ImpactAlpha, June 21 – There’s a new game playing out between companies and investors in sustainable finance. Publicly-listed companies know that being seen to meet environmental, social and governance, or ESG, targets while minimizing materiality risk is now a critical consideration for raising capital. They’re wising up – learning how to play the ratings, and in turn, out-maneuver investors.
How come? Most ESG issues are difficult, if not impossible, to objectively measure and compare. The situation is made worse by an alphabet soup of frameworks and standards, leading companies to report on issues in entirely divergent ways.
Without objective extra-financial metrics on which to fall back, investors rely on an unwieldy patchwork of third-party ratings and corporate disclosures, all using different methodologies. It has become hard to make sense of the noise. And, counterintuitively, it’s becoming harder—not easier—to trust that companies are doing what they claim.
It was much simpler when the only signal that mattered to investors was a company’s bottom line. Financial performance is binary: you’re up or down, black or red, and that isn’t easily fudged.
The same can’t be said for the myriad extra-financial issues that listed companies now need to address if they want to bypass negative impact screens or gain entry to sustainable investing universes. Without objective evidence to back up ESG claims, talking the talk has the same practical value as walking the walk.
The fact that ESG disclosures are subjective, and even unreliable, is not new. The problem is that companies are learning to play the ratings.
Perceptive investor relations teams are increasingly motivated to better understand the ways in which investors gather extra-financial information – such as using natural-language processing to analyse annual reports, earnings calls, shareholder decks and other publicly shared information, or by using third-party ratings – to understand how to use communication to their advantage.
A recent National Bureau of Economic Research paper titled “How to Talk When a Machine is Listening: Corporate Disclosure in the Age of AI“ finds company executives have started to adapt their statements and delivery to cater to the algorithms parsing text and speech for trading signals. “Increasing AI readership motivates firms to prepare filings that are more friendly to machine parsing and processing,” the academics argue. “Technological progress and the sheer volume of disclosure make the trend inevitable.”
Recently, UBS analysts revealed to the Financial Times that carbon is now a buzzword on corporate earnings calls. Mentions of carbon and associated keywords have tripled over the last three years, reaching 1,600 per quarter. Google searches for the word in a financial context have also reached an all-time high.
It’s no coincidence that the growing emphasis on carbon emissions comes during a period of rapid growth in sustainable investing. As the analysts observe, the momentum behind green investing is a big motivation for companies, as accelerating flows of cash into carbon-conscious companies and funds have driven up valuations.
While many companies have a genuine, evidenced commitment to sustainability targets, others may be less sincere, flooding their communications with keywords that speak to material issues. The financial incentives to do so are there.
The game works in reverse, too. In its latest shareholder deck, Tesla embedded a single line about its $101 million Bitcoin sale as a JPEG image, which prevented journalists and others from easily keyword searching the document.
Tailoring investor communications to appease shareholders is as old as finance itself. But ESG and machine learning have raised the stakes.
In our view at Util, what’s needed is more evidence-based data, as well as more sophisticated machine learning analysis. Util’s approach is to track the impact of a company’s revenue against the U.N.’s 17 Sustainable Development Goals (SDGs) as an alternative to ESG metrics. We believe this is a more objective and data-driven way of analyzing impact.
We founded Util with a vision of creating an objective metric for non-financial value that can sit beside financial value. We only look at one data input for companies: their products and services. This category falls outside the remit of any one standard and, thanks to its objectivity, is not subject to the same fragmentation of opinion.
When it comes to ESG, we support what our peers are striving to achieve, as well as efforts to standardize reporting frameworks. But we don’t ally with a specific set of standards because what we measure is a qualitatively and quantitatively different: impact, not ESG.
A metric of extra-financial value that lives up to that of financial value must be as universally objective, reliable and consistent as a currency. Only then can ESG and impact not be managed and manipulated by the very companies they seek to measure.
Patrick Wood Uribe is the CEO of Util, a U.K.-based fintech company that tracks companies’ impact in regard to the U.N. Sustainable Development Goals.