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Data is driving today’s ESG impact gold rush

Sirtaj Brar, director of the Data Economics Company (left), and Sean Penrith, chief executive of Gordian Knot Strategies (right).
Sirtaj Brar, director of the Data Economics Company (left), and Sean Penrith, chief executive of Gordian Knot Strategies (right).

FICO scores revolutionised lending by standardising borrowers’ risk profiles. Sirtaj Brar and Sean Penrith explain how new technology can drive similarly smart choices in ESG impact investing.

  • Investors are keen to base their decisions on environmental, social and governance (ESG) factors, but accurate and standardised data is rarely available.
  • Previous attempts to assess the positive impact of supposedly sustainable investment opportunities have proven somewhat disastrous.
  • A FICO-like system for ESG investing would support more accurate assessments of data, channelling capital into vital solutions while minimising the risk of greenwash.

The climate solution space is attracting a tremendous amount of capital – as much as $12 trillion annually by 2030, according to McKinsey. These investments may help humankind to avert a global catastrophe. Currently, rising temperatures and extreme weather due to climate change threaten millions of lives.  Fortunately, forward-thinking investors are willing to act. They want to protect grasslands, promote reforestation, and decarbonise industries rather than support enterprises that harm the environment. But, as they seek information to test one potential planet-saving enterprise against another, they’re confronted with a hard truth: Environmental, social, and governance (ESG) data is tough to wrangle.

Globally, there’s no single standard on what to measure or how. That’s why a 2021 EY survey found that 46 percent of asset managers said that ESG data often had limited value because they were unable to access day-to-day metrics. They want more precision.

History offers some guidance on how this problem could be solved. More than a half-century ago, engineer Bill Fair and mathematician Earl Isaac solved a similar dilemma for banks and other institutions when they invented FICO scores to calculate creditworthiness.

Blended from various data streams, FICO scores are far from perfect. They are, however, consistently standardised. Consequently, they have become a crucial tool for judging whether prospective mortgagees,  auto-loan applicants, and other consumers will pay in full and on time.

Data as a secure digital asset

Climate solution investors would gain enormously from a FICO-like system for ESG impact investments. Without it, they are left on their own to rank their investment portfolios’ downstream benefits using data that may or may not be reliable. This dynamic is already a big reason why so many environmental-based projects are difficult to assess.

Take, for instance, a 2022 Yale University School of the Environment analysis that studied several non-U.S. reforestation efforts. Many of the projects were failures because the seedlings were planted in mud, left untended, or because they planted species that were wholly inappropriate for their climate. Incredibly, though, the project managers’ data still showed successful outcomes in certain cases. Most often, this was because had measured the vast number of trees initially planted rather than the true indicator of success – the few that continued to flourish over the following years.  To avoid such debacles, investors are increasingly deploying solutions that connect public and private capital to promote reforestation, carbon markets, and other green efforts. These technologies track organisational growth, programme implementation, impact-fund structures, carbon acquisition portfolios, conservation financing options, and domestic and international carbon policies.

These solutions can even turn this data on ESG impacts into secure digital assets, allowing their users to control, share, transact, and monetise the information.

What millennials want

These solutions arise as the demand for trustworthy climate solutions information will only increase. Investors should know that a staggering 85% of millennial and gen Z investors want fund managers to influence companies’ environmental objectives, even if the risk is greater, according to a 2022 survey by the Stanford Graduate School of Business, the Rock Center for Corporate Governance, and the Hoover Institution. Only 35% of baby boomers agree.  PwC’s 2022 Global Investors Survey highlights the importance of reliable data in this regard. Seven in 10 investors said that companies “should report on sustainability’s relevance to strategy, the cost of meeting sustainability commitments (including climate goals), and the effects that sustainability risks and opportunities have on assumptions behind the financial statements.”

Crucial, too, is increased reliability of reported information. Investors clearly want to place more trust in what’s reported, with 87 % reporting their suspicions that corporate disclosures contain some element of greenwash.

Stopping greenwashing

Greenwashing, or giving a misleading picture of environmental friendliness, presents serious risks for investors. The Forest Stewardship Council has certified wood production as sustainable since the early 1990s, for example. A few years ago, however, critics asserted that the Council was not only failing to curb tropical deforestation but, worse, covering for illegal timber operations. Investors do not want to deploy capital based on false premises.

They have good reason to beware. One form of greenwashing – retroactive changes to ESG scores – is “widespread and repeated,’’ according to recent Massachusetts Institute of Technology’s Sloan School of Management research. In a six-week sample of one company’s data, the researchers found that 85 % of measures were altered.

“While the score changes were mostly small in magnitude, the ongoing retroactive changes affected the classification of firms and the link between ESG scores and returns,” the study reported. The free-for-all that now predominates in much ESG investing and reporting – rather than a standardised scoring system – makes these alterations possible.

Only a distillation of diverse sources of data based on quantitative and qualitative sources can confirm and measure returns on investment – including the environmental returns – while preventing greenwashing in the process.  The FICO system helped propel the lending industry to unprecedented growth, and opened doors to prosperity for individuals and small businesses. Today is ESG-related technology’s “do good” moment to combat climate change with a similar scoring system. The planet cannot afford to wait.

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