4% of our profile, and we were winning awards. And that's, unfortunately, hasn't changed all that much in the intervening 15 years since I left the company. If you look today, just at public companies, mind you, there are a lot more private companies than there are public, but if you look at just U.S. public trading companies, less than half today, 15 years later, report on their scope three emissions. And less than half of those have any formal audit of their data. This is today. So this existential metric, we have lots of metrics to track in the world of sustainability. This one that's existential, I mean, there are a couple, but this one certainly is, is really, really poorly tracked. Now, the good news in the US at least is that that's how to change now because of regulation. In the state of California, they just passed legislation that requires companies above either 500 million or a billion dollars in revenue, depending on the reg to report on their scope one, two, and three emissions annually. So if you're a public company of that scale, you won't have a choice anymore, which I think is good. It's not sufficient, but it's good. It's not for me. It's at Bartlett in California or any company that does business in California. It's for any business that does business in California. And it's not revenues in California. It's global revenues. It's a new business in California. They have emptied essentially the SEC. The SEC has been considering for more than two years now a regulation to require the same thing. And they put out a policy recommendation and they've received over 15,000 comments on that policy recommendation with a lot of pushback from industry saying this is too complicated. But it doesn't much matter now what the SEC says because California is the fourth largest economy in the world. And if someone wants to sell in California, they have to provide this information. The EU is actually requiring it as well for certain size companies. And so it's very late in the game. But at least as relates carbon emissions reporting in disclosure, not action. They're different. But reporting in disclosure, there is going to be a recommend. I love that. And I love that for a couple of different reasons. One is that we're now going to maybe probably switch over to some of the work you've been doing recently, which is expanding on this discussion. In essence, what you measure is what you get at some level. And you have a particular take on the ESG world and the ESG metrics that I really resonate with. But it's kind of contrarian to the popular quote unquote approach to ESG. Maybe introduce that at a high level. And then I'd like to talk very specifically about an example that you and I spoke about beforehand. But just maybe just give us the broad approach. And then I'd like to drill into this one particular fund as a good example. Okay, I'll try ESG as a concept has been around since 2004. It first showed up as an output of work that Kofi Anand did on the global compact. He got 18 financial institutions together who wrote a report in 2004 called Who Cares Wins. And that was where the term environmental social governance investing first appeared. It was at the time intentionally opaque. The authors of that publication essentially said, you know, ESG investing can be a great way for investors to assess risk of companies to enhance shareholder returns. At the same time, they also said ESG investing could be a great way to advance the sustainable development goals and ensure planetary welfare. And so it wasn't clear exactly. It was at both things. Was it one? Was it about product shareholder primacy? Was it about fixed the planet? Not clear. But it was certainly a way for a recommendation for investors to engage in understanding measures apart from traditional financial measures. And at the time, very few people paid attention. There was an investment movement that had started long before called SRI or social responsible investing, which was principally about negative screen. You know, if you're doing business in South Africa, for example, it's a company, you know, as an SRI investor, you might whatnot want to invest. If you're a tobacco company, if you're a fossil fuel company, etc. But it was really just negative screen. And so ESG became part of the vernacular starting in the year 2004 and very little happen. You have to roll the tape forward and tell about a decade later. And the reason very little happened is the prevailing wisdom on Wall Street was that companies that invested in ESG or sustainability or corporate social responsibility, those investments were drags on profit performance. And by the way, to intersect these two stories, I can tell you as a matter of fact that when I was at Timberland, which is the same time period, Jeff, the CEO, devoted fully one third of his remarks every 90 days to Timberland's justice agenda. So when he and the CFO reported to Wall Street, they reported on traditional measures. Jeff, two thirds of his remarks were about the business, our order book, our innovation pipeline, our gross margins, a third was the justice agenda. I sat next to him for 28 straight quarters. He never got one question. Okay, across seven years on that third of his remarks. And it got to the point that we had semi annual analysts meetings as well. And after going to them for two or three times, Jeff said, I'm not going anymore. And so what do you mean? You're the CEO. You know, you have your investors. You have to go. He said, now, you know, ultimately, they'll