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Assessing Companies’ ESG Health

How do we determine whether companies are actively engaged in environmental, social and governance issues?

An oft-discussed weak spot in the socially responsible investing space is the lack of clarity around its central definitions, priorities and processes. What does investing responsibly even mean? Does the answer have to vary from investor to investor, pet concern to pet concern? What factors should we use in determining whether companies are actively engaged and concerned about ESG (environmental, social and governance) issues?

“This is an industry that everybody defines somewhat differently,” says Konrad Sippel, executive director and head of product development at STOXX, a global index provider partially owned by Deutsche Börse. “There haven’t been clear standards around what it actually means, and which factors should be used. That’s primarily because the research houses in the space haven’t really disclosed on how they approach the topic.”

Sippel explains that STOXX clients have increasingly been vocalizing the common opinion that this opacity in the ESG space is a problem. A crucial part of knowing what ESG investing means is knowing what goes into the creation of an ESG index or strategy – but this knowledge is often proprietary information.

Last week, STOXX indicated a break from that norm by launching a family of global ESG indices that hold full transparency as a central tenet.

“We’re doing something different here,” says Sippel. “We are fully disclosing how we approach the topic, and we hope that the investment industry is going to adopt that as a standard.”

A foundational part of the compilation of any ESG index is determining what indicators companies will be rated on in the process of selecting those that are leaders in corporate sustainability. For this, STOXX has deferred to a list of key performance indicators (KPIs) formulated by the Society of Investment Professionals in Germany (DVFA) and The European Federation of Financial Analysts Societies (EFFAS). The two organizations created the list of KPIs in the hopes of offering the industry a common standard of what to look for when considering sustainability from an investment perspective.

The indicators are divided into E, S and G categories, and include “Programs and Targets to Protect Biodiversity” in the environment category, “Supply Chain Monitoring System” in the social category, and “Policy on Bribery and Corruption” in the governance category.

For the actual assessment of companies’ ESG health, STOXX partnered with Sustainalytics, a global provider of ESG research. Using as its pool the companies in the STOXX Global 1800 index, Sustainalytics evaluates a company by assigning a rating from 0 to 100 for each indicator. For a company to be selected for inclusion, it must have a score of 75 or higher in at least one category (E, S or G), and a score of at least 50 in the others.

These Sustainalytics ratings for each company will be made public on the STOXX website, which represents a new level of transparency for Sustainalytics, too. Bob Mann, managing director of Sustainalytics North America, says that while the firm’s research and ratings are already disclosed to its clients, making that information available to the wider public will be new territory. He adds that Sustainalytics built a custom algorithm for the STOXX indices, and that it’s different from the one it sells its clients.

Sippel calls the comprehensive disclosure on the website of the indices’ company ratings, weighting schemes, and index algorithms “one of the defining aspects of the index.”

“Obviously if you’re going to talk about transparency, then you’re going to have to deliver on that,” he says. “I think that’s pretty unique in this space – to make available the ratings that are used to construct the indices, all the way down to the final numbers.”

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