Alt data, Libor and ESG in the time of Covid

The week on Risk.net, September 26–October 2, 2020

7 days 021020
Risk.net montage

Protocol delay casts doubt on Libor death knell timing

Two-month delay to Isda fallback protocol leaves FCA’s planned end-2020 statement in the balance

Fund managers seek to plug holes in ESG data

Social intel proves elusive as virus reawakens sense of corporate virtue

Alt data aims to shake up credit scoring business

Young firms, using machine learning methods to scrape consumer info, are challenging the established agency model


COMMENTARY: Who you are on your worst day

Analysts looking at environmental, social and governance (ESG) issues have a problem this year: unusual levels of niceness.

It’s not the only problem they have. Demand for socially responsible investments has been growing for years, fuelled not only by demands for more ethical finance from retail investors and customers, but also by increasing evidence that a good conscience tends to correlate with a healthy financial performance. But producing a good ESG index is a difficult task; which metrics to include, and how to score them, is very much a matter of personal judgement, and there’s no objective comparison or sense check as there is for forecasts of earnings or credit ratings. Also, the value of different metrics can change depending on the degree of freedom companies have – in the US, environmental regulations are lax and patchy, but they’re tighter in Europe, ironically reducing the value of environmental performance as a predictor of credit quality.

The Covid-19 pandemic, though, has made things even more difficult. To take an extreme example, low carbon emissions are a positive in ESG terms; 2020 has seen the airline sector leap up in ESG rankings because, with fleets grounded due to travel bans, they’re burning far less aviation fuel. It’s safe to assume this won’t be a permanent shift (and it wasn’t a shift the airlines particularly wanted to make). Other companies are improving voluntarily – some are providing assistance to employees in financial difficulties, others are donating services or supplies to help the anti-pandemic effort. Laudable behaviour, and the sort of thing that should mean a higher ESG rating – if there were an established way to incorporate it, which there isn’t, the analysts warn. Finding the data and incorporating it takes time and effort, and by the time it’s done, the situation will have changed again.

But it’s still worth doing. It would be extremely foolish to work on the basis that the pandemic will be over within a few months and the world will return to normal forever. Obviously there are signs of hope in vaccine development, but months if not years of abnormal conditions still lie ahead. And beyond Covid lie the next global disruptions of business, whether emerging diseases, geopolitical flashpoints or natural disasters.

It’s also worth the ESG sector noting that not everyone rises to the challenge of a disaster such as Covid. Many will be drawn into fraud or other financial crimes, reacting either to a perceived weakness of supervision or to genuine financial distress. Many more will take advantage of their subordinates’ fear, uncertainty and isolation to impose worse working conditions or weaker ethical safeguards – in the worst cases, they will break the law to do so, trusting that they will not be found out.

Crises, maybe, are like tequila: they lead you to do things you wouldn’t normally do, but they don’t fundamentally change what sort of person you are. “You are who you are on the worst day of your life,” as the saying goes. If ESG analysts can move fast enough to take advantage of it, the Covid-19 pandemic could be a motherlode of information on the true social consciences of thousands of companies – and an invaluable key to predicting their behaviour in future crises.


STAT OF THE WEEK

Although the number of SARs filed by banks has increased from 839,000 in 2014 to 1.1 million in 2019, according to FinCen data, only a tiny percentage result in criminal prosecution.

 

QUOTE OF THE WEEK

“In a crisis, it’s wartime and you want to solve your own problem as soon as possible. You never know where the market is running. So, if you can price your portfolio reasonably within your default resources, but then wait to analyse a hedge with another CCP, the market could move against you, and you suddenly have one winner and one loser. It’s very difficult” – Marcus Zickwolff, CCP12

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