ESG, impact, responsible AI, and the overlooking of governance: an interview with Matthew Sekol

Matthew Sekol is a Global Sustainability Industry Advocate at Microsoft, guiding companies across industries through ESG and how Microsoft can support them. He also sits on the LP Advisory Committee for Morgan Stanley’s Next Level Fund, which invests in female and diverse-led and founded startups. Additionally, he writes an excellent ESG newsletter, The ESG Advocate, clearly and cleverly applying an ESG lens to key stories and current affairs.

In this interview, Hannah Leach, co-founder of VentureESG, sat down with Matthew to discuss the difference between ESG and impact, responsible AI, and the consequences of overlooking governance in ESG initiatives. This session was originally broadcast live to the VentureESG community.

Hannah Leach: Welcome Matthew and thank you for joining us. To kick us off, I’d love to hear about how your ESG journey came about, particularly as so many in our community are just starting on a similar journey themselves.

Matthew Sekol: I actually came into this relatively late in my career. Maybe around the time I turned 40, and I’m 46 now. Most of my career was spent supporting IT technology, but when I joined Microsoft in Capital Markets — and this is prior to COVID and the social issues in the US in 2020 — I saw this big disconnect between the way that the ESG data ratings agencies and capital markets firms were assessing companies and then what those companies actually thought was happening.

I started exploring with some non-financial services companies and would ask the CFOs, “What are you doing about ESG?”. They would often respond with, “Oh, that’s sustainability. We have our CSR report”, but I didn’t think they really understood what these rating agencies were doing and how they were assessing them. Then, once COVID hit and after George Floyd’s horrific murder, there was a laser focus on ESG in the corporate world, but I still find that corporations aren’t quite grasping the differences between saving the world and what the impact of the world is on their company.

So that’s what led me to start my newsletter. I’m always trying to learn and put out ideas because I really believe there’s something interesting about looking at issues that impact your company through these interconnected pillars.

Hannah Leach: So you alluded there to something we often discuss: the difference between ESG and impact. At VentureESG, we talk about ESG as referring to internal practices and processes that affect a business and impact relating to the outcomes driven by a product or service. Do you encounter this distinction in your work? Do you frame it in the same way?

Matthew Sekol: I encounter this problem all the time. My role at Microsoft is to meet with some of the world’s largest companies, mostly around the topic of sustainability. In this group, I come across a range of priorities. Some of those companies are focused on aligning to regulation, which in the US means they’re largely focused on carbon disclosures. Other companies are trying to tackle a more meaningful intersection: how they can impact the world based on their business model. And clearly, there’s a large range of commitment within that category.

But then there’s this third pillar which is under-prioritised, which is the impact of the world on the company. Plenty of companies want to save the world, but not enough companies are focused enough on saving themselves in order to be resilient enough to get to the point where they can save the world. That’s how I think about it: I think that the chief sustainability officer or chief ESG officer should really be reporting to the chief risk officer, rather than the CMO or CFO. So it’s that third pillar, the ESG pillar, that I try to bring to companies.

Hannah Leach: In Europe, the major drivers for VC engagement with ESG are SFDR and LP-pressure, but none of this regulation, including that coming in the US, has really been designed with tech or B2C companies in mind. So we’re seeing people push to disclose and report what they’re required to, rather than focussing on what is material to the companies they’re investing in, which represents a big risk, particularly in ignoring the non-climate-change elements of ESG. How are you thinking about this tension?

Matthew Sekol: Well, the expression that always emerges is: “You can’t manage what you can’t measure”. There is an expectation now, regardless of the type of company, that you will be measuring certain things. So it’s expected that you’ll be managing DEI appropriately and that you’ll be measuring carbon, even if you’re a technology company. When I think that becomes a distraction is when this gets in front of more material matters that companies ought to really be focussing on, or when the act of disclosure gets in front of the change that companies would otherwise be making in the world.

In particular, many startups should be considering things which aren’t necessarily environment-related, yet that is where the regulation is going. As companies that take advantage of scalable technologies to go to market quickly, startups need to recognise that technology is an ESG risk as well as an opportunity, and many of those risks fall into social and governance — for example, in the use of AI and the development of cybersecurity. Simply, don’t let the required disclosures get in the way of addressing material issues.

Hannah Leach: Absolutely, and developing that culture of education and understanding around ESG issues is really key, both within companies and for VCs to provide support with. Relating to AI ethics, one of the thornier topics at the moment surrounds the ESG risks of generative AI: How are you seeing the ESG conversation around ChatGPT and generative AI evolve?

