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Supplier assessment

Client Profile

Business Overview: A US-based online furniture retailer.

Business Need: The client was looking for an ESG research firm that could help the client in the following areas:

  • Design a CSR methodology to evaluate and rate its suppliers;
  • Develop an excel based tool to conduct the research;
  • Conduct an evaluation of 50 of its largest suppliers and provide a rating.

Offering

  • Sustainometric designed a methodology and raking grid to evaluate client’s suppliers on the most appropriate indicators around labor standards, health and safety, code of conduct and environment;
  • Designed an excel based template to collect information and generate automated scoring;
  • Prepared four pager company reports based on each supplier’s performance.

Business impact

  • A robust supplier CSR assessment framework comprising the most appropriate indicators;
  • Completed supplier assessment without hiring any additional employee in the procurement team.
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Revenue quantification and ESG assessment

Client Profile

Business Overview: A global index provider, specializing in sustainability-driven indices.

Business Need: The client was looking at moving away from existing data provider to:

  • Gain control over data which could then be leveraged across various other products
  • Focus on key tasks such as refining methodology, understanding market trends & new product development

Scope of Engagement

  • Assessment of ~500 companies on Environmental, Social & Governance parameters
  • Exposure analysis: Identifying risk exposure based on companies’ key revenue-generating activities
  • Country analysis: Simulating risk exposure based on company’s presence in various high-risk countries
  • Negative screening: Quantify revenue exposure to certain activities that do not meet ethical criteria

Business impact

  • Ready access to trained staff which enabled setting-up 5 people team on a short notice of 5 weeks
  • Significant reduction in costs with the ability to use collected data across various product streams
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ESG integration

Client Profile

Business Overview: The client is a UK based asset management division of a leading Australian financial services company. Through this engagement, the client wanted to supplement its fundamental analysis with ESG analysis of stocks under coverage.

Scope of Engagement

  • Analysing portfolio companies across 10 sectors on environmental, social and governance parameters
  • Updating the client’s existing methodology with most relevant ESG indicators for each sector
  • Setting-up an excel template to extract data on pre-defined indicators from external ESG database and developing a scoring scheme to rate companies on these indicators
  • Preparing a brief summary of companies’ sustainability performance and key highlights from Y-o-Y comparison for ‘Top 5’ companies
  • Geographical scope: Global.

Business impact

  • Access to trained associates with prior experience in sustainability research.
  • The client’s stock portfolio now integrates ESG analysis along with traditional fundamental analysis.
  • Helps the client make better-informed decisions thus ensuring higher long term returns and lower portfolio risk
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Palm oil benchmark

Client Profile

Business Overview: A non-profit organization that rates palm oil companies (producers and traders) to enable investors and supply chain stakeholders to take informed decisions.

Business Need: The client was looking for a partner who could help them in the following areas:

  • Improve and expand coverage of the existing rankings and new rankings for other commodities.
  • Improve data dissemination by understanding investors’ needs.

Scope of engagement

  • Annual evaluation of palm oil producers and traders on client’s defined methodology.
  • Developing a dynamic dashboard and data download formats to suit the needs of various users such as investors, NGOs and companies.

Business impact

  • Successfully expanded coverage without increasing headcount and optimized research cost due to no fixed cost during the lean period.
  • Improved data dissemination
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AI outlook in ESG Research

Sustainability concerns are making noise in a post-COVID world, but the difficulties involved in extracting and analysing the non-financial information to facilitate informed decision making in ESG investing and sustainable finance present a challenge. Artificial intelligence algorithms offer a solution by improving the efficiency and effectiveness of the data extraction processes, but the challenges of ESG reporting implies the element of human judgement is not going away soon. This article takes a closer look at this intersection of artificial intelligence and sustainable finance.

With the discourse on sustainable finance and ESG investing accelerating following Covid-19, the discussion surrounding the challenges to extract and analyse non-financial material data has also picked pace. This is where artificial intelligence, a branch of computer technology that leverages data to automate complex tasks, holds tremendous potential to improve the efficiency and effectiveness of data mining and analysis. Artificial intelligence (AI) has seen significant impetus in recent years as part of the 4th Industrial Revolution to leverage digital mechanisms for socio-economic development; and it is only opportune to utilize its merits to deepen sustainable finance and ESG investing.

But how does AI revolutionize the way financial companies deal with data?

First, AI can make data extraction more efficient. Reporting frameworks for sustainability or non-financial data vary from each other, both in content and in their applicability per jurisdictions. And since most disclosures are unaudited, the consistency of the reported data varies between companies, further complicating the extraction process and making intra-sectoral comparisons unreliable. Moreover, a lot of non-financial information is often found on third-party sources or unstructured data sources, which adds to the time taken to identify and compile the information. AI technologies can help scrape these multiple sources of information for keywords and data, thus extracting granular information at a far rapid pace as compared to human analysts. That would also aid the comparability and consistency of the extracted information. Once the algorithm’s process is set, the AI bot can repeat it multiple times at fast speeds, despite the sources having large volumes of irrelevant information.

A part of this pertains to small companies, be it small-caps in ESG investing or smaller-issuers in sustainable finance fundraising. Most large companies anyway publish sustainability reports as per the industry’s reporting frameworks, often to boost their branding as a corporate citizen. However, the small companies who often do not report material non-financial information present a challenge; and this is where the ability of AI to quickly extract relevant data and keywords from third-party sources becomes even more relevant. Why so? Because as the interest around ESG investing and sustainable finance deepens, the financial sector will have to expand beyond the large-caps and large issuers to the smaller companies, just like small-cap funds are launched in traditional investing once the investor demand pushes the valuations of the large-caps to the roof or their fundraising needs are met.

