The ESG Skills Gap: Three main challenges and how to overcome them
Benjamin Stone, Analyst
The demand for well-structured and transparent Responsible Investment (“RI”) and Corporate Social Responsibility (“CSR”) practices will not slow down. From our experience working at the intersection of finance and sustainability, we have observed that ESG knowledge building can be a deal-breaker when it comes to successful implementation. We have identified the following barriers that organisations commonly face when they embark on their ESG journey – whether it involves the firm-level or the investment process. Complexity: ESG is multifaceted and spans numerous organisational, economic, and societal topics.Applicability: Which E, S, and G topics should be included in responsible investment or corporate sustainability practices differ depending on firm specific characteristics.Accessibility: Ascertaining comprehensive ESG knowledge is challenging, given the current amount of information available and rate at which new information is being released.
Complexity
Although this may seem self-evident, it is important to stress that the ESG acronym is underpinned by a multitude of individual topics, that can be incredibly complex in themselves, and may require their own specialist knowledge and skills. As an indicative example, and by no means exhaustive list, please see the table below.
ESG bundles these topics together, depending on what the objective is. For an investor that is simply comparing all companies on the same issues, it may result in financially material issues being overlooked or an unnecessary focus on less material issues for the business. If the purpose is to find those that perform best on a specific topic, then maybe a blanket approach may be warranted. There is also a tendency not to recognise the extent to which these topics are related or could relate to each other. Biodiversity and community relations are two different issues, yet both are likely to be affected by the adverse impacts of climate change. Supply chain management covers both environmental and social, cutting through nearly all the individual topics listed under these two pillars. Beyond the underlying ESG topics, complexity also arises through the myriad of ESG focused regulations, disclosure frameworks, industry bodies, educational forums and engagement groups that seek to advance sustainable finance. Common regulatory initiatives that asset managers should be familiar with include, for example the EU SFDR and the Hong Kong SFC Management and Disclosure of Climate-Related Risks by Fund Managers. Managers should also pay attention to the SEC’s increased interest in ESG, particularly around climate risk, as well as the UK SDR, with the FCA recently publishing a discussion paper on potential investment labels that funds could classify themselves against. Firms also need to understand reporting frameworks and the difference between materiality, double materiality, and dynamic materiality, as well as how organisations such as SASB, GRI, and TCFD utilise them within their own frameworks. At a high level, SASB is rooted in the concept of financial materiality, whereby sustainability issues are decided based on their likelihood to impact current and future market value of the firm. The GRI is based on double materiality, which not only considers how sustainability issues impacts a company’s market value but also how a company’s activity impact on those sustainability issues. TCFD takes a slightly different focus, arguing that climate change is a financially material, non-diversifiable issue that impacts all businesses, no matter what industry they are in. For those who want to claim positive impact, understanding intentionality and additionality, and demonstrating how your business activity has contributed to both will be key. Intentionality is where an investment or action has a pre-defined environmental or social objective, whilst additionality is the extent to which your pre-defined objective occurred because of your investment or action. This is particularly important as it relates to the SDGs, where we often see dubious claims about how a specific business activity has positively impacted an SDG. This usually includes a high-level impact claim that is not connected to the underlying SDG targets, or impact that has occurred in a country that has already met the SDG in question. Therefore, the complexity of ESG through its underlying topics, approaches, regulations, reporting frameworks and other industry bodies makes it challenging for firms who do not have strong internal ESG capabilities to create a successful and authentic approach to ESG.Applicability
There is no one definitive “playbook” for how to incorporate ESG practices within a corporate strategy or investment process. Instead, the relevance of each factor to the business and its external impact differs depending on a company’s culture, mission, industry, size, stakeholders, or location. For an investment manager, actions and oversight will invariably cut across key business functions, such as the Human Resources (HR), Investment Teams, Legal and Compliance, Technology, Marketing and Communications, Investor Relations etc. Investment management firms are human-capital intensive firms, and therefore the HR function often has the responsibility of structuring and implementing the ‘S’ related topics. This includes setting in place structures for building and retaining talent, improving DEI, and spurring employee engagement. The IT team, whether outsourced or internal, focuses on managing the automation, cybersecurity and data protection aspects. The office management team collaborates with building management and similar departments / firms on the environmental footprint. The investment team will be focused on integrating ESG in the investment process, ensuring that a systematic and repeatable system is created. The C-suite and senior management teams will need to understand how ESG impacts each different business function (and the impact of those business functions on the external world) and have ultimate oversight of the progress. For an asset manager interested in incorporating ESG in their investment process, at the very minimum, they need to understand the following: Relevance: How is ESG and broader RI practices relevant for the current investment thesis or strategy?ESG Approach: How and why are specific ESG issues important for the investment performance and/or its impact? Which approach, whether it be exclusions, positive screens, ESG integration, sustainability-themed investments, or impact investing, is best suitable for executing the investment thesis and meeting the objectives of the fund?Data: What metrics should be used to measure the ESG issues identified as important? Which ESG data sources best capture the identified ESG metrics?Analysis: How is the ESG information combined with traditional financial information? How does this influence the investment decision?Stewardship: How is ESG included in post-investment activities such as engagement, voting, and advocacy? How is this monitored and what are the objectives?Reporting: What ESG information is meaningful to report on?