make a judgment based on our performance, but they don't care about what I have to say. And so I'm not going. And once again, he sent the junior varsity because he thought it was a waste of his energy. And that was, you know, 2000, early 2000s, right? After the CSG report came out, no one on Wall Street thought it was a good idea. They thought it was net negative. In mid 2010s, 2014, 2015, 2016, two reports came out of Harvard. Okay. One was a study that looked at 90 twin pairings of companies. So twins, meaning Walmart and Kmart or, you know, the same industry, same type of business, same relative size, etc. And they dubbed these companies high and low sustainability companies and looked at their returns over an 18 year period, Bob Eccles, George Sheriff, and a number of other people at Harvard did this report. And they found that for the first five or six years, returns were about the same high and low sustainability companies. And after about year six, there's this divergence. And if you map it out over 18 years, the high sustainability companies outperformed the low by 480 basis points. Wow. That is a big number on Wall Street. Okay, if you can find 480 basis points about performance, that's a monster. Years later, a couple years later, George Sheriff from did a report on, called first evidence of materiality that looked at, well, what if we break this down further and say, by industry, which companies were focusing on immaterial versus material sustainability factors for their specific industry? So for example, an accounting firm, whether they use a lot or a little water is probably not a big deal. Their travel probably matters. For a footwear and a parallel company, their emissions are probably a big deal. Their attention to code of conduct and labor issues is probably a big deal. So specific to each industry, who's focusing on material versus immaterial factors in E-Pound? The companies that were focusing on material factors outperformed those focusing on immaterial factors by 600 basis points. And so all of a sudden, Wall Street started to pay attention and that they thought, wait a minute, if in fact we've been wrong and sustainability marries with better equity returns, we can package this into an idea that's really consistent with investor psyche right now because investors are increasingly concerned about the planet, any human is. Money is transferring generationally to millennials into women who are more concerned about these issues. And by the way, asset managers had a huge problem at the time, which was if you remember, there was an enormous shift going on from actively managed funds to passively managed funds. And the gross margins of the asset management industry contracted by about 500 basis points over this period. ESG was a perfect answer. What if you could package this idea that doing well leads to doing good, you can invest behind your values and make more money. And by the way, we, on the asset management side, charged fees about 40% higher than we did for our traditional funds. So you make money, we make money, the planet gets better. Who wouldn't love this idea? And so they started to market ESG funds. And it was started slowly, but kind of in the year 2019, 2020, 2021, massive ramp up of number of ESG funds, rebranding of traditional funds as ESG funds, additional AUM pouring into the category, mostly in Europe. People miss this. Okay. In the US was about 10% of ESG AUM. Europe is about 80. Okay. So it's overstated about how big it is in the US. And by the way, it's overstated overall. We can get to that if you'd like to talk numbers. But that's the story of how ESG got famous. It was a win and win, right? For asset managers for the investor and for the planet. And for about two or three years, it actually worked pretty well because returns of ESG funds did outperform traditional funds, which only caused more money to flow in, which made it a self fulfilling prophecy, because if funds are flowing, it's going to cause those equity values to go up. And so everyone was really happy. Well, if you roll the tape forward, to this year, ESG funds have underperformed traditional funds by 640 basis points year to date. And if you look cumulatively over the last five years now, ESG funds have underperformed traditional funds. And so the Bloom came off the rose at the same time there was political theatrics in the US about, you know, whether ESG funds are woke and all this crazy stuff, which isn't relevant. But the Bloom came off the rose because performance actually suffered. Now, if you, so that's the kind of ESG 20 year run, we can talk about bigger, smaller, it is separately. But I will tell you that from my perspective, the contrarian take I have is that ESG funds do not deliver alpha, never will. That's market out performance. I'm happy to describe why. But more importantly, ESG funds have nothing to do with planetary welfare, nothing. So even though they're called ESG, which from a retail consumer standpoint or investor standpoint means environmental, social, those are things I think I want to be behind. Nothing to do with the welfare of the planet. And you say why the simplest answer I can go into detail. But the simplest answer is this ESG funds are secondary market vehicles. Okay. So let's say Raj, you own Facebook stock and want to sell it. And I'm an asset manager and I buy it from you. Okay. You sell your Facebook stock. I give you money. I put it in my fund. Facebook got no money. Okay. Or Timothy, you own Tesla and you don't