Over the last decade, ESG (Environment, Social and Corporate Governance) traits and their associated constraints have become an important feature in the investment management industry. This has manifested itself in various forms, from subscribing and adhering to the UNPRI (United Nations Principles of Responsible Investing) all the way to having a specialist in-house ESG team that incorporates these issues into investment decision-making processes. In fact, some asset management CEOs believe that ESG is so important that “every public company needs an ESG expert as a board director“.
ESG and RISK
I have had the privilege of interacting with ESG teams at various asset management houses. In doing so, I have observed that the best way to make ESG part and parcel of your research and investment process is to make it another aspect of your risk process.
Over the last 20 years the process of managing risk has evolved within investment houses. Initially, risk was a department that operated outside of the research and investment process. Fund managers would make decisions and the risk department would evaluate the risk associated with these decisions. Fast forward to today and the picture has changed. The risk department’s only responsibility is to provide reports (e.g. Value at Risk, Scenario Testing, Trigger Breaches) to the fund manager, who is then responsible and accountable for their funds’ risk exposure.
This is why it makes sense to integrate ESG into the risk department. ESG is then solely responsible for generating reports, such as
- the Environmental, Social and Governance scores of the underlying securities and the resulting weighted scores of the fund.
- the Carbon Emissions Scope 1, 2 and 3 (‘direct’, ‘indirect’ and ‘all other indirect emissions’ respectively) for the constituents and consequently the portfolio.
- trigger breaches with respect to ESG compliance (e.g. no tobacco, coal and gambling exposure).
The fund manager is then responsible and accountable for their funds’ ESG and reputational risk exposure.
ESG risk ultimately lies with the Parent
Risk and ESG are similar in another important aspect. When evaluating risk on an issuer’s debt, one needs to consolidate this up to the parent who is ultimately responsible for this debt. ESG factors, reputational risk, trigger breaches and carbon emissions work in exactly the same way. The information must flow to the top where it is “summed up”. The corporate hierarchy tree, a fundamental element of symbology is the only way to do this. An example will clarify my point.
The graphic below displays a part of Siemen’s corporate hierarchy tree, including the parent, issuers and instruments at the different levels.
Data (from various vendors) can be associated with all the entities in the tree. For example:
- Reputational Risk Data might be associated with the Ultimate Parent.
- Carbon Emissions (Scope 1 and 2) are associated with an Issuer.
- MSCI ESG scores are associated with a Security.
So when the ESG team requests this data for a bond ticker that exists in a particular portfolio, what do they get? The answer to this question is that the business can easily define its own rules that outline how data is inherited/passed between different levels of the corporate hierarchy tree. The challenge lies with the technology used to do this. In particular, the data request engine needs to know how to walk the tree in order to retrieve the information requested.
The Quintessence Data Solution
And this is where we come in. Quintessence timeseries can be configured by custom rules that return the information as if it was residing directly on the bond ticker! Or all elements of the corporate hierarchy tree!
Feel free to contact me for more information on how Quintessence can facilitate your ESG process.
