17 years from Baue’s article publication, this so-called Rashomon Effect is still prevalent among the ESG Rating approaches available on the market.
Of course, we cannot agree more on the idea that ESG is indeed measurable—we launched IMPACTIN with the very purpose in my mind to provide a concrete solution to the 6 main issues we see today in the market approaches to ESG Rating:
ESG Risk-basedmethodologies, lost in intention-checking;
Subjectivity, due to a human-based analysis;
Rating dilution, often aggregating hundreds of indicators;
Black-box rating methodologies, usually non-repeatable;
Long update cycles (sometimes > 24 months), due to a limited agency’s analysts workforce vs. thousands of emitters to analyse;
How to fix it ?
At IMPACTIN, we approached the problem the other way around, and built natively our quantitative ESG impact rating methodologies on the following principles:
ESG Impact scoring approach, based on a small set of relevant ESG impact indicators;
Objectivity, due to a our quantitative and automated approach;
Key ESG indicators (SMART Data), quantitative and selected for their relevancy, coverage, quality, etc.;
Repeatable and deterministic method;
Frequent and automated updates , thanks to our quantitative approach and our automated data-analysis pipeline.
Our ESG Impact rating can thus be used by AMs in their Sustainable Finance activities (thematic funds creation, portfolios and indices Impact Rating, scorecards, reporting…), and to improve the Engagement process with emitters, but also for the emitters to track their own ESG Impact performance through dedicated dashboards.
Yes, “what gets measured gets managed“, and we think there’s still plenty of room for better ESG measurements, through ESG Impact scoring. And that’s the precisely the solutions we provide to the Sustainable Finance market.
InsurTech: ESG Risk underwriting is a solution we offer to the Insurance Market, with ESG Impact scoring and Physical Risk assessments;
SustainTech: we provide a unique ESG impact rating solution, allowing toscore the sustainable ESG impact of a company, a territory (city or region), a country, or a financial index / investment portfolio.
Among the 2020 initiatives worth noticing in Sustainable Finance, DBS bank engagement deserves a closer look. DBS is a Singaporean bank, regularly awarded, and one the biggest bank in Asia, outside China. Last June, the bank published its own taxonomy for sustainable and transition finance, which defines sectors considered as sustainable activities.
The DBS initiative was released the same month as the EU taxonomy for sustainable activities, whose official publication took place after several years of development, and which will come into effect in June 2021 in Europe. Technical appendices of the EU Taxonomy had been modified last November regarding the list of sectors, after a 4-weeks long concertation, and are expected to ben published very soon.
We propose hereafter a brief overview of both initiatives, not to judge which is the “best”, but in order to understand how these entities tried to solve the problem of defining a taxonomy for the ESG investments, in their respective contexts.
EU taxonomy for sustainable activities
We already discussed the EU taxonomy several times these last months. Its first merit is, simply, to exist. But all the limits that we evoked, are still present: lack of a defined threshold to define a sustainable fund, lack of precisions, and many questionable criteria, whose purpose is to indicate, depending of a sector, if a fund is sustainable, or not. The worst thing is that, to date, neither sanctions nor controls of how the taxonomy will be applied are defined… Clearly, every AM will do what it wants.
And, de facto, it’s already happening: cf. our article providing 3 key takeaways on AMs’ first taxonomy tests published by the PRI. This trend will, obviously, goes on, since, in matter of so-called sustainable or green funds, greenwashing is now the rule—especially in a market context where the Sustainable Fund share showed a steady and strong growth in 2020, despite—or probably, thanks to—the COVID-19 pandemics, and where the retail market is looking for impactful investments, aligned with its increasing environmental and social concerns.
As example, in France, a boom happened with the SRI labeled funds (“Label ISR”), with now 618 of them, including many ETFs. This label was a tentative to provide a guarantee of sustainability for a fund. Patently, nothing is more wrong—many of the labeled funds having Carbon intensive or controversial activities in their investments… and the label doesn’t provide any kind of a measure of the ESG impact… But how can “SRI labeled” funds be invested in non-responsible companies, one may ask? Simply because the label doesn’t require this to be granted. Almost all you need is a policy, i.e. a “good” intention, a home-made ESG strategy more or less restrictive depending on the AM. There is no obligation to provide a quantification of the positive impact for an investment to be granted with the “SRI Label”…
So, once more, a useless intention check, and eventually, as usual, a disappointed customer—thanks to a label whose objective was initially to foster the Sustainable Finance, and not to obfuscate even more the situation, and to contribute to the ambient greenwashing.
A first and very important point, is that a bank asked itself the good questions, and didn’t waited for an imposed regulation to address these issues but acted on it by itself.
The bank taxonomy provides us with a list of sectors, specifying for each if it is eligible to a green or transition label, or related to an SDG objective. And the result is… quite good! What is even better, was to start with the purpose in mind, with the target objective: the point of this taxonomy is to help end customers understanding if a fund is composed of sectors of activities having, or not, a positive impact on the three aspects: green, transition, SDGs. DBS then provides us with a list of existing initiatives which might help to check the sustainability of a company or a project.
