If you only rely on company performance data, you're probably missing a trick

ESG and climate risk exposure

ESG and climate risk integration has long been about what companies do and how sustainably they do it, not where they operate.

Now, the mapping of companies' geographical exposure to ESG and climate risk factors is quickly becoming a key part of the ESG and impact investment toolbox.

In part, that’s because institutional investors' growing alignment with the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) means that quantifying firms’ exposure to physical and transition climate risks is now becoming a top priority.

And when it comes to ESG, the burden of expectation weighing on asset owners and managers continues to intensify. It’s no longer enough to walk-the-walk on the UN Principles for Responsible Investment (PRI), or to quantify Sustainable Development Goal (SDG) impacts. Clients and stakeholders expect and demand that ESG data is also used to manage downside risks and even to capture alpha more effectively.

Where to begin? Include risk exposure in your ESG integration

Achieving and reconciling these three objectives is always difficult, but even harder if you don’t factor in geographical exposure. That means using data not on how companies manage risk, but on the risks they are exposed to in the first place. Why? It might not matter for global atmospheric CO2 concentration where in the world a company emits carbon. But almost all the other positive or negative corporate ESG impacts affecting companies vary according to the characteristics of their local operating environment, meaning any material effects on their balance sheets are shaped in some way by geography.

So far, the few players that have sought to integrate risk exposure have mostly had to rely on crude matching of headquarter locations. That may work for some governance issues, and across other factors in small-caps and some pockets of emerging market (EM) investing. But elsewhere, it falls prey to the garbage-in garbage-out rule: invest in a company and you take on exposure across all the geographies it operates or manufactures in, sources from, or sells into – not just the place the CEO can see out of their office window.

Making a start: the physical ESG footprint of the upstream oil and gas industry

To begin filling the data gap we’ve developed the Corporate Exposure Tool (CET); the first dataset to capture ESG, climate and political risk exposure from asset to industry level in upstream oil and gas (O&G).

Covering over 3,000 private and public companies and almost 11,000 assets, the CET precisely quantifies and benchmarks the direct operational exposure of the entire investable universe of upstream oil and gas assets to more than 150 social, environmental, governance and political risks. The tool does this through the lens of four key commercial metrics – production, capex, NPV at a 10% discount rate, and reserves – at spatial risk resolutions that vary from below 1km2 to national level.

Why did we begin with upstream O&G?

We know the CET is a good fit for the next chapter of investment in the industry, especially with it already on the back foot as climate concerns crystallise into a range of near-term business risks. True, some institutions are choosing to divest entirely. But survey evidence and investment practice so far suggest that for every institution that decides to divest, several more will stay invested over the medium to long term.

Investors in it for the long haul want to minimise their benchmark divergence and ratio of risk to return; reap the benefits of what remain attractive dividend and capital growth prospects; and, above all, vigorously engage management teams on their climate goals, particularly the transition to cleaner or renewable energy. All of this enhances the need for transparent and robust data that can allow for risk-adjusted benchmarking and provide a common and objective basis for discussion between corporates and investors.

Data is just the first step

Our relationship with our sister company, Wood Mackenzie, helped us to integrate commercial data assets with our risk data to provide a world-leading database. But this is just step one.

In the words of the late statistician Hans Rosling, “the idea is to go from numbers to information to understanding”. Understanding the negative and positive impacts that companies may have in the world, and what these impacts may ultimately cost them and us, should be an imperative for investors looking to stay ahead of the curve.

Whether you want to know what questions to ask on ESG or climate change, how to align with TCFD, or how to factor in ESG management or impacts into your broader portfolio construction process, CET allows you to measure and benchmark risk precisely and reliably.