The ESG risk score of your investments

The ESG risk score of your investments

Financial institutions that understand that sustainable investments are important can use the ESG risk score to indicate how sustainable a company operates, and thus how sustainable investments in that company are. The abbreviation ESG stands for Environmental, Social and Governance.
 
 

 

What is ESG?

Environmental

How does a company commit itself to, for example, reducing CO2 emissions, water use and waste? Does the company recycle? Does the company report on its own impact on the environment?

Social

Does a company provide safe working conditions and good pay for employees? Is there a policy against discrimination, for example? How does the company treat its suppliers? What is the company doing to keep child labour out of its production process?

Governance

Is the company prone to corruption? How is the supervisory board composed? Is the company lobbying the government? How transparent is the company about the policy and its activities?
 

In your quarterly report, you will see an infographic like the one above, probably with different figures.

  1. At the 1, you will see a composite bar.
    • The blue part shows the total risk exposure. That is the ESG risk that the companies in your portfolio run in total.
    • The green-grey part shows the controlled risk. That is the portion of risk that the companies in your portfolio have under control.
    • Green represents the part that is not under control. That is the ESG risk score that the companies in your portfolio run, and ‘your’ ESG risk score is therefore 52 - 34 = 18.
  2. At the 2, you will see that 18, in green, with a number in grey next to it, which represents the benchmark. In this case, your ESG risk score remains below the benchmark, which is favourable.
  3. At the 3, you will see a bar with a classification of your ESG risk. 18 falls into the ‘low’ block. You can also see that the weight of this classification is increasing rapidly: an ESG score of 40 or more already falls under ‘very high’.
 

ESG research

Based on the three ESG themes, our partner, Sustainalytics, conducts research and assesses the ESG business performance of these companies. Sustainalytics is a global leader in ESG research. For this research, Sustainalytics uses a method consisting of 3 building blocks.

Building Block 1: Corporate Governance

The first building block forms the foundation of the research: Corporate Governance. This research is the same for every company, all companies are examined for the same Corporate Governance factors. This includes, for example, shareholder rights and management remuneration.

Building Block 2: Material ESG issues

The next building block consists of research into so-called Material ESG issues. These are focused on the business processes, the sector and the location. Based on this, factors are investigated that can have a major impact. Some factors are: 

  • access to basic services; 
  • bribery and corruption; 
  • business ethics; 
  • community relations; 
  • data privacy and security; 
  • emissions and waste; 
  • human rights; 
  • health and safety. 

For instance, in an oil company, some of these factors will consist of “emissions and waste”, “bribery and corruption” and “health and safety”, while for a software company “data privacy and security”.

Building Block 3: Idiosyncratic ESG issues

The last building block consists of an investigation into the Idiosyncratic ESG issues. These are ESG issues that arise at a company that are not expected, the “black swans”. Controversies can of course occur within the context of the aforementioned factors. If there is an oil leak at an oil company, this company will receive a higher score for “emissions and waste”. This risk is a known problem, but what if an oil company suddenly has a “data privacy and security” issue with customer data? Then that is considered an anomalous event that is not immediately expected in that industry. That is called an Idiosyncratic ESG issue

The company also gets a higher score for that issue. Sustainalytics then looks at whether this could also be an unexpected risk for other companies within the same industry. An ESG Risk Exposure then emerges from this method. Sustainalytics then examines how well these risks are managed. That which cannot or is not properly controlled is the ESG risk. The lower the score, the better.

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