want you want to sell Tesla. And I want to buy no problem. Tesla didn't get name that money. It's a secondary market transaction. There's nothing that happened to Tesla. You're not reallocating primary capital into businesses that need it that are green businesses. Just putting money around. And so there's many other reasons. But for that reason alone, ESG investing has nothing to do with planetary welfare. Yeah, I love that. I mean, I think in your article that was in Harvard last year, Harvard business review, ESG investing isn't designed to save the planet. And in that, you sort of save, you know, there's a requirement of $3.5 trillion to sort of really make progress. You invest that amount of money into real assets and to real change. We really want to make a difference right now in terms of the environment. And then you make the point that that is very different from the trillions that are flowing into ESG for the reason you just cited that it's a secondary market. It's just changing hands of shares versus real investment. And then you go on and like you talk about this a little bit, you give us very specific example of BlackRock. Now, this is a mouthful, right? This is a real marketing nightmare. But BlackRock's US carbon readiness transition fund. And they go out and start marketing this as a way to save the environment. And you have a take on that. So I don't need to just pick pick on BlackRock, though they're an instructive case. There are one of many asset managers who are marketing funds with titles similar to the one you just described. What's interesting about the BlackRock US carbon readiness transition fund is when it launched, it launched as the biggest ETF ever launched on a single day. In April, I think of 2022. And if you go to your computer now and Google BlackRock US carbon readiness transition fund, you can pull up the prospectus and see on the prospectus in 10 seconds what they're investing in. So here I have it in front of me. And it's got, I literally did it just now. And here's their top 10 holdings, Microsoft, Apple, Amazon, NVIDIA, alphabet, meta, alphabet, master card, Tesla, Berkshire, Hathaway. And so you said, well, wait a minute. Well, well, well, well, I thought US carbon transition readiness fund would be orsted and battery manufacturers and Tesla sure. And you know, other companies that are helping us decarbonize US carbon readiness transition fund. Why is this a bunch of tech companies? NVIDIA, alphabet, Amazon, Apple. Well, it's because of how these funds are constructed, which people don't typically understand. These funds are constructed based on ratings 80% of ESG ratings come from one company, MSCI. How what is MSCI rating? How do I know what an A plus is versus an A versus a B B minus how do they get these ratings? Well, two things people miss. One is it's vertical, not horizontal. So ratings are versus your peers in the industry. Chevron again, Shell has rated gone X on mobile. It's not X on mobile versus Tesla. It's X on mobile versus Shell. Okay, that's first which people don't appreciate. The second thing is the ratings are based on the impact of the planet on the company, not the impact of the company on the planet. So what MSCI is rating is how resilient is the company's P and L to ES or G shocks. So for example, is your factory in a floodplain? Is your factory have workers that are likely to go on strike because you're not paying them properly? These are the risks that MSCI is looking at when they come up with a rating. So it's the ES or G shocks on a company due to things like climate change, not the influence of the company on the planet, okay, which is really confusing for people because they assumed ESG, it's about how good the company has nothing to do with it. This is why Elon Musk went crazy when his Tesla was downgraded as an ESG stock because of governance issues, right? And he's like, you know, we're one of the, you know, most enabling companies in terms of the E revolution and we just got downgraded it's because he didn't understand that that's not what they're rating. And the CEO of MSCI has come out publicly and said in an article called the Bloomberg wrote called the ESG Mirage, which is excellent. I recommend it. He came out and said, we don't think that most retail investors, institutional investors or portfolio managers understand what we're doing, okay? And yeah, that's how ESG funds are compiled. So that makes sense that a company like Apple or Amazon or alphabet could make it into an ESG fund, but it doesn't have anything to do with US carbon readiness transition. Wow. That's pretty startling. So what do we do about this? How do we fix this? It's a mess. What should MSCI? Is an MSCI? That's the company. What should they be doing when they evaluate? What's the way forward here? So the illusion of sort of cul-de-sac that we seem to be in. So Timothy started to highlight an important distinction that I think is part of the solution, which is, according to the international energy agency, they say that we need now about 4 trillion a year of spending on climate transition technologies, essentially, to transition from where we are to a world of less than 1.5 degrees. For the first time last year, globally, we spent over a trillion. So we're about a quarter of the rate we're supposed to be at. By the way, that number goes up each year. So the 4 trillion doesn't stay 4 trillion. 