ESG investors, fund managers and companies are increasingly aware of the threat of greenwashing and the need for hard metrics. This is a special challenge for the “S” in the acronym.
It is becoming easier and easier to review a company’s environmental impact and, to a lesser extent, its corporate governance. But assessing and benchmarking their social impact is much more difficult.
According to rating agency Moody’s, social considerations were the most frequently mentioned ESG topic last year, driven by the Covid pandemic. But how can investors get a real sense of whether a company’s supply chains are sweatshop-free and modern-slavery violations, for example?
In recent years, a growing number of companies and platforms have emerged that aim to address the problem by providing clear, comprehensive, and accurate social value metrics. RepRisk and Factset are among those using algorithms, artificial intelligence (AI), social media sentiment, natural language processing (NLP) and data to measure social value and impact for the benefit of ESG investors and companies in the process help to manage their risks in this area. Technologies like blockchain can provide more detailed, accurate and timely information about supply chains.
For example, RepRisk uses a combination of AI and machine learning with human intelligence to systematically analyze the publicly available information from over 200,000 public and private companies and more than 55,000 infrastructure projects in 23 languages.
“RepRisk essentially serves as a reality check on how companies around the world conduct their business – are they true to their word when it comes to human rights, labor standards, corruption and environmental issues?” said Alexandra Mihailescu Cichon, the company’s executive vice president of sales and marketing . “This perspective, combined with a transparent, rules-based methodology and daily updates, ensures our clients have consistent, timely, and actionable data at their fingertips.”
The Social Value Portal helps companies to quantify and communicate social, economic and ecological value creation. According to CEO Guy Battle, “Clarity about the social value initiatives a company seeks to deliver allows people on the ground—whether fund or asset managers, property managers, suppliers, users, or company employees—to pull together, target important ones Initiatives and help communities thrive. And you get this clarity through a consistent and understandable framework against which you can report and against which you can measure.”
However, some investors are skeptical about the accuracy and usefulness of the information these technology assessments provide. Sophie Lawrence is Stewardship and Engagement Lead at Rathbone Greenbank Investments. She says that until there is a broader regulatory framework mandating the disclosure of comparable, independently verified social data by companies, “we caution against over-reliance on third-party ESG data tools that use technology to collect company-reported social data.” to scrape and aggregate them for investors. This approach runs the risk of giving an oversimplified picture of company performance.”
Johan Vanderlught is an expert in sustainable finance at Van Lanschot Kempen, an independent wealth manager. The metrics used depend on the AI techniques a data provider uses, he says.
“Transparency in terms of data and methodology is a challenge with traditional data providers like MSCI, Sustainalytics and ISS ESG and remains so even more with AI ESG data providers. Ultimately, the quality of the data depends on the independence of the data source, and that is no different for social data than for environmental data.”
There are numerous factors and variables that need to be managed. But there are also extensive possibilities for different interpretations of facts and figures. Tiia Sammallahti, CEO and founder of whatimpact.com — a technology provider that helps businesses achieve social value through partnerships with charities — cites the example of a grocery retailer making donations to local homeless people.
“They can also automatically increase this value by including the broader benefits of homeless people who are better nourished and therefore more able to find employment or housing,” she says. “But it doesn’t necessarily take into account whether the food on offer is healthy.”
Sammallahti suggests that qualitative survey and interview data could be more accurate and useful than numbers published by the company in question or metrics derived from algorithms. “The key is to combine tools that are robust in their proxy numbers with qualitative, evidence-based reporting that verifies impact,” she argues. “In this way, a more precise calculation can be compared with the results.”
According to Nicola Stopps, founder of Simply Sustainable, an ESG consultancy, investors can and should demand more data from companies and data providers that focus on the impact of corporate policies and impacts, while also taking greater account of supply chains.
“This is critical, as new evidence shows that incorporating ‘S’ criteria into investment analysis leads to higher returns, lower volatility and reduced downside risk,” she says. “In particular, better integration of social indicators can help identify more resilient and profitable investment opportunities that already align with established and anticipated regulations. It is critical for investors to develop a strategy across their entire portfolio that encompasses engagement, advocacy and integration. Voluntary policies and “tick-off exercises” are not a solution to avoiding investment risk.”
Despite the complexities and contradictions, Ioannis Ioannou, Associate Professor of Strategy and Entrepreneurship at London Business School, is generally optimistic. He believes that competition between technology companies with different approaches and newcomers to the industry will be beneficial in the long run.
That’s because ESG issues in general – and S issues in particular – are complex and constantly evolving.
“We’re far from having a single optimal approach or metric that adequately captures what’s happening on the ground,” he says. “The more ideas we have, the more approaches, and the more we critique and question them as they compete with each other, the greater the chances that once the industry starts to consolidate, we’ll have more robust metrics and approaches.”