Matthew Sekol: Well, let me first give you some of the official Microsoft answer. At Microsoft, we’ve built a Responsible AI Framework with several pillars as a guide to implementing responsible AI. So that covers the major ESG risks that AI companies ought to be looking at.

In terms of my own perspective, what I’m seeing is that companies aren’t necessarily sure yet about the power of OpenAI and the risks associated with using it. So, for example, we get a lot of fundamental questions about AI that are very applicable to OpenAI and ChatGPT integrations: questions of liability if a company builds a model and it hallucinates and does something, questions relating to whether Microsoft can see the data, which of course we can’t, etc.

My advice is that entrepreneurs should be exploring AI if it makes sense for their startups and whilst there are a lot of interesting use cases, they shouldn’t get in there if it’s not appropriate. If they are exploring it through, I recommend looking at the Microsoft Responsible AI Framework and the Montreal AI Ethics Institute, which has a lot of great guidance on the latest research. From an ESG perspective, this is really key: if you’re not building on a foundation of responsible AI, then you’re open to a large ESG risk, both in terms of impacting customers and stakeholders, but also in terms of reputation, as we’ve seen when news stories about this go viral on social media.

Hannah Leach: From the perspective of investors in generalist funds, when we’re thinking about AI, how and where do you think we should be focussing our efforts?

Matthew Sekol: I think the investor level should be focussed on asking the challenging questions as your startups go through the process. You don’t necessarily have to be an ethicist, but you do need to be asking thoughtful questions. It’s similar to thinking through a standard materiality matrix, but focused on the products whilst also going through a stakeholder mapping exercise: what is the product or service doing? How will AI augment it? What are the risks that AI could present? What are the things that could go wrong?

Investors should really be working with the startups, not necessarily at the deep technical level, but asking the right questions to make them think in the right way.

Hannah Leach: In Geoffrey Hinton’s notes when leaving DeepMind, he spoke of the long-term adverse impacts of generative AI — do you think this complicates the framing of the difference between ESG and impact?

Matthew Sekol: So a couple of years ago, Brad Smith, Microsoft’s President and Chief General Counsel, wrote a book called Tools and Weapons. When we think about ESG and long-term risks or opportunities, I always think of Brad’s book because ‘tools and weapons’ is just ‘opportunities and risks’ flipped.

In the book, he basically goes through the evolution of Microsoft in reflection of the technologies that were being developed and implemented along that timeline. What emerges is that every technology has two sides to it — it can be implemented less thoughtfully (or even exploited for harm) or it can be a massive opportunity to capture an entire market and maybe even solve ESG-related problems. Balancing these two sides is crucial and these capabilities have to be understood by those building and using that technology.

Take generative AI, for example. While it presents tremendous opportunities, it also carries long-term risks for the job market. Just this morning, I used Bing Image Creator to generate an image for my newsletter. It quickly provided me with options, and I selected one without needing to consult a digital artist or pay anyone. But it could go even further: someone could commoditise my newsletter by using generative AI to output content based on a prompt. Suddenly, my newsletter becomes obsolete. So, there are risks associated with the effect of the technology itself, and then there are ongoing risks produced by the use of the technology: so for generative AI, content creation requires careful monitoring. As an English major, I hate to think about whether it will displace me, but we never know how good it’s going to get.

Hannah Leach: Well, I think your newsletter should be safe for a little while at least.

Jumping to a very different topic and one you’ve written a lot about: the collapse of Silicon Valley Bank (SVB). We haven’t actually spoken about it at a community level yet, but it’s obviously very interesting to our members and their portfolio companies. What was your take on what happened, and what role did ESG really play?

Matthew Sekol: So ESG played a role in the situation, but not necessarily in the way it was sensationalised on social media. Initially, there was a lot of attention on SVB being labeled as one of the greatest ESG banks due to their climate investment fund, community investments, and emphasis on diversity in their CSR report (which they called an ESG report). However, upon closer investigation, I discovered that there were significant governance issues at play, which are things that the Federal Reserve has also concluded in their recently released report. With the politicisation of the E and the S, governance can often be forgotten, especially in the US.

Simply, SVB was over-leveraged on bonds and lacked the liquidity to cover withdrawals in the case of a run. The bond investments turned out to be losses when interest rates rose, and last year they had to sell them at that loss to cover withdrawals. Compounding the problem, they had no chief risk officer for about eight months and lacked financial risk experience at the board and executive levels. This left them vulnerable during a tumultuous time when bond rates were unfavourable and the startup community has changed significantly — VCs and startups are much closer linked now than when SVB was started forty years ago and withdrawals are much easier with technology, so the bank run could build rapidly.

