Climate portfolio services: RepRisk

Central banks, sovereign wealth funds and other official-sector asset owners increasingly need to receive early warnings about any risk exposures they may have to companies breaching their environmental, social and governance (ESG) standards. To do this, several of the largest asset owners have turned to RepRisk.

The Swiss company has developed a machine learning tool that quickly flags potential ESG risks. It screens information related to around 160,000 private and public companies, processing 500,000 documents daily in 20 languages. This allows RepRisk to detect most irregularities likely to have local or international consequences at an early stage.

Conduct-based analysis

In contrast to many other companies providing ESG screening services to official institutions, RepRisk does not score companies based on a detailed analysis of their policies. Instead, it focuses on actual performance and the real impact of a company’s operations on the environment, labour conditions and social responsibility.

This reporting is aimed at highlighting ‘conduct-based’ exclusions – that would trigger investors divesting from a company’s debt and equity because its corporate actions do not comply with ESG requirements. 

“We are not that interested in policies: we’re interested in what happens on the ground. Many of these companies have great policies, but these are not correctly implemented,” says an official at one of the world’s largest sovereign wealth funds (SWFs), which has worked with RepRisk since 2008. 

“RepRisk covers so many sources that I feel quite confident that if there is a story out there, they have covered it and reported it back to us. Very seldom do we find that there’s been an incident and we were not informed by RepRisk.”

RepRisk’s approach is proving very useful for sovereign asset owners with strict exclusion criteria in their equity and corporate bond portfolios. 

“You just don’t want to rely on an index provider directory, scoring companies ‘above’ or ‘below’ a certain threshold. You really want to know exactly which companies are infringing your rules – and do not want in your portfolio,” says the head of reserves at a top-10 central bank (as measured by foreign exchange assets). 

Very seldom do we find that there’s been an incident and we were not informed by RepRisk

Official at one of the world’s largest sovereign wealth funds

RepRisk not only offers official institutions with detailed information of individual breaches, but also broader regional and sectoral coverage. It covers companies specialised in emerging markets as well as developed economies, both large and small. 

“RepRisk really covers the entire universe of potential and current investments. It’s really quite impressive,” says the reserve manager.

During the past year, RepRisk identified two companies not complying with the environmental criteria set out by a major SWF client. 

One was a problem with a plantation company in Africa, which RepRisk flagged through concerns in non-governmental organisation (NGO) and local media reports. 

“[It was] not something that you would have found reading the papers,” says an official at this SWF. 

The other company was a European gas emitter, which RepRisk identified as part of the fund’s portfolio, and was subsequently excluded.

“Everything we do is about identifying and assessing ESG risks,” says RepRisk chief executive officer Philipp Aeby. “From the beginning, we managed this huge incoming stream of documents, including from traditional media, social media, regulators, think-tanks and non-government organisations.” 

The granularity of RepRisk analysis is crucial to identifying environmental risks because markets have struggled to properly assess them in the past, says Aeby. 

“Generally, markets are efficient when information is distributed by high-level publications, such as The Wall Street Journal. However, they are not that efficient when information is not broadly distributed,” he tells Central Banking.

“In fact, from a regulatory and central bank perspective, markets tend to be inefficient when it comes to ESG. We have seen many scandals that had sudden, big impacts on company valuations. Think, for example, of BP’s Deepwater Horizon accident or Volkswagen’s emissions scandal.”

The human factor

RepRisk supplements its use of artificial intelligence tools with a team of more than 90 analysts that corrects misinterpretations or inaccurate correlations. The accuracy of its programme can range from 82–91% – a high level in artificial intelligence, but still very low when compared with human curation, says Aeby.

For instance, during the Black Lives Matter protests in 2020, an article published by one leading newspaper analysed the role of corporates in racial inequality. The text included negative assessments, but also positive examples for some companies. Because of the negative sentiment the article included, the system associated all companies mentioned with negative ESG factors – something RepRisk analysts had to override and correct.

“When you hand a report to a compliance or risk department, or to a regulator, you have to be sure the screening has not established fake links. That happens very often when you only base your screening on artificial intelligence: that’s why we maintain the human element,” adds Aeby.

Data access

The level of reporting is intense, with daily email alerts highlighting relevant information for client portfolios. And every second month, the company produces an in-depth report, where it lists all the allegations made against companies present in a portfolio.

But probably the most relevant element among RepRisk services is its ESG risk platform. 

“Our flagship solution is a web-based tool. Increasingly, clients want to integrate data directly into their own risk management or compliance systems,” says Aeby. 

“We provide them with a data feed. It allows them to customise the data and find the perspectives more relevant to assess their exposures.”

The reserve manager at the top-10 central bank says the database can analyse specific topics in detail: “If it’s an environmental issue, you can learn more about companies and reports on specific events you are interested in. For instance, on toxic pill management, battery production or biosphere damage.

“It helps to narrow it down to a few companies that are actually manageable. Otherwise, it would be impossible for us. Once we have the number of companies we want, we can start checking allegations, see whether they are true or not.”

The SWF regularly goes back to the reference database to check more articles on a specific plantation or mine, to access more reports on a specific company and check their conduct in other countries. This is the starting point for it to contact primary sources such as an NGO, government agency or the company involved.

“If the original article is not in English, they provide an English summary, which is very convenient for us,” says the member of the SWF. 

“Then they tag that article with a lot of metadata. For instance, which other companies are involved and name of the project, whether it is a new or recurring incident, and what type of ESG issues are involved. This makes it much easier to find what we need to know, when we need to know it.”

The Central Banking Awards were written by Christopher Jeffery, Daniel Hinge, Dan Hardie, Rachael King, Victor Mendez-Barreira, William Towning and Alice Shen