Global climate goals can only be achieved if the finance industry plays its part. Photo: martinwimmer Source: iStock

Sustainability: here to stay

Author: Robert Bluhm

Sustainability is becoming ever more important. Various initiatives have emerged to focus institutional investors' attention on social considerations, as in the case of the Corporate Social Responsibility Directive. Under the EU directive, large companies are required to disclose non-financial information about environmental, social and employment issues.

The United Nations promotes the Principles for Responsible Investment (PRI). Organisations can choose to follow the principles on a voluntary basis, which involves taking environmental, social and governance (ESG) factors into account in corporate investment analysis and decision-making processes. Agenda 2030 has been adopted by the UN General Assembly and sets out 17 sustainable development goals.

Global climate goals can only be achieved if the finance industry plays its part.

Ever since the Paris Climate Summit in 2015, it has been apparent that global climate goals can only be achieved if the finance industry plays its part. But in the absence of clear criteria for sustainable investment, private money is unlikely to be channelled into sustainable development.

In response, the European Union agreed an action plan for financing sustainable growth in March 2018, which was soon followed by proposals for regulations.

The Taxonomy Regulation will define criteria for measuring how green (environmentally sustainable) a given investment is.

The Transparency Regulation will establish rules on how financial market participants report the procedures for integrating sustainability risks in financial products, investment decisions and investment advice.

The Benchmark Regulation will be amended to include a low carbon benchmark and a separate benchmark for securities with a positive impact on CO2 emissions.

In light of developments in Brussels, institutional investors are wondering whether they should start restructuring their portfolios immediately. The EU does not yet require financial investments to consider ESG criteria, but investors are increasingly coming under pressure to at least provide a broad-brush picture of the ESG features of their portfolio. What is more, once there are standards for comparison, clear definitions and greater transparency, there will be growing public pressure on investors to increase the proportion of sustainable investments and to report on them.

The EU action plan proves that sustainability is not a passing fad. For some time now, foundations and ecclesiastical institutions have been applying sustainability criteria when investing their money. According to the German insurance industry association GDV, more than three quarters of all insurers already consider ESG factors when investing. Welfare institutions, pension funds and treasurers are increasingly considering ESG-compatible investments too.

Robert Bluhm, Sustainability Officer, Head of Securities Product Management, Universal-Investment Photo: Alexander Habermehl

Universal-Investment can help

Two years ago, we began expanding our reporting range to include sustainability components. Our ESG reporting tool is now available to all investors with assets on the Universal-Investment platform. The product is based on the MSCI model – MSCI is the world's largest ESG research provider.

Portfolio sustainability is measured using a scoring system on a scale of 0 to 10, then compared with the ESG and CO2 ratings for both a sustainability and conventional benchmark. Further analyses indicate which individual positions feature particularly positive or negative sustainability scores. Business involvement evaluations and impact monitoring indicate the proportion of highly controversial industries, countries and practices present in a portfolio. An ESG analysis and carbon footprint calculation can be produced for each individual portfolio.

The MSCI ESG research model also uses the best-in-class approach, which identifies companies that are noticeably more sustainable than their peers. For example, industries that use a lot of water or energy are not classified wholesale as "do not invest".

ESG and CO2 reporting represent the first steps in improving sustainability. In addition to being better for the environment and society, sustainable investments offer tangible benefits:

– Better understanding of risk

ESG criteria are a valuable addition to traditional risk metrics, because they indicate the risks to society in general. Those risks may be linked to potential financial losses, such as the cost of environmental damage.

– Performance benefits

Gains can be classified in relation to specific ESG criteria. Academic research has consistently found a positive correlation between emphasis on ESG criteria and risk-adjusted performance.

– Future-proof

Anyone who already uses ESG reporting will be better prepared when new rules on sustainable investment emerge.

as per October 2019

Issuers in the spotlight

MSCI is a leading ESG rating agency and MSCI ESG Ratings are designed to help investors to understand Environmental, social, and governance risks and opportunities. In an interview with universal spotlight, Leonid Potok, Vice President (Client Coverage) from ESG Research at MSCI, explains how the team of analysts evaluates data and separates the wheat from the chaff.

Leonid Potok, Senior Associate (Client Coverage), ESG Research, MSCI Source: MSCI

universal spotlight: Mr Potok, how does MSCI calculate the ESG rating for securities issuers?

Leonid Potok: There are 38 ESG Key Issues that we use to determine the ESG rating. That said, when you are rating ESG factors, less is often more. So we limit ourselves to between three to eight thematic areas for each issuer, which are selected according to the materiality principle. For example, if a company has serious governance failings, that will be immediately apparent from the ESG rating. This is important information for investors – it can be worth money.

How does MSCI obtain the information needed to produce the ESG rating?

Our global team of 185 experienced research analysts assesses thousands of data points across 38 ESG Key Issues, focusing on the intersection between a company’s core business and the industry issues that can create significant risks and opportunities for the company. To assess companies’ exposure to and management of ESG risks and opportunities, we collect data from the following sources:

  • Macro data at segment or geographic level from academic, government, NGO datasets (e.g. Transparency International, US EPA, World Bank)

  • Company disclosure (10-K, sustainability report, proxy report, AGM results, etc.)

  • Government databases, 1600+ media, NGO, other stakeholder sources regarding specific companies

Companies are invited to participate in a formal data verification process prior to publication of their ESG Ratings report. At that time, companies have the opportunity to review and comment on the facts contained in their existing MSCI ESG Ratings report, as well as to provide MSCI ESG Research any additional ESG information if they wish. This process is also in accordance with the objective of frequently updating company reports with the latest available information as provided by companies. Issuers may request to see their reports and/or to provide updates or corrections at any time.

Do you use big data and artificial intelligence when evaluating the information?

Yes, we use technology and AI, to extract investment-relevant insights from unstructured data. Machine learning and natural language processing help us increase the timeliness and precision of data collection, analysis and validation to deliver dynamic content.

Does MSCI adjust its ESG reporting to reflect regulatory changes?

We are actively engaged with regulators: MSCI ESG Research was represented in the EU technical expert group. So when there is a proposal for a new regulation, such as the EU Taxonomy Regulation, we are well positioned to help our clients to deal with the new requirements. Which is what we do.

MSCI Interview as per January 2020 

Author: Robert Bluhm
Date of issue: 2/7/2020