All of these issues fall under governance, specifically corporate governance principles and how the risk committee is run. Additionally, in 2015, a group of banks and others suggested that certain aspects of Dodd-Frank — the post-2008 financial regulation in the US — should be rolled back. One of those aspects the CEO of SVB expressed concerns about: the threshold number for liquidity and stress tests. Eventually, in 2018, the threshold was increased from $50 billion in assets to $250 billion in assets. The week before SBV shut down, their assets had grown to $212 billion, from around $40 billion in 2015. With the benefit of hindsight, the Federal Reserve has now acknowledged that they probably should have engaged with SBV, considering the risk associated with that exponential growth.

So governance is a critical pillar, and in many cases, it’s the one that can really bring a company down. While environmental and social risks can be managed, even reactively, a governance risk poses significant challenges. Clear governance principles, active advisory boards, and effective risk management are essential to mitigate these risks.

Hannah Leach: You mentioned that the G in ESG is often ignored in the US and I would posit that that’s fairly true in Europe too, particularly when it comes to VC firms, at both the fund level and the portfolio company level. Although, I do think the tide is changing now. What do you think VC firms can learn from the SVB and FTX experiences, thinking about how we operate and the way that we invest in portfolio companies as they grow?

Matthew Sekol: When we look at recent examples like FTX, it reminds me of previous incidents such as Enron and Worldcom, which led to the implementation of Sox regulations in the US. It’s crucial for VCs to bring expertise on how companies are run, particularly in terms of governance, while considering the broader ESG aspects that companies should focus on. Sustainability and disclosure processes can serve an additional purpose here, in giving valuable insights into how startups are operating. However, startups really need that guidance in governance and it goes beyond having a set of principles. One aspect to consider is the composition of their advisory board. Are they relying solely on family and friends, or do they have a diverse range of perspectives? If it is just family and friends, it’s essential to understand the influence dynamics and whether the CEO is open to feedback and input from board members. Navigating the complexities of advising startups and ensuring their decision-making processes are sound is crucial for their success.

It’s worth noting that even corporate boards often lack ESG expertise. Therefore, we can’t expect startup leaders, who are focused on product development and other challenges, to prioritise ESG to the extent they should at the moment. As an ESG advisor, you can bring that expertise to the table and be the one asking the right questions. Pay close attention to how they respond, as their reactions can reveal valuable information about their approach. In conclusion, never ignore governance because it’s the one thing that can take you down, so make sure your startups understand this.

Hannah Leach: Even in the corporate world, people are struggling to find the right sustainability and ESG experts — it seems there simply aren’t enough people in the market. Then in the VC world, we have to find people with startup and venture understanding in addition to understanding ESG, and there really aren’t many people in the middle of that Venn diagram. From your experience in the corporate world, do you have any advice for how VCs and tech companies should be thinking about building that capacity given its growing importance in the next decade?

Matthew Sekol: It’s a challenging question because the current focus is on disclosures. Many companies are seeking expertise in that area. However, startups may be different as they’re unlikely to hire a sustainability person just to do a CSR report, if they even produce one at all. We’re currently in a transition period where sustainability expertise is growing, but there’s still a shortage of ESG experts who can identify risks across the E, S, and G. The long-term goal is to integrate these topics, rather than treating them as separate functions.

I’ve noticed, even at Microsoft, that some people who joined the company after sustainability impacted their industries now lack an understanding of why ESG more broadly is material to their specific industry. For example, in the airline industry, the focus is on sustainable aviation fuel and reducing carbon footprint, but it’s also about the recovery from COVID-19, especially regarding business travel — which is a social risk. So it’s important that the full risk spectrum of ESG is considered.

I think it’s important to have leaders within organisations, even at the startup level, who understand these topics well. They should be able to conduct a materiality matrix and stakeholder assessments to at least communicate the importance of ESG to others in the company. These assessments can be simple and don’t really require hiring consultants. For a materiality matrix, creating a three-by-three grid and charting material ESG factors based on stakeholder importance and company importance is a great starting point. Then for the stakeholder assessment, start with thinking about groups rather than individuals. This work is valuable because there are non-financial factors that can impact a company’s reputation, ability to go to market, or ability to develop successful technology.

