How to Understand ESG and Your Compliance Practice
by Kristina Drye, on May 12, 2021 10:10:01 AM
Move over, KYC, AML, ETFs... a new acronym has entered the compliance space. ESG, or Environmental, Social, and Governance Criteria, has emerged at the forefront of the compliance industry as the standard to watch for any reputable organization. But you may be wondering: what is ESG, how is it related to compliance, what does it mean for you, and how can you manage risk to comply? This article is here to help answer those questions.
What is ESG?
According to Investopedia, ESG, or environmental, social, and governance criteria, are a “set of standards for a company’s operations that socially conscious investors use to screen potential ventures.” The term is also known as “socially responsible investing” or “sustainable investing.” As the name suggests, there are three primary components.
- Environmental - indicates the level to which a company operates with responsibility to protecting the environment.
- Social - indicates the level to which a company manages relationships with those it deals with - employees, suppliers, customers, and communities.
- Governance - indicates the level to which the company responsibly manages its assets, leadership, executive pay, audits, and shareholder rights.
ESG has come to the fore in two primary ways. First, companies are being required to adapt to meet the consumer demand for a responsible and socially conscious marketplace. Second, ESG criteria help investors and the marketplace avoid working with companies that pose a larger risk due to shady, or irresponsible, practices in any one of the three areas above- or a combination of them. Consider the BP Oil Spill of 2010 and the emissions scandal of the Volkswagen brand. Both of these operations, which might have been caught in an appropriate ESG review of the respective company’s practices, resulted in a loss of billions of dollars respectively.
Though it is relatively new, ESG is no small matter. The US SIF Foundation indicated that at the beginning of 2018, investors held $11.6 trillion in assets chosen according to ESG criteria. This was a nearly 70% increase from the same period two years prior. As of 2020, three of the largest financial institutions - JP Morgan Chase, Wells Fargo, and Goldman Sachs- publicly published ESG reviews. Western Union has done so since 2019.
What does it have to do with compliance?
Because ESG requirements are used by investors to assess companies, companies are relying on Chief Compliance Officers to uphold social responsibility by ensuring ethical practices, thereby attracting investors. In addition, the roles and responsibilities of compliance professionals are expanding beyond the traditional remit of the job.
One role of compliance is vetting third parties for risk. This risk can include illicit activities like corruption, shady money practices including money laundering, or connections to criminal organizations and rings. Compliance officers also play a role in monitoring supply chains to screen for negative conduct of any sort, ranging from human rights violations to bribery. As DEI initiatives and workplace security come to the forefront of social responsibility, some organizations are adding to ESG scores by screening their own employees for behavior. And it isn’t limited to just the employees of the company - it extends to suppliers, distributors, and franchises as well.
As you might expect, many companies are turning to advanced technology like AI to manage their ESG requirements for compliance. Large companies like IBM and WalMart are testing advanced technology to enhance the transparency of their supply chains through blockchain. Apps like Acorns allow low-fee, high-transparency investment. Other technologies like GOST (Giant Oak Search Technology) can help with tasks like screening and vetting for illicit activity and negative associations along the supply chain or providers and consumers.
How GOST Can Help
A tool like GOST allows for fast screening and vetting at scale and can be used by any institution to achieve ESG goals at multiple levels. Because the technology is trained on algorithms specific to human behavior, a company could screen its employees or its providers for associations with corruption, money laundering, human trafficking, or any other specific activity the company is looking for. The Risk and Reliability scores given to a screened population allow human analysts to conduct further investigation only on the highest risk cases while leaving the rote work to a computer. Because algorithms can be trained for any behavior and search the open and deep web in any language, the only limit to searching for risk affecting an ESG score is the variety of risk targeted. With a proven track record by government and financial institutions in identifying bad actors and risky activity, it’s a trusted way to eliminate the “bad guy” from your supply chain.
The Two Investment Megatrends of the decade: ESG and Tech
The CEO of deVere has cited that following COVID-19, the two investment megatrends of the decade will be the rise of ESG compliance and the rise of advanced technology. To be on the forefront of both means that you will need to use advanced technology to screen and identify risk in a way that optimizes your company’s ESG score for prime investment.
It is often said that “the only thing more costly than compliance is non-compliance,” and in the age of ESGs, that rings truer than ever.