The approach might seem a bit simplistic, at first, especially when the 20 pages of the DBS taxonomy is compared to the 100+ pages of the EU Taxonomy and its 593 pages of Technical Annex—but it definitively not the case, because the objective pursued is very clear: providing a “label” for the funds, and be transparent with the customer regarding its investment. Also, interesting to notice, is the fact that the bank has for objective to use this framework for every financial transaction, and so that it implies its use for real-world project funding, grants, etc.
Can a bank be considered sustainable with only 5% of its funds being managed according to SRI principle? Certainly not, obviously… and the last point is here to give the promise that everything will be controlled by an external, independent audit. Of course. Because if nobody is controlling or verifying such an initiative, it will have no credibility, indeed…
It is thus very reassuring to see an initiative such as DBS’s one emerging, despite the many difficulties inherent to the financial sector, and even more, to see it coming from a region, Asia (Japan exc.), there the SRI market is still underdeveloped respectively to the Western financial markets (EU, USA).
As the Asian market is now indeed becoming the driving engine of the worldwide economy, it is here demonstrating a strong will and vision, which will surely allow it to catch up with the (supposedly) more advanced markets, and maybe to quickly surpass them. The future will tell.
We will thus be impatiently looking forward to seeing if DBS will deliver on its promises and ambitions and will also have the courage to be fully transparent on the negative aspects, and the probable difficulties to be encountered along the path.
Providing truly positive ESG impact funds for the Sustainable Finance is not an easy task, and it requires difficult choices for an Asset Manager, among which divestments from rogue companies that no one wants to make due to their (strictly) financial ROI, a necessary transparency, which can put the bank in a delicate position—but, in the end, it is the only choice to create a truly positive economy.
The Virtual-Reality Grand Finale & Awarding Ceremony of SESA 2020 has been announced—do not miss this opportunity to discover the winners of this startup competition: Register here on EvenBrite to assist to the virtual reality ceremony, which will leverage Virbela VR technology, used to build engaging virtual worlds for remote work, learning, and events. Meanwhile, you can also explore the list of regional finalists.
For the second year, we had the pleasure to parcipate in the SESA jury, and we thanks the whole SESA team for that! This year, 7 countries are competing in 9 categories and each country will provide a national winner for each category to the Grand Finale jury: Startup of the Year, Best Newcomer, Founder of the Year, etc.
Germany is indeed a very interesting market regarding Sustainable Finance, with a high potential: despite the fact that the country is the largest European economy, it trails other countries on sustainable finance, and ranks as fourth regarding green funds. To remediate the situation, the country announced in 2019 its ambition to become a leading location for sustainable finance.
Participating to startups and entrepreneurs’ competitions is indeed a good way to get additional feedbacks on our startup pitch and business model, and the occasion to network.
Launching a business is always challenging, but probably even more in a context of worldwide pandemic with months spent in lockdown… but it was the occasion for us to focus on our product roadmap and R&D—and it allowed us to deliver several innovative products in a record time.
By voting for us, you will not only support Women Entrepreneurship in a domain, FinTech, were only roughly 10% of the startups have a women for CEO, but also support our project, IMPACTIN, which aims to support the global transition towards a Positive Impact finance, by providing Impact scoring of emitters (countries, regions, cities, companies) and investments portfolios, and regulatory compliance with sustainable regulations (EU Taxonomy, etc.)
The PRI released early September a report with case studies from 37 Asset Managers—including e.g. BlackRock, Crédit Suisse, Amundi—, which agreed to test their funds regarding the Green Taxonomy compliance, to be mandatory by the end of 2021. Beyond the exercise itself, positive and necessary, what are the results, and what can we learn? Here are our three key takeaways.
First, let’s start with the funds being tested: they are quite different, hence very difficult to compare. Some AM used fixed income, and others equity funds, another green bonds and climate change thematic funds, and even funds not proposed as “sustainable funds” on the market. Due to the heterogeneous nature of the funds, we cannot compare or benchmark the results.
The taxonomy integration approach are also very different, each AM having its own way—but usually the method is based on external rating providers, which doesn’t support today the taxonomy requirements with their existing ESG scores, designed well before the taxonomy. Some methodologies are based on several suppliers, well known for having divergent view of a same company—the “aggregate confusion” of ESG ratings pointed out by the MIT Sloan study. Another common constatation: the great majority of AM mention the lack of trustable and exhaustive corporate data. When data was lacking, “estimates” have been made. Such a limitation obviously leads to unprecise and subjective ratings… So, yes, we definitively see here that the traditional ESG rating approach hit its limits, and the taxonomy tests case studies are the living proof of that. But how to comply with the regulation, to be applicable in 2021? All AM hope that the market leaders will provide their solutions well before the regulatory deadline—But, considering their ESG scoring approaches, and data… good luck with that.
