Now it is perhaps very tempting to discharge the responsibility for ESG risk assessment to an external ratings business. Enumerating risk has its obvious attractions, but there are potential shortcomings users should be aware of. These are not limited to the apparent inconsistencies that have come under recent scrutiny by both the EU Commissioner for Financial Stability, Financial Services and the Capital Markets Union and the European Securities and Markets Authority, but include:
-- Coverage is one such shortcoming. There are generally reckoned to be over 400 million companies in the world. Ratings agencies barely scratch the surface of that universe as they tend to focus on thousands of larger, higher profile organisations. The tail is very long and very geographically dispersed indeed.
-- Are they sufficiently independent not just in terms of who pays to be rated? A questionnaire completed by the company will often form the foundation of an assessment by the ratings agency, but are such self-declarations any more than the company ‘marking its own homework’?
-- And as KYC teams discovered, a risk assessment done at one point in time is just a snapshot and that investment confidence will only come from having a truly dynamic, continuous approach to risk monitoring.
-- Nor do financial crime teams solely rely on human-researched risk assessments in the form of watchlists - the lesson they learned is that such lists only form part of the picture and they supplement them with their own intelligence-led approach to risk management thanks mainly to AI-based risk screening and monitoring tools.
Heads of Impact Investing could be forgiven for being both
confused and frustrated by the lack of clarity around ESG
compliance and how to invest with confidence. But banks and asset
managers have already learnt how to leverage content and
technology to make informed choices about whom they do business
with - KYC now underpins every stage of the client lifecycle. Yes
the risks and the nature of the relationships are different, but
wealth managers looking to mitigate ESG investment risk would do
well to observe the lessons from their financial crime
colleagues. Know your investment will likely end up to be the
ultimate reputational risk mitigant.