ESG has become a powerful marketing message that reflects the mood of many more investors who are interested in how their funds are invested, not just their performance. The phenomenon is cross-generational and applies equally to private and institutional investors. ESG not only manifests the public interest in climate change, environmental impact, social and corporate governance, but is also considered a useful set of measures in assessing the sustainability of a company in a rapidly changing world.
In essence, ESG is becoming mainstream and it is here to stay. A 2019 Russell Investments survey of 300 active investment management firms reported that 82% had a formalized Responsible Investment Policy, a 26% increase on the previous year. ESG captures the zeitgeist, or spirit of our time: it is about individuals expressing their will and having an impact on the factors that matter to them.
The interesting difference with ESG as opposed to the long list of buzzwords that have come and gone in the fund industry is that ESG is not a technological breakthrough but rather a cultural one.
It is a reflection of a shift in society, where ethics and good governance are coming to the fore, rather than being another technology innovation. In this way ESG is not just the flavour of the month but a rising tide buoyed by public opinion.
Nevertheless, could there soon to be a link between ESG and operations, extending to include the technology suppliers that investment management firms rely on? In the same way that investors are becoming increasingly interested in the ESG credentials of their fund managers, it is surely just a matter of time before investment managers become interested in the ‘ESG ratings’ of their IT infrastructure, cybersecurity and software development suppliers?
Those using development teams overseas in third world offices could come under increasing scrutiny. How far will the ripple effect of ESG extend beyond the initial impact zone?
The flow of inquiry in any supply chain is most often downhill. So how long will it be before investment managers begin to experience criticism concerning partners in their supply chain, such as IT and infrastructure providers? Anything that comes to the front and center of the investment management world will eventually require ‘look-through’.
Regulators ask questions of managers and their dependent suppliers or outsourcers. There is always a further level of look-through. Investors may eventually challenge their investment managers during ODD investigations asking questions like “You might have ticked the ESG boxes, but are you dealing with suppliers who are themselves involved in questionable practices?’
If the ESG wave does reach the technology provider’s shore, how might they be impacted? From an environmental perspective, infrastructure firms should begin by taking a closer look at where their servers are and how their servers are power-managed. Are their datacentres environmentally sound? Most public cloud-based services have a reduced carbon footprint which is great news as more managers move to public and hybrid cloud environments.
Data transparency and reporting plays a huge part in any ESG strategy, so firms should be looking for solutions that allow them to interrogate data from multiple sources to extract the information their investors are looking for. A solid data management strategy could meet these needs by integrating due diligence information, sector information and could look at alternative data sources to corroborate and verify facts and sources.
In terms of social impacts that technology providers must consider, certainly the practice of offshoring would be one area of concern for investors and money managers. Many software firms or managed service providers have long-established development or operational teams in eastern Europe or the Indian subcontinent as a labor cost arbitrage. The treatment of these staff could become a focus.
Similarly, the COVID-19 pandemic has necessitated the provision of secure, remote working solutions from many IT infrastructure firms. This has led to an increased focus on governance and staff conduct of remote workers from the regulators. Are the systems in place to ensure good governance?
Firms may have been forced to accommodate or accelerate remote working strategies, but many industry voices see this persisting beyond the end of lockdown, with the expectation of a better work/life balance and ability to offer flexible working options to more employees. Responding to the pandemic by laying off great swathes of your workforce due to an inability to work flexibly will not be seen as a positive action in ESG terms.
In this respect too, technology plays a big part of course. It underpins any successful flexible working programme and allows remote and flexible workers to collaborate effectively, wherever they may be in the world. By simulating the necessary interaction between employees, without leaving their desks, technology can reduce the requirement for national and international travel, playing a part in reducing carbon emissions generated by travel.
The Black Lives Matter movement of course, has had a massive impact globally. Racial tensions are at an all-time high and the investment management industry has not been unresponsive. In early June, Gavin Lewis, managing director at BlackRock and co-founder of The Diversity Project, launched a new campaign to raise awareness of the everyday fight black people must endure against racist stereotypes. The #IAM campaign, which has been initiated across Twitter, Instagram and LinkedIn, encourages black people and non-black allies to answer the question ‘who are you?’ in a photo of themselves alongside the hashtag. It certainly won’t end there. Will technology partners of the investment management industry come under increasing scrutiny for their race relations policies and diversity programs? Some businesses have been moved to add a “D” to ESG—prioritizing diversity and justice to foster and protect a more inclusive society. ESGD investing, like ESG investing today, also doesn’t mean sacrificing financial gains to serve moral purposes. A more equitable society naturally means a better flow of capital, and more opportunity means more significant innovation. In fact, McKinsey, among many others, has reported that diverse organisations actually perform better.
When looking at governance, the questions that could be leveled at technology providers are numerous and wide ranging. Interrogations might relate to money laundering, data protection, cyber security, conflicts of interest, HR compliance, mitigating key-man risk or even awareness among staff of internal IT policies.
To conclude, the focus on supply chains has pervaded so much of our society already and while many IT firms could probably be ‘creative’ in their answers to ESGD-related due diligence questions, maybe now is the time to start formalizing a sound response.