ESG

ESG analytics require foresight and action used to inform business decisions: drive revenue, mitigate risks, and cut costs.

The Power of Data and Action

ESG are set of standards, metrics, and criteria, some more than 200 years old, enabling institutions to include when material non-financial information into decision-making.

First U.S. ESG strategy began in 1898 with Friends Fiduciary (Morgan Stanley). In 1898, they adopted a “no weapons, alcohol or tobacco” investment policy designed to align their investment funds with their core values.
The term ESG was first coined in 2005 in a landmark study entitled Who Cares Wins supported by the UN Global Compact, ABN AMRO, Goldman Sachs, Westpac, and others.
As of 2020, 88% of publicly traded companies, 79% of venture and private equity-backed companies, and 67% of privately-owned companies had ESG initiatives in place. [NAVEX Global].
More than three out of four (77%) small and mid-caps have a formal purpose statement related to ESG. [Quoted Companies Alliance].
80% of the world’s largest companies are reporting exposure to physical or market transition risks associated with climate change [S&P Global Market Intelligence].
76% of consumers say they will stop buying from companies that treat the environment, employees, or the community in which they operate poorly [PwC].
The latest biennial review by the Global Sustainable Investment Alliance (GSIA) in 2020 reported $35.3 trillion in global assets under management employing an ESG lens.

Benefits

ESG analysis benefits civil society, companies, and investors for the following reasons:

Forecasting pathways for transition to a low-carbon, sustainable, and equitable future.
Addressing climate risks – physical and transition risks – and opportunities – within a time-bound stress tested model.
Enhancing identification of opportunities, turning risks into opportunities.
Decreasing capital costs.
Growing risk-adjusted returns.
Assessing industry shifts to determine investment risks and opportunities.
Improving operational efficiency.
Responsiveness to investor and customer sentiment.
Mitigating regulatory risks.
Strategically aligning capital and business operations within planetary boundaries.

Metrics and Indicators

Alongside programs and frameworks such as the EU Taxonomy, the UN Sustainable Development Goals, and others, ESG analysis supports institutions in directly and indirectly measuring impacts to institutions, companies, securities, assets, and supply chains.

The Sustainable Development Goals uses goals, targets, and indicators. The Global Reporting Initiative (GRI) uses indicators. ESG uses metrics at the single metric level while when ESG metrics are combined, they are combined into ESG scores. Scores can then be sorted into pillars. And once this is done, you have ESG ratings.

Environmental

Climate change and carbon emissions including climate risk and both physical and transition risks, and adaptation and mitigation.
Air and water pollution including impact of nutrients, chemicals, aerosols, and ozone depleting substances.
Biodiversity integrity and loss.
Deforestation and change in land-use and agriculture patterns.
Energy efficiency.
Waste management.
Water scarcity, quality, and quantity
Ocean acidification.
Changes in biogeochemical flows such as nitrogen and phosphorus.

Social

Human rights.
Product safety.
Labor standards.
Data protection and privacy.
Discrimination prevention.
Employee engagement.
Customer satisfaction.
Community relations.
Supply chain risks.
Land tenure and property rights.
Free prior and informed consent.

Governance

Board composition, governance, and independence.
Fiduciary duty including audit committee independence and financial accounting rigor.
Bribery, corruption, conflicts of interest, and whistleblower schemes.
Executive compensation.
Lobbying and political contributions.
Supply chain governance.
Asset level governance.

ESG is also different from sustainability and corporate social responsibility.

Sustainability is how society meets its needs without overburdening the environment or weakening society. History of recent sustainability movements began in the 1970s when the book The Limits to Growth was commissioned by the Club of Rome. The World Commission on Environment and Development: Our Common Future (also called the Brundtland Report) by the UN in 1987 defined sustainable development as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs”.

Corporate Social Responsibility (CSR) is when corporations engage in activities that benefit society without direct connection to their goods or services, and then communicate about these activities. CSR grew in the 1990s when corporations began developing environmental and social activities not related to their core businesses funded by staff volunteer hours and goods and services donated by the company.

Process

Responsible Alpha’s process is the explicit and systematic inclusion of ESG issues in investment analysis and investment decisions related to investments in companies, securities, assets, and supply chains. This is the process to measure, manage, and monitor financially material ESG factors in investment decision-making.

Stage One - Analysis: Assessing and identifying all relevant financial and ESG information. By integrating public and private data sources within a rigorous analytical framework, Responsible Alpha identifies material factors over an historic economic cycle.
Stage Two – Framing: Responsible Alpha’s process employs a discrete time horizon specific to the industry’s economic cycle, the product life cycle, the timeliness and consistency of the data, the maturity of the security, and the time horizon and strategy of the investment decision. Strategies assessed can include active and passive management – such as exchange-traded funds (ETFs), value and growth strategies, thematic strategies such as climate transition and green bonds – such as climate and sustainability bonds, supply chain risks and opportunities, and numerous other criteria.
Stage Three – Risk Analysis: Conducting industry standard scenario analysis of material issues within a risk and return lens. This includes repricing risks and opportunities for companies, securities, assets, and supply chains.
Stage Four – Forecasting: Responsible Alpha provides quarterly forecasting short-term to 2025, mid-term to 2025 to 2035, and long-term to 2035 to 2050.
Stage Five – Impact and Engagement: Incorporating historical material ESG impacts and current forecasts, via forensic accounting, reperformance, and remeasurement, into liquidity, turnover, leverage, performance, and valuation financial ratios.
Stage Six – Sharing Best Practices: Responsible Alpha’s process includes working with industry and stakeholder coalitions to develop scalable and functional best practices to support the global transition to a low-carbon, sustainable, and equitable future by 2025.

Risk Management

Responsible Alpha's risk analysis process incorporates the following risks, starting from short-term to long-term impacts:

Operational Risk.
Reputational Risk.
Liquidity Risk.
Credit Risk.
Market Risk.
Legal / Regulatory Risk.
Business Risk.
Strategic Risk.

esg integration double materiality flow chart

Double Materiality and Validity

Responsible Alpha conducts double materiality analysis focused on time-bound and valid transition risks and opportunities that face companies and investors if they are going to start their transition to a low-carbon, sustainable, and equitable future by 2025.

Based on a strong understanding of the underlying scientific principles, data, and reporting, Responsible Alpha’s process involves integrating only the material financial and ESG issues that are considered likely (66% to 100%), very likely (90% to 100%), and extremely likely (95% to 100%) certain to affect corporate performance and investment performance in the short-term – until 2025, mid-term – 2025 to 2035, and long-term – 2035 to 2050.