5 trillion, 6 trillion, 7 trillion. And so to the extent we don't double each year or even more than that, we're falling further behind our ability to deliver a safe plan. And so people need to understand the distinction between climate transition dollars, which are the ones that IEA is looking at, and ESG. They're unrelated. The Venn diagram is almost empty between the two. So I think where we have to focus is, I don't care if MSCI changes the ratings or not, because it's still a secondary market thing. It's not where I would focus my energy retention. Where we have to focus on energy intention is, how do we get more capital deployed to address climate transition? What falls in that bucket? Well, categories like climate tech venture investing, right? Which had a great growth run for about three or four years. It's gotten crushed this year because of higher interest rates. But investment of venture dollars in future solutions around battery, long-term battery storage, hydrodigent energy, a whole bunch of technologies and ag tech that are required for us to decarbonize or essential that one area. A second area is impact investing, which is mostly focused on the kind that is concessionary, mostly family funds and rich people who are willing to invest in solutions and not require market based returns. But the biggest source of capital comes from multilateral financial institutions and nation states and blended capital arrangements between public and private institutions. A good example, this is a form of financing that's called just energy transition partnerships, which are focused on helping countries that are principally coal dependent, transition their grids. So, for example, Bangladesh is 98% run on coal right now. And they don't have the money. Even if solar is better per unit than coal, they don't have to cap X to make that transition and also cost a capital in these markets like Bangladesh, African markets, developing markets is typically 3X what it is in western markets. And so, whereas an investment in solar might work in the US, if you're interested rate is 3x US rates in Bangladesh. It doesn't work even if you had the capital and they don't have the capital. So just energy transition partnerships are an attempt to fuse multilateral financial institutions, commercial banks, nation states to create a blend of capital, some of which is concessionary and for loans that are forgiven, some is genuine loans, etc. It helps spur this transition and so far there are three that I know that would be in the process of or have been negotiated for South Africa, Indonesia and Vietnam, both all in the billions of dollars that fuse kind of these various forms of capital and layer different types of capital to push and support a transition. These are really important things. That's the way we actually accelerate a climate transition. It's not whether your sister is buying an ESG fund at BlackRock. It's whether we are investing primary capital in either innovation or transition. So I love that distinction. It's like we've all fallen into this marketing trap of you know reading in the Wall Street Journal of the FT all of this money going to ESG and then we sit back and go oh thank god isn't that a good thing and you're sort of opening up the story and saying ain't necessarily so. In fact it's not so at all. It's not going in the right direction. So it reads to an interesting discussion about what is the role of private industry versus government in trying to make this transition because you know there's a whole other school that we can get into that you've written about which is the accounting and if we had better metrics would companies react differently. So what this basically means is there's a lot of externalities things that we're using or taking from the environment that have a cost or should have a cost associated with them where we're destroying natural capital. How do we capture that? How do we measure that? Carbon is the most obvious one. The next one that's coming up is biodiversity but if we could capture the cost of these things and companies could then put them into their accounting then we'd have a true cost of production and I'm oversimplifying it for the moment but that's one angle right Ken where we could go down and we could say if we had better accounting and better metrics and it gets a little bit into what you were talking about before in terms of some of your scope three complexity but is that the way we should be going? Is that the way that we should be forcing private companies to price those externalities? Have them show up on their P&Ls or on their balance sheets and and then hope that the market will react and force them to do the right thing. A lot there. So I don't think ESG is a random one-off win-win solution meaning we have a 50-year history since the publication of the Limits to Growth in 1972 of trying to have companies lead the way to solve environmental and social challenges and you look over five or ten year periods and find things like eco-efficiency which was led by Amory Lovings at the Rocky Mountain Institute that said you know we can solve these problems easily because the math works in terms of ROI and it does for certain things like LED light bulbs but that's one maybe one tenth of the solutions actually are win-win the other 90% are NPV negative. We've tried things like fortunate at the bottom of the pyramid we've tried creating shared value a lot of these come out of academic institutions that then become consulting firms around win-win meaning just like ESG's quote win-win win for the planet win for the investor. Well I think we typically find