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How Controversy Monitoring Can Help Shape ESG Policy

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Tracking the companies that are performing well in terms of ESG is just one part of the sustainable finance story – but like everything, there’s a dark side too.

Monitoring errant companies can be just as valuable as tracking those with the best records, particularly for establishing risk management strategies. One key means of doing this is through controversy monitoring.

Contravention of sustainability rules or norms, or actions that are contrary to companies’ stated ESG aims might not be detected in the regular ESG data. When they do appear, the damage can be great for investors and financial institutions that support them. As well as hitting their returns, controversy can inflict reputational harm on investors. They may also incur regulatory penalties.

But by using natural language processing and other sophisticated software applications, financial firms can scour thousands of documents, including media reports and social media posts, to establish details that were not included in public announcements.

These sentiment indicators can suggest red flags in the form of present controversies – if a company has been found to have fallen foul of child labour laws, for instance – or potential future issues, such as rising water waste levels or increasing dissatisfaction among employees.

Add-on Monitor

For Rachel Segal, senior ESG analyst and ESG team lead at Pzena Investment Management, controversy monitoring is a useful add-on to provide context for the other sustainability research.

“It’s part of our ESG governance, we use it to make sure that we’re staying on top of anything that may be impacting the companies in which we invest,” Segal tells ESG Insight. “It doesn’t mean that it has to change our investment thesis but it’s still important to know what’s going on and keep us as up to date as possible.”

Segal is one of four speakers due to attend ESG Insight’s next webinar, entitled “How to manage ESG data for controversy monitoring and portfolio screening”, on October 18. In it, leading figures from the ESG investing, technology and data sectors will discuss why controversy screening is important and how companies can best implement an effective strategy.

Red Flags

Another speaker, Gaurav Bansal, director at tech strategist RCloud Consulting, said controversy screening can help establish if a red flag is in fact a red herring. For some companies, failing to report important ESG data can be just a factor of their size – smaller companies generally have less ability to report their sustainability performance – or a lack of reporting technology.

On the face of, the failure may look like an attempt to withhold information. But Bansal says that contextual information gained from screening media and other alternative sources can help bring greater clarity.

He uses the example of an asset manager with investments in companies that have poor greenhouse gas emissions. If they operate with in a country with less stringent carbon-reduction rules, then the metrics may only look poor through the lens of jurisdictions with tougher regulations.

“Potentially, you could argue that some of the asset managers within countries that are less committed may not be as concerned as those in other jurisdictions. But using controversy monitoring you could see if it’s an isolated incident per investor,” he says.

That touches on another nuance of controversy reporting: different clients may have different levels of tolerance when it comes to what constitutes a red line.

Segal, for instance, said that involvement in child labour or modern slavery would be among major red flags for Pzena that would trigger research and engagement on the issue as if it were financially material to the business. If Pzena is unsatisfied that the issues are being remediated and the engagement “fails” then it would sell the stock.

Systemic Risk

On the other hand, some environmental practices may be subject to closer examination if the flagged issue is not material to the investee company’s business.

“Sometimes they are signals of more systemic risk at the company,” Segal said. “So, if a company has multiple and frequent flags about, say, environmental pollution, then there’s probably something worth exploring there.

“There are some instances where local operating practices are not as stringent as maybe Western or international operating practices – that’s when there’s a case-by-case argument for looking at how egregious it is, is it something that we have a strong red line on?”

Segal and Gaurav agree that controversy monitoring is a part of ESG screening that can’t be easily automated. The nuances of such incidents can’t very well be built into an algorithm to be run across all data. It requires human intervention and judgement.

That’s especially important for Pzena, Segal said, which is a value investor that looks for stocks that appear undervalued. As such controversy within its investee stocks is something Pzena is used to, Segal said.

Mostly those controversies are immaterial to the business. But it takes a skilled eye to recognise the impactful controversies from the mild incidents. Automation of the screening process alone is likely to result in stock exclusions and divestment when engagement would be a better remedy.

“That takes away any of the company-specific nuance,” Segal said. “For us, it’s really engaging with companies more than divesting that we think has the greatest impact.”

Segal and Gaurav will be joined on the October 18 webinar by Justin Kew, senior ESG analyst at Balyasny Asset Management, and Alex Merola, executive director of commercial strategies, ESG & private markets, software solutions at S&P Global Market Intelligence.

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