Pim Poppe: Considerations implementing ESG
By Pim Poppe, Managing Partner at Probability & Partners
Most asset owners and asset managers are currently developing and implementing ESG policies. An ESG framework consists of many pieces and clients invite us to help them design or improve some parts.
What strikes us is the wide bandwidth of different ESG approaches and the broad array of implementation strategies. These differences are not surprising, because there are many components to implementing a coherent ESG policy. It is also not surprising because the DNA of these asset owners is different. Some are true ESG leaders and believers, others are followers or even laggards, and some are only regulatory-driven.
The graph below places the ESG components in an investment management process. We are not going to elaborate on all the steps here. They are self-evident.
It is interesting to note that more than half of the steps will be affected by ESG considerations. Furthermore, it is meaningful to note that a wide range of skills is needed. It is about portfolio management, risk management, performance measurement, data management, data preparation, building a conceptual sound framework, understanding market dynamics, and last but not least, a thorough understanding of the regulatory prerequisites and boundaries for reporting.
In our view, there are several key questions. Sometimes they are asked and answered adequately, sometimes the questions are not even being considered. Some examples:
First question: Should investment beliefs and ESG ambitions and goals be separate domains, or should they be more of a cohesive whole in a kind of twin-peaks model? You could go even further by integrating both completely.
Second question: Are climate risk management and ESG separate parts, or should they be managed in one go? Both views have pros and cons. Preventing and mitigating climate risks are, in fact, the asset owner’s pure self-interest. ESG is primarily about doing good, or at least doing no harm without financial self-interest. That would argue for different approaches. On the other hand, the themes overlap and so do the data and systems to manage them. The common denominators would advocate an integrated approach.
Third question: Does the implementation go clockwise or counterclockwise? In other words, does one start with reporting rules or with ESG ambitions and goals followed by ALM and Investment plan? Often this question is not even really asked, but the approach is implied by the character of the asset owner.
Fourth question: What is exactly the overarching goal of an ESG Policy? Is it a) a better risk-return profile, or, b) do no harm (minimizing negative impact) or c) do good (maximizing positive impact), or d) a mixture of a, b and c, or e) something else.
Fifth question: What should be the ESG themes and measurable targets for the ESG themes?
Sixth question: What is the expected contribution of ESG policies to financial performance? Is it positive, neutral, or negative? The answer to this question usually lands in the investment beliefs.
We do see structured, coherent ESG approaches. But we also see clients focusing only on preventing financial losses by ESG policies, market participants being driven by regulatory compliance, and market participants defining goals that never will be measured or implemented.
The answers are driven by client beliefs, preferences, and practical considerations. What is essential, in our view, is that before implementing, you oversee all the pieces, answer the key questions, and design an integrated ESG system. Finally, implement it step by step.
Probability & Partners is a Risk Advisory Firm offering ïntegrated Risk Management and Quantitative Modelling Solutions to the financial sector and data-driven companies.