E, S, and G
Do reliable metrics exist for quants?
ESG data has been notoriously difficult to manage. Some of the challenges include the lack of data, too much data, and even conflicting data! Can the complexity of ESG be broken down to more clear-cut metrics? A QuantMinds International 2023 panel discussed the real issues quants face when looking at ESG data, more specifically the aggregation of E, S, and G components in metrics. The panel then explores what changes they’d find valuable that could really benefit investors and aid them in their decision making process.
ESG is a specific tool used to measure the performance of a company. But aggregating the information together into E, S and G elements doesn’t help those investors or modellers that want to focus purely on environmental and climate change risk factors, or indeed sustainability or social well-being as standalone metrics.
How can you compare women in the boardroom v emissions scores,
The lack of reliable, standardised and comparable data is already a problem for quants wanting to pursue mathematical trading strategies – not to mention the sheer diversity of the ESG agenda.
Additionally, concerns were raised about data quality. Some data points are easier to score than others. Temperature rise scores, for example, can be notoriously difficult to nail down accurately, and could therefore skew any models.
I hope the ESG moniker lasts for as short an amount of time as is possible,
This is where companies’ claims of sustainability are questioned because the general public doesn’t believe in the methodology. The UK CP22/20: Sustainability Disclosure Requirements (SDR) regulation is one national regime that is seeking to do something about greenwashing by strengthening how sustainability claims are measured.
Mapping the 17 UN Sustainable Development Goals (SDGs), covering an end to poverty, inequality, climate and nature risk, among many other things, is not easy but many data providers try to do it. Producing a good quality, over-arching ESG rating in a globally standardised manner has, however, proved beyond the ability of the industry so far.
The panellists argued that financial services (FS) professionals shouldn’t rely solely on ESG ratings, but instead weave in a combination of their own internal data, solvency and credit information, plus publicly available data from the likes of the carbon disclosure project (CDP), which is the original rater of climate risk emissions. Combining this with ESG ratings from providers like MSCI or Sustainable Fitch is the best approach.
There isn’t a globally agreed standard yet for ESG ratings. This makes things harder for investors, but governments and regulators are working to try and bring some commonality to the area.
Some more standalone information is imminent in certain segments, such as the EU Green Bond Standards (GSB) in the sustainability arena for instance. This code is designed to harmonise the European sustainable bond market and improve transparency and market integrity in this segment.
The International Sustainability Standards Board (ISSB) should also emerge as the global standard setter and go to metric, as national bodies and regimes align with it over time. The UK SDR, for example, will eventually align with it in its battle against greenwashing.
A potential systemic concentration risk, from pushing everyone into the same limited pool of ESG approved instruments, was also debated, alongside an illustration of how to score ‘brown’ and ‘green’ companies with a climate change metric using a mix of data. This standalone metric allows investors to pursue short, long or targeted climate change strategies, as they see fit, and easily tick the sustainability box, as well as model the transition towards a greener economy.
The panel concluded that ESG will stay as the green economy develops. But it may be called something else in the future to emphasise its disparate S and G elements in a more standalone way. Aggregation may not last forever.
