Investment
Three lessons when assessing ESG risks
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Wirecard, the German payments company, filed for insolvency on 25 June 2020 after the group revealed over-indebtedness and reported incidences of fraud.

Having issued an investment grade bond in September 2019 at a yield of around 0.5%, in less than 12 months holders of this
bond had lost c.80% of their investment value.

It is another in a long line of examples of how environmental, social and governance (ESG) risks can have a material impact on the creditworthiness of a company.

No risk assessment can be 100% certain and fraud is notoriously difficult to identify. We believe there are three lessons that we can
take away from this event when assessing ESG risks:

1. Do not rely on a single data provider.
2. There's more value in analysing the underlying inputs than the
headline scores.
3. Apply qualitative judgment to overweight the bigger risks.

Do not rely on a single data provider.

There is no single perfect ESG data provider. Each provides useful information, but there will be gaps. We believe investors need a systematic way of digesting the information from many sources to help make an informed view.
At a headline score level, outputs from data providers are often contradictory, sometimes wrong. For example, for Wirecard, three of
the most prominent data providers offered very different assessments (lower percentile suggests higher risk; ESG rating 1 is the highest rating and 5 the lowest on our scale):

- Provider 1: Wirecard was 54th percentile in its coverage universe
(ESG rating 3).
- Provider 2: Wirecard was 82nd percentile (ESG rating 2).
- Provider 3: Wirecard was 12th percentile (ESG rating 4).
This variance in ESG assessments by different providers led us to introduce our proprietary scoring system, which combines ESG data from multiple providers to provide an additional data feed into our credit research hub.

There's more value in analysing the underlying inputs than the headline scores

 In our analysis, Wirecard received the lowest possible ESG rating versus its entire peer group. The firm scored negatively on the 'key issue' index for governance risk factors such as financial system stability, accounting and financial transparency.

The combination of strongly negative accounting/controversy flags from one data provider (which is unusual for the software and
services industry group), uniformly negative data from another provider, and our judgment of the relative data quality led to a governance rating in the second percentile.

In our view, the risk assessments concerning accounting practices provide an important insight. We believe past exposure to serious governance controversies is a fair indicator of elevated credit risk.

Considering the underlying inputs raised some interesting insights:
Provider 1: Wirecard scored materially worse than its peers for accounting practices, though other governance metrics considered material by Provider 1 were within one standard deviation of the industry group mean.
Provider 2: Scored Wirecard as 'average' for business ethics and corporate governance.
Provider 3: The picture was uniformly negative. This included concerns about audits, internal controls, corruption, anti-competitive behaviours.
The data was markedly more extensive and detailed than that provided by the other data providers, which had the effect of inflating the effective weighting of the provider's dataset in Insight's governance rating calculation.

 

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