Rethinking the ESG data challenge
Environmental, Social and Governance (ESG) data is fast becoming one of the most significant determinants in investor strategy. The year 2020 has been one for the bad books in most cases. During the emergence of COVID-19 and the months following, markets took quite a tumble. However, ESG investments were not hit as hard. Stocks with strong ESG data have been resilient in tough market conditions, even before COVID-19.
The Economist Intelligence Unit (EIU) reported in late 2019 that "growing investor and consumer activism" is a major reputational risk for companies as the investor demographic is growing younger. EIU reports that 76% of the younger investors cite that healthy ESG data is a determining factor when managing assets. This in contrast to 37% of those from older generations.
The caveat here is in defining or measuring ESG data. ESG scores are determined using a great amount of quantitative data and narrative disclosures by companies. Third-party ESG scoring companies often resort to estimations for data that is not readily available. In these cases, it's the ESG rating provider that makes decisions around what data is used and how. Investors want to know more about the ESG data, how it is measured and how it relates to their personal perspective.
With business technology such as that provided by Diligent, a company can define, track and report its ESG data plans in detail. Software can provide access to standards and procedures, leverage AI technologies and analysis algorithms, and provide valuable insight in order to add transparency and accountability to ESG scoring.
What is ESG Data?
The world of business is evolving as society is growing more concerned about its impacts on humans and the planet. ESG data is a set of standards used to measure a company's stewardship and sustainability. A socially conscious investor uses ESG data to screen for potential investments.
Investor decisions are based on these criteria:
- Environmental: A company's performance as a steward of nature and its use of sustainable practices
- Social: A company's management of people and resources
- Governance: A company's effective leadership and business practices
The collection of reliable ESG data is becoming more prevalent as ESG scores become a standard reference for investors to determine company impacts. A well developed ESG plan will ensure that a company can attract the investment capital they desire.
Not only can an ESG score tell a tale of sustainable business practice, but it is also a thermometer to test the temperature of a company's internal culture. ESG data considers a company's impact on customers, the local community and the well-being of its employees.
For such an important metric, it may be surprising how much of a challenge it is to evaluate ESG scores. An obstacle for investors is navigating various scoring systems. Many systems may be unreliable due to a lack of standards or transparency. Most ESG data providers define their own materiality matrices and use proprietary methodologies to calculate ESG scores.
If you're relying on a third-party to deliver quality data, how can you trust the provided results? Quality is a subjective term.
When it comes to ESG practices, investors look for what they consider to be the most well-defined data. There are many discussions among stakeholders concerning what information to consider and how to integrate the information into an investment decision.
Third-party ESG data providers often introduce inconsistencies through differing methodologies, company philosophies and proprietary data generation. There is no definite market infrastructure to provide companies with transparency concerning how they are scored. Diligent's Governance Intel software provides a tool to manage these challenges and more.
Meeting the ESG Data Challenge
Investors rely on consistent, comparable and material information on which to base their asset management decisions. They increasingly cite material ESG factors as the main determinants of a company's ability to generate sustainable performance.
Material ESG factors are positive or negative factors of a company's business model such as margins, risk and growth. Examples may be found in supply chain management, worker health and safety, environmental policies and corporate governance.
By providing ESG scoring systems, data providers have made significant contributions to the global advancement of ESG investing. However, it is important to understand that these providers' methodologies introduce inherent limitations to the data. Data limits can be compounded by relying on a single-source ESG data provider.
Differences in Data Collection Methodologies
With each ESG data provider comes a proprietary data collection methodology. Unique data sourcing, research and scoring systems result in a single company rating differently from one provider to another. Reliance on one data provider locks a company into that provider's ESG investment philosophy, data acquisition, materiality, and aggregation and weighting.
Evaluating the Differences
Issues among ESG data providers generally arise in three key areas of their data collection processes.
1) Materiality
Transparency is generally the issue when an ESG data provider reports on materiality. Typically, providers develop their own processes to rate a company's financial performance. Proprietary methodologies don't provide full transparency. Further compounding the issues is the fact that many material data points depend on narrative disclosures by companies.
