The Increasing Demand for ESG Scoring and the Benefits of Standardization

As we start off the New Year, TriLinc Global will be discussing notable trends from 2015 that we see as relevant to the development and growth of the impact investing sector in 2016 and beyond. This is the third post in a four-part series.

Coinciding with the rise of entrants in the impact investing space is a similarly mounting demand for increased rigor and standardization around ESG reporting. According to US SIF Foundation’s biennial survey, “Unlocking ESG Integration,” the inclusion of ESG factors into portfolio management grew at a rapid pace between 2012 and 2014, reaching almost $5 trillion in US-domiciled assets. However, a key challenge for asset owners and investment managers has been the lack of an effective, uniform and all-inclusive way to measure ESG factors and impact goals.

Ernst & Young’s 2015 global survey, “Tomorrow’s Investment Rules 2.0,” reported that although 71 percent of institutional investor respondents considered integrated reports – which include both financial and ESG information – essential to making investment decisions, over 25 percent said that nonfinancial information had not affected their investment decisions over the past year.  The reason for this was primarily due to the difficulty of verifying and comparing ESG and impact data across firms.

In response, industry players are making strides to develop ESG assessment tools and services, so that investors can use ESG data to more effectively drive investment decisions and portfolio monitoring practices. As of 2014, Bloomberg, one of the largest information gathering and dissemination models in the investment management industry, had gathered and reported ESG data to 17,000 ESG data service subscribers on over 11,000 companies spanning 65 countries.  By adding “non-financial” ESG data to its product offering, Bloomberg has been an active change agent in the sector.

Another new player in the field is Morningstar, which is partnering with Sustainalytics to bring ESG scoring into the mainstream by assigning ratings to global mutual and exchange-traded funds (ETFs).  Resulting from heightened investor demand for more transparent information about ESG practices, Morningstar will test how companies and investment managers effectively gather, report and incorporate ESG information into the analysis and risk profile of their investments.  The new Morningstar ESG ratings will guide institutional firms that create and manage mutual funds and ETFs for the retail market, and will empower “main street” investors to make investment decisions that are both value-based and values-based.

Another industry partnership seeks to offer institutional investors insights into ESG risks, including those not reported through public companies’ mandatory public disclosures. In September 2015, Institutional Shareholder Services (ISS), which provides corporate governance and proxy voting services, began offering its clients ESG screening, analysis and stewardship tools using analytics and metrics provided by RepRisk.  This partnership helps ISS clients – asset owners, investment managers, hedge funds, broker-dealers and custodian banks – manage compliance, reputational and investment risks related to their portfolio companies’ ESG activities.

The burgeoning development of analytical frameworks underscores the demand for the integration of ESG variables into investment management practices.  However, the industry has not yet established a universally accepted approach to ESG methodology, measurement, benchmarking and reporting, as it has for other investment performance metrics.  A growing but still nascent trend, ESG integration will achieve mainstream proportions as sector players assess the various options and coalesce around broadly accepted approaches. Such standardization is crucial to better investment decision-making practices, and will lead to improved risk management and an enhanced understanding of ESG across a portfolio’s performance.

– This post is the third in the four-part series, “Impact Investing: What’s to Come in 2016,” written by Melissa Tickle, TriLinc Global Impact & ESG Analyst.