While the responsible investing community boosts its efforts to improved reporting and engagement from regulators, SolAbility, a sustainability consulting firm based in South Korea, takes issue with reporting- and policy-focused research and proposes a new approach to identify outstanding sustainable value.
SolAbility created the “ESG 2.0” method, which has two main areas of focus -performance and strategy, and distances itself from the traditional focus on reporting and policies followed by mainstream ESG research.
While programs such as the Global Reporting Initiative or the UN PRI increasingly promote reporting and policy as crucial steps to identify sustainability risks and opportunities, SolAbility argues that this approach generates ESG benchmarks that fail to accurately identify long-term investment value, and can be especially misleading when covering small companies in emerging markets. Given the fact that large cap companies have the resources to produce detailed reporting matching the scrutiny of ESG ratings, smaller firms in emerging markets that could offer tremendous opportunities in terms of sustainability are being unnoticed.
“ESG ratings today show a suspiciously strong correlation to company size and sustainability report volumes. In other words: conventional ESG research methodologies are no longer able to identify outstanding sustainable value”. This message, in one of SolAbility’s recent promotion pieces, was bold (and bolded).
The key components of the ESG 2.0 method are:
– Focus on performance and strategy over policies and management systems
– Include company size to adjust for reporting differences and/or deficits
SolAbility applied its ESG 2.0 methodology in a recent report titled “ESG 2.0 Emerging Asia” which highlights companies and countries that present enormous sustainable investment opportunities, but which would have never been identified as such through traditional ESG research approaches based on policies and reporting. According to the report:
“’Conventional’ ESG screening and analysis methodologies are geared to assess large-cap global companies – based on policies, commitments, and voluntarily disclosure. Under such a methodology, a company’s ‘ESG performance’ depends on policies and disclosure. The ‘strict’ and ‘rules-based’ approach means that most ESG and SRI rankings have become a rating of Sustainability Reports and corporate commitments in the form of policies and certifications of management systems – all of which have little meaning and even less impact on the day-to-day operational efficiency.”
Improved reporting and policy engagement have been tough-to-get achievements and they offer one viable option to identify ESG issues. Nevertheless, it is worth keeping an eye on initiatives such as ESG 2.0 – they might not only add value, but complement existing ones.
SolAbility is a consultancy specialized in sustainability services. Founded in 2005 by a former analyst for the Dow Jones Sustainability Index, SolAbility has served companies to developing and implementing sustainability policies, management systems and strategies. The focus on operational implementation and the hands-on exchange with sustainability practitioners has allowed SolAbility to develop a unique sustainability assessment methodology (ESG analysis tool) that is based on practical realities (both managerial and operational) rather than on academic indicators or policy requirements as generally applied by ESG rating agencies. The added value of this approach is highlighted by the outperformance of both SRI and conventional benchmarks of an SRI/ESG fund based on SolAbility’s ESG research on Korean equities.