ourselves disappointed and that these ideas typically fade after five or seven-year cycles we go on to the next one. Why is that? It's because you know business doesn't want to be regulated and so it's great if there are win-wins because then the planet wins and business wins and people are profitable and share prices go up and that's terrific. Unfortunately now over the 50 years that we've been trying this and the same time that you know CSR reports have grown exponentially we have carbon emissions growing exponentially and ever more destruction and so I think we should pull up and say well wait a minute we've tried this corporate voluntary win-win path for a long time and yes there are case studies of companies specific instances that do work but don't translate a case study into empirical outcomes it's not the same just because it worked once doesn't work it's always applicable and so my view is okay second point you talked about okay what you measure your manage and so maybe we should be doing this focusing on measuring and dollarizing externalities there's an enormous movement mostly in Europe a lot in the U.S. though that was cam out of Harvard called impact accounting at Harvard it's called the impact weighted accounts project and what they say is look what you were saying Timothy let's dollarize externalities so if we have a company like Bowen and they're reporting on their economic value added today because they're required to so here's the EBITDA let's also create a set of accounts for their social value added did they add or detract from social welfare and let's create dollars associated with each and now let's do it for their environmental impacts and let's do it for their communal impacts and then let's sum across all these areas and see are they ultimately a net positive or negative societally to do that work is enormously complicated okay and accounting firms love this idea because they get to employ hundreds and thousands of people literally to do this account the problem for me isn't that we don't know that exon mobile is a net negative because of the externalities we know this already okay whether we get to the precision around is it a net negative of x or y who cares you know what we what we it's not the measurement that's preventing exon mobile from making a conversion to a renewable energy supplier that's profits associated with fossil fuels and so I think given limited time and bandwidth focusing our energies on impact accounting to precisely measure externalities is not a helpful exercise I think instead with one unit of energy what I would propose we do is focus on pricing externalities what you were saying because business is respond to those signals not theoretically what might my P&L look like were I charged with externalities but if I did have to pay 200 dollars of metric ton of carbon well substitutes would I pursue how would I change my strategy how would I change my source and strategy and by the way this is starting to happen in Europe there is this mechanism called CBAM which is the carbon border adjustment mechanism that covers seven different commodities aluminum steel etc and says to people outside Europe okay here's the carbon intensity associated with a ton of steel made in the EU if you want to import to the EU you have to hit that mark if you don't you pay a penalty per metric ton and you can buy credits to offset that but we are we're insisting that for each commodity this is the mark you have to hit if you don't you pay and you can say wait a minute but don't we need those taxes to be uniform and global and the answers no ideally they would be but if you take a block the size of the EU and say for these seven commodities this is the mark you have to hit it's going to force companies okay to carbonize faster or pay or avoid and so that's an example not of us focusing as much on measuring all externalities but just figuring out for a commodity what's the carbon intensity of it and pay attacks or border attacks yeah and those are the kind of things that I think will have a profound impact so you pick the carbon market and that that's a fascinating one because it's been relatively well researched and there's been a lot of effort put into how do we track carbon all the way down to satellites now measuring things like that and it seems to me I was at a conference last week where this came up the next thing is biodiversity you know the destruction of biodiversity and increasingly commercial efforts to create offsets for biodiversity which in essence says you know if you are doing harm of 10 units of biodiversity you can buy from Raj 10 credits for biodiversity because Raj has invested in a wonderful biodiverse farm and is doing that is that the way we're going to go by one-offing some of these things let me do carbon and then we'll do biodiversity and then we'll do is that a viable way of going forward it's worrisome to me there's if you just stick to carbon for a second I'd recommend to your listeners a great article that appeared in the New Yorker I think two weeks ago called the Great Cash for Carbon Hustle which describes the carbon offset market and the largest verifier called the Vera of carbon offsets and a project in Africa which is one of the largest projects in the world that was used to offset by companies like Delta and Nestle and others, that turned out to be mostly fraudulent. And so there are real problems, even in the carbon offset market before you get to biodiversity, around things like additionality, meaning, would