2) Data Acquisition and Estimation
Every provider performs its research in its own way. Most data can be acquired through public means. However, providers may use statistical estimation models to fill in the gaps.
3) Aggregation and Weighting
Each provider has a unique method of ranking and assessing particular ESG factors. These are proprietary judgments based on provider perspectives.
Navigating the Challenges
The cliche "If you want it done right, do it yourself" provides some relief to these challenges. Diligent offers many tools that leverage company data in order to provide valuable insight into the company's ESG strategy. By teaching your board the necessary skills to understand ESG, you save time and increase ESG data accuracy, easing some of the common issues.
The best way to mitigate the ESG challenge, however, is to use standards and guidelines to create measurable activities and outcomes. In September 2020, the World Economic Forum's International Business Council (IBC) published a consolidated collection of ESG global standards. Products like Diligent Compliance come — with the IBC's standard library, which allows a user to track progress and practice against these principals.
Diligent Compliance empowers organizations by offering a customizable solution to achieving the ESG standards that meet their specific needs.
With Diligent Compliance, you can:
- Leverage best practice frameworks and standards
- Upload your businesses policies
- Measure against requirements and identify and address gaps
Highlight and Identify Gaps in Compliance, Risks, Policies and Reporting Across the Entire Organization
Effective internal auditing, risk assessment and regulatory compliance are essential to good governance. Diligent Compliance finds gaps and addresses them by producing improvement plans. It allows you to:
- Analyze overall compliance with obligations in real-time
- Easily convert gaps into corrective and preventative actions
- Streamline audit process and delivery
- Build compliance and risk improvement plans complete with costs, savings and benefits reporting
Understand What Investors Need
With Diligent Governance Intel, you can automate news tracking over tens of thousands of sources. Monitor ESG trends and changes to regulations and get reports on stakeholder sentiment. Your company will gain insights into factors like company health scores and industry and competitor ratings, information critical to identifying red flags. Keep your board and leadership teams ahead of the curve.
Hold your organization accountable for corporate ESG promises and avoid costly consequences from non-compliance to local or industry-specific regulations by:
- Creating and monitoring common controls
- Allocating tasks to functional teams across the business
- Creating meaningful reports for regulators, auditors and leadership
- Increasing visibility and reporting of management and policy effectiveness
Benchmark Practices with Governance Analytics
Diligent partner CGLytics provides access to the world's most extensive governance data set. View and compare board effectiveness scores and executive compensation models. The platform flags potential discrepancies in diversity, governance and executive pay. Empower your organization with Diligent's ESG Solutions to:
- Define and initiate your commitment to the environment, society and good governance
- Turn standards and guidelines into tangible, measurable activities and outcomes
- Gather pivotal intelligence from thousands of news sources
- Measure governance health and identify risks and red flags
- Visualize progress towards bold, long-term ESG promises
At Diligent, we aspire to empower leaders and executives with the technology, insights and processes their organizations need to govern, endure and thrive in the digital age.
Equipping Boards with the Right Data
Effective oversight of ESG will depend on whether today's boards have the right information at their fingertips. In a research report by Forrester and Diligent, governance professionals indicated that '''visibility into sustainability and ESG issues''' was their greatest dissatisfaction.
Do You Have the Data Your Investors Have?
How does your board composition compare to those of your peers? What skill sets are board members lacking? What conflicts of interest might your investors have uncovered? Tools like Diligent Nominations provide quick access to information that helps board members identify governance red flags raised by shareholders and activists.
While some investment fads ebb and flow, sustainable environmental, social and governance practices are here to stay. Investors are careful with their assets and are more involved in supporting companies that echo their own sustainability ideals.
Having the tools to build a solid ESG data plan, provide measurable accountability and leverage market insights is crucial to providing information to investors. Data gives the investor the confidence needed for investment decisions, and Diligent technology delivers the tools boards need to deliver on their ESG promises.
