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Technological disruption leading to ESG integration
Technological disruption leading to ESG integration
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Technological disruption leading to ESG integration

05/11/2018

Environmental, social and governance (ESG) issues are taking an increasingly central role in the investment strategies of even mainstream institutional investors

To get the full benefit out of the ESG trend, asset owners and managers will have to harness a range of new technologies including artificial intelligence (AI), machine-learning, big data analytics and even satellite imaging.

“ESG analysis enhances the understanding of companies, the risks they face and how they are dealing with them,” says Trevor Allen, product sales specialist at BNP Paribas Securities Services. “It gives investors a more holistic view of the business.”

However, the data that investors need to analyse ESG challenges is incomplete, with some sectors and geographies covered better than others.

“A lot of the data that is available is on companies in the Western, developed economies”

Trevor Allen, product sales specialist, BNP Paribas Securities Services

At the same time, where there is data, there is often so much that it is virtually unmanageable. The growth of the digital economy means that everything creates reams of information, from smartphones to the largest industrial facilities. According to former Google chief executive Eric Schmidt, every two days we produce as much data as we generated from the dawn of civilisation up until 2003.

It also lacks standardisation, with inconsistent disclosure from investee companies making it difficult to compare companies with their peers or to make meaningful distinctions between different industries or regions. “We need an agreed lexicon for how we discuss these topics,” Allen adds. “In finance, there are global standards. In sustainability, there are no agreed standards globally, or even regionally. On the whole, quantity is not the problem with data. The issue is quality, consistency and relevance.”

However, the availability and efficacy of data is going to improve for a number of reasons. Firstly, data providers such as Bloomberg, MSCI and Reuters, as well as a host of smaller, specialist research houses such as Sustainalytics and Ecovadis, are providing greater amounts of ESG information tailored to the needs of investors focused on these issues.

Looking beyond corporate-generated data

There is also a shift in emphasis from just focusing on data to putting that data into context using tools and techniques such as big data analytics and scenario analysis. At the same time, a growing number of new regulations and guidelines have emerged, such as the Task Force on Climate-Related Financial Disclosures (TCFD)[1] and the Principles on Responsible Investment (PRI)[2]. Driven by all these factors and by the demands of investors, companies are being more transparent and providing more information.

Yet even as this happens, there is a trend to look beyond corporate-generated data. “Often, the information they provide on something like greenhouse gas emissions is not granular, it is usually aggregated at company level and it can’t be broken down by sector, activity or country,” says Jean-Philippe Hecquet, investment risk and performance specialist at BNP Paribas. “When information comes from the company itself, you have to ask – can I really rely on this data?”

Companies frequently only provide information on their Scope 1 and 2 emissions (those produced directly by the company through its operations or indirectly through things like transport or power use) but increasingly investors and customers – particularly those signed up to initiatives such as RE100[3] and the Science Based Targets[4] – want to know about Scope 3 emissions (those found in the supply chain).

2 days to produce the same amount of data it took from the dawn of civilisation until 2003 to generate

Source: Eric Schmidt, former Google chief executive

With the TCFD recommending that investors assess the impacts and opportunities of the physical risks of climate change and of the transition to a low-carbon economy, information from corporates alone is increasingly inadequate and a number of fintech companies are looking to go beyond company-reported data, Hecquet says. “They don’t want to work with companies at all. They are looking to access the data through other channels.”

New channels for data

One example of this is the use of satellite imagery, which can be used for a range of analysis from shipping movements to rates of crop growth to the extent of flooding events. Such information can be used to both drive business strategy – one successful application allows winegrowers to decide when to harvest their grapes – and to identify risks.

The information satellites gather is increasingly being processed by AI and machine-learning to produce valuable insights, which can inform investor strategies.

The European Space Agency recently launched a satellite that can pinpoint CO2 and methane leaks, and similar launches are planned by NASA and the Environmental Defense Fund. The information these machines collect could help companies to cut their emissions, regulators to enforce low-carbon regulations and investors to engage with corporates on specific risk issues and monitor emissions-reduction efforts. It could also help in the administration of future carbon markets.

“Satellite imagery systems will be very disruptive. The issue at the moment is how to integrate the information into risk models and develop a link to company performance,” Hecquet says. Once this has been done it will affect everything from share prices to insurance premiums.

Back at ground level, another promising technology is natural language processing (NLP), whereby apps browse websites extracting vast amounts of unstructured data and collating it into actionable insights. TruValue Labs[5], for example, says that its “customisable AI-powered engine uses machine-learning and NLP to analyse unstructured data in real time, extracting relevant metrics and turning them into material insights”.

TruValue analyses more than 75,000 online sources, including news reports, regulatory and legal actions, government and NGO data in real time and alerts clients to controversies and “ESG factors identified by the Sustainability Accounting Standards Board as having a material impact on company value”. Hecquet says: “Because it can process huge amounts of information very quickly, it can improve asset managers’ reaction to controversies as well as providing more data points and information that is much more granular.”

Blockchain will also create new opportunities, from improved, decentralised management of data across networks to better traceability of information in supply chains. “A few investors are taking these tools and integrating them in their systems. They can be incorporated in all sorts of products, from portfolio construction to risk analysis and stress-testing,” Hecquet says.

When it comes to the practical application of many of these technologies, it is still early days. But financial services firms need to be ready to embrace them or they risk being left behind.

[1] https://www.fsb-tcfd.org/

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