Next, AI can make data analysis more effective. It is capable of qualitative and quantitative analysis. Qualitative because it can correlate the financial data with the captured non-financial information to help the investing decision process, can make informed investment decisions based on this analysis. Quantitative because it can power quants-based funds and indices entirely; AI is anyway being used heavily by the hedge fund industry for quants-based strategies.

Last, AI can enable profitable investing decisions. A secret sauce of making profitable investments is timing! Using AI will not only help the financial sector screen companies for non-financial information faster with more accuracy than fatigued human analysts. This combination of speed and accuracy would lead to better timing in investments, thus translating into improved profitability!

Despite its merits, there is a need to exercise caution.

First of all, technology cannot be used in isolation. Given the inconsistencies between the data reported, disclosure methods and sources of information, we cannot just rely on technology. Some human intervention is still needed for judgement and analysis in order to understand the accuracy of the information. An element of engagement with the company reports is also needed to dig deeper and reaffirm the methodology behind the reported data. Perhaps as AI technologies evolves further, the human need will be eliminated. But we are still some time away from that.

A follow-up argument to this human vs. technology debate also connects with cost. The US and European financial sectors have seen significant mid-office (analyst-level) work offshored to emerging markets like India, Philippines and Sri Lanka which offer a cost advantage in terms of the analyst workforce. This needs to be compared with the probable cost-saving the sector can gain by using AI technology for data extraction instead of human analysts, however this will make sense only with extremely large universe. This arithmetic cannot be forgotten for sure.

Second, AI technologies that exist today for ESG data extraction are still unable to solve the issue of greenwashing, an eternal criticism the ESG space faces given the inconsistencies in reporting frameworks and the voluntary nature of the disclosures. Most non-financial reporting are unaudited, fuelling further the fire of greenwashing. AI technologies that can tackle this issue will be the real game-changers in this business.

Next, AI algorithms are strengthened as more and more historical data is inputted for that algorithm to learn from (called machine learning in technology parlance), which reduces its error-rate overtime. Since ESG and sustainable finance is still evolving in most geographies, there may be a dearth of historical data; hence the output of the algorithm would have an error-rate. That also necessitates human supervision. Also, simply depending on historical data may not suffice.

Also, many regulatory changes (ergo regulatory risks) on sustainability are still anticipated. That necessitates the fund managers to take a forward-looking view as well, not just use technology to scrape historical data.

Finally, there is still a talent gap at the intersection of technology, statistics, finance, sustainability, and social sciences, all being critical components to build a sustainable future. Even many Board members are still not fully conversant with ESG guidelines. That makes the human intervention tough as it is.

But despite these immediate headwinds in depending excessively on AI technology, the long-term advantages offered by AI offer a clear rationale to weave it within our sustainable finance and ESG investing initiatives. As the abilities of automation and algorithms improve, the day may not be far when AI even becomes capable to not only identify and extract the relevant information, but also audit the material information and deliver critical insights without any human intervention. And with the post-COVID economic slowdown reorienting the focus of companies and governments towards lean-cost solutions, the long-term cost advantages offered by AI might also offer an economic rationale to do so.

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EU Taxonomy must address two key concerns to create long-term impact

Image Source: https://unsplash.com/photos/0NRkVddA2fw, photo by Guillaume Périgois.

While the EU Taxonomy augurs well for a green future, concerns around the availability and measurement of the data needed for disclosures coupled with the confusion to issuers and investors as it is yet another framework in a marketplace already crowded with disclosure frameworks must be assuaged. That will hasten better alignment with the Taxonomy and help create a greener Europe in the long-term

The recent update surrounding the EU Taxonomy should augur well for the progress towards a green future. But for issuers and investors who must traverse that journey, it also raises certain concerns around the companies’ sustainability reporting practices and the ESG investments that uses sustainability disclosures as the basis for their investing decisions.

Let us take a step back to see quickly what the EU Taxonomy strives for. It enables companies and institutional investors operating in the EU or the UK to classify projects to be able to define the environmental performance of those economic activities. As per the Taxonomy, each project needs to be classified into one of the six broad economic activities namely climate change mitigation, adaptation, pollution, circular economy, water, and biodiversity, while ensuring no major damage to the other five. The projects must also comply with the basic safeguards and EU’s technical screening criterion. The Taxonomy obliges issuers to disclose their turnover/costs and investors to disclose the extent of their investments that are in line with this classification. The broad motive is to align projects better towards a low carbon future and enable better decision-making for economic activities.

How does this impact sustainability reporting and ESG investing?

While some details are awaited before the taxonomy becomes mandatory from next year, it might be opportune to see how sustainability reporting practices and ESG-oriented investing might get impacted.

The first and foremost challenge for issuers is about the reporting frameworks. An issue with sustainability reporting globally are the varied standards and frameworks, and the ensuing confusion on what to adopt whilst balancing transparency and compliance costs. The EU taxonomy may add to that. One difference worth mentioning here is the taxonomy is a mandatory disclosure while most other frameworks are not. Mandatory compliance might position the taxonomy as a more generally accepted non-financial reporting standard, with the others layering over it. For instance, EU companies that want to report further on climate risks may add TCFD or CDP disclosures to their EU taxonomy reporting on green projects. Voluntary nature of other frameworks often results in inconsistencies in the disclosures across companies, making sectoral comparisons tough for financiers. This may be partly rectified if the taxonomy’s methodology is followed consistently across. Of course, a lot depends on item-wise comparison of the reporting requirements between the taxonomy and other frameworks, to understand how much of it overlaps.

