ESG stands for Environmental, Social and Governance and is one of the hottest acronyms in the Sustainable Finance ecosystem. Not only in Europe, where it recently received official recognition in the newly established public policy framework on Sustainable Finance, but also on the other side of the Atlantic, where ESG investing has been developing since the early 2000.
At a time when investors seem to increasingly express interest for ESG investing, not only the institutional ones, and Sustainable Finance is overall ready to go mainstream in Europe, we find that the S element has so far received less attention that the E and the G. Also, it seems to be the less mature and more pliable within the ESG investing paradigm.
In this article, we will talk about the S element of ESG investing, along with some considerations on how it can be measured and the ensuing challenges surrounding the data on the S.
The inward and outward aspects of the S in ESG Investing
At its very core, ESG investing aims to include non-traditional (i.e. non-financial) data in the assessment of economic activities or companies underlying an investment portfolio. Looking at ESG investing from this perspective, it is based on a proactive sustainability-focused analysis, where there is explicit inclusion and use of environmental, social and governance risks and factors (i.e. non-traditional and non-financial data and factors) within the context of a more traditional financial analysis. The outcome of this screening allows to identify companies and investment opportunities that will perform well in a changing and more demanding ecosystem for these types of issues.
So far, investors seem to have been concerned more with the Environmental and Governance perspectives of the ESG investing paradigm. We can only attempt to give some explanations as to why this has been the case so far. On the one hand, ESG investing has only recently been opening more to retail investors and has historically been the preference for institutional investors. The Social factor, which was at inception linked for its most part to social issues on inequality, has been far and detached from the social context of institutional investors. On the other hand, whilst it is possible at certain levels to measure the performance of investee companies and economic activities for the Environmental and Governance aspects, it proves to be very complicated to do the same for the Social element. This has left the Social element behind, with an inherent lagging development due to the lack of parameters for its quantification.
The recent worldwide events of the global pandemic coupled with a more immediate accessibility and renewed appetite for ESG investing by retail investors has somehow placed the Social element under the spotlight and reshaped it to be more in line with the current times. Some examples coming from the other side of the Atlantic, for instance, are especially indicative of this new trend. We can look at the role that retail giants have been called to play in the global pandemic, making available their infrastructures and partnering with other providers in order to offer testing facilities for COVID 19, for instance. This is part of what we can define as the outward Social element, where companies make a positive contribution and impact on the Society.
Another aspect of this new trend on the S pertains how companies deal with their employees and stakeholders – the inward element of the S. Whilst this is a more traditional way to look at it, nevertheless the global pandemic gave a renewed twist to the S element, with companies exploring the best ways to support employees during the pandemic, for instance, by not imposing a compulsory return to an office environment as well as providing physical and mental health support during working from home arrangements. This is also where it might seem possibly more appropriate to slightly adjust the S to refer to Stakeholders rather than Social.
Is there Data on the S?
Of course, big companies make big headlines in the news and have a broader reach for their renewed Social endeavours, but what happens to smaller companies? We share the view that one of the challenges with ESG investing lies in the availability and the reporting of data. From a European perspective, the EU Commission has recently commenced a consultation on the revamp of the existing Non-Financial Reporting Directive (NFRD). Acknowledging the importance of reporting on performance on social and environmental issues, the European Commission commenced this endeavour in order to strengthen the foundations of the Sustainable Finance infrastructure in Europe. However, we see that the requirements of the NFDR are imposed mainly on so-called large Public Interest Entities. These are, by and large, entities with more than 500 employees and, in practice, include large listed companies, banks and insurance companies – whether listed or not – provided they have more than 500 employees.
The answer for Europe is that whilst data required for ESG analysis is currently available and will be increasingly more in the future, there is of course a bigger challenge for smaller size companies than there is for bigger ones. In fact, it will be more difficult, especially for companies not required to comply with the NFDR in Europe, for instance, to obtain data on social and environmental performance.
In a world where data is the driving force behind every movement, one of the challenges of the market for ESG investing lies obviously in data reporting on how companies fare on sustainability and social related aspects.
Whilst there seems to be in Europe an attempt to create some pipework for the reporting on environmental and social elements, this is currently mandatory only for larger companies, with smaller and medium enterprises possibly paying the price in the eyes of the public and the investor base for the lack of data reporting on environmental and social performance of their strategies.