The investment teams then, when implementing the processes on a daily basis, will need to be able to identify, analyse, engage, and report on E, S, and G issues. If the teams do not have the skills required to do so in a consistent way, the firm may consider engaging external support, while building internal capabilities. As such, today’s investment professionals not only need to be highly skilled in financial analysis etc. but also understand global and local sustainability challenges and how these may have an impact on the investment and vice versa. For investment strategies that require more complex ESG skills, such as climate scenario analysis or modelling – it is advisable to hire individuals with these specific skills to support the implementation. Regardless, everyone should be able to articulate ESG processes and its importance to investors, regulators, and wider stakeholders. Not understanding how to effectively incorporate ESG topics within the business activities, firm culture, and investment processes leaves ESG disconnected and isolated, with little chance of any significant tangible impact on the business, or of the business on the world. Accessibility
The third challenge that we commonly see is the issue of ascertaining ESG skills. This comes as no surprise to us, and there is a clear gap that currently exists between the demand and supply of ESG professionals that are already equipped with comprehensive ESG knowledge. Not all firms are likely to have the available resources or a holistic understanding of how ESG relates to their business to justify a new hire to spearhead an entire ESG programme. Instead, it may be more appealing to promote someone internally, who already understands the business well and to task them with developing a firm-wide ESG programme, which depending on the scale and difficulty with implementing it, could lead to additional hires or external ESG support in order to meet these ambitions effectively. As a result, we often see the individuals or small teams responsible for ESG having transitioned from another role in the business, or are balancing it with their existing role and responsibilities. As part of their new mandate, these individuals will reskill themselves through proactively researching and navigating the plethora of ESG information and regulation that is available, which still is quite the “jungle”. Given the vast amount of ESG information available and the speed at which new innovations and thought leadership is being published, those who are self-learning and new to this space may feel overwhelmed, which has been found to be linked to “ESG fatigue”. Therefore, ensuring that these people have easy access to the right tools and resources to stay on top of the latest developments is crucial for successful implementation and dissemination of ESG knowledge to the wider firm. Without access to ESG resources, knowledge and skills, the challenges arising from complexity and applicability are reinforced, ultimately creating a business environment where greenwashing and other misleading sustainability or impact related claims can arise.Solutions
All three challenges outlined above can severely slow-down a firm’s ESG journey and its ability to successfully embed ESG within business activities and overall strategy. To build a strong process for including ESG throughout your firm, you should consider the following: What aspects of ESG are important for us as a firm?Who / which teams should have responsibility for oversight and implementation?Do we have the right skills to successfully build and implement and communicate our ESG strategy?
If you are struggling to answer any of these three questions, then depending on your firm’s resources, size, culture, industry, consider the following actions: Define your fundamental values as a firm and conduct a materiality assessment to help guide the strategy in order to build a holistic understanding of where ESG sits in your firm.Identify key people for driving and overseeing the ESG strategy from within.Conduct tailored ESG training sessions or workshops to different teams so that they are empowered to successfully implement actions on identified priority ESG topics.Conduct generic ESG training for the whole firm, so that everyone is on the same page and the firm avoids unintentional greenwashing.Seek external ESG support in the interim, while you build strong internal ESG capabilities.
One of our core values is empowering market participants to contribute to the ESG evolution in the best way that suits their own corporate culture, investment approach and assets that they trade. We help our clients understand how ESG can add value to their practices, and help build the skills needed to stay on top of the ESG evolution. We have recently built an Online ESG Training Platform to help firms access ESG knowledge and train their teams.
If you have any questions or would like to discuss how you can spark lasting change within your firm, please get in touch at info@northpeakadvisory.com.