A recent study of asset managers by the investment arm of Institutional Shareholder Services (ISS) showed that more than 12% of respondents reported heightened importance of ESG considerations in their investment decisions or stewardship activities compared to before the pandemic.
In the area of hedge funds, there has been an increased demand for ESG-integrated investments since the start of COVID-19, according to 50% of all respondents of a hedge fund survey conducted by BNP Paribas Corporate and Institutional Banking of 53 firms with combined assets under management (AUM) of at least USD 500B.
ESG criteria may have a practical purpose beyond any ethical concerns, as these criteria may be able to help avoidance of companies whose practices could signal risk. As ESG gets more traction, investment firms such as JPMorgan Chase, Wells Fargo, and Goldman Sachs have published annual reports that highlight and review their ESG approaches and the bottom-line results.
But even with more options, the need for clarity and standards on ESG has never been so important. In my opinion, there must be an enhanced effort to standardise and harmonise ESG rating metrics.
How are ESG ratings made?
ESG ratings need both quantitative and qualitative/narrative disclosures by companies in order to be calculated. And if no data is disclosed or available, companies then move to estimations.
No global standard has been defined for what is included in a given company’s ESG rating. Attempts at standardising the list of ESG topics to consider include the materiality map developed by the Sustainable Accounting Standard Board (SASB) or the reporting standards created by the Global Reporting Initiative (GRI). But most ESG rating providers have been defining their own materiality matrices to calculate their scores.
Can ESG scoring be automatically integrated?
Just this month, Morningstar equity research analysts announced they will employ a globally consistent framework to capture ESG risk across over 1,500 stocks. Analysts will identify valuation-relevant risks for each company using Sustainalytics’ ESG Risk Ratings, which measure a company’s exposure to material ESG risks, then evaluate the probability those risks materialise and the associated valuation impact. ESG rating firms such as MSCI, Sustainalytics, RepRisk, and ISS use a rules-based methodology to identify industry leaders and laggards according to their exposure to ESG risks, as well as how well they manage those risks relative to peers.
Their ESG Risk Ratings measure a company’s exposure to industry-specific material ESG risks and how well a company is managing those risks. This approach to measuring ESG risk combines the concepts of management and exposure to arrive at an assessment of ESG risk – the ESG Risk Rating – which should be comparable across all industries. But some critics of this form of approach feel it is still too subjective and too industry-specific to be relevant. This criticism is relevant when you understand that the use of the ESG ratings and underlying scores may in future inform asset allocation. How might this better automated and controlled? Perhaps adding some AI might be useful to address this?
In one example, Deutsche Börse has recently led a USD 15 million funding round in Clarity AI, a Spanish FinTech firm that uses machine learning and big data to help investors understand the societal impact of their investment portfolios. Clarity AI’s proprietary tech platform performs sustainability assessments covering more than 30,000 companies,198 countries,187 local governments and over 200,000 funds. Where companies like Cooler Future are working on an impact investment app for everyday individual users, Clarity AI has attracted a client network representing over $3 trillion of assets and funding from investors such as Kibo Ventures, Founders Fund, Seaya Ventures and Matthew Freud.
What about ESG Indices? What do they tell us about risk?
Core ESG indexing is the use of indices designed to apply ESG screening and ESG scores to recognised indices such as the S&P 500®, S&P/ASX 200, or S&P/TSX Composite. SAM, part of S&P Global, annually conducts a Corporate Sustainability Assessment, an ESG analysis of over 7,300 companies. Core ESG indices can then become actionable components of asset allocation when a fund or separately managed accounts (SMAs) provider tracks the index.
Back in 2017, the Swiss Federal Office for the Environment (FOEN) and the State Secretariat for International Finance (SIF) made it possible for all Swiss pension funds and insurance firms to measure the environmental impact of their stocks and portfolios for free. Currently, these federal bodies are testing use case with banks and asset managers. Its initial activities will be recorded in an action plan, which is due to be published in Spring 2021.
How can having a body of sustainable firms help create ESG metrics?
Creating ESG standard metrics and methodologies will be aided when there is a network of sustainable companies to analyse, which leads us to green fintech networks (GFN) of companies interested in exploring how their own technology investments can be supportive of ESG objectives. Switzerland is setting up a Green Fintech Network to help the country take advantage of the “great opportunity” presented by sustainable finance. The network has been launched by SIF alongside industry players, including green FinTech companies, universities, and consulting and law firms. Stockholm also has a Green Fintech Network that allows collaboration towards sustainability goals.
We should be curious about how ESG can provide decision-oriented information about intangible assets and non-financial risks and opportunities. More information and data from ESG data providers like SAM, combined with automation or AI tools can potentially provide a more complete picture of how to measure the long-term sustainable performance of equity and fixed income asset classes.
