Investments based on environmental, social and governance principles have grown dramatically more popular in recent years, but the way they are assessed still varies widely.
Recent analysis suggests that over a quarter of the world’s assets under management, or $23 trillion, is now invested according to environmental, social and governance (ESG) principles. The figure was calculated by the Global Sustainable Investment Alliance, a trade body comprising seven of the world’s largest sustainable investment membership organisations, and represented a 25% rise from 2014 to 2016.
As public concern over issues such as climate change and gender inequality has grown in recent years, so ESG has risen in popularity as an investment category. Investors are now showing much more interest in how companies are operated and governed, and in the impact their investments may have on society and the environment. Yet it can still be difficult to gauge a company’s performance in these areas, simply by reading financial reports. The way that ESG is defined varies widely, and there are a multitude of associated terms that have overlapping or unclear meanings, such as “corporate social responsibility”, “impact investing” and “microfinance”.
The lack of a single set of globally agreed standards is making it difficult for investors to compare and contrast ESG investments and for companies to decide how best to demonstrate their ESG credentials. It has also perpetuated the idea that investing according to ESG principles necessarily means sacrificing performance, when the latest research shows this is not the case. In the worst cases, companies have exploited this lack of standards to distort or fabricate ESG performance, a practice dubbed ‘green-washing’.
What is being done to create standards for ESG investing?
Various private companies have therefore developed their own ESG criteria to fill the gap. The market index provider MSCI, for example, measures “thousands of data points across 37 ESG Key Issues” to rate and compare companies and securities.
Meanwhile, the European Banking Federation (EBF) in Brussels is developing Principles for Responsible Banking that intend to set a global benchmark for what it means to be a responsible bank. Their aim is to align the banking industry with society’s goals, as expressed in the Sustainable Development Goals and the Paris Climate Agreement. Developed by 28 banks from five continents, the EBF now wants to consult other banks and stakeholders around the world for their feedback and suggestions.
What Deutsche Bank is doing to help improve ESG standards
Deutsche Bank has taken an active part in consulting on the proposed EBF principles. We feel that this is the furthest-reaching effort happening right now towards developing a set of common standards for not only measuring and implementing ESG, but also increasing the transparency around it. However, this process will take time, and we have therefore been developing ways to plug the information gap in the short term.
Although deemed to be harder to measure, the social and governance elements of ESG are not, in fact, impossible to measure. It’s more an issue of measuring the right social and governance data and putting these together in a way that creates a representative and transparent picture of a company or investment opportunity.
In April 2018, Deutsche Bank launched “α-DIG” (pronounced alpha-dig), an artificial intelligence system designed to measure adherence to ESG principles in a quantifiable way, and thereby integrate ESG into the traditional investment process. The system processes vast quantities of qualitative data, such as reports, press releases and news articles, using specially designed algorithms to assess how well companies are adhering to ESG principles relative to their rivals. In doing so, it analyses the intangible aspects of a company, such as human capital, innovation, brand value, management quality and environmental sustainability.
How α-DIG is helping to plug the gaps in ESG reporting
α-DIG assesses all aspects of ESG. For environmental factors, it will look at things such as the transition risk associated with carbon footprint by analysing the latest press releases to see which companies are reducing their emissions and committing to meet their carbon targets. For social factors, it will score companies according to the extent to which they employ a diverse labour force, and other measures of corporate culture. And for governance it will alert the user to controversies: litigation, for example, or regulatory breaches.
Companies are known to try and bury certain bits of data in their quarterly reports and also drip-feed negative ESG content into the public domain to reduce its impact. What’s more, the team behind α-DIG found that most ESG data released by companies was stale and out of date.
Although not currently available directly to clients of Deutsche Bank Wealth Management, the technology is being trialled by institutional investors, and we hope it will prove a valuable addition to the analyst’s tool-kit as ESG standards mature.