this have happened absent the carbon credit or not? Because if it would have happened anyway, why are we paying for it? And things like leakage and permanence, and it's very difficult to assure that what you're paying for today won't get burned down tomorrow. Or that what you're buying today doesn't cause someone to do something 20 feet over that they wouldn't have done anyway around leakage. And so carbon offset market is a, what's the technical term? It's a mess at this point, okay? And that's the one you said we know how to measure. Okay, and so I'm worried about it. On the other hand, we do need more capital deployed to advanced solutions. And governments don't have the bandwidth that we require. We need private capital invested as well. And so I'm not conceptually opposed to the idea of getting markets more engaged. I do worry that absent appropriate verification and audit, we end up with this kind of gaming of the system, even in carbon for getting biodiversity. And I'll tell you just one thing which I found instructive. I've mentioned to you that one of our daughters works at conservation international, which is one of the largest environmental NGOs that does excellent work around the world. And she works in the biodiversity team. So I've learned a good deal about this world from her. And when we were talking about credit, she said to me, what do you think of the idea of biodiversity credit to you for them or against them? And I said, well, you know, here's the complexity of this. And here's what's going on in carbon. And so I'm not sure and I need we need more money and markets. And she said, you know, I have a different question. This may sound stupid may sound simple as what's a question. She said, why don't we just mandate that certain parts of the world legally are off limits? We know from mapping where the intensity of a biodiversity are. Okay, we know where carbon is sequester. And there's actually amazing overlap between the two. Why don't we mandate that? And I said, you know, what you ask is ostensibly a naive question. Is actually the right approach as opposed to relying on markets to solve these problems. But the problem is that a lot of these places where carbon is sequestered that are biodiversity rich are very poor countries. And they have the choice, for example, of drilling for oil in Ecuador to disturb the Asuni National Forest, but provide income for their people who are very poor, or preserve nature and not get paid for it. And it's really difficult in that environment, based on the system we operate in, to do quote the right thing for the planet. By the way, I'm pleased to report that in Ecuador, they had a public referendum on this question, and they decided not to drill. Okay, which is incredible. You know, given the amount of money they're for going. But I thought her question was instructed. It's just like, what do we value? And do we put a price on nature? And how do we support poor places in the Congo and Ecuador? I said that their stores of biodiversity. And I don't know. That to me is a more straightforward and likely to succeed approach, or harder, I guess, politically, to make happen. I think that Ecuador is one of the countries that has given nature rights under the law, and people get sued on behalf of nature, or our friends of the Pachamama Alliance have been part of that. But what you were saying about the carbon thing, I did read that article in New Yorker and it reminds me of that quote. So Eric offered that every great cause begins as a movement, becomes a business and eventually degenerates into a racket. And I think you've seen that illustrates that, that perfectly. And it's all offsets, and all of that is kind of. It's the most beautiful Catholic church practice in the past of selling indulgences. Right? You can leave up the license to send, or if somebody else can pay the penalty on your behalf, et cetera. I agree with your daughter. You know, I think that's coming to the chase there. You'll be willing to move in that direction. Yeah. So what do you see as coming next again? What is your focus now? You are a part of the investment world as well. How are you deploying these ideas? So I, as I've mentioned, I believe that we need policy to help lift the floor in certain industries, and the one that I come from is fashion and apparel. And so I've been spending a good deal of time the last two years on architecting and trying to support the passage of a piece of legislation in New York State, which would be the first consequential piece of legislation in the United States to govern the practices of the fashion industry. So whereas the EU has passed a lot of legislation on this front, the US has done almost nothing. And so I worked with a woman named Maxine Bedard. Maxine is a lawyer who started a fashion marketplace years ago for ethical fashion, realized there was none. Decided to close the business and took a year off and traveled the world to understand why, well pregnant. And she started in a West Texas cotton field and ended up in a dump and Ghana visiting four continents in between, the book is called Unraveled, which won awards that she wrote. And then she started an NGO called the NSI, which I joined her in helping kick off. It stands for New Standard Institute. And the first piece of legislation that we've architected is called the New York Fashion Act. And the New York Fashion Act says, if you're a brand that sells in excess of $100 million globally that chooses to sell in the state of New York public