The other is about data. The taxonomy encourages more disclosure, reducing greenwashing by the issuers and investors. But more disclosure implies more data. The challenge is whether granular data required to assess a project are available and accurate; and if not, the cost to prepare such taxonomy relevant data could be a daunting exercise. As it is, revenue/cost segmentation by business-lines is hardly standardised across companies, and segmentation on green and non-green basis may be unavailable in most cases. Mid to small sized firms may find limited resource and ability to compute it. Moreover, the taxonomy involves metrics very few companies might be reporting currently, say biodiversity loss or noise pollution, which are tough for companies and investors to compute. Such companies may need the help of ESG research and consulting firms, who have the expertise to collect or estimate a firms’ performance on focused metrics and can assist in filling the gaps in disclosure, which will naturally come at a price. In any case, disclosure per taxonomy-criteria will be necessary for companies so that they do not end up being excluded from the investment universe for the lack of proper reporting.

ESG-oriented funds must disclose their policies on how they integrate sustainability risks into their investing decisions and how they look at the sustainability impacts. This transparency might help further filtering of greenwashing tactics. However, ESG rating models are not standardised and each fund or rating agency prefers its proprietary models, making ratings incomparable for the same company. Thus, the taxonomy may force them to adapt their ESG-data questionnaires and processes in a way that brings more consistency in the way the data is used and modelled, improving comparability. Again, matching the taxonomy’s criteria to the model’s variables might require specialized consulting assistance.

While ESG-oriented investing assets have grown steadily to over $40 trillion, mostly centred in the developed markets, surveys show millennials are evincing interest in sustainable and values-based investing, implying adherence to frameworks like the EU taxonomy might bode well for companies and investors who are mindful of the growth drivers.

While the taxonomy adds compliances and a hunt for granular data, it clarifies eligible activities so that capital flows can be reoriented to hasten the long-term vision of a green Europe. Greenwashing and inconsistent disclosures were making this road longer. Private capital is only going to come into more demand to meet the SDGs, since public spending, aid and philanthropy remains woefully short. Strengthening the sustainability yardsticks for capital, which the taxonomy aspires for, may be an apt thing in such circumstances. If implemented effectively, the taxonomy might supersede or streamline other disclosures, easing compliance in the long-term. With the Commission expected to publish a report by December 2021 on the provisions that would be required to extend the scope of the Taxonomy to social objectives, the direction in which EU policymakers are thinking is clear. Those adapting their data processes and ESG questionnaires quickly, be it with external assistance or internally, might enjoy the first-mover advantage in Europe’s rapidly evolving responsible investing landscape!

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Uncluttering the reporting landscape with TCFD recommendations

Quick Read:

  • Growing investor scrutiny continues to push businesses into a chaotic and convoluted reporting landscaped with no clarity on the what’s and how’s of strategic discussions on their approach towards climate change reporting;
  • The TCFD recommendations are a universal set of financial disclosure guidelines designed to enable systematic and comprehensive reporting on climate change related business risks, and their subsequent strategies;
  • Better informed and impactful business valuation by mainstream investors is the final culmination of the Task Force and its recommendations;
  • Need to steer the conversation from whether businesses should accept the TCFD recommendations to how to ensure their successful integration into their annual business and financial filings.

Responsible business practices and an elucidation of business performance on environmental, social, and governance parameters is no longer just a cause for passionate idealistics driven by good karma and make-a-difference zeal. On accounts of transparency and accountability, businesses are finding themselves at the receiving end of local and international pressures to discuss and deliberate their strategy to address the most pressing and rattling challenge of our times – the Climate Change. Climate Change linked risks are increasingly being viewed as a make or break opportunity for businesses to either flourish or perish away. Nevertheless, amidst the growing investor scrutiny, the clarity on the what’s and how’s of these strategic discussions remains chaotic and convoluted.

Sensing this unwarranted roadblock, the Task Force on Climate-related Financial Disclosures (TCFD) were introduced by Mark Carney, Governor of the Bank of England and Michael Bloomberg, at the G20 Summit in 2015. The TCFD are a universal set of financial disclosures designed to enable systematic yet comprehensive reporting on climate change related business risks, and their subsequent strategies. Bridging the gap between the businesses and the investor communities, the Task Force is aimed to help the latter gain a better insight into their investee’s business response to climate change, and thus make a sagacious investment decision.

Let’s see how the TCFD works and how it helps unclutter the reporting mess.

The TCFD Way

Unlike the plethora of reporting formats and recommendations, the TCFD does not only highlight the impact of business activities on the environment; it also focuses on the impact of environment on a business as well. Better informed and impactful business valuation by mainstream investors is the final culmination of these reformed disclosure diktats.

The TCFD streamlines disclosures within the annual filings on four key areas:

  1. Governance

A commentary on a business’ governance i.e. management & the Board’s role in assessing and thus, managing their exposure to climate change linked risks and opportunities.

  1. Strategy

Business’ subsequent approach to address actual and potential climate related risks and opportunities, and the latter’s impact on the business, its corporate strategy, and financial planning thereof. Here, businesses are also encouraged to assess their business resilience in conjugation with different climate-related scenarios.

