When we started our sustainable investing journey in 2008, it was on the back of visiting the SKOLL World Forum and realizing that a significant amount of the world’s problems can be solved by innovative and holistic business solutions. The biggest challenge was (and continues to be) how do you know your capital contribution has solved or at least contributed to the solution?
The answer, already back then, and largely still to date: you cannot know unless you were willing to spend a lot of the invested capital on data collection and verification.
The term ESG (Environmental, Social, and Governance) investing was first coined at a Worldbank conference in 2005 “ Who cares, wins”. The outcome of the study:
“[We] are convinced that in a more globalised, interconnected and competitive world the way that environmental, social and corporate governance issues are managed is part of companies’ overall management quality needed to compete successfully. Companies that perform better with regard to these issues can increase shareholder value by, for example, properly managing risks, anticipating regulatory action or accessing new markets […]”
— Financial institutions with total assets under management of $3 trillion at the time.
Interestingly, no one at the time spoke of a “trade-off” or “concessionary” financial returns. In fact quite the opposite, they believed that companies would perform BETTER in the future if they manage their ESG contributing factors. The biggest issue with ESG investing to date has been a perceived need by many in the investment community to “repackage” and “reposition” existing financial assets with an “ESG” or “SDG” (United Nations Sustainable Development Goal) wrapper to create an appearance of care. The reality is that there are hardly any authentic “ESG” investment products.
Without improving the quality and frequency of ESG data, investors cannot discern between an asset that genuinely contributes or at a minimum does no harm, versus one that appears to contribute but actually does not.
What has changed for investors between 2005 and 2020?
Firstly, the demand for investments that offer more than just a financial return has exploded to over $100 trillion in the last decade. The “changemaker” investors that drive demand for authentic contribution share some common characteristics. As per the framework, 17Africa developed on these investors, they:
- Are committed to addressing societal and environmental outcomes along with financial returns;
- Demonstrate a willingness to overcome behavioral biases in making investment decisions; and,
- Accept that the pursuit of social and environmental outcomes may require a new framework for risk assessment
Secondly, transparency has become far more common and in-demand both to seize market opportunities as well as mitigate downside risks. The number of signatories that have signed up to the United Nations Principles of Responsible Investing (“UN PRI”) has grown from $4 trillion in assets managed by 30 signatories in 2006 to over $100 trillion in assets and over 1,000 signatories now. Members specifically sign up to Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
In addition to more formal investment disclosure requirements, no company can afford to have their “weakest link” such as a possible breach of social and environmental standards, like paying below minimum wages or being caught out polluting a river or ocean, be exposed. The public will demand to see that business shut down!
How do investors reliably and cost-effectively ascertain the societal and environmental outcomes of an investment opportunity at scale?
Who determines what matters and how to measure it? This is especially pertinent at a time when what mattered even a year ago has been largely overshadowed by current societal needs to fight off a pandemic and protect those that are vulnerable so the world can prosper again.
The solution lies in the ability to capture, manage, and maintain data through the emergence and application of technology. The ability to accurately and immutably collect, collate, and disseminate data electronically continues to advance. Investors can access an ability not only to provide cost-effective real-time data on non-financial key performance indicators (“KPIs”), but can also provide customer and societal feedback loops on how this service was received and whether the need has been met or new needs are emerging.
Companies are either proactively driven by market (consumer) demand or by force through regulation and investor disclosure requirements to not only report on financial and impact KPIs but to start developing the infrastructure required to track and assess risks on a real-time basis.
The potential live reporting of environmental outputs and social standards allows investors to work from a new risk framework that takes the real market drivers of our time into consideration. Direct linkages between companies’ ESG performances and profitability and/or cost of capital can finally be made objectively.
You pollute, you pay. You discriminate, you will be discriminated against. You cut corners on human life, investors will cut corners with you.
You can review a series of technology-driven solutions in “Sink or Swim; Prioritise Impact or watch your Business drown.
It is insane to think that by investing in “ESG-labelled” public securities your funding will have any direct impact on the causes we need to care more about and most importantly direct NEW capital to. Secondary trading is exactly that — “second-hand” trading. You are not directly funding the production of new goods and services. Indirectly, however, as long as we are able to at least measure and prove the impact any asset achieves, data-driven ESG will result in the reduction of risk, and therefore cost of capital for those assets that outperform on ESG standards.
Furthermore, the data-driven evolution of ESG will provide for a mechanism to correctly “label “ investment strategies and products that really matter to the well being of people and planet.
What does data-driven ESG look like
ESG measurements that actually indicate impact can be achieved in one of the three following ways:
- Tailoring ESG metrics to specific types of companies or industries that are KPIs specifically relevant to that industry category for example; how much energy, waste, or water consumed per $1 revenue in the automobile industry
- Obtain live proof points of the ESG metrics being achieved through APIs into the companies and external data sources versus just a self-report interview, or even worse a policy disclosure, where you check the box.
- With industry-specific KPIs being tracked live, it will become possible to generate longitudinal rich data series that establish correlations between verified outputs and genuine positive impact outcomes created. One could then use these predictive models to show what impact each $1 invested will have and therefore make investments where impact is the imperative, not a by-product.
This would be the true unlocking of economic value through ESG as it was intended to do from its inception in 2005. It is up to all of us, companies and investors, to agree that an “ESG policy” in itself is just not good enough. We want and can have live and direct ESG data that not only will produce enhanced returns but over time will be able to predict impact outcomes to truly move the world forward.
To find out more visit the Proof website.