or private, you must comply with the follow frameworks that already exists. So this bill doesn't create any new frameworks. It says for due diligence on your factories, you have to comply with OECD requirements for due diligence. It says that for reporting, you have to report on the following things publicly. Where your factories are, tier one, two, three, and four, by address, whether you pay a living wage or not, how much water you use, what percentage of recycled materials you use, how much carbon you admit, things like that. It has to be an electronic format, it has to be available publicly annually on your site. You have to also sign up for and be approved by an organization called Science-based targets. Science-based targets is the largest organization globally that validates companies, plans to decarbonize. And it requires setting of both short and long-term goals and requires that those goals be in compliance with planetary boundaries. And so 400 fashion companies already have signed up for and been approved for science-based targets. It says if you're above a certain threshold, you have to go through that process. And different than any of the legislation I've seen, it also says, if you don't deliver on these goals, at the discretion of the Attorney General in the state of New York, you can be fined up to 2% of global revenue. So my former company, you know, there's a $35 million fine. If you, let's say, sign up for Science-based targets, but miss your targets. Now, there is a remediation process. So if you miss your targets, you have 18 months to remediate. If you don't, then the Attorney General can issue this fine. But, you know, a fine like that puts teeth in the bill. And the point is not to find companies. The point is that we can't rely on Stella McCartney, Johnny, Patagonia, Eileen Fisher, and seven other great companies to decarbonize the industry, because they represent less than 1% of production. So unless H&M detects she and Nike all collaborate on solutions, we won't advance decarbonization in Bangladesh, where, by the way, it's the second largest country for a parallel manufacturer in the world. We won't decarbonize there without support from the brands, okay, to engage with multilateral institutions, banks, country, et cetera. And they'll do it if it's in their financial interest. If we just say, "Hey, it'll be cool. Cool if you tried to do this," which is what we said. And if you'd sign up for these voluntary things, that'd be great, which a lot of good companies have done, the problem is I would venture today absent such regulation less than 5% of the companies will deliver on their commitments today. Not because they're not trying, but because the system doesn't incentivize them. Imagine, for example, if you were a CEO of a public company and you got on a call at the end of the quarter, and said, "Hey, I have great news to report. Our revenue shrank by 12%, but our carbon emissions came down by 20." And so on an intensity basis, we're on that journey to decarbonize, and we're proud of it, questions, please. What the questions would be. There wouldn't be, hey, Raj, congratulations on your decarbonization efforts. Can you talk a little more about that? I'd be like, "What happened to your top line?" That's the world we live in. That doesn't mean that the CEOs are wrong. They're operating based on the assumptions, and strategies, incentives, and structures that are in place. So we have to change those. We have to change the rules. We have to change the incentives if you want behavior to change. Just relying on good actors who are doing this for the good of their heart and soul, and they want to sell their purpose. So I said, "Is proven to be insufficient?" Are you sure we live with what Bob will have been doing to imagine? Where he's been trying to bring together most of the major players in some industries. Yeah, Paul Pullman in the fashion industry is co-founder of a group called The Fashion Packed. He, along with the CEO of Caring, are trying to get CEOs together together to make public commitment. and to do things like jointly secure renewable energy credits and power purchase agreements and things like that, and they have had some success doing that. I worry, however, that that is but another of these voluntary consortia led solutions that ultimately are insufficient. So in the parallel industry, we've got a lot, we've got the sustainable power coalition, we've got the fashion pack, we've got the global fashion alliance, we have the textile exchange, we have, you know, literally tens of consortia that are made up of players in the industry to try to volunteer to carbonize. Different than any of those consortia, NSI, which I mentioned that Maxine leads, takes no money from anyone in the industry. And the reason we do that isn't because we don't like industry or don't like money, right? We could use the money in the support, but because we think you'll end up with watered down solutions that don't address the problem. And it's harder to do it that way because we need money to lobby, we need money to play the game politically, but we can't take it from companies because we've seen how it corrupts. Can given the political paralysis in the US in Washington, I don't see prospects of passing these kinds of laws at the federal level, are we going to have to rely on states like California and New York and some of the other larger economies within the US to nudge this movement alongside what Europe is doing to get making shift happen. So I