Environment, Social, and Governance Criteria - The New Lens for Investors
July | 2021
Traditional methods of assessing stocks were robust, despite which investors suffered losses. Learning from historical challenges, investors added an extra lens for stock evaluation. Not entirely relying on the financial analysis of a company or technical analysis of the performance of a stock, investors started to capture the overall health of the company and ascertain the roots or fundamentals of the company, for the greater good of the society.
This newly added lens is called ESG (Environmental, Social, and Governance) criteria. Multinational companies are evaluated by global report and ratings agencies on their ESG performance, and these reports and ratings are used extensively by financial institutions, institutional investors, stakeholders etc.
Financial institutions started creating funds based on ESG principles and invested in multiple stocks in the companies with higher ESG ratings. These are known as ESG funds which even individual investors can buy and their investment dollar is exposed to minimal risk.
The ESG report and rating providers play a vital role in assessing companies with high degree of accuracy as these agencies are the backbone of the entire ESG value chain. There are numerous ESG data providers, varying by industry coverage, data capturing techniques, methodologies used, rating scales etc.
The ESG criteria and its growing relevance
ESG scores provided by a third-party rating agency define certain standards of a company’s operations and their impact on the environment, social business relationships, and transparency in governance. This helps socially conscious investors screen potential investments and avoid companies that could be a financial risk due to their ESG-unfriendly practices.
Environment – The company’s energy consumption patterns, amount of waste created, natural resource conservation, treatment of flora and fauna, pollution etc. are used in evaluating the environmental risk, compliance with government regulations, and how these companies are taking ownership and measures to mitigate those risks.
Social – The criteria focuses on the company’s choice of vendors to do business with across their value chains: Do they share the same values as claimed by the company? It looks at the company’s encouragement to its employees to do voluntary work, donate a part of the profits back to society, caring about employees’ health and safety, stakeholders’ interest, and business relationships.
Governance – This criterion is of utmost importance and given a higher weightage by most of the rating agencies. Investors want companies to not engage in illegal practices, avoid conflicts with board members and stakeholders, keep away from politics, maintain a healthy gender equality index, not involve in white collar slavery. An important standard is the transparency and accuracy of accounting methods.
There has been a steady increase in the value of global assets applying ESG data to drive investment decisions. The ESG market is measured by the amount of assets under management in ESG funds. According to JP Morgan, the market was broadly about $45 trillion in asset under management (AUM) in 2020. In 2018, North America and Europe accounted for around 90% of the market.
Increasing demand for ESG rating agencies
There are over 100 ESG research and ratings providers producing sustainability reports. These could be non-profit organizations, financial institutions, pure play rating agencies providing various kinds of research reports and rating on topics like diversity, consumer loyalty, specific location coverage, financial size of the company, and companies covering the full gamut of ESG globally.
The competition is extremely high, and the market for ESG data also known as non-financial data or alternate data is increasing. Many agencies have merged and partnered to sustain extreme competition. Today, markets are experiencing a shift from shareholder interests to stakeholder interests driven by regulatory push for transparent and accurate disclosures, shareholder activism, and advanced technologies enabling monitoring of ESG metrics.
With the increase in socially-conscious investors, more ESG funds are created, and the demand for ESG reports and ratings also increases. The ESG rating providers are now partnering to serve clients better and with larger scope.
The ESG rating providers are evaluated on the basis of their ESG research coverage (regions, companies, sectors, and revenue), scope (what aspect of ESG do they monitor), data sources (primary or secondary data, their accuracy), reputation and usage (recognitions, platforms used, and deployments), rating scale and methodologies (1-10, 1-100, AAA – D, AAA- CCC, percentile etc.).
The challenge is to keep the data accuracy high throughout the operations. Since the data flows from multiple sources in both structured and unstructured form, inadequacy and inconsistency of data, data management and analytics is a huge task.
Creating varied data models, identifying right methodologies, validating the framework created, and improving cohesiveness and standardization across different sectors is also very important.
The talent required to perform ESG activity is inadequate. Creating a talent pool with high degree awareness of ESG work is a challenge. The rigor that goes into ESG ratings has substantially increased, requiring skilled data scientists, analysts and BI engineers. In addition, ESG as a topic is still evolving in universities, making hiring even more difficult.
Even if the competition is extreme amongst the ESG ratings providers, there is a huge demand for ESG ratings and reports from financial institutions, institutional investors, company stakeholders etc. And this offers a level playing field for all ESG ratings providers.
How Wipro can help ESG ratings providers
Wipro can support ESG ratings providers through the ‘design, build and run’ operations for ESG ratings and reports. This includes:
Wipro’s ESG research management team can provide the operational capacity to continuously run the operations on a managed services basis, with continuous improvement and addition of automation to existing operations.
Wipro covers the work of ESG information across a wide range of companies in manufacturing, extractive, pharmaceutical, healthcare, biotechnology, REIT, banks & other financial institutions, utility, retail, hotels & entertainment facilities, gaming, semi-conductor, electronics, construction and maintenance, internet, restaurants, beverage & tobacco, human resources, consulting, and leisure & travel.
Wipro’s ESG research and scoring operations team can support the day to day operations 24 X 7 for 365 days on a managed service basis.
How the managed services structure benefits clients:
Investors are not only interested in the financials of companies, but also the actions that companies take today in determining the impact on tomorrow. This equips investors to make informed, responsible, and ethical investment decisions. Companies need to understand their role in the Environmental, Social and Governance systems – as much as in the economic system. These three interconnected systems constitute the new business environment.
The users of the ESG product will be able to view and compare a wide range of environmental and social performance indicators across different sectors and regions along with governance structures in companies to identify risks and opportunities and make conscious investment decisions and strategies.
The evolution of non-financial data, increased use of the non-financial/alternate data for investment decisions, and the constant push from regulatory bodies to disclose ESG score has now made it mandatory for companies to set up their ESG operations and/or outsource their existing ESG operations for better business outcomes.
For more details on how Wipro can empower you on your ESG operations journey, connect with us
Suprav Patnaik
Practice head - Data and Insights Practice, Wipro
Suprav currently leads Wipro's Data and Insights practice, leveraging comprehensive machine learning and analytics solutions for solving business problems. He has 15 years of experience in the BFSI domain working in varied roles in service delivery, RPA, and analytics.
Abhijit Gangurde
Solution Consultant – Data and Insights Practice, Wipro
Abhijit supports Wipro’s Data and Insights practice by building data and analytics solutions for financial and non-financial clients. He brings marketing and analytics expertise and holds an MBA degree in Marketing from SIBM Pune.
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