State Street Global Advisors (SSGA) has developed a system for scoring companies on their environmental, social and governance (ESG) practices that it believes will help unlock a shift towards sustainable capital markets.
R-Factor, according to the $2.8trn (€2.5trn) asset manager, is “the change needed for ESG to become an integral part of the financial system”.
Rakhi Kumar, head of ESG investments and asset stewardship at SSGA, said the system was the first “that puts companies in the driver’s seat and allows them to take the action needed to enhance their scores”.
“It is built to address the current challenges with ESG data by removing opaqueness around ESG materiality in the scoring process,” she said.
Kumar told IPE that investors had not been giving enough guidance to companies about the information they wanted and that “the whole purpose [of R-Factor] is to bring transparency to the scoring process, especially around the financial materiality of ESG”.
“We had the vision that, as an asset manager, just coming up with products was not enough,” she added. “We actually had to do something to engage, to be transparent with companies – and this was the only way we saw of actually helping create sustainable capital markets.”
The score is integrated into SSGA’s stewardship process, with the manager screening companies for voting and engagement based on their scores. SSGA discloses the score and the basis for it during engagements with companies.
“This gives boards and management teams a roadmap for the specific dimensions that investors are evaluating to assess a company’s sustainability efforts,” SSGA stated. “It also helps companies identify which metrics to disclose and manage to improve future scores, creating a positive feedback loop in the market.”
According to Kumar, the benefit of the scoring system’s transparency was with respect to companies and clients.
“There is a lot of concern that what is going into an ESG product may conflict with returns, but with this we can explain to clients the financial materiality of the factors we’re considering,” she said.
“[Companies] are very grateful for the transparency and feel they can actually understand what we’re doing,” she said. “Many of them are saying ‘this is really good, this we can work with’.”
She added that SSGA made it clear to companies that the requirements were a minimum, and that they could continue to provide other information if they felt this was necessary for other stakeholders.
SSGA worked on the scoring system for about 18 months and went public with it at the end of April.
“People are actually starting to realise this is a game changer,” Kumar said, “particularly if you’re really trying to move the needle in terms of getting more financially material data available in the capital markets, and to make it as accessible as financial data.”
How it works
In building the R-Factor system, SSGA differentiated between environmental and social issues on the one hand, and governance issues on the other.
For the environmental and social side, the asset manager turned to the materiality framework provided by the Sustainability Accounting Standards Board (SASB).
SSGA noted that other reporting frameworks that pre-dated SASB left it up to companies to define what was material by sector, which had led to inconsistencies in company reporting.
Kumar said SSGA wanted to use a commonly accepted transparent framework and not “build a new black box”.
Because companies have “yet to fully align their disclosure practices” with SASB – the framework is voluntary and the standards were only recently codified – SSGA takes raw metrics from three different environmental and social data providers.
“We have to leverage multiple sources of data to improve coverage but also to take out any variations or noise that comes from the low correlation between the different data providers,” said Kumar.
For the governance component of the R-Factor score, SSGA drew from 16 national corporate governance codes, which it said were “transparent and supported by a large number of investors”. For the remaining countries the International Corporate Governance Network code is used.
More concretely, this aspect of the score construction involves SSGA’s stewardship team taking metrics supplied by another data provider, ISS-Governance, and mapping those seen as relevant in a given market to the principles articulated in the corresponding governance code.