  1. Risk Management

As the word says, it’s the discussion on existing risk management procedures i.e. identification, assessment, and management upheld by the business with specific reference to climate change, and with further integration to the organisation’s overall risk management framework.

  1. Metrics & Targets

An elucidation of metrics and targets employed by the business to measure, assess, and manage climate change linked risks and opportunities for corporate strategy formulation. Here, the businesses are recommended to disclose information on their Scope 1, Scope 2, and if relevant Scope 3 GHG emissions and the related risks.

The TCD leverages the existing modalities within business processes without creating an additional reporting burden. They are flexible and voluntary (except for PRI signatories who will be mandated to report on the strategy and governance indicators come 2020), yet fully equipped to enhance a company’s resilience towards climate change.

 Why does it matter?

Reporting on climate change resilience is often viewed by companies as an opportunity for them to disclose their direct or indirect impact on the environment. For instance, the routine environmental reporting by around 6,500 companies on the well-acknowledged and accepted Carbon Disclosure Project. However, the need is for the companies to understand how, where, and when climate risks can open an unwarranted vortex of unpredictable strategic and operational risks for them. While, there are many reporting formats that aim to help companies better adopt integrated reporting, which is slated to cut the clutter from their annual filings; what they miss by a wide margin is the investor’s increasing need for not only greater clarity and transparency, but also the business case of climate change. According to the European Asset Allocation Survey, 2018, the number of investors upholding climate change linked risks and opportunities in their investor agenda increased from 5 per cent last year to 17 per cent in 2018. Investors acknowledge that companies are increasingly being exposed to a range of physical, regulatory, and marketplace risks linked to exacting climatic uncertainties, something that can be detrimental to their business viability. And, these risks are expected to get aggravated a lot sooner than expected due to a rapid transition to a low-carbon economy. And, amidst this growing critique, businesses are often found to go out on a limb without clear and standardised reporting requirements.

The TCFD offers that much needed respite in the form of a voluntary framework supporting consistent disclosures on physical, liability, and transition risks associated with climate change. It offers businesses an opportunity to exhibit social consciousness of a business while taking relevant issues head-on and demonstrating ability to manage and adapt to climate change. In the eyes of the investors, it gets viewed as a proactive publication of financial data pegged to a climate change risk profile, which paves the way for a valued long-term partnership.

Nonetheless, an effective adoption of the TCFD recommendations demands internal collaboration amongst different departments (viz. finance, risk, investor relations, legal, and sustainability) to create an environment that fosters integrated thinking and holistic implementation of climate change strategic decisions.

Our take on TCFD

The TCFD is not touted as the be-all and end-all solution to the existing reporting woes. According to the TCFD 2018 Status Report, the climate-related financial disclosures are still found to be in the nascent stages of adoption. While, the businesses are gradually moving toward reporting on climate related information, only a handful of the assessed companies taken from the pool of largest companies in eight specific groups including Banks, Insurance Companies, Asset Managers, Asset Owners; Energy, Transportation, Materials & Buildings, Agriculture, Food & Forest Produce are able to report on their direct or indirect climate impact. Even fewer companies are able to elucidate their business resilience under different and exacting climate change scenarios.

Therefore, an integration of the Task Force’s recommendations into existing financial and annual reportings along with ESG criteria needs a better understanding and development of:

  • a sound leadership to propel a wider acceptance of climate change issues into corporate strategy and financial analysis. For tactical measures, incentivisation of board members and the management is suggested to be taken first as a reputational issue for them and the business alike, and later as a strategic move.
  • integrated risk management systems evolved to move beyond management of conventional risks toward risks and challenges that come with transition to a low-carbon economy and business models.
  • a clarity on climate risk assessment and scenario analysis to address the TCFD recommendation – ‘describe the potential impact of different climate scenarios, including 2 degree C scenario on the organisation’s business strategy’. And, this translation of outputs of climate change scenarios into concrete business and financial impacts requires a thought out strategy.

To conclude, the TCFD recommendations are designed to offer a clear and comprehensive direction to the otherwise muddled reporting landscape. They uphold the accepted view on disclosure practices i.e. the Context matters. The TCFD aids in internalisation of varying context inherent to sectors and organisations and serves as a single vernacular of climate change linked risks and opportunities while cutting the clutter out of reporting landscapes. Therefore, the need is to steer the conversation from whether businesses should accept the TCFD recommendations to how to ensure their successful integration into their annual business and financial filings.

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For more information, please contact – hello@sustainometric.com

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Mirror mirror on the wall (street), how fair are the ESG ratings, after all!

Quick Read:

  • Inadequate understanding of ESG Rating approaches fuels cynicism on its merits and validity to steer sagacious investment decisions.
  • For integration of ESG issues into ratings – Materiality Matters and ‘One Size Doesn’t Fit All’.
  • Company’s exposure to ESG related risks and opportunities not conjugated with its ability to produce an enhanced sustainability report.
  • ESG Rating is not a Certificate of Virtue but a tool to flag outliers masquerading as vulnerabilities
  • Do not treat ESG Ratings as settled facts isolated from their context; its an output of a research pegged to a comprehensive methodology

 

 The popularity and acceptance of Environmental, Social, and Governance (ESG) targeted investment strategies has accelerated significantly over the past decade. But, so has the cynicism around its merit and accuracy in driving sagacious investment decisions. Some label it as a system fraught with inconsistent and subjective methodology, while others argue over its inherent bias, and incapacity to timely predict and integrate ESG signals in to a final rating (such as BP’s Deepwater Horizon oil spill and Volkswagen emissions scandal). Incidentally, a predominant share of this criticism is based on a myopic and often an inaccurate understanding on the workings, differences, and the premise of ESG rating approaches.

