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The ‘S’ of ESG – Part 2: new pathways
The ‘S’ of ESG – Part 2: new pathways
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The ‘S’ of ESG – Part 2: new pathways

19/11/2019

We discuss the latest developments offering new solutions for investors integrating the ‘S’ including technology, regulation, and the importance of collaboration.

The ‘S’ of ESG has been harder for investors to define and quantify than environmental and governance factors. In BNP Paribas’ 2019 Global ESG Survey, 46% found it the most difficult pillar to analyse and embed in their strategies, a higher proportion than either the ‘E or the ‘G’. Various issues including availability of data, difficulties of interpretation, and regional differences, have contributed to this ‘S’ conundrum.

Nonetheless, there is no doubt that effective integration of social issues is an imperative. Recent research from Deutsche Asset & Wealth Management and Hamburg University has found a positive correlation between good Social performance and good financial performance. As we explored in ‘Part 1: a challenging factor’, social issues are closely interconnected with both the environmental and governance aspects of ESG; improving one area can lead to improvements in the others.

Imaginative technology: measuring the unmeasurable

Technological developments – such as satellite imagery – can improve monitoring of metrics that would previously have been difficult to quantify. “Let’s take child labour, say, an agricultural supplier pledges not to use child labour. This means they need to monitor, according to international standards, whether a child is on the field for more than a certain number hours a day (in many cases, four). If this is the case, then this constitutes child labour”, says Anjuli Pandit, Primary Sustainability Manager at BNP Paribas. “Some of our clients are partnering with local NGOs and using satellite imagery to check that suppliers are not supplying false data on this.”

A second example is blockchain and the integrity of the supply chain. Multinationals can use blockchain as proof that production has at no point involved companies or state entities with a history of forced labour or other human rights abuses. For all suppliers within the multinational’s blockchain network, every time a product changes hands within the supply chain, its precise location and time-stamp is documented by creating a new block. The ledger generated by this process creates a permanent history of every product from its manufacture through to its sale, which cannot be doctored without such tampering being recorded.

Moreover, artificial intelligence (AI) is being used to process and analyse huge pools of data. This includes great strides made in crunching unstructured data: disparate information that does not come in a standardised format, such as chat on social media.

“In the future AI could be applied to social media to evaluate social metrics, such as how well employees at a particular company, and their customers too, think they are being treated”

Leon Kamhi, Head of Responsibility, Hermes Investment Management.

Governments and authorities

Government legislation in a number of countries is now increasing the legal responsibility for companies to check conditions in their supply chains. An example is the UK’s Modern Slavery Act, passed in 2015. Section 54 of the Act requires large and mid-sized companies to provide a slavery and human trafficking statement each year, which sets out the steps taken to ensure modern slavery is not taking place in their business or supply chains. Many of these statements provide not only general information but also hard numerical data that can help investors assess materiality. This could include data showing the number of audits initiated for suppliers at high risk, or the number of suppliers that have established corrective action plans.

The regulatory pressure on companies to provide useful social data is likely to increase further. For example, in the US, the Human Capital Management Coalition, which includes influential investors such as CalSTRS, has petitioned the Securities and Exchange Commission to require issuers to disclose information about their human capital management policies, practices and performance. International collaboration is also key. “One of the things we have been making a big effort on is encouraging the International Organization of Securities Commissions (IOSCO) to play a role”, says David Harris, Group Head of Sustainable Business at London Stock Exchange Group & Head of Sustainable Investment at FTSE Russell. “IOSCO helps join up regulators globally and comes up with global frameworks, which then regulators in each country can use as a basis for their own regulations which can support global standardisation.”

Solutions through standardisation

One cause for optimism is progress towards standardised reporting by investee companies on listed exchanges. A key step forward is the Sustainable Stock Exchanges Initiative, a UN working group and forum for exchanges to improve ESG reporting by their member companies.

Since 2015, when the Initiative called on all exchanges to provide guidance on ESG reporting, the number of exchanges doing so has more than tripled to 43. Exchanges wanting to provide guidance to issuers were greatly assisted by the Initiative’s Model Guidance on Reporting ESG Information to Investors. This breakthrough publication covers the full range of ESG factors, however, it is perhaps most significant for investors wanting social data, given the relative paucity of guidance. Furthermore, the Guidance includes specific suggestions relating to social issues including that companies develop reporting on “human capital”: the total value to the company of the skills, knowledge and qualifications of its employees.

The custodian’s role

Although analysing social issues is challenging, investors do not have to face this challenge on their own. Custodians can use big data techniques such as natural language processing and AI to seek relevant social data on securities they hold on behalf of investors – sifting through news reports, press release and corporates filings, social media, for example. Custodians can then analyse and aggregate this information at a sector, region, or company level, making it easier for investors to compare performance across portfolios, or identify sources of risk. Furthermore, social factors (as is the case for environmental and governance factors) concern risk, be it health and safety or community relations. In the 2019 BNP Paribas ESG Global Survey, 36% of respondents saw ESG data aggregation as the most important ESG service provided by a custodian, and 43% regarded analytics and risk monitoring as a key custodian service to support ESG investing.

Realism or optimism?

It is important for investors to be realistic at this embryonic stage of ESG reporting. Information on social performance is still far from perfect. For example, a company may have well-designed policies to promote fair career progression for women, but lack hard data showing what these policies are achieving.

“We need to focus on intentionality in the medium term - understanding whether a company is taking action because they genuinely wish to create a positive impact”

Anjuli Pandit, Primary Sustainability Manager, BNP Paribas.

What will happen to the ‘middle child’ of ESG in the future? Many possibilities exist. One is that cultural and legal norms for social performance become so ingrained that they become a standard part of good business practice, rather than being a specific collection of metrics tracked by investors. Another possibility is that a whole new spectrum of reporting factors replaces the current paradigm, with separate metrics to track specific areas such as gender diversity, health and safety, or employee engagement. It is hard to forecast with accuracy what will happen. The only sure thing is that this fast-moving area of investing will not stand still.

Read more

The ‘S’ of ESG – Part 1: A challenging factor

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