would say two things, one is that the US passed at a federal level, the inflation reduction act, which is poorly named, but it's the largest piece of climate legislation passed in the history of the world, and it's having a massively profoundly positive effect on decarbonization in the United States as we speak. And it's happening mostly in red states, interestingly, in large part because they're non-union states, and that's where the capitals being deployed. I mean, in the billions, if not trillions of dollars already. And so I'm very enthused, I believe that the US will actually deliver on its Paris Climate Accord commitment to reduce carbon emissions by more than 40% from a 2005 baseline because of the inflation reduction act. Now you can say, whoa, that sounds really good. You sounded like you're pretty bummed about other things. Well, the issue here is, US isn't that important. US is important as a signal. Okay, but it's 13% of global emissions. India is more important than the US. China is more important than India. Okay, and so yes, it's good that the US is acting, but it's insufficient. That's first part. Second part is, I think the state-led solutions where you can't get stuff done federally are just fine. I mean, there's no way people can't comply with a California wreck if they want to stay in business. And same thing with New York, if you're in the fashion business, you imagine you're saying you're going to walk away from New York. By the way, when you do this, so far, four other states have reached out to us for the exact wording of the legislation. And there are all states that have democratic houses and both legislatures and a democratic governor. And when you add those states in one of whom's California, you have a fact is essentially de facto federal legislation if you get New York and California to pass anything. But the inflation reduction act was about $400 billion of spending on which was what was the amount. That was the amount they said initially when they passed current estimates are it's in the trillions of dollars, meaning it was open. The first estimate was that it was going to be $400 billion is $387 billion. And now it's way in a trillions because a lot of the uptake on the subsidies that were in the bill have flown way beyond what they originally estimated to be. So the government is going to spend channels. Yes, the government is spending trillions on subsidies. So the better way to do this, by the way, the economist at a great piece about this is they looked at subsidies versus taxes as a way to accomplish decarbonization. And they found that taxes or taxation was about twice as productive or said differently subsidies cost twice as much as taxes. But I'll take subsidies versus nothing, meaning, you know, heat pump adoption, EV purchases, batteries, hydrogen, all these things are now subsidized massively in the United States. You buy an EV now, as long as the parts are made above a certain threshold in the US, it's a $7,500 credit off the top. Same thing, you know, heat pumps, et cetera. So I mean, there's enormous transition to happening, as we speak in the United States factories, foreign factories being built now in the United States because of these requirements on US content. I mean, so it's massive what's going on. So does that make you an optimist novel that we're going to start together very optimistic about the impact of policy to change vectors. Someone said the other day something I thought was really good, which is, you know, commerce is essentially a sailboat. And what it needs is the wind of policy to direct it. Okay, that wasn't exactly what they said, but it's something like that. And I think we're seeing that work when it comes to the inflation reduction act. That's not what I mentioned. I'm optimistic about the US ability to decarbonize. I'm not optimistic about the globe's ability. US isn't hard relative to China and India. China and India have air pollution problems, particulate matter problems. They have keep the lights on problems. They have keep people out of the streets problems and employed. They need all of the above in terms of energy. And so it's a lot harder problem. I think in those places, then it is in the US. Wow. Well, Ken, this has been a fascinating walk through what I think is real talk with real solutions on what we need to be addressing as we move forward on the climate issue. I'm glad we end on an optimistic with regard just to the US. At least there's an example there. And I think with the EU and the US starting to make progress on this, it's going to ratchet up the pressure on China and India to be able to sort of say, hey, listen. We're starting to get our act together. What are you going to be doing? So hopefully there'll be a knock on effect from that. So thank you, Ken. We really appreciated your candor and your you're just deep intellect on this. It's really impressive. Well, thank you guys for having me. It was fun and I hope it's useful for your listeners and I look forward to remaining in touch. Great. And thank you for our listeners for listening in on this week's podcast. If you enjoyed it, go over to Apple Tunes, give us a rating, leave some comments and whatever channel you're listening on feel free. Of course, hit the subscribe button so you can hear us every week when we come out and Ken, thanks again, really appreciate it. Text sounds, thanks for your production health and pick them on array. Thank you for helping support and produce this show and we'll see you all next week.