Some of the areas of contention targeting the ESG ratings and our assertion in defense are examined below.

  • Materiality Muddle

Investment relevance of ESG considerations is often the top cited criticism against the ESG based investment strategies. A generally accepted view is that while ESG ratings ends up covering a wide array of issues, they seldom cover a material ground. Proponents of this contrasting standpoint bleat on about either too little material data or too much of immaterial information. While, the deduction is intuitive, its logic is based on an outdated definition of ESG ratings that focused more on screening than analysis, and solely relied on company disclosures than on an investigative library of data. The historical ‘rating’ methodology, which is the basis for the (lack of) ‘materiality’ argument, followed a all-in approach where quantity of ESG factors subjugated their quality (relevance). But the tide has turned, and now the matured ESG methodologies employ advanced analytical tools and modelling techniques covering issues in multiple dimensions over a comprehensive database. Rating agencies and ESG investors are aware of the subjective relevance of ESG factors specific to industries and companies, which gets captured into their comprehensive ESG scoring frameworks that are sensitive to these variations. Further, their is an undeniable, unanimous acceptance and acknowledgement that less than 25 percent of the data points in the traditional ESG scores meet the criterion of materiality.1 A growing share of organisations have already started using materiality maps designed by the likes of SASB (Sustainability Accounting Standards Board) to streamline a list of relevant and material ESG issues across their investment portfolio. Industry working groups such as the Task Force on Climate-related Financial Disclosure (TCFD) and sustainability reporting organizations (GRI, CDP) are persistently working towards an expedite adoption of a set of comparable and consistent disclosure vernacular that companies can appropriate to their respective business lines. Additionally, companies are increasingly being encouraged to identify, actively intervene, and report on material ESG issues that can potentially have a direct impact on their bottom line, and thus enable investors to make a discerning investment decision.

In a nutshell, the adage ‘One Size Doesn’t Fit All’ is succinctly applied and suggested as a clarification to the naysayers of ESG influenced investment decision.

  • The Timing Argument

Another common argument against the relevance of ESG factors is around their ability to reflect the potential risks, which in turns leads to misleading financial valuation. The alleged oversight of events can be attributed to investors’ inability to fully comprehend the differences in ESG reporting and rating approaches. Case in point, the 2015’s Volkswagen Emission Scandal. A cursory understanding of the German automaker’s high ESG rating is argued to be a misnomer from most raters who failed to highlight the possibility of an emission evasion scandal that eventually ensued. However, since 2007, the company was rated consistently low (amongst lowest quartile) on its corporate governance criterion by different raters such as Thomson Reuters, Sustainalytics, and MSCI. The deception stemmed on accounts of poor governance and not environmental performance per say, which was misinterpreted by the ESG skeptics. Volkswagen’s governance issues were very much a public information, erroneously missed by the investors’ community. Therefore, labelling such an event as a failure of ESG investing is grossly misplaced and misleading.

The ESG investing opposers propagate a flawed role of ESG factors in investment decisions. ESG ratings are not designed to operate as a radar of fraud or a predictor of future. On the contrary, they should be viewed as a tool to flag outliers that masquerade as inherent system vulnerabilities with susceptibility to ethics breaches, litigation, and other adversaries. The ESG methodology is a means to an end of ascertaining critical intangibles associated with operational integrity and risk oversight, something that is otherwise equivalent to finding a needle in a metaphorical portfolio haystack. ESG Rating should not be viewed as an absolute objective truth when they are essentially a series of researched and thought out opinions that do not command blind following.

  • Bleating About Bias

ESG Ratings are vehemently deplored for operating on an innately biased premise. Let’s look at individual arguments. It is asserted that companies with higher market capitalization and large CSR departments tend to get better ESG rating than their mid to lower market cap peers. And, often the rationale for the critique is based on the supposed bias in the rating agencies’ methodology, which allegedly overemphasize the differences in resources devoted by respective company types towards preparation and publication of annual ESG disclosures. However, a robust ESG Rating model does not uphold this naive approach. It maps the basic business segment information with area specific data inputs. For examples, in case of MSCI ESG Rating, biodiversity data points are mapped to information from The Nature Conservancy, and WWF; toxic waste to inputs from Toxics Release Inventory, labor statistics from ILO, and so forth. In short, no analysis is ever conducted detached from reality and the objective facts. A company’s exposure to ESG related risks and opportunities is not conjugated with its ability to produce a bedecked sustainability report. Similar critique is directed towards the bias of ESG Rating towards geographies with stringent reporting requirements such as in Europe, say when compared to those in North America. Here the issue is more of the quality of reporting than the qualification of ESG Rating as a guidance to drive investment strategies. In a 2016 study by Schroders, it was observed that 58 percent of European fund managers positioned ESG factors as a critical consideration for an astute investment decision, meanwhile, only 14 percent of their US counterparts said the same.2 So, in reality it’s the investor sentiment and demand that is driving the growing heed to ESG factors in corporate reporting, and not the other way.