Eventually, the results: in a word… divergent. It seems easy to get a percentage of the eligible funds depending on the sectors—since the taxonomy defines which sectors are eligible—, but when it comes to the calculation of the compliance score with the taxonomy… well, “surprise”: one AM says less than 5%, others 20%, some other “a majority of the funds” without even providing a percentage… In brief, a nightmare—especially considering that the EU didn’t define any compliance threshold to reach.
we definitively see here that the traditional ESG rating approach hit its limits, and the taxonomy tests case studies are the living proof.
To date, the institutional or retail investors will not be able to understand anything about the taxonomy compliance, and neither who will be controlling the compliance, nor will they be able to discriminate between truly sustainable funds, and others. A taxonomy compliance percentage doesn’t mean nothing, per se: it needs to be explained, justified.
The EU taxonomy is a great project, and it’s absolutely required for the good progress of Sustainable Finance. But the road ahead will be quite long, and for the EU taxonomy to be useful, the final objective must not be lost in the process: empowering and enlightening the sustainable investors, allowing them to understand how much sustainable a fund truly is, in order to make responsible investment choices, based on trustful information— pedagogy and responsibility being shared between the companies, the AM, and the end investors.
The “Positive Impact” thinking has been making the buzz for a while now, but the approach is often mixed up with the more restrictive notion of “Positive Social Impact”, or limited to the direct impact linked to a company “Business Model”, and, by doing so, it misses 90% of a company impact—and, incidentally, of a Positive Impact portfolio composed of “Positive Impact” companies.
The UNEP-FI Principles for Positive Impact Finance indeed define “Positive Impact Business & Finance as that which serves to deliver a positive contribution to one or more of the three pillars of sustainable development (economic, environmental and social), once any potential negative impacts to any of the pillars have been duly identified and mitigated.”
An Iceberg Model of Positive ESG Impact
The iceberg metaphor is well known, and self-explicit: 90% of the iceberg is not visible, being immersed below the waterline.
The same applies to the concept of Positive Impact. Most of the Positive Impact portfolios approaches or Positive Impact startups focus on the identification and quantification of the direct outcome of their business model impact: e.g. improving the health of the customer, reducing social inequalities, improving social inclusion or diversity, etc.
This kind outcome is of course very desirable and positive, and its more directly visible. But it’s the top of the iceberg, visible above the waterline.
Impact, below the waterline
By focusing on the direct business model outcome, the risk is to overlook the overall ESG impact (Environment, Social, Governance), linked to any company’s operations—let’s call it the Corporate Impact—, and particularly to the specific Key ESG Impact topics related to the sector of activity: the Sectoral Impact.
For instance, the Retail and Apparel industry is well known to have strong issues related to water pollution or child labor.
You might say that this is covered by the traditional CSR processes and reporting, by CSR certifications, or by the traditional SRI analysis. The problem with the SRI analysis approach is that it is well known by professional to be poorly relevant, subjective—an “aggregate confusion”, according to the MIT Sloan Sustainability Initiative.
Regarding common (and sometimes trendy) CSR certifications (e.g. EcoVadis, B-Corp, etc.), they are usually based on self-assessment with a strong bias toward the checking of intentions, policies, and signature of initiatives (PRI, PSI, etc.) more than the real outcomes. Recently, a paper indeed questioned the link between a supposed intention, and the concrete ESG performance delivered. Focused on the PRI commitment of Asset Managers, the study concluded that “overall, only a small number of funds improve ESG while many others use the PRI status to attract capital without making notable changes to ESG”.
A good and transparent CSR disclosure process and reporting will provide us with the ESG data required, which is indeed available through different Data Brokers (with, unfortunately, heterogeneous coverages and qualities), after data entry. But to be able to leverage these ESG data, they need, according to us, to be handled appropriately:
Quantitative ESG indicator selection: The relevant quantitative ESG indicators to assess need to be carefully selected, among the thousands ESG indicators more or less relevant available on the market. The objective is to be able to evaluate the quantitative outcome—i.e. impact—on the ESG topics. Among others, the coverage of each indicator needs to be taken into account as selection criteria, in order to allow ranking and comparison between peers.
ESG Impact scoring: The ESG indicators need to be scored to evaluate the positiveness of the impact, based on quantitative metrics, and specific impact thresholds. As exemplified here above, we must now move beyond intention-checking (such as ESG initiative commitment, or existing corporate policies) to measure the sustainable and positive impact of a company, or investment portfolio, and “do not harm” is one of the guiding principles for the implementation of Impact Scoring.
Conclusion: don’t overlook impact below the waterline!
Positive impact is not restricted to the sole outcome of a company’s business model, and thus needs to be assessed at the global level of a company’s operations, i.e. on the three, and still relevant, dimensions of Environment, Social, and Governance—and, in case you didn’t notice, that’s precisely why we launched IMPACTIN: Sustainable impact, measured. That’s our motto.