This doesn’t require much structured training, it’s really about getting startups in the mindset of thinking through the lens of ESG. Financials are undoubtedly critical, especially for startups, but it’s crucial to recognise the value of non-financial factors as well. By the way, I’m currently writing a book on this topic, aiming to explore how you can get corporates and startups to incorporate ESG thinking into their businesses. The focus on ESG has largely been driven by investors, asset managers, hedge funds, and private equity, but it hasn’t yet fully permeated operational work.

Hannah Leach: Skeptical VCs and founders often ask us to show them the effect of ESG consideration on performance and to show them the data. But unfortunately, since the VC industry has only really been talking about it for two years, we can only reliably point to data in public markets, which sometimes isn’t enough to sway them. So you have to look at other reasons such as pointing to the risks of not doing this and making sure that is understood at the highest levels.

Another limiting factor is time and money: given these restraints on both sides, how do you think investors should be providing guidance to portfolio companies around ESG and impact? Should they be thinking about compliance? Should they be talking about more operational integration similar to GDPR? What are the right levels and the right places to spend that time and money?

Matthew Sekol: Well there are compliance things that you really need to be doing, especially if a startup is looking to build B2B relationships, especially with the big corporates. These companies are now looking at carbon and DEI metrics in RFPs and RFIs and they now form part of their supplier policies. So startups need to consider these as a licence-to-operate in that space and so it’s really key to invest in making sure everybody in the startup is on the same page about that and that the message is consistent.

Hannah Leach: And then how should companies think about actually activating ESG? How do you get people excited about doing the work?

Matthew Sekol: We’re currently experiencing a unique moment in history where employees hold significant power. This power stems from the sense of purpose they feel, which has been driven by a few factors. Firstly, extreme weather events have started affecting regions in the global north, making it impossible to ignore the impact of climate change. Secondly, the COVID-19 pandemic has caused us to reflect on what truly matters, emphasising the importance of family and personal well-being. Lastly, social justice issues have been prominent, particularly in the US.

So while ESG focuses primarily on the impact of the world on the company, there is a fluid intersection with purpose — the pursuit of ESG factors like sustainability and DEI can be motivated by that purpose. Embracing this has a material impact on the company: for example, DEI initiatives positively impact talent retention, attract better talent, and foster more diverse thought within the organisation. So as advisors to other companies, it’s crucial for us to build on this sense of purpose and drive its meaning for the company. Employees are seeking meaning in their work and aligning their purpose with ESG efforts can help retain them. Moreover, it can lead to new opportunities as employees gain a better understanding of stakeholders, perhaps uncovering potential markets or solutions.

Hannah Leach: On the investor side, what’s one piece of advice for ESG people within VC funds who are battling with people who are not onside?

Matthew Sekol: So one piece of clear logic regards DEI. I sit on the LP Advisory Committee of Morgan Stanley’s Next Level Fund, investing in diverse led and founded startups. We’re clearly facing a crisis right now that has pulled back VC funding and that has disproportionately affected marginalised founders. As a result, there are real opportunities being missed: the problems that diverse founders are trying to solve are often unmet needs across broad swathes of communities and often regarding material social justice issues. Furthermore, those founders will teach you so much about what it actually means to solve a material challenge. There isn’t enough investment going there.

Hannah Leach: Do you think that all funds should be ESG funds?

Matthew Sekol: I do, and particularly if we add the T of technology to the end of ESG as a way of thinking about risk and opportunity. That is just core to every startup now and you really have to be managing those material risks and opportunities to be successful.

Hannah Leach: There are so many people who say they have extensive ESG skills and experience, how would you advise a company seeking to kick their ESG into shape to focus their recruitment efforts? And what would be your top competency to have on your leadership team?

Matthew Sekol: That’s a great question that is so hard to answer. It’s difficult because individuals with deep expertise in, for example, environmental science may have a narrow focus and not consider the interconnectedness of environmental, social, and corporate governance issues. For instance, they might switch from a high-emitting carbon supplier in one region to a low-emitting carbon supplier in another region without considering the broader implications for the impacted communities. We can’t approach these complex issues in such a one-dimensional manner.

In terms of finding the right talent, I would go back to something Brad Smith wrote about on his blog, and that’s about the need for people who have adaptive skills, and those are often those with liberal arts and humanities backgrounds. We need individuals who can tackle these challenges in their multifaceted complexity. You do certainly need people who can go deep like those environmental scientists, but fundamentally, you really need that breadth.

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