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The Digital Economy – a term first coined by Don Tapscott in 1994 – is not easy to define or measure. At one end, it is limited to the production and consumption of digital goods and services. On the other end, according to the European Parliament, “The digital economy is increasingly interwoven with the physical or offline economy making it more and more difficult to clearly delineate the digital economy“. We are, however, witnessing the Digital Economy transitioning to an economy that is digital.
Given the pervasiveness of the Digital Economy, its future will be determined by the complex interplay of several trends. Some of the trends that illustrate the future trajectory of the Digital Economy are:
We will see AI becoming ubiquitous as it is leveraged in every sector and sphere of activity. According to one estimate, AI is estimated to contribute USD 15.7 trillion to the global economy by 2030, which is more than the current GDP of China and India combined! We are also likely to see rapid progress in technologies related to Extended Reality (XR) in the coming years. COVID-19 is accelerating this trend, as we can see from the offerings of companies like Spatial and MeetinVR that facilitate virtual business meetings. The analog world’s rendering into its digital twin will see us moving towards a metaverse – a virtual shared space imagined in Neal Stephenson’s novel Snowcrash. Some of the biggest names in the tech industry – Apple (Apple glass), Facebook (Oculus), Sony (Playstation) – are assiduously working towards this direction.
Given the importance of telecom infrastructure to the Digital Economy, 5G networks are being rolled out in countries worldwide (Figure 1). However, even as 5G is being deployed, the buzz around 6G is getting louder. 6G may transmit data 100 times faster than 5G and may see deployment by 2030 given the decadal cycles for telecom: 1G in the 80s, 2G in the 90s, 3G in the decade following 2000, 4G in the decade starting 2010, and 5G beginning in the 2020s.
The availability of high bandwidth, low latency networks could lead to newer applications and further breakthroughs in innovative technologies.
The Future of Work
With the rapid growth in automation and AI, we are likely to see significant labour market disruptions. Moreover, COVID-19 has been a watershed for the global economy – its impacts will continue to be felt for many years to come. According to the International Labor Organization, 495 million full-time jobs were lost in the first two quarters of 2020 due to COVID-19. Lower and middle-income countries have suffered the most, with an estimated 23.3% drop in working hours – equivalent to 240 million jobs.
A recent report from the World Economic Forum estimates that by 2025, 85 million jobs may be displaced due to automation and AI, while 97 million new roles may emerge. We will see significant changes and turbulence in labour markets across multiple industries and geographies in the years ahead. If we look at how the top ten skills required by the top 10 US companies have been changing over time, we get an indication of the Future of Work. Companies are more focused on “soft” skills, that are not easily addressed by AI & Automation.
We are also likely to see a shift from humans adapting to technology to technologies adapting to humans. For example, the acceleration in digital twins combined with advancements in XR could allow unskilled workers to do skilled jobs. AR could guide a worker to repair a piece of mechanical equipment without long years of previous training. Similarly, the emergence of ‘Low Code No Code’ (LCNC) applications will allow ordinary individuals to do tasks that previously required specialised training.
Scientists have long focused our attention to limit the carbon dioxide in the atmosphere to 450 parts per million to avoid catastrophic climate change. In 2016, the World Meteorological Organization reported this concentration had crossed 400 parts per million, leaving us with a shorter runway to prevent calamitous climate change. We are, therefore, likely to see increased efforts to tackle climate change in the decade ahead.
Digital technologies can impact the global climate agenda in multiple ways: smart grids, smart buildings, smart appliances, intelligent transport systems, shared mobility, and 3D printing, to name a few. Digital technologies will also allow new sources of renewable energy to be tapped. For example, the molten core of the earth is over 6,000°C. “Just 0.1% of the heat content of Earth could supply humanity’s total energy needs for 2 million years,” according to AltaRock Energy. Advances in the use of digital technologies that allow for precise directional drilling will allow for advanced geothermal systems to be established as reliable power sources.
Tech bloggers like Doc Searls and Stephen Lewis had begun to theorise about a Splinternet as early as 2008. There was a danger of governments carving the world into geopolitical blocks and creating technology barriers. China’s Great Firewall and the US’s recent responses under the Trump administration are likely to hurtle us in the direction of a fractured internet. We may end up with the US dominating the western internet and China dominating a competing block of countries. The Digital Economy’s evolution would fracture into different camps, making it very different from what it is today.
The most valuable companies in the world today are in tech. Seven of the top ten companies in the world by market cap in 2020 are tech companies.
The recent investigation into competition in digital markets undertaken by the US House Judiciary Committee observed: “Over the past decade, the digital economy has become highly concentrated and prone to monopolisation. Several markets investigated by the Subcommittee – such as social networking, general online search, and online advertising – are dominated by just one or two firms. The companies investigated by the Subcommittee – Amazon, Apple, Facebook, and Google – have captured control over key channels of distribution and have come to function as gatekeepers. Just a decade into the future, 30% of the world’s gross economic output may lie with these firms, and just a handful of others.“
The call for the regulation of big tech will gain momentum in the coming years. The European Union is likely to lead here, just the way just it did in the case of its General Data Protection Regulation.
