Going viral

How technology is driving ESG to the next level

Covid-19 has raised the temperature on ESG, while datasets have gone viral. Making sense of what’s material remains elusive, but technology is starting to identify the way forward.

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2 Mar 2020

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The rapid spread of the novel coronavirus or what is now known as Covid-19 has given pause to businesses, especially in the Asia-Pacific. As BCP (business continuity planning) manuals are dusted off the shelves, many are likely to be short on one important section: a holistic approach that links them to the company’s ESG (environmental, social, governance) strategy.

That should not come as a surprise. ESG today is very much portrayed as a force for good – companies responding to expectations beyond the narrow base of shareholders. The other and just as pertinent element of ESG is as a way to mitigate risks. As the Covid-19 outbreak is becoming plain for all to see, business as usual isn’t going to cut it in a globalized marketplace buffeted by rapid adoption of new technology, the re-ordering of established supply chains, climate change and now, biological threats.

With revenues plummeting sharply from makers of smartphones to retailers of perfume, has Covid-19 forced businesses to press the reset button? Beyond the gathering dark clouds is there a silver lining emerging from this global health emergency? Can new technology play a role? Going forward, should companies embed ESG even further, and not just within BCP manuals post-2020?

The conversation has to start somewhere. Within finance, companies in the region have initiated it even as investors scramble to incorporate ESG into their approach to asset allocation. In the aftermath of Covid-19, it should be no surprise if companies, investors and other stakeholders accelerate that process in the months to come.

Indeed, from simply excluding companies that are not ESG compliant some asset managers and institutional investors for instance are increasing their exposure to sustainable companies. In Japan, the Government Pension Investment Fund (GPIF), the world’s largest pension fund, has been integrating ESG factors into its investment process.

The increased focus on ESG in financial markets has resulted in the emergence of ESG raters not only looking at the validity of assets such as green bonds, but also the issuing company as a whole, in an attempt to help investors make sense of the data from companies. The three global credit rating agencies such as Fitch, Moody’s and S&P have each developed their own methodologies in assessing the sustainability merits of a company. Likewise, companies such as Sustainalytics have been cited for their ESG assessments.

But as information continues to grow on green bond issuance, and more widely on ESG practices of companies, the volume and speed in which to process that information becomes even more important. Enter the new age of ESG ratings where technology, in particular machine learning/artificial intelligence (AI), can play a part. One of the leaders in this groundbreaking way of interpreting ESG data is Truvalue Labs.

Founded in 2013, Silicon Valley-based Truvalue Labs is able to provide around the clock data ESG analysis on a particular company. This is in contrast to monthly or even annual ESG reports traditionally produced by analysts. According to Truvalue Labs’ CEO and co-founder Hendrik Bartel, the company aims to aggregate all publicly available data on a particular company, assigning less weighting on the information reported from a company’s annual ESG report.

“At the moment there is no agency that details exactly how you have to report ESG from the company perspective. All ESG data is basically extracted out of company’s self-reported unaudited report that happens once a year,” he observes. “These reports are well made but they don’t have much material information in them. Companies will never disclose all the negative activities they have done but only focus on the positive items. We do this because we see a high number of greenwashing in those reports.”

As an alternative to sourcing ESG information from companies directly, Bartel along with his team opted to take and evaluate commentary about a company from news sources, government databases, NGOs (non-governmental organizations) and social media. “We pull in data from 120,000 raw data sources and we are doing this in several languages including English, French, German, Spanish and Japanese. We are looking to add Mandarin and a number of other European languages to our system in the future,” shares Bartel. At the moment, Truvalue Labs covers approximately 16,000 securities spanning 12 years’ worth of data.

For asset managers ESG is being seen as the new competitive advantage, encouraging their drive to be connected to as many relevant alternative data sources. “You need to have ESG data in order to stay competitive,” highlights Bartel. “I think some of our clients are starting to realize that they will never have enough analysts to start focusing on this. They are starting to look for technology driven scalable solutions in order to augment their analysts and allow access to a broader universe.”

During the past seven years of operation Truvalue Labs has been able to onboard a number of notable names to its list of more than 50 clients including State Street, RBC Global Asset Management and GPIF, helping them in analyzing their ESG investment decisions. “Our clients get this kind of data in real-time rather than waiting for an ESG rating change from one of the big agencies,” says Bartel.

Truvalue Labs is not alone when it comes to increased technology usage in ESG evaluation, with companies such as MSCI basing their ratings on artificial intelligence and alternative sources of data. According to some investors, the increasing use of technology in ESG analysis is giving them a chance to retool their approach towards investments. “What most ESG analysts are doing is looking at all the bad things companies do and try to exclude that. It’s a very rough job. What companies are doing now is not excluding the companies that don’t fit your value system, it’s including the companies and adding more weight to the companies that do fit,” explains Daniel Gerard, head of investment and risk advisory, Asia Pacific at State Street.

But what led to this point of looking at ESG metrics? One only needs to look back more than a decade ago to the period of volatility and greed that marred the financial industry. For many, the global financial crisis was a watershed moment that highlighted not only the need for corporate transparency, but also opened the possibility that financial products could be positively used to impact the wider community.

Issued by the European Investment Bank in the summer of 2007, the world’s first green bond, also dubbed a climate awareness bond, was the first-time bond proceeds were specifically directed towards environmentally friendly projects. It represented an encouraging step for the financial industry against the predatory sub-prime loans of the past. In 2019 total green bond issuance hit a record US$254.9 billion in issuance, an increase of 49% from 2018 according to data from the Climate Bonds Initiative (CBI).

Positive steps forward

While the emergence of ESG ratings is a step in the right direction for the finance industry, there are inevitably several challenges that need to be tackled, such as clarity on definitions of what being an ESG compliant company entails and which international body sets the standards.

In addition, to the absence of international unified ESG standards there is also a low correlation or divergence among ESG ratings from different providers in the market. A recent white paper by MIT (Massachusetts Institute of Technology) titled “Aggregate Confusion: The Divergence of ESG Ratings” revealed that there were noteworthy differences regarding how ESG raters scored the same company.

Specifically, the paper looked at how different ESG raters were accessing companies based on scope (if raters are looking at the same items), weight (if raters are placing relative importance on certain attributes) and measurement (if raters are measuring the same items).

They concluded that 53% of total differences in ESG ratings were based on measurement while 44% was due to variances in scope. “Raters disagree both on the extent of the definition of ESG as much as they disagree on how various aspects of ESG are measured,” states the MIT whitepaper. Interestingly, only 3% of diversion was the result of weighting, highlighting that importance on ESG items was generally uniform across raters.

Efforts, nevertheless, have been made to address the lack of clarity and divergence issue. In the United States for example the Sustainability Accounting Standards Board (SASB) has crafted guidance on sustainability best practices based on the context of the industry they are operating in.

According to SASB they have 77 specific industry standards spanning consumer goods such as e-commerce to transportation including airfreight and logistics. A meaningful move as ESG or sustainability scores given to companies should be viewed in the operating environment they are working in. Moreover, while these standards apply to United States-based companies there ideally should be an effort to start this conversation internationally or with the actual ESG raters themselves.

“To change the situation, companies should work with rating agencies to establish open and transparent disclosure standards and ensure that data is publicly accessible. If companies fail to do so, the demand for ESG information will push rating agencies to base the creation of the data on other sources prone to diversion,” advises the MIT whitepaper.

Covid-19 could be the wake-up call companies needed to reassess their policies and overall approach towards technology and the effective integration of ESG data which will have critical impact and long-lasting ramifications for the future. 

Date

2 Mar 2020

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