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State Street adds big data to ESG vendor selection

The trust bank is developing A.I. tools to help fund managers measure corporate intangibles.

Dan Gerard, State Street

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State Street is developing tools to help investors make sense of the rapidly growing number of data vendors focused on ESG (environment, social and governance) mandates.

ESG is growing in importance worldwide, as asset owners such as pension funds, distributors such as private banks, and regulators push investors to take such factors into account. There are many companies now providing data on ESG to help investors, from traditional vendors such as MSCI to fintechs like TruLabs, Sustainalytics, Arabesque and, in Asia – as reported by DigFin yesterday – MioTech.

But as data sets are building to address ESG needs, analysts are confused by the signals these send.

Daniel Gerard, Singapore-based head of investment and risk advisory for Asia Pacific at State Street’s Data Exchange business, says the huge divergence among analysts’ scores for listed corporate behavior is unusual.

“When it comes to credit ratings, the major agencies’ views overlap 99 percent of the time,” he said. “In ESG, one vendor can rank a company in the top quartile, while another vendor will rank the same company in the bottom quartile.”

Data dispersion

This dispersion of results reflects the youth of the industry, the lack of standardization about how to measure data, and different ways to aggregate data into a view. Moreover, approaches among traditional vendors relying on financial statements are totally different to tech startups mining alternative sources of data such as social media mentions.

But whatever the reason, such discrepancies are a major headache for portfolio managers or sell-side analysts. For now, ESG remains an intangible but real risk, be it to an equity or a credit: for example, an ESG screen might have picked up warning signs about Volkswagon’s fiddling with emissions gauges before it blew into a scandal in 2015. “But if there’s no overlap among various measurements, analysts won’t trust it,” Gerard said.

If there’s no overlap among measurements, analysts won’t trust it

Dan Gerard, State Street

State Street has introduced a service to use big data analytics to examine the relationships among these vendors, as well as to try to understand what ESG measurements might mean.

For example, Gerard says corporations seem to exhibit better returns when they have a middle management that prioritizes aspects of ESG – but this is only a correlation, and the bank doesn’t have enough data yet to validate it.

What’s relevant?

Such relationships can also change. A few years ago, investors accepted paying a premium for polluting companies in the U.S., but under the Trump administration, which has rolled back environmental protections, low-carbon ESG scores aren’t worth so much. “ESG matters when society values the factors you use,” Gerard said.

Getting data is hard, particularly as corporate disclosure remains mostly voluntary. This is why so many fintechs have sprouted up to sift through alternative data sets for correlations.

But this leads to the biggest challenge for ESG metrics: categorizing them. It makes no sense to apply the same polluting standards to a mining company as to a telco – nor the same standards on gender diversity in the workforce. What’s more valuable, a metric about sexual harassment lawsuits, or female representation on boards, or providing mothers with child care at the office? Does a company’s improving greenhouse-gas emissions rating offset its worsening record of labor relations?

Investors want to understand materiality

Dan Gerard, State Street

“A firm’s valuation starts with the accurate disclosure of relevant information,” Gerard said. “Investors want to understand materiality, anything impacting a company’s earnings or credit risk.” Can investors measure intangible risks, like they measure risks around inflation, lending or economic growth?

State Street, like many of the vendors in its database, begin with accounting standards such as SASB to determine when data is relevant and how to categorize it. Then this information has to be somehow integrated into a portfolio manager’s other risk-management systems.

But it is very early days, so there’s nothing to do but get started and build and learn as the industry evolves. Gerard likened the situation to field surgery during the American Civil War (in the 1860s): “A lot of patients were dying but you’re getting there.”

Doc, what’s my ESG rating?

State Street’s product, ESG-X, doesn’t provide the data but allows managers to look at vendors at a portfolio-level view, an ddecide which ones they prefer. There are limits to the information State Street can provide, as participating vendors didn’t want to have too much of their proprietary data made available. “This is for headline ESG risks at the portfolio level, not the security level,” Gerard said.

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State Street adds big data to ESG vendor selection