  • Subjectivity Syndrome

The root cause of inefficacy loosely attributed to ESG Rating converges to a central theme of subjectivity in methodology and analysis. A lack of convergence in ESG measurements is averred at a granular level i.e. how E, S, and G factors are dealt in definition and examination. And, since there are no standardized rules for environmental and social disclosures, it is alleged that companies can and they do compensate for weak ESG practices with robust disclosures that often omits critical non-financial data. In an utopian self-serving scenario, the above argument might hold water, nevertheless, more systematic reasons are found to be at play behind observed divergence in scores for the same company or between two companies across rating agencies. Again, one should not forget that ESG Rating does not claim to issue a certificate of virtue to a company’s performance, it is in fact an indicator of vulnerability as gauged by the methodology followed to ascertain a certain score/rating, and that is where the entire discussion needs to be steered. Just like there is no single way to analyze ‘hard’ financials or risk-return measures of an investment, similarly, no absolute ESG score exists for a company. Every rating agency operates on an individual understanding on different views of past and future with varied access to data, therefore, there will always be legitimate and acceptable differences in how they define, measure, evaluate, and report E, S, and G for a company. For instance, FTSE maintains two different sets of databases, one catering to companies’ ESG performance in operation, and other to their Green Revenues i.e. their contribution to the green economy, as both can sometime be mutually exclusive realities. Therefore, it is for the investors and the data users to determine and internalize such differences in approach and ratings, and not for the rating agencies per say. The onus of objective integration of ESG Rating into an investment decision stays solely with the investor.

By a learned mind and an experienced investor, ESG Rating should be read in the same stride as an investment analyses i.e. as a Fact-based Opinion. Essentially, ESG ratings are not advisable to be treated as settled facts isolated from their context, which is an output of a research pegged to a comprehensive methodology. This means it is imperative for an investor to understand the backend rating process and the indications it generates. To conclude, within the context of mainstreaming of ESG ratings into investment decisions there is only one caveat –

Don’t judge ‘the score’ without understanding ‘the signal’.

  1. “Materiality Matters: Targeting the ESG Issues that Impact Performance.” 10 May. 2018, https://corpgov.law.harvard.edu/2018/05/10/materiality-matters-targeting-the-esg-issues-that-impact-performance/. Accessed 22 Feb. 2019.
  2. “Global Investor Study 2016 – Plan Sponsors – Schroders.” https://www.schroders.com/en/sysglobalassets/digital/insights/2016/pdfs/global-investors-study-pension-funds.pdf. Accessed 22 Feb. 2019.

Photo by: Rick Tap on Unsplash

For more information, please contact – hello@sustainometric.com

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ESG to SDGs: Connected Paths to a Sustainable Future

Quick Read:

  • The United Nations’ Sustainable Development Goals are increasingly being viewed as an opportunity to usher in a new and refined age of affirmative action through responsible investing.
  • A broader level mapping of investor’s existing ESG considerations employing SDGs as a practical framework would help in mainstreaming the former’s granular acceptance and also anchor responsible corporate behaviour.
  • SDGs though being more thematic than corporate centric, can help in aligning sector and company specific ESG factors with broader societal and environmental goals.

While the UN Sustainable Development Goals (SDGs), adopted as part of the 2030 Agenda for Sustainable Development, require no highbrow introduction, their successful fruition unarguably demands a systematic assessment of strategies appropriated by investors and corporates alike.

SDGs did not enter the global lexicon until 2015, nevertheless, in past decades, investors are known to have directed their focus and concerted efforts towards ‘Socially Responsible Investments’, essentially designed on an early premise of ‘social screening’ that had enabled them to weed-out companies with detrimental business models and/or obvious exacting impact on the environment and the connected communities. Further, post the embodiment of ESG (environmental, social, and governance) issues under the UN Principles of Responsible Investment in 2006, investors better aligned their interests and strategies with the broader objectives of society, and set the tone for mainstreaming of ESG investing. Not surprisingly, today, the global initiative has over 1,600 signatories representing over USD 70 trillion in assets under management, a remarkable growth on a global scale.

Yet, despite this exhilarating market response, often corporate participation and actions are found to fall short on both commitment and output, which is invariably linked to their inability to integrate sustainable business practices into their corporate strategy. Both investors and the corporates are argued to face roadblocks in thought and direction to further their capital utilization for impactful societal and environmental changes. So, while ESG investing did pave the way for accelerated market transformations and for the better, a tangible gap has been consistently noted between the potential investment opportunities and their realization.

Providentially, in 2015 the global investment scenario underwent a pragmatic shift with the advent of the 17 Sustainable Development Goals by the United Nations. Their inherent granularity rendered the requisite flexibility and universality that could enable investors and the private sector players to understand and address the pressing sustainability challenges pertaining to their business models while meeting their fiduciary duties.

Notwithstanding their global acceptance and undeniable relevance, many stakeholders are still seeking answers to the questions on what is the investment case of SDGs? If and how they can impact the investment strategies, corporate responses, policy action, and more importantly, how the existing frameworks of ESG investing can be scaled to meet the new global targets of sustainable development? Let’s delve!

SDGs Business Case and ESG Facilitation

SDGs outline the pivotal areas of impact and offer a practical framework to complement and support the ESG considerations, which are part of investors’ existing fundamental research methodology. In other words, SDGs help in mainstreaming the granular acceptance of ESG based investment decisions while anchoring their wider reach in corporate circles. Let’s look at the overarching linkages between the investment case for SDGs and ESG driven investment decisions, and how they can lead to tangible consequences for both the investors and the corporates.