Governments will also require data monopolies to share data. China mandates its automakers to share data generated by electric vehicles with a government research institute. This data is essential for public safety and planning battery-recharging stations. The Australian Government promotes the concept of sharing “designated datasets” that could include data held by the private sector that has significant community benefits. Similarly, France’s Law for a Digital Republic requires the sharing data by certain categories of the private sector. Such blurring of boundaries between public and private data will become more important.
We will also see the growing importance of data trusts. These are structures where data is placed in the custody of a “Board of Trustees” who have a fiduciary responsibility to look after the interests of data owners. Such data trusts might give individuals better control over their data.
Every aspect of the economy is being digitalised today. In the next decade we are likely to witness foundational shifts in how the Digital or Data Economy is structured. It will also see increasing risks as cyber threats grow exponentially from cybercriminals and state actors. That the world in 2030 will be very different from today is obvious. We may, however, be surprised by the extent and sweep of the change ahead of us.
Singapore FinTech Festival 2020: Economic Summit
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In September this year, China – the world’s largest emitter of greenhouse gases – announced it would achieve carbon neutrality by 2060. Japan and Korea, too, have upped their mid-century targets to bring net emissions to zero.
The New Zealand Government has set a legislated goal for the country to be carbon neutral by 2050; has amended our Emissions Trading System (ETS) to ensure price signals encourage a move to low carbon; set up a green investment fund; invested heavily in research into reducing emissions from livestock production; and, most recently, made carbon-related financial disclosures mandatory for specified companies, banks, insurers and investment managers. We have also made it our mission to encourage governments to phase out fossil fuel subsidies (some US$400bn each year) that promote excessive consumption.
The Ripples Reach Cities and Businesses…
The political signals have flowed through to regional and local government. The C40 group (cities around the world working towards sustainability goals) now has 96 participating members – with many cities finding opportunities to collaborate with others in the network on joint projects.
It is becoming obvious that fossil fuel industries are at a disadvantage against increasingly cost-competitive renewable energy. Governments are working out how to manage a ‘just transition’ for the energy sector, while forward-leaning energy companies are re-shaping their business models in anticipation of a low carbon future.
Political signals encourage businesses to factor climate change into their planning and investment decisions. Businesses everywhere have read the political tea leaves and we see weekly announcements of pledges for carbon neutrality, ethical investing, green financing and so on. Whether it is Blackrock or NZ Super Fund making environmental, social, and governance (ESG) considerations integral to their investments, or Ikea’s IWAY (its ESG code of conduct for itself and its suppliers), business is showing a deeper commitment to sustainability than ever before.
Some industries will have to be more invested than others in emissions reduction, but this opens a world of opportunity and innovation. Energy & Utilities companies are implementing waste-to-energy solutions – Singapore’s Integrated Waste Management Facility (IWMF) is set to be the world’s largest energy recovery facility – and adoption of carbon capture, utilisation and storage (CCUS) facilities is at last gathering momentum across energy systems. Industries like aviation and maritime, too, have to play a key role in a circular economy.
… And Individuals (the Last – and First – Pieces of the Puzzle)
The ripples have spread to individuals – people like you and me. I know there are still plenty of climate deniers around. But mindsets are changing – and when that happens, the ripples become a tidal wave of real change. If we each start thinking we can do it and we will do it, the change will happen. If we make it clear, in our preferences as consumers, and in our expectations of the businesses we buy from or invest in, the change will happen.
The numbers who recognise we must live within our planetary boundaries are growing, values are changing (especially in light of the pandemic), and our low-carbon future is a high-tech one – not hemp shirts and home-made candles (unless of course these are your thing). Digital is a critical part of the story. Blockchain and distributed ledger technology (DLT) is being used to cater to a new generation of consumers, conscious of buying what is good for the world in the face of climate change and biodiversity loss. Food products are being branded using track-and-trace capabilities of Blockchain for ‘farm to fork’ visibility.
Who doesn’t want to breathe clean air, have lower energy bills, and eat safe and healthy food? Maybe we will see more initiatives like America’s Pledge, bringing together an entire ecosystem committed to fighting climate change, growing the economy, and protecting public health – an ecosystem of states, cities, businesses, universities, and citizens.
We now have the rules, the policy tools, the technologies, and – increasingly – we have the will to act. As we re-build our economies, our businesses, and our lives, let us re-build better. So, I would echo Sir David Attenborough’s optimism – it is just that we do not have his (95 years) lifetime left to put things right.
Singapore FinTech Festival 2020: Impact Summit
For more insights, attend the Singapore FinTech Festival 2020: Impact Summit which will cover topics tied to climate change and sustainability to build a better future