The ESG Opportunity For The Industrial Sector

Next Gen measurment

The industrial sector is recognizing the demand of society to transform the way they approach strategy, drive performance, and report results. The implications of ESG are significant – as is the potential for bold leaders to reinvent and inspire their organizations.

What Does ESG Stand For

Short for “Environmental, Social and Governance,” ESG considers the impact a company has on its employees, customers and the communities where it operates. In essence, these regulations are intended to act as a standardized system of protections, with both local and global implications.

Environmental protections are ensured by the regulation of carbon emissions, air pollution, water pollution, water scarcity, and deforestation. Social protections are ensured by regulating things like worker safety, customer success, data hygiene and security, diversity inclusion, community relations, and mental health. As a result of this standardization of ESG regulations, ESG ratings are becoming a risk mitigation proxy for investors and insurers.

ESG – An Untapped Investment Opportunity

In the early stages of regulation and enforcement, those with implementation experiences have a greater voice in influencing the path of regulators and hence reducing inevitable burdens and risks.

When businesses create sustainable advantages that deliver lasting value, it’s a story worth telling. Reliable data and smarter technologies help businesses identify, measure, and demonstrate accountability that builds trust.

Behind closed doors, there are negative expressions related to the burden of adherence and reporting; however, this is a disservice to the massive opportunity waiting to be exploited if you are willing to look for it. We are beyond the era where hollow words will appease minority activist investors – ESG conditions on investment are central to investment agenda.

What Is ESG Investment Opportunity

Source: Principles for Responsible Investment (PRI). Data as of April 30, 2017. Methodology: Total AUM includes reported AUM and AUM of new signatories provided in sign-up sheet that signed up by end of April of that year. Total AUM for the past three years excludes double counting resulting from subsidiaries of PRI signatories also reporting and external assets managed by PRI signatories. AUM for previous years include some element of double counting.

ESG Score – A Competitive Advantage

If all players in a market are compelled to make costly investments to adhere to ESG policies, there is no loss of competitive advantage. In a market where professing your firm’s ESG credentials can be used to increase the availability of investment or positively influence customer buying decisions, speed of adoption is critical to creating a competitive advantage.

At some point, these will be legal requirements imposed by regulators. If short term thinking motivates heel dragging, the consequence will be rushed implementation at that point. As a result of this, change will be prohibitively expensive.

The long term data presents a compelling picture of the many benefits of being focused on ESG investment issues. Higher ESG performance has been strongly connected to a number of key investment factors including:

+ Higher profitability and lower volatility
+ Better cash flow management
+ Higher valuations
+ Generating better financial returns

It’s a compelling list of investment advantages for ESG-focused investors. And it makes intuitive sense. Management teams who are good at managing their environmental, social, and governance risks and opportunities generally create more value for investors in everything they do: success breeds success. So ESG performance matters to investors and this explains why the demand for meaningful ESG data is on the rise.

A robust ESG policy signifies strong recognition of externalities and practices in use to actively avoid those risks, investors rightly understand that these risks have been priced into the investment. Where no ESG focus exists those risk factors are not visible and those costs are currently being covered by local communities, ecological damage, or other irresponsible shortcuts that will eventually have to be reimbursed. ESG risk can be seen as a type of toxic debt with unknown terms and costs, precariously waiting to be called upon for repayment.

The Devil Is In The Data

But…there’s a problem.

There are two main ways investors have traditionally accessed ESG information; both present data quality challenges:

Company Sustainability Reports

Companies present their ESG performance in annual sustainability reports; these reports include details of how they are performing versus their ESG goals, along with whatever other ESG information management chooses to disclose. There are a number of challenges for investors with this ESG information source. Firstly, the publication of sustainability reports is an annual event which includes outdated information from the preceding year. Secondly, some companies use their sustainability reports to “greenwash”, which is a polite way of presenting progress without actually doing anything. And thirdly, by picking their own ESG goals to track in their sustainability reports, companies are presenting biased and subjective information.

Traditional ESG Rating Providers

The other traditional way investors have accessed ESG data is through the ESG rating agencies such as MSCI, Sustainalytics, Bloomberg and Thomson Reuters. However, the challenge with this ESG scoring approach is that each rating agency has a different scoring approach which is not disclosed to investors. So, the various ESG rating agencies present very different ESG scores for the companies they are scoring — and that includes for the world’s largest and best understood companies as shown below. It’s a remarkably confusing picture for investors looking for clear guidance regarding ESG performance.

ESG Scores Graph


The upshot of these ESG data access challenges is that there is a scarcity of high quality useful ESG data available across the market at a time when demand for high quality ESG data is booming.

Government imperative to leverage new technology in regulatory design – accurate and timely data from the process edge is essential to operations.

Following increased collection and centralization of data, it is possible to unlock the adoption of big data, Artificial Intelligence, and Machine Learning to provide insights and transparency.

Conclusion & Impact

Regardless of opinion, whether you are for or against regulations, ESG ratings are becoming a risk mitigation proxy for investors. Knowing this, your decision as a business is to either cooperate to compete or protest and become obsolete. One can’t blame investors for using ESG in such a way either, it’s a good business decision; an ESG-cooperative with good ratings is a tempting pair of dice to roll.

ESG Risk Event Graph

Source: Bloomberg, Data as of November 30, 2016 past performance is no guarantee of future performance.

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