In my country there is considerably less research that incorporates ESG than in more mature markets such as the EU. Where it has, this has mostly focused on G, largely disclosure issues and executive remuneration. My personal project was to consider how to encourage more ESG research, particularly with an environmental and social angle, and this post provides an update on the progress to date.
I have discussed the challenge with the buy and sell-side. Speaking to sell-siders – a mix of research heads, equity analysts and salesmen – the message was that investors are increasingly asking them to incorporate ESG in their research and recommendations. Since the sell-side is under pressure, with significantly reduced commissions and regulatory changes like MiFID II etc, some view ESG as a distraction, others as an opportunity to distinguish themselves, especially with thematic research. Most indicated that the principal obstacles are their lack of ESG knowledge and the cost of obtaining ESG data, when investors were unwilling to pay for this. Some also complained about limited company disclosures. As a result, only a handful of thematic research notes with an environmental flavor were produced in the past year, despite my country having a host of problems ranging from water shortages, floods, fires etc, and large companies (mines, petrochemical, cement and energy) with considerable negative environmental impact that should be factored into investment cases. I asked the sell-side bank analysts to rank 7 key issues impacting my company over the next 5 years. Climate change came last with a score of 2/100, with the majority giving it zero.
On the buy-side, a few leaders already include ESG in their investment process, using external data providers. Nonetheless, very few have done as much, especially among smaller investors who simply don’t have the resources to hire ESG specialists. Some large investors, who are members of the PRI, prefer not to change their processes to embed ESG, although they may use it in basic screening. There’s still healthy skepticism as to whether factoring in ESG improves performance/returns or simply increases costs. One event brought corporate governance to the fore, when a retailer (a one stage the 5th largest on our stock exchange by market cap) collapsed after fraud. Moreover, a number of other scandals have arisen in the past three years, where auditors were heavily criticized in a corporate failure. In the WEF’s latest Global Competitiveness Report (2018), my country has plummeted from the perennial #1 in “strength of auditing and reporting standards” to outside the top 50 in the past 5 years. So investors are increasingly concentrating on governance as a consideration.
Positively, there has been a dramatic upsurge in interest in how climate change impacts banks recently, after an NGO forced one large bank to include a resolution on improving their disclosure on climate change risk (effectively implementing TCFD) in their 2019 AGM resolutions. Although it was voted down at the board’s behest (given ridiculously short timeframes for the disclosure, in my opinion), investors are now asking the whole sector about climate change.
Initially, my plan was to create annual awards for the best ESG-related research, as an incentive to encourage equity research that incorporates sustainability. This remains a work in progress, particularly getting suitable judges and some funding. The other aspect, which became very evident in my discussions, was the need to improve corporate disclosure of material ESG data, in order to enable better analysis in the first place.