Investor’s view: what is ESG data and how it mitigates risks
In 2021, the trend towards responsible investing continues to gain momentum. Company`s environmental, social and governance indicators confidently play an important role in investment decisions. Considering the situation with climate change, growing poverty rate with COVID-19 on the background and the recession of the global economy, representatives of the banking sector are trying to protect their portfolios from high-risk projects. The analysis of ESG-data (environmental, social and governance) helps in such case a lot.
This tool was discussed at an online meeting of ESG tools of financial institutions within the framework of the Ukrainian Agribusiness Sustainability Webinar Series which is a joint initiative of the Dutch Development Bank FMO and the first international association of sustainability practitioners the “Association of Sustainable Development Experts”.
Mind is the main media partner of the initiative.
Environmental & Social Manager for Agri, Food, Water
What is the ESG data
ESG data refers to the environment, social and governance data which are the three central factors in measuring sustainability and ethical impact of an investment in a company or business. For example this data includes: how much water the company consuming, how much CO2 it is emitting, how many employees it has, whether gender equality is observed, how wages are paid, etc.. On governance we would be reporting on their board of directors, internal checks and balances around corruption or bribery.
However, it is important to understand that superficial collection of this data and its reflection in reports can allow you to meet the local regulatory requirements but it will not affect the environment in any way.
If you are a top manager of the company who goes deeper and uses this data as a management tool truly, it has the ability to forewarn you of risks, to help you make strategic business decisions at any unexpected turns in the company's strategy.
Moreover, it is no less effective driver for the company's social image and enhancing the reputation, with the possibility of further access to other sources of capital: from green bonds to accessing impact funds. ESG-data truly adds value, so don`t limit yourself while collecting data.
Head of ESG and Sustainable Investments
ESG DATA & PLANNING
ESG is good for business. ESG leads to value-add and creates trust with third parties and banks. Good ESG is profitable and leads to successful exits. Exits are everything in private equity. Third parties, especially banks, trust our due diligence process and know that our clients are clean. We take a proactive approach to ESG and it is not a burden for us or our clients. Even though I am not an investment officer, I work with the investment team closely and we work together as a team. We are constantly involved with our clients and are up to speed on everything. This is why when the pandemic crisis occurred, none of our companies went bankrupt and all of them are alive today.
Proactive ESG management helps manage risks and creates opportunities. ESG is incorporated in all stages of the investment process, starting from the identification of a deal, screening, site visits, investment committee approval, deal execution and monitoring/reporting. The ESG risks are assessed during the initial due diligence stage. An ESG action plan is developed to address and mitigate all risks identified during the due diligence phase. An ESG action plan is developed with the cooperation of the client for every single deal. The ESG action plan is part of the ESG Due Diligence report. Our due diligence which includes site visits, interviews and reviewing documentation, is based on the EBRD sub-sectoral environmental and social guidelines and IFC Environmental, Health and Safety Guidelines.
All ESG action plans are included in the investment agreement, as a guarantee that they will be completed. In addition, on a quarterly basis we conduct site visits, and follow up with the clients to ensure that the action plan is going according to plan and if there are any problems, help the company to address and resolve them in a timely manner. Gazelle Finance also managed a Value Add Service Facility. Through this Facility, we are able to provide a grant or 0% loan to the client to implement the ESG action plan.
Head of the Department of Environmental and Social Risks
What we can do with ESG-data
First of all, ESG is important in decision making process asit helps to define a risk profile and as a result overall level of risk. The outcome of due diligence process and data collection should be considered in structuring of financing in the form of covenants, action plan and etc. Moreover, in case of significant risks, mitigation should be taken before agreement. In case of risks, that cannot be mitigated, it should be rejected, as it produces high level of risks for organization, society, environment.
ESG due diligence process have to match with bank`s business model and with structure of portfolio. Namely: if bank`s portfolio includes a lot of different type activities and big number of clients, it means that process of environmental and social assessment should cover most of portfolio in order to mitigate those risks. And for this goal the bank has to establish process which can cover most of portfolio.
