How do we Measure the S in ESG?

by Anandita Ketkar

Given that Environmental Social Governance (ESG) is playing a greater role in investment decisions, what technologies or methods are there to measure this social component? [1] 

The challenges in measuring the “S” in ESG 

Factors which are encompassed by the “S” in ESG have become increasingly prominent in the wake of growing interest by investors and the public [1]. By some estimates, more than $22 trillion in assets under management are labelled as ESG [7]. “S” practices are as common as the “E” and “G” factors, and can be deemed a barometer for corporate culture, either to judge the legality of corporate practices or as a specific measure of impact on workers’ wellbeing [2]. Their scope goes beyond this, however, and emerging evidence shows that the integration of ESG criteria in investment analysis leads to improved returns and less volatility [1]. The EU’s Non-Financial Reporting Directive introduces the concept of double materiality, stipulating that companies should disclose both information necessary for understanding their impacts on society and the environment, and the financial risks posed to the company by social and environmental issues [1]. Like environmental impacts, social issues are financially material [1]. For example, Boohoo lost £2bn of its market value in August 2020 after poor labour practices and low pay were exposed in its supply chain, leading to a potential US export ban after an investigation into modern slavery in the company’s supply chain [4]. 

What components are in the “S” in ESG?

Standard-setting organisations such as the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) have built on the existing frameworks for social issues in ESG. The social parameters they evaluate are:

• Human Rights: the Corporate Human Rights Benchmark CHRB details Agricultural Products, Apparel, Extractives and IT Manufacturing based on their high human rights risks including modern slavery  
• Product quality issues and the health and safety of manufacturing processes 
• Data security and digital rights e.g. MSCI breaks down its analysis of “Product Liability” into a range of risk factors including where a business has “Exposure to Business Prone to Data breaches”. SASB also includes “Data Security” under its “Social Capital” heading [2] 
• Socio-economic inequality alongside diversity and inclusion 

There remains the issue of identifying the most useful indicators for evaluating these social issues. This stems from a lack of consensus in the industry surrounding what constitutes the “S” in ESG. 46% of investors surveyed found the “S” to be the most difficult to analyse and embed into investment strategies [8]. The UN Principles for Responsible Investment state that despite the increasing performance of “S” factors, social issues are less tangible, with less advanced data to show how they can impact a company’s performance [9]. 

Current technologies and methods 

It is clear that as companies and investors work on their assessment of ESG practices, qualitative processes must be augmented by data-driven elements [1]. This is because contrary to perception, social performance is not less likely to be subject to regulatory action or punitive measures and thus presents a significant risk to revenue streams [1]. As technology increases the volume and granularity of available data, investors can benefit from enhanced disclosure of social issues beyond only what corporations themselves decide to disclose [1]. For example, the increased resolution of satellite images have monitored the prevalence of illegal labour in fields, construction sites, quarries, mines or forests [1]. Given that supply chains account for up to 40% of corporate ESG impacts for 1600 companies in the MSCI World Index, blockchain technology has been increasingly used for evaluating supply chain integrity [1, 3]. Indeed, many negative social and environmental impacts arise from outsourced suppliers and vendors [1, 3]. Average ESG impacts are determined from data on labour standards and resource-use which is linked to information on the countries and sectors where raw materials are sourced [3]. 

Frameworks such as the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises continue to provide extensive social considerations within the remit of ESG. The ILO Tripartite Declaration of Principles Concerning Multinational Enterprises stipulates that “Multinational enterprises should give priority to the employment, occupational development, promotion and advancement of nationals of the host country at all levels”, which synthesises the “Human Capital Development” indicator by the MSCI and S&P/ RobecoSAM encompassing staff turnover rate, talent attraction and productivity levels [5]. 

Conclusion

As more data and research delves into the “S” of ESG, it is imperative to continue monitoring resources on an ongoing basis. Harvard University’s Impact-weighted Accounts software is in development, measuring environmental and social impact in monetary terms [6]. In the future, rating agencies and data providers should integrate these revised accountable statements into their own data products, to provide actionable signals for business leaders. As rating agencies including FTSERussell, ISS ESG and Refinitiv comprise common themes across reporting frameworks such as “Labour Relations” (MSCI), “Employee Engagement” (SASB) and “Collective Bargaining Agreement” (Sustainalytics), a cohesive “S” reporting framework will be improved as reporting standards develop and data technologies are integrated [2].

References:

[1] Amplifying the “S” in ESG: Investor Myth Buster, White & Case LLP. URL: https://www.whitecase.com/publications/insight/amplifying-s-esg-investor-myth-buster?utm_source=linkedin&utm_medium=organic&utm_term=&utm_content=&utm_campaign= [Accessed on 28/08/21]
[2] Time to Rethink the S in ESG, Harvard Law School Forum on Corporate Governance. URL:  https://corpgov.law.harvard.edu/2020/06/28/time-to-rethink-the-s-in-esg/ [Accessed on 29/08/21]
[3] Corporate sustainability: German law to confront complex ESG supply-chain impacts, Scope Ratings. URL:  https://www.scoperatings.com/ScopeRatingsApi/api/downloadstudy?id=da0510be-6094-4309-a5e4-c6511fd043ac [Accessed on 29/08/21] 
[4] More than £1bn wiped off Boohoo value as it investigates Leicester factory, The Guardian. URL:  https://www.theguardian.com/business/2020/jul/06/boohoo-leicester-factory-conditions-covid-19 [Accessed on 29/08/21]
[5] Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy, International Labour Organisation. URL:  https://www.ilo.org/wcmsp5/groups/public/—ed_emp/—emp_ent/—multi/documents/publication/wcms_094386.pdf [Accessed on 29/08/21] 
[6] Impact Weighted Accounts, Harvard Business School. URL:  https://www.hbs.edu/impact-weighted-accounts/Pages/default.aspx  [Accessed on 29/08/21] 
[7] 2016 Global Sustainable Investment Review, Global Sustainable Investment Alliance. URL: http://www.gsi-alliance.org/members-resources/trends-report-2016/ [Accessed on 29/08/21] 
[8] ESG Global Survey 2019: investing with Purpose for Performance, BNP Paribas. URL: https://cib.bnpparibas/esg-global-survey-2019-investing-with-purpose-for-performance/ [Accessed on 29/08/21] 
[9] United Nations Principles for Responsible Investment “PRI”. URL: https://www.unpri.org/pri/about-the-pri  [Accessed on 29/08/21]