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Corporate, investor attention pivots to the S in ESG

The signs are promising that the social pillar of environmental, social and governance investing will receive more attention in 2020 than in previous years, thanks, for example, to high-profile public discussions about corporate social responsibility such as those that took place as part of the latest World Economic Forum gathering in Davos, Switzerland.

In the run-up to the Davos event held from Jan. 21 to Jan. 24, at which the words "society" and "stakeholders" were heard frequently, the World Economic Forum's International Business Council published a consultation paper on ESG metrics and disclosure, which acknowledged that more work is needed to achieve a robust system of reporting to demonstrate the alignment of corporate actions with the needs of society, potentially even requiring its own global accounting standard to improve comparability.

For investors, social on its own is still a relatively small component of ESG markets. For example, the social bond market, which funds projects with a positive social impact, grew to $12.71 billion in 2019 from $11.19 billion in 2017. In comparison, the green bond market, which targets environmentally friendly projects, reached $254.9 billion in 2019, a 49% year-over-year increase.

But with the E pillar of ESG reaching an important milestone in 2019 following the EU's unveiling of a sustainable finance taxonomy, attention is turning to the S, arguably the trickiest part of ESG for companies and their investors to measure and monitor.

'Judgmental and qualitative'

"The social aspect is the most difficult one [of the three] because when you start digging into it, it starts to be quite judgmental and qualitative," said Florence Fontan, head of company engagement at to BNP Paribas Securities Services, the securities services unit of French bank BNP Paribas.

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In a 2019 global survey of 347 asset managers and owners by BNP Paribas Securities Services, 46% of respondents said the S is the most difficult to analyze, compared to 30% for environmental and 24% for governance components.

One problem is that the scope of social is vast, covering everything from child labor to consumer rights to hazardous waste affecting the lives and livelihoods of communities. There are also variations between companies, sectors and geographies.

Another factor is an individual investor's interests and values, Fontan said. For example, a pension fund for employees in the healthcare sector might avoid investments in the tobacco industry, while a pension fund for teachers might look at companies' education policies and access to training, she added.

Measurement complicates matters too. Investors can measure a company's environmental record and quantify its impact on, for example, biodiversity or water. In contrast, Fonterra said, knowing whether a company's suppliers treat their employees humanely is hard to track with meaningful metrics.

The lack of standardized data is a struggle for all three pillars, but particularly acute for social, said Jeroen Bos, head of specialized equity and responsible investing at NN Investment Partners, the investment management arm of Dutch insurance group NN Group NV. "There are no data sets that will tell you to add 10 million or subtract 10 million or add 10% to a share price or not so that remains a bit of an art in terms of estimating the monetary value of those impacts," he said.

These challenges help explain the results of an NNIP survey conducted in 2019 of 290 professional investors, which found that 15% of respondents believe the S has the potential to drive long-term returns, compared to 66% for environmental and 40% for governance.

In search of transparency

NNIP, which takes a similar approach to that of other investment companies, pulls information from multiple ESG-focused data providers, such as Sustainalytics, MSCI and Truvaluelabs, before running its own analysis.

Consultancy Opimas estimates the total global spending across all of ESG on data, including indices and content, will reach $745 million by 2020, up from a forecast $505 million in 2018.

While the appetite for data to support investments is growing, investors are also calling on companies to increase transparency around their social strategies, Bos said.

NNIP recently launched three new impact investing funds focusing on the United Nations Sustainable Development Goals, which was launched in 2015 to zero in on poverty reduction and other societal issues and has steadily gained traction in tandem for burgeoning investor demand for impact investing products, Bos said.

Risk and reward

Reinforcing this interest is a growing body of evidence of the interconnectedness of each of the three pillars as well as S's powerful role in risk mitigation, said Markus Müller, global head of the chief investment office at Deutsche Bank Wealth Management.

"The strongest factor to reduce not just overall risk, [but also] systematic risk and idiosyncratic risk, is really delivered by the S," he said, citing research showing that companies with a more diverse organization demonstrate better resilience than others to external and internal shocks.

In a report compiled with the Università Cattolica del Sacro Cuore in Milan, Deutsche Bank Wealth Management drew data from 1,063 companies in 18 countries, taking into account their financial performance from 2002 to 2016, measured against the average performance of European, U.S., Japanese and U.K. stocks. It compared the E, S and G data, which demonstrated that the social pillar reduces a company's systematic risk 42x more than the environmental pillar and 4.7x more than the governance pillar.

On the flip side, companies that do not uphold societal standards and practices as outlined by the UN and other organizations leave themselves more heavily exposed to reputational and other risks, which can hit both its top and bottom lines through loss of sales, fines and litigation, Müller said.

All told, Müller believes S's time has come to play a more prominent role in ESG investing.

With the EU's environmental framework in place, regulators will now focus on social and governance, said Müller, who co-wrote a recent Deutsche Bank Wealth Management report entitled "The 'S' in ESG. The ugly duckling of investing."

Social "is currently not a beautiful swan but we think there is potential. With more data being available, with having solved the problems around the E and having a common taxonomy around the E, investors will refocus on the S," he said.