With ‘we’ culture and AI, ESG is here to stay
The hyper-transparency of information ensures the ESG genie cannot be put back in the bottle
27 Apr 2020 | Daniel Yu

ANDREW Cuomo, the governor of New York, responding last week to a reporter’s question about the protests outside urging an early lifting of the lockdown, replied: “It’s not about me; it’s about ‘we’. Get your head around the ‘we’ concept. It’s not all about you.”

Herein lies the crux of the matter at the centre of the ESG (environmental, social, governance) movement if it were to succeed. While several companies have stepped up their CSR (corporate social responsibility) activity during this period, will we see them, and the rest in the private sector, doing likewise when this health emergency passes?

In a previous article, Paras Anand, chief investment officer at Fidelity International, a fund manager with over US$370 billion of assets under management, calls Covid-19 “a watershed moment” for ESG as at this time what becomes extremely visible is how companies are thinking about their broader stakeholders and the issues related to sustainability.

But what about the long-term impacts on ESG issues including on worker health and safety, and systemic risks like income inequality? A study using artificial intelligence (AI) to get behind the news headlines to provide more systematic insights into what is driving ESG investing provides both a downbeat view going by historical data, but also hope that Covid-19 could indeed be that tipping point. And with a healthy dose of the ‘we’ culture that Cuomo alluded to where all stakeholders now have a say, ESG is here to stay.

“Looking back over the past two decades, market cycles – particularly crashes – offer an opportunity to evaluate the trajectory and influence of ESG investing,” explains Thomas Kuh, head of index at Truvalue Labs, an AI-based ESG data analytics group based in San Francisco, which conducted the study. In 2000, for example, the end of the tech frenzy marked the end of a decade of ascendancy in ESG investing. “Following the crash, many investors quickly turned their attention away from sustainability, reflecting the reality that ESG did not have deep roots in financial practice.”

It was a similar story in 2008 during what was described as the Great Recession following the collapse of Lehman Brothers and the sub-prime mortgage crisis. Once again, Kuh relates, most investors and policymakers were quick to jettison ESG because there were more “serious” issues to address. “Had bankers, regulators and investors given ‘serious’ consideration to concerns raised by ESG investors about predatory and subprime lending, and systemic risk from banking deregulation and lax oversight, they might have been better prepared for what happened.”

With the Covid-19 global pandemic precipitating a market crash, he believes that once again there is a chance to assess progress in ESG investing as a source for identifying risks and opportunities, and making sustainable, long-term investment decisions. “It is critical to appreciate the mediation between financial markets and the real economy,” Kuh shares. “By bringing sustainability considerations into financial and economic decisions that drive social and environmental outcomes, ESG investing is intended to reduce external costs that negatively impact peoples’ lives and the environment, and to mitigate systems-level risk.”

But will it be different this time? Kuh reckons ESG investing is a more resilient discipline. “Today, it is axiomatic that integrating material ESG issues into investment decisions can improve financial and sustainability results.”

He also points out that the internet has radically transformed the economics of information, contributing to what the World Economic Forum (WEF) refers to as “hyper-transparency”. Data and other information are now more inexpensive to disseminate and easy to access than ever before, he notes. “Technology simultaneously facilitates data proliferation, and through AI and massive computing power, enables collection and analysis.”

As a result of this highly interconnected world, and with social media and other communication channels, companies that used to be able to control the narrative about their businesses are now joined by others, he continues. These actors – key stakeholders include large asset owners, employees, customers, communities, suppliers and environmental advocates – now have a voice in determining what is material for investors and many have put sustainability on the agenda.

Data proliferation and technology in the information age have also transformed both the determination of what is material and how quickly this can change, he argues. Introducing the concept of dynamic materiality, Kuh explains that it is the process determining which ESG issues matter most when the pace of change quickens due to new technologies and views forged in an interconnected world. “Our analysis identified the three issues (greenhouse gas emissions, labour practices and business ethics) that are most consistently material across industries.”

By combining natural language processing and machine learning to measure the actual flows of information, he says the pandemic is an extraordinary case of dynamic materiality in terms of magnitude and speed. 

Chart 1

Chart 1 illustrates how the volume of information about coronavirus has spiked since mid-January, when it barely registered. At the beginning of this time series, he notes, more than half of the small amount of information about Covid-19 was from Mandarin language sources. At the end of February, Covid-related content was about 10%. And as of March 26, it represented 73% of total content. At the same time as Covid-related data as a proportion of overall data increased dramatically, Kuh points out that the overall volume of ESG-related information fell by about 8% in this period and non-Covid ESG content dropped by 75%. “This is unprecedented in Truvalue Labs’ 13-year time series.”

This shows how quickly in today’s world an extreme event can “crowd out” news and other information flows from outside of the immediate crisis. “Typically, a spike in volume stems from a significant event at a particular company like BP, VW or Boeing. In each case, the proximate cause of the problem exposed deep-seated management and governance failures. By contrast, the magnitude of Covid-19 is orders of magnitude greater as it has disrupted social life and the entire global economy and therefore affects multiple sectors and nearly all firms,” he adds.

Parsing Covid-related content to discern which ESG issues are paramount in the context of the pandemic, Kuh’s study shows that while the virus is the impetus for the story, within it is a narrative about what is happening at companies that reveals insights about culture and quality of management. In the aggregate, these firm-level events identify the ESG issues that are most material in this context.

Chart 2

Chart 2 documents which SASB (Sustainability Accounting Standards Board) categories received the most information flow in the context of Covid-related content. Five SASB categories represent 77% of the volume. By March 26, Truevalue Lab’s study showed employee health and safety (29%) emerged as the dominant category, followed by labour practices (20%), access and affordability (10%), product quality and safety (9%) and supply chain management (9%). 

Almost half of the volume (49%) is attributable to employee health and safety and labour practices, which along with supply chain management had no data flow at the beginning of the period. The drop in product quality and safety from 29% to 9% reflects the shifting narrative about the virus as it spread from China to the rest of the world. The data validates the perception that the pandemic is a severely disruptive social and economic crisis borne by people as citizens and as employees. 

The future of ESG after Covid-19 will be different this time, predicts Kuh. “The social and technological conditions that gave rise to dynamic materiality signify that there is no turning back on sustainability. ESG investors and other stakeholders won’t allow the current economic downturn to be an excuse for abandoning their objectives – as if addressing employee health and safety, income inequality and climate change are luxuries.”

ESG investors will experience ebbs and flows, and there will always be naysayers, Kuh agrees. “Public policy will be instrumental in determining the pandemic’s impact on companies, stakeholders and the environment. Initiatives like the EU Action Plan on Sustainable Finance will embed sustainability into the fabric of mainstream finance and establish de facto global standards.”

The digital age has given corporate stakeholders the agency and tools to pursue a socially and environmentally sustainable world, he believes. “The ESG genie cannot be put back in the bottle.” And as Cuomo puts it plainly: it’s not about you; it’s about ‘we’.

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