Environmental, social and corporate governance issues have grown in prominence. What used to be deemed a soft issue, with little impact on the broader functioning of the business, has captured the interest of customers, the public and shareholders alike. Experts at RiskMinds International 2019 explored the impact of this change.
For risk professionals, ESG needs to be treated like any other risk category, says Julie Sherratt, Head of Investment Risk, TD Asset Management. Speaking at the RiskMinds Invest Summit, at RiskMinds International 2019, she told delegates portfolio managers were increasingly judging ESG exposure in the same way as they might currency exposure.
Having gone from a position of knowing little about ESG a few years back, her team now produces a regular ESG risk dashboard for portfolio managers. This involves explaining the often abstract ratings and making sure the differences between ESG ratings providers – thrown up by a variety of approaches, opinion, data and modelling techniques – are understood.
Although it is a comparatively new entrant to the risk agenda, her team finds that the business is largely receptive to ESG matters, because there is client demand for it. Portfolio managers regularly face multiple questions about ESG issues and need to be able to answer them knowledgably and with confidence.
Gaps in the data
However, she cautioned that much of the current ESG data is unstandardised, self-reported, and unregulated. As such, ESG risk analysis is an evolving space that is ripe for advancements. AI is likely to be increasingly used as ESG data becomes less nascent. Collaboration will also help build momentum in ESG analysis, with more people understanding, informing standards and building the transparency necessary to create a more complete risk picture.
For David Suetens, Independent Director and Founder at Bridgebuilding, a globally recognised taxonomy, and wider disclosure for ESG can’t come soon enough. This will help create more complete and comparable standards and accelerate ESG issues onto more board agendas. Only once there is a reliable data set can businesses take decisions about the actions that need to be taken by each of their functions.
It is also important that such a taxonomy is not binary – it’s not just about the good and the bad. In order to have real impact it needs to capture the companies in the middle band as well.
Glass half full or glass half empty?
Recognising that sustainability and private finance aren’t a marriage made in heaven, Suetens said there are still some major steps that need to be taken. Among them, there is a need to accelerate the ESG thinking into private equity, real estate and debt funds.
On the positive side, however, he highlighted a number of ways ESG has made its way into the public and business consciousness in recent years. The banking industry in particular – which faces fewer ESG challenges than some other sectors – has made a lot of progress. A third of global banks are now signed up to align their businesses with the Paris agreement.
A new skill set
In order to make sense of the profound change that an ESG focus will bring, companies will need a new skillset. Climate change is still taught to economics students as an externality – something that can’t be planned or predicted, a form of market failure.
Instead, it needs to be seen as core to a business and to truly understand it they will need skills and perspectives from a broad mix of disciplines. This will likely lead to hiring people from totally different backgrounds, including physicists and climate change engineers.
Companies need to understand the complete ESG picture. Very few companies use scenario analytics to test climate change strategic resilience – what would be the financial impact?
ESG is a “data hungry” discipline he says, likening the current state of play to where we were with financial reporting 30 years ago. It’s not going to go away, and there is a lot of progress still to be made.
What should your climate scenario analysis look like? Read the feature by Gaurav Ganguly, Head, Group Risk Economics, HSBC, in our latest eMagazine.