  • Universal Acceptance and Scalability

SDGs were formulated to bring a global consensus on pressing and pervasive social and environmental challenges, which thereby rendered them universality in application and scalability in context, to gauge the impact of ESG investment strategies.

Henceforth, investors have shown overwhelming endorsement of investible SDGs by augmenting the purview of their responsible investment portfolio and seeking intersections with the goals and their corresponding targets. Through mapping of SDGs to their existing ESG considerations, directing capital flow toward positive and measurable impact, and driving accountable and responsible business behavior from investee companies, investors are endeavoring to give a broader context to their current business engagements. For instance, the Dutch pension funds managers PGGM and APG Asset Management have tenaciously formulated taxonomies identifying the demonstrated areas that can be considered as Sustainable Development Investments (SDIs) and can help to create a market standard for such investments across 13 of the 17 UN SDGs. Thus, setting out investment routes to their achievement. Further, 18 Dutch financial institutions with signatories such as ABN-AMRO, Achmea Investment Management, Aegon PGGM, Rabobank, Robeco and more, have launched a SDG Investing Initiative (SDI) to facilitate action in four broad areas – accelerating SDG thematic investments through systematic deployment of blended finance instruments; mainstreaming SDG centric investments amongst Dutch retail investors; supporting integration and uptake of sustainability standards and indicators; and identifying and addressing regulatory barriers and incentives to SDG investment. Meanwhile, the Swedish International Development Cooperation Agency (SIDA), a government agency has formed a partnership of 18 institutional investors, pension funds, and investment companies, called the Swedish Investors for Sustainable Development (SISD) to explore investment opportunities, associated hurdles, and serve as a global learning platform related to SDGs.

Nevertheless, it’s only the large pension funds that have been able to realign their investment strategies to the SDGs, and they too along with the smaller players struggle to abridge the wide gap in capacity and expertise in mainstreaming the direct impact of their investment decisions. This reluctance and inability can be attributed to the lack of clarity on financial consequences and the measurability of progress in the face of limited information on a concrete investment criterion linked to the SDGs. However, a well-managed and well-understood ESG engagement at the corporate-side can help investors align their investment decisions toward broader SDG-aims and channel their finances to areas with SDG relevance, instead of grappling with the enigma to mirror their business commitments and fiduciary duties in a sacrosanct manner.

  • Macro and Micro Relevance

SDGs are unavoidable universal considerations that stand to impact all countries and sectors, at least at macro financial level. Investors with highly diversified and long-term portfolio have high risk exposure to the widespread risks, as articulated under each development goal, which are essentially concentrated in corporates and other business entities. Therefore, investors play an indelible role in indirectly rooting for formation of sustainable businesses, markets, and economies.

It is in this respect, the ESG considerations can proffer a new strategic lense to view and assess the business decisions under SDG-led scenario. At macro level, linking of SDGs to existing ESG considerations will serve as a common communication medium to shape and articulate business decision-making process and investment strategies. The UN SDGs and their underlying targets can be a reference point to address the uncertainty in time and extent of risk internalization and opportunity realization, a persistent dilemma faced by investors across the globe. Further, they have the potential to strengthen the existing ESG frameworks while enabling a reflection of financially material regulatory, operational, and ethical risks into investees’ business accounts, of course in a foreseeable future.

At micro level, the UN PRI signatories believe that their investments in corporates and other business entities hold long term profitability potential only when the latter is driven to contribute in development of equitable and sustainable financial systems and societies. There is increasing stipulation from stakeholders across markets, asset holders, and managers to assume a broader long-term interest and approach into account while evaluating any and all business decisions. And, while SDGs are more thematic than corporate centric in nature, they do help align sector and company specific ESG considerations with broader societal and environmental goals. An SDG and ESG amalgamated business approach will move companies to direct their attention toward financial and non-financial factors such as corporate governance, direct and indirect environmental footprint, human rights issues and more, that can help them maintain a social license to operate, and also facilitate a transition toward a rather active stance on adoption of new business models through disruptive or realignment strategies. Essentially, it will be an opportunity for businesses to localize their efforts to meet their own financial objectives while enabling the achievement of SDGs.

  • Data Capture and Connect

A successful achievement of SDGs necessitates a systemic response anchoring transformative changes in knowledge, skill, and institutional arrangements catering to all sections of the society. And, this is essentially a highly data intensive process, both at the macro (global) and micro (company/sector) level. Often lack of data and insufficient transparency on ESG performance of investee companies is cited as a key barrier to progressive and impactful investment decisions. Since companies provide deficient information on their ESG performance to the investors, the latter is constrained to ask targeted questions that are designed to highlight inherent risks and opportunities within the investee’s business, which can potentially help them achieve sustainable business performance. This is often referred to as the Catch-22 of Sustainable Investing. Further, many of SDGs such as SDG2: Zero Hunger; SDG3: Good Health & Well-being have an inherent qualitative character, which is often difficult to capture and connect with a company’s performance vis-à-vis the positive or negative effects it has on achieving SDGs targets. These two challenges in isolation can undermine the effectiveness of respective strategies to assess and report; however, a connection of ESG to SDGs is expected to – first, facilitate companies in gathering and sharing the presumably copious amount of data (once their ESG considerations are in sync with SDGs’ targets) with investors especially on those goals which are deemed as the right fit with their businesses; and second, herald a trend of public reporting on their initiatives and progress around the selected SDGs on standardized indices, thereby addressing the concerns around quantifying the otherwise qualitative targets.