ESG data is also used in monitoring of fulfilment of covenants. This is also include monitoring of negative information in media, e.g., we define share of portfolio with high or significant risk and on a semi-annual basis we make monitoring of negative E&S information in open media sources.
One more way how to use ESG data is for reporting goals. Often, IFIs require from r clients the annual client`s report which could also be an instrument for monitoring. In this report client shall report environmental and social aspects of activity during the reporting period, for example a year.
Also, ESG data can be used for bank`s sustainability report in order to show your approach, structure and the performance of your portfolio to third parties.
The last but not least, ESG data may be used for communication with stakeholders.
Environmental and Social Officer, Private Equity
I will explain in practical example. Let`s take a chemical or pharma project in Ukraine. In the early stage, we would like to see things like are the communities affected, are there any major issues in the supply chain is there, perhaps, a high risk of soil and/or groundwater contamination. And if any of this is true, we ask questions, like “Are these risks now mitigatable and how expensive is it to mitigate this?”. We then match the information that we gathered with the ability of the company to manage these risks and we look at the systems that they have in place, do they have processes, procedures to look at these issues, do they have capacity in place and how strong their E&S team, is there any E&S team at all? And perhaps, the most importantly: is there a commitment from the management to look into these issues and address them as we work forward.
We also engage with external consultants, preferable local who know better the company's environment and other aspects.
And all this information, that we gathered, we benchmark with our E&S requirements which are heavily based on the IFC performance standards. Then any gaps that we have identified, we address it in the environmental and social action plan which is actually contractually agreed when we decide to invest in a project.
And looking back at the abovementioned example, if financial institution finds out that there is soil and groundwater contamination, then comes after the assessment of the capacity, the budget and the commitment of the company. It shall be considered if the situation is manageable, maybe the situation is not that bad or maybe there are available technologies and it`s not that costly to address this. So we feel comfortable and address this in the ESAP, and we call this a performance gap.
The importance of collecting E&S information at the first step of due diligence process is also that we do not want to wait until the last minute, when is finished the whole due diligence process from the commercial, legal etc. After those streams are finalized we look at environmental and social issues, and sometimes that would mean a lot of time is spent and capacity spent from our colleagues on a deal that going to be rejected for environmental and social reasons because the risks are too high.
MYTHS IN WORKING WITH ESG-DATA
- The ESG team can be assembled later or even managed by one person. I came across with a lot of instances, when company would want to start the ESG assessment without having the ESG team mobilized. And the key trigger for this would be project manager, who would consider that he will deal with everything. But in ESG it is not working like that. In case you want to get complete data, you have to have the ESG team on board from the very beginning, that will include experts on environmental, social and governance issues, managers for sustainable development, labor protection and others.
- Outsourced team knows it. Oftentimes, when a company plans to start data collection in the field, they outsource researches and there is nothing wrong about this approach. However, I`ve seen it many times, that those people are sent out to the field without being instructed. Of course, they have pretty good understanding of what kind of data should be collected and how to collect this data, however, they may not necessarily be aware of company`s next step, for instance, how company is going to continue stakeholder engagement. If the company is not proactive, and does not give them clear instructions , then the company is risking to create huge room for interpretations. In such context each and every research team member will talk about the company, within the limits of his/her understanding, which may not be 100% correct, since it will be the interpretation and not facts-based information. Be proactive and always tell the research team about Do and Don’s in terms of communication with the stakeholders when they are collecting information.
ESG data collection requires sophisticated tools. Focus groups discussions and individual interviews is one of the effective tools for collecting ESG data, which does not require significant costs or time. In every context, the key ESG knowledge is with communities and stakeholders. By talking with a local fisherman, hunter or herbs collector, you may get more information about biodiversity, than through any articles written about this area. At the heart of interesting discoveries and data is simple communication and interaction with people.