Sustainability Tool Shows No Trade-Off

    This article is a part of NordSIP Insights – Handbook – “Systematically Sustainable”.

    “Powerful, objective, scalable and trustworthy – that’s what INNORBIS stands for,” says Angelica Lips da Cruz, Founder and CEO of INNORBIS at the company’s fourth workshop at the start of November. Joined by Leslie Pendrill, professor of experimental physics at Chalmers University of Technology and William Fisher, research associate at the BEAR Center – INNORBIS’ methodological experts – Lips da Cruz discussed how the company could help answer today’s sustainability problems.

    Angelica Lips da Cruz, Founder, INNORBIS

    INNORBIS, a FinTech company based in Stockholm, has developed a dