Abstract

Investing in the environmental, social, and governance (ESG) area first came into prominence in 2004 when the erstwhile UN Secretary-General Kofi Annan took the initiative to incorporate ESG into the capital markets.

ESG is on the way to becoming a multi-billion-dollar market.

Different stakeholders such as ESG research firms, data providers, asset managers, rating agencies, and stock exchanges have started to invest heavily in the various components that make up the entire ESG life cycle.

ESG ratings now are essential parameters for institutional investors who intend to de-risk their investments.

We discuss the key industry trends in ESG, the current challenges organizations face, and the possible solutions to address such issues.

The changing face of ESG 

Organizations are becoming increasingly conscious of the environmental and the societal impact of their businesses in general.

This results in greater transparency in corporate decision-making, ESG data trends show.

The ESG market has been growing at about 35%, hitting the $1 billion mark in 2021. Some of the emerging trends in ESG are:

• Investors have increased their focus on sustainable businesses over short-term profits. It has raised the pressure on companies to disclose ESG parameters. In October 2020, Bloomberg and MSCI Inc. launched the Bloomberg Barclays MSCI Emerging Market Asia Credit ESG index suite. The objective was to track the performance of the emerging market US dollar-denominated credit debt in the Asia ex-Japan region while incorporating measures for environmental, social, and governance risk and exposures. 
• Regulations around ESG have also been strengthened. In Europe, asset managers had to integrate ESG considerations into their fiduciary duties by 2021. The US and others need to follow similar regulations. 
• As regulators work on ESG disclosure norms, companies could adopt the comprehensive reporting standards of organizations such as Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-Related Financial Disclosures (TCFD). Increasingly, public organizations have begun to realize the need to comply with and disclose sustainability reports. Besides aiding compliance, such disclosures help create a positive brand image to attract investments. The increasing awareness of the customers, who are willing to pay a premium to ensure that the products and services they procured are produced sustainably, is another motivating factor.
• Credit Rating Agencies (CRA) focuses on building capabilities and enhancing existing offerings via acquisitions or partnering with ESG specialist startups or data providers to fulfill investor demands.
• The IT industry is a new entrant in the ESG ecosystem. It is best poised to support scaling up ESG operations by leveraging artificial intelligence (AI) and machine learning (ML) technologies.
• Asset managers have started forecasting revenue, asset book value or, company valuations based on ESG factors. Sell-side research brokers consider including ESG factors into their investment recommendations (such as buy, hold, and sell) and forecasted company financials.

Leveraging ESG is not all that simple

Despite all these new growth trends, investment management firms must cover much ground to realize the full potential of ESG incorporation.

The challenges include:

• Lack of ecosystem collaboration for a common cause: Processes are disjointed and fragmented between various ESG ecosystem stakeholders, including regulators, ESG reporting framework boards and data providers, ESG research firms, asset managers, rating agencies, stock exchanges, and other organizations. Ecosystem participation is a must to achieve ESG vision 2030 as agreed in the Paris Agreement. 
• Plethora of ESG disclosure frameworks (and associated reporting bodies): Differences in methodologies are responsible for differences in scoring and interpretation. Companies need to be aware of the appropriate reporting standards and internally equip themselves to capture and report the disclosures accurately.
• Different ESG ratings for the same company: Varying scores occur as each rating firm has its proprietary scoring methodology. The rating parameters and biases are based on both perceptions and analysis based on the available data against the sustainability indicator.
• Authenticity of data is a must before reporting: While the authenticity of company data is a prerequisite for accuracy, lack of auditing results in greenwashing and may be illegal.
• ‘Analyst inference'-driven and not ‘data inference'-driven: Publicly available sources are where data is mainly collected and where further detailed clarifications are not available, leading to analyst inferences.
• Absence of regulations: Enforcement is lax when rules are in force. Furthermore, ESG-related disclosures are hitherto voluntary and not mandated.
• Lack of awareness of ESG: Organizational lack of understanding of ESG and its benefits poses a problem. Moreover, the absence of a well-defined regulatory framework often results in involuntary disclosures, primarily arising from competition pressure or investor demands. 
• Lack of ESG platform to capture data and report disclosure: Most existing ESG platforms and tools target investors and asset allocators to help them gain insights and better manage risks. ESG management platforms for organizations are not expected. The implication—current processes to measure and report organizational ESG disclosures are manual and excel-driven. 

Effective ESG implementation needs collective effort

Unless there are correlated efforts to support all the stakeholders involved in the ecosystem, the risks of lack of rigor will persist.

Governments can align regulations to meet the goals of the Paris Agreement, while ESG framework bodies can create a blueprint for unifying global reporting standards. Primary stakeholders include organizations who need to step up their ESG performance. It also incorporates rating agencies and data providers who need to converge to expected standards and increase their coverage by manifolds. The public needs to be made more aware of the long-term impact of their choices.

The IT sector has an important role to play in this ecosystem. Potential solutions include: 

For organizations in general: 

• Create new platforms or augment existing enterprise resource planning (ERP) platforms to include the collation of data to derive various ESG parameters. 
• Ease of reporting with canned reports that are aligned with regulatory requirements. 
• Deploy real-time intelligence with ‘if-what’ and ‘what-if’ analyses on ESG scores or compliance around the impact on the respective organization for operational decisions being taken. 

For rating agencies and data providers: 

• Leverage ML and democratized AI capabilities to decode qualitative information and create unbiased inferences efficiently.
• Enable intelligent platforms that can help rating agencies and data providers scale and provide more real-time insights to enable informed investment decisions.
• Ensure compliance with the local regulatory demands with geography and segment-specific personalization. 
• Augment current financial risk metrics with ESG scores to provide financial investors with a transparent tool for making better investment decisions. 

For public awareness: 

• Integrate ESG information from various sources and display inferred data for every product being sold in online marketplaces such as Amazon. 
• Make ESG-related news mainstream and not limit it to informed investors, as is the current trend.

Public domains increasingly become substantial information repositories, making information access easy for end-customers and investors. Therefore, the onus of providing accurate ESG information rests on each organization. Lack of information may potentially be perceived as ‘insensitivity’ on the company’s part. Inaccurate information or misrepresentation is even worse as it may lead to serious and irreparable reputational damage.