ESG investors, fund managers and companies are increasingly aware of the danger of greenwashing and the need for hard metrics. This is a particular challenge for the ‘S’ in the acronym.
It’s becoming easier to verify a company’s environmental impact and to a lesser extent, its governance. But assessing and benchmarking its social impact is much harder.
According to ratings agency Moody’s, social considerations were the most frequently cited ESG issue last year, driven by the Covid pandemic. But how can investors get a proper sense of whether a company’s supply chains are free of sweatshops and modern slavery contraventions, for example?
Over the last few years, a growing number of companies and platforms have sprung up that aim to address the issue by providing provide clear, comprehensive and accurate metrics on social value. RepRisk and Factset are among those that use algorithms, artificial intelligence (AI), social media sentiment, natural language processing (NLP) and data to measure social value and impact for the benefit of ESG investors, while helping companies manage their risk in this area. Technologies such as blockchain can provide more detailed, accurate and timely information about supply chains.
RepRisk, for instance, leverages a combination of AI and machine learning with human intelligence to systematically analyse the publicly available information of over 200,000 public and private companies and more than 55,000 infrastructure projects in 23 languages.
“Essentially, RepRisk serves as a reality check for how companies conduct their business around the world – do they walk their talk when it comes to human rights, labour standards, corruption and environmental issues?” explains Alexandra Mihailescu Cichon, the company’s executive vice-president for sales and marketing. “This perspective, together with a transparent, rules-based methodology and daily updates, ensures that our clients have consistent, timely and actionable data at their fingertips.”
Social Value Portal helps businesses quantify and communicate social, economic and environmental value creation. According to CEO Guy Battle, “clarity around the social value initiatives that a firm is looking to deliver allows people on the ground – whether it be fund or asset managers, property managers, suppliers, occupiers or corporate employees – to pull in the same direction, target important initiatives and help communities thrive. And the way you’ll get that clarity is from a consistent and accountable framework to report and measure against.”
However, some investors are sceptical about the accuracy and helpfulness of the information that these technological evaluations produce. Sophie Lawrence is stewardship and engagement lead at Rathbone Greenbank Investments. She says that until there is a more comprehensive regulatory framework in place requiring the disclosure of comparable, independently verified social data by companies, “we would caution against an overreliance on third-party ESG data tools which use technology to scrape company-reported social data and aggregate it for investors. This approach risks creating an overly simplistic view of company performance.”
Johan Vanderlught is sustainable finance specialist at Van Lanschot Kempen, an independent wealth manager. The metrics employed depend on the AI techniques a data provider chooses to use, he says.
“Transparency regarding data and methodology is a challenge with traditional data providers like MSCI, Sustainalytics, and ISS ESG, and remains even more so with AI ESG data providers. Ultimately, the quality of the data is dependent on the independence of the data source, and this is no different for social data than for environmental data.”
There are numerous factors and variables to manage. However, the opportunities for different interpretations of facts and figures are also extensive. Tiia Sammallahti, CEO and founder of whatimpact.com – a provider of technology that helps companies on social value through partnerships with charities – takes the example of a food retailer donating to local homeless people.
“They may also automatically increase that value by including the wider benefits of homeless people being better nourished and therefore more empowered to move into employment or housing,” she says. “But this doesn’t necessarily take into account whether the food being provided is healthy.”
Sammallahti suggests that qualitative surveys and interview data could be more accurate and useful than figures published by the company concerned or metrics derived from algorithms. “The key is to combine tools that are robust in their proxy numbers with qualitative, evidence-based reporting that verifies the impact,” she argues. “This enables a more accurate calculation to be matched with the results.”
Investors can and should demand more data from companies and data providers that is focused on the effects of the companies’ policies and impacts, while paying closer attention to supply chains, according to Nicola Stopps, founder of Simply Sustainable, an ESG consultancy.
“This is key, because emerging evidence shows that the integration of ‘S’ criteria in investment analysis leads to improved returns, less volatility and lower downside risk,” she says. “Better integration of social indicators in particular can help to identify more resilient and profitable investment opportunities that are already aligned with established and anticipated regulation. It is key for investors to develop a strategy for their total portfolio covering engagement, advocacy, and integration. Voluntary policies and ‘tick-box’ exercises are not a solution for avoiding investment risks.”
Despite the complexities and contradictions, Ioannis Ioannou, associate professor of strategy and entrepreneurship at the London Business School, is generally optimistic. He believes that competition across technology companies with different approaches plus new entrants into the industry will be beneficial in the longer term.
That’s because ESG issues in general – and S issues more specifically – are complex and continuously evolving.
“We are far from being able to have a single optimal approach or one ideal metric that would adequately capture what is happening on the ground,” he says. “The more ideas we have, the more approaches, and the more we criticise and scrutinise them as they compete with each other, the higher the chances that once the industry starts consolidating, we will have metrics and approaches that are more robust.”