Question: What are key points to keep in mind when assessing the ESG performance of a company?

Douglas A. Jaffe

When assessing large corporates with a wide range of potential ESG issues, a challenge is narrowing the scope and determining what are material, high-priority issues and then assigning realistic timelines to mitigation efforts. Assessing materiality is not easy, especially in “dirty” industries, where differences in viewpoints from stakeholders or value chain partners can be extreme. ESG discussions are very polarizing with some seeing corporates focused on highlighting successes and putting a positive spin on progress, while critics may focus on shortcomings and historical failures. It is not uncommon to find contradictory information on an issue. The “truth” can be labeled subjective and easily masked by parties with incentives to avoid a fact-based assessment if it does not fit the larger mission, be it condemnation or green washing. Moreover, there tends to be a focus on visible, current ESG risks that may be more easily remediated, as opposed to dealing with legacy issues that are less newsworthy and more intractable.

The trend is towards quantitative, ratings-based approaches to ascertain the truth or divine trends. This has value for certain types of data but can miss the on-the-ground reality, especially when operating in difficult jurisdictions. Unless you physically visit sites, talk to local parties, and collect quality intelligence, it can be hard to get a full picture. Also, if you only look at the company in isolation and not its larger supply chain or up/downstream partners, you are likely missing issues. Moreover, the picture you get will only be a snapshot and will not show if a company is moving in a positive or negative direction. Monitoring and assessing over time is necessary to track progress and ensure issues are being remediated. In our experience, it comes down to budget and C-suite willingness to invest the time and effort to do a proper assessment. And, once a risk assessment is greenlit, it should not simply be handed off to an external consultant but should also have internal support and buy in. Existing employees and business partners will have useful insights, and both strong desires and vested interests to help make the company a better corporate citizen.

Flora Wang

The term ESG has become the victim of its own success in that the three-letter acronym suggests it is something simple, something that can be easily synthesized into one score. This couldn’t be further from the truth. Climate change, only one of the many subjects under the E pillar, has an entire science discipline behind it and the analysis of its impact on businesses relates to a wide range of issues such as policies and regulations and technology development. Other ESG topics like biodiversity, digital inclusion, supply chain management are no less complex. Effective ESG analysis therefore needs to be issue specific to begin with. Where there is a need for an aggregated ESG score, a more thought-through approach than a linear aggregation of a host of issues with very different natures is essential for the result to mean something.

When performing ESG analysis on a specific company, it is also important to bear in mind that ESG are only attributes of the company. No analysis on the attributes is effective without a good understanding of the core, which in the case of a company is its business fundamentals, its development history and future plan, and the people behind it. Therefore, the second important underpin for effective ESG analysis is that it needs to be company specific. A sector-based approach to ESG analysis without sufficient appreciation of company specificities will need a good deal of luck to hit the mark. Lastly, effective ESG analysis should not be overly reliant on what a company reports. This approach punishes companies with poor disclosure when poor disclosure is not necessarily poor practice. Moreover, it is also backward-looking especially when the historical information is used in a formulaic manner to produce a rating. Good ESG analysis requires a seasoned analyst to put such information in the context of the company and its business and interpret it into forward-looking insight.

Flora is Director, Sustainable Investing for Fidelity International. Based in Hong Kong, she leads Fidelity International’s engagement efforts with investee companies in Greater China on ESG issues.

Alastair Campbell

After establishing Thomson’s group office in Beijing in 2004, our CEO charged us with creating a CSR program appropriate for local conditions. Looking at different precedents, it soon became clear that there was a very broad spectrum of solutions to the concept. Some were purely passive, for example simply offering donations to selected good causes, while others had direct involvement in community programs. We chose the latter route, primarily because we were in the process of transforming our business in China and wanted to establish a new and positive image for the company and attract local talent. The results were unquestionably beneficial to both the company’s image and our business development. In today’s context, I suspect similar choices confront a wider range of organizations when they debate how to implement ESG commitments. In a world where climate change, environmental degradation and female empowerment are issues of daily disputation, there is no avoiding the challenges of carbon footprint, environmental impact and non-discriminatory governance. Moreover, the ever-broadening range of issues and the media attention focused on them demand a more substantial and proactive approach.

But the reality of implementation is not easy to verify in the absence of global standards and definitions. Large organizations can afford to employ consultants to design programs and publish a plethora of documents and commitments, but do the underlying actions match the polished presentations prepared for the annual report? Our experience is that in many cases they fall short. Many leading companies boast comprehensive ESG programs on their websites, but the real challenge is dependent on human factors, in particular an understanding of risk and the need for continuous monitoring. One new industry to watch in this space will be electric vehicles; the supply chains on which their batteries depend source raw materials from countries whose mines are far from compliant with even basic ESG standards. To what extent will this affect consumer preferences? In China we already see a price war between Tesla and local producers Nio, Xpeng and Li Auto, so ESG concerns are unlikely to be a priority in the mind of consumers.

Ryan Manuel

The past decade has seen companies labour under a plethora of ESG measurement techniques. Many of these are quantitative: There is a push to try and develop ESG such that it can be used in a cost-benefit style analysis. Asset managers in particular are working towards tracking the whole value chain of any given investment. A series of benchmarks and tools are now at any analyst’s finger tips. But these also bring problems of false legibility — that is, the belief that order can be imposed on, that ESG can be measured, and that everything made readable. Yet with every new tool comes also an incentive to game the rules. As Chinese politicians say, policy from above brings counter-policy from below. So, a large part of assessing ESG performance is not just figuring out the numbers; it is calculating who wins from gaming those numbers and why.

The new ESG techniques also bring exciting new ways to consider overall performance. Modern business develops and uses extraordinary amounts of data. The shift is such that many firms call themselves “tech companies”, no matter their original industry. Many companies are not only developing ESG policies and measurements, but they are also selling their internal solutions. Businesses can pick and choose from various approaches to ESG. And with that, we are also rethinking what we mean by “value”. The next decade is likely to see ESG moving to be a central part of business balance sheets. Having a good ESG policy, measurement method, and benchmark against which you perform is one thing. (It is also in and of itself very impressive). But being able to assess all elements of one’s environment and social impact would serve as an even more substantive signal. It shows the market a remarkable control of one’s entire value chain. Data assets — including not only the data themselves but also ways of collecting, loading, extracting, analysing and presenting data — are well-valued. Could a company be able to verify, monitor and analyse its ESG data, and reassure the market that ESG is not merely three letters in search of a noun, then that shall be yet more valuable.

Ryan is Chief Asia Strategist, Silverhorn Investment Advisors. He also founded Official China, an initiative that uses machine learning and big data to read and analyse Chinese information systematically.