Prima facie the mentioned causality might seem a farfetched idea, nevertheless, a broader level mapping of ESG considerations to individual SDGs and their respective targets will be a good starting point. So, let’s discuss how these ESG considerations within the investable universe can be attributed to individual SDGs.

The Direct Connect

 ESG based investment decisions are directed toward long-term value creation for the business and the society. Consequently, it draws a direct connection with the SDGs’ concept of creating ‘shared value’ that represents a constructive intersection of market potential, societal demands, and policy action for a sustainable and inclusive approach to economic growth and well-being.

At the corporate side, ESG considerations can be broadly mapped to SDGs, as illustrated in the graph below, which is a general representation that can be relevant to most sectors and sub-sectors. While companies find it comparatively easy to identify and align Environmental and Social considerations (as they invariably assume a directly mapped context to SDGs); association via their Governance function is rather indirect, and many a times found to be linked to their existing environmental and social functions. Nevertheless, ranging from tangible to intangible associations, all of the 17 goals can be attributed to individual elements of ESG considerations.

A general representation of ESG considerations broadly mapped to the 17 SDGs

Cynics do argue against the goals as being too complex and interconnected for an all-inclusive reflection into the existing ESG frameworks and considerations. Regardless, the transformative potential of SDGs to galvanize investors’ attitude toward an integrated path to sustainable development cannot be emphasized more. The co-existence and synchronization of ESG considerations with the SDGs can expedite corporate contribution within the broader space of the Global Goals, and that privilege is almost in investors’ hands. To conclude, the United Nations’ 17 SDGs are an opportunity to usher in a new and refined age of affirmative action through responsible investing, an opportunity certainly not to be missed.


For more information, please contact – hello@sustainometric.com

53c7df027962d-request-for-information_53c7df02793cf

Sustainability reporting and the influx of information request

An increased focus on corporate sustainability performance has led to the development of many ESG/thematic indexes, benchmarks, and ratings. The information required for such indexes, benchmarks, and ratings, may not be publicly available, therefore the index or benchmark providers send “information requests” to the companies. As a result, companies receive plenty of “information requests”. While it is in interest of the companies to provide such information, they often choose not to provide such information due to lack of understanding of the methodology or resources. Hiring a specialized firm to help respond to such “information requests” may not only save time and resources, but also can go a long way in helping companies communicate better about their sustainability practices.
Corporate sustainability has been gaining increasing attention by various stakeholders. The growing importance placed on companies’ sustainability performance has led to the development of many ESG/thematic indexes, benchmarks, and ratings. The ESG indexes, benchmarks, and ratings are based on a company’s score derived from company’s ESG performance on a pre-defined methodology. Similarly, thematic ratings/benchmarks evaluate a set of companies on the most material themes, such as health and safety in textiles, access to medicine for pharma companies, and data privacy for telecom and technology companies. These rankings/benchmarks are widely used by the investors and other stakeholders in their decision-making process. Some of the most recognized ratings/benchmarks are Dow Jones Sustainability Index (DJSI), Financial Times and the London Stock Exchange (FTSE4Good), Carbon Disclosure Project (CDP), Institutional Shareholder Services (ISS-Ethix), Morgan Stanley Capital International (MSCI) Indexes, Access to Medicine Index, Access to Nutrition Index (ATNI), Access to Seeds Index, Responsible mining, etc.
For a company, an excellent ESG rating provides the following key benefits:

  1. Attracts additional capital investments, i.e. a large group of investors rely on these ratings in decision making;
  2. Better risk management, thus lowering cost to operate and higher long-term returns;
  3. Builds reputation, brand and market credibility, i.e., inclusion into ESG indices, thus high brand value and stakeholder value creation;
  4. Attracts and retains customers, e.g., consumers favoring green products / sustainable products;
  5. Easy access to resources, both labor and materials; and
  6. Re-affirms license to operate.

Therefore, it is important for the companies to be a part of these ratings or indexes and score well. Many of these indexes and ratings use the information provided by the companies through their annual reporting and websites, however increasingly these agencies also ask companies to provide additional information. Therefore, companies are experiencing an influx of “information requests” from various rating firms. As per CDP, the number of companies reporting to its investor program in 2017, has risen by 33% since 2013, DJSI saw approximately 50% rise in company participation between 2008 to 2017, MSCI received feedback on ESG ratings from approximately 20% constituents of the MSCI ACWI Index in 2016 as compared to 10% in 2015.
While there are many advantages of providing the information, often companies do not respond to these requests due to:

  1. Lack of knowledge on what information will give them better ratings;
  2. Time and resource constraint to respond;
  3. Lack of reportable ESG performance data or availability of standard data;
  4. Lack of clarity on the range of metrics requested and level of transparency provided by the rating firms; and
  5. Lack of user-friendly format in the requests received.

To overcome this challenge, at Sustainometric, we help companies and their investor relations team to organize and fill the information requests from various agencies. We leverage our years of experience of working with some of the most prestigious names in the indexes and ratings to enable companies identify the most appropriate answers to the questions in these information requests. We also train companies’ investor relations, sustainability and/or communications team to understand the questions and metrics requested. This improves their ESG ratings resulting in the inclusion into the ESG indices and overall helps creating stronger sustainable brands.

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