ESG Data for a Better View of the Big Picture

Businesspeople who speak about social responsibilities are “unwitting puppets of the intellectual forces that have been undermining the basis of a free society.” No, this is not a quote from a raving presidential tweet; it is 50 years old and demonstrates that the debate about corporate social responsibility is nothing new. At the same time, it illustrates just how fundamentally the mood has changed. An economist who wrote something of that kind today would hardly stand a chance of winning a Nobel Prize like Milton Friedman did years ago. The quote above comes from his essay titled The Social Responsibility of Business Is to Increase Its Profits.

Various criteria have always had to be taken into consideration when investing money, but in the past it was mainly the financial return that stood in the foreground for everyone from retail investors to billion-dollar pension funds. Today that no longer universally applies, as evidenced by headlines and comments in recent months. Goldman Sachs, for instance, declared that it would no longer underwrite IPOs for companies with all-male boards of directors. State Street Corp.’s investment unit, in turn, plans to vote against the boards of major corporations that lag behind on sustainability standards.

BlackRock Chairman and CEO Larry Fink even went as far as to write that “we are on the edge of a fundamental reshaping of finance” in his influential annual letter to chief executives. “In the near future – and sooner than most anticipate,” he continued, “there will be a significant reallocation of capital.” Lastly, the Harvard Business Review trumpeted nothing less than an “ investor revolution.”

Sustainability investing is experiencing an unprecedented boom. The business magazine Forbes writes that the total volume of sustainability-linked investments is estimated to exceed USD 20 trillion, which equates to one-quarter of all assets under professional management worldwide. Sustainable assets feature different target attributes such as “impact,” “sustainable,” “value-based,” “ mission-driven,” or “green,” to name just a few. The abbreviation ESG, which stands for Environmental, Social, and Corporate Governance, has taken root as an umbrella term. The objective of ESG is to make the sustainability and societal impact of an investment measurable.

The ESG concept came to public attention in 2004 via a United Nations report bearing the catchy title Who Cares Wins. Kofi Annan, the UN Secretary- General at that time, invited the CEOs of the world’s 50 largest financial institutions (21 ultimately participated) to create a framework for integrating ESG criteria definitions into capital markets. Their closing report, which was co-financed and co-published by the Swiss Confederation, summarized their findings.

So, does this mean that everything is in place to facilitate sustainability investing? No. The biggest challenge today lies in valuing companies by ESG standards. And that’s not a trivial task, as the Harvard Business Review puts it. The universe of ESG data, it writes, still feels “like the Wild West,” though substantial progress has been made in improving the quality and availability of ESG information.

A Booming Asset Called Data

It is questionable whether this Wild West will soon be tamed. But there’s no question that it will change to a great extent: Data availability, at least, will no longer be a limiting factor. The quantity of ESG data will increase exponentially, just like the ranks of data providers will proliferate. These forecasts were put forth in a white paper titled Data, the Future of Financial Information that SIX recently published (see box). It examines the spectacular growth of the booming asset called data, with a focus on the financial industry. For the world 10 years from now, the authors of the white paper come to the conclusion that “besides the centrality of data, it looks as if nothing will look like the past.”

The biggest change concerns the aforementioned growth in the vast quantity of data, particularly in the area of alternative data, which differs from traditional financial data such as revenue, earnings, debt load, outstanding liabilities, etc. that companies disclose themselves as part of their reporting. Alternative data, in contrast, is usually not financial data, but instead relates to things like traffic, the weather, communication, or energy consumption, for example. Alternative data can originate from a wide range of different sources such as social media, satellite imagery, road and transport users, and sensors. It contains information that is either interesting in itself or which enables a reanalysis of already existing data.

Sound abstract? Consider a concrete example: Foursquare is an app that lets users virtually “check in” at locations where they happen to be, such as at an airport or a restaurant. A couple of years ago, the CEO of Foursquare pretty accurately predicted the quarterly revenue figure for a restaurant chain. Its reported 30% slump in sales had already been portended by the behavior of the app users.    

This example illustrates why people in the financial world are extolling the virtues of alternative data today. Alternative data, The Economist writes, harbors the potential to balance out the knowledge advantage that corporate insiders have over normal investors. You can read in blogs how “you can beat the DAX” using alternative data, and Swiss private bank Pictet calls alternative data “the key to achieving greater alpha in the future.” And financial market researcher Optima estimates the value of the market for alternative data at already USD 7 billion for 2020.

Customized Sustainability Indicator
Alternative data will become especially important for compiling ESG information. “The biggest obstacle to investment is that most sustainability reporting by companies is aimed not at investors but at other stakeholders,” the Harvard Business Review writes. ESG data has heretofore been missing in most corporations’ quarterly and annual reports, not because companies don’t want to disclose this information, but because they simply don’t or are unable to collect ESG data.

This constraint will disappear. The white paper by SIX envisages a world in which the quantity and depth of information know practically no limits, enabling investors to arrange their investments in alignment with their personal preferences. One investor perhaps might want to invest only in companies that vigorously promote gender equality, whereas another investor wishes to take action on environmental protection and climate change. Other investors perhaps would like to shun weapons manufacturers or coal companies. 

 “With increasing investor demand for ethical investing and with the progression of data science and innovation, there is no dispute that alternative data, especially ESG data, will continue to gain importance,” says Marion Leslie, Head Financial Information at SIX, stressing that “however, it is important that this data is connected to core reference data. Otherwise it’s meaningless.”

Back to Milton Friedman, the Nobel laureate in economics who opined that companies have only one responsibility: to create value for shareholders. Perhaps in some circumstances the American economist wouldn’t actually have been so fervently critical of ESG as one might think. After all, a number of studies show that companies that adhere to ESG criteria systematically outperform those that don’t. Former Bank of England Governor Mark Carney stated it a bit more radically: “Businesses that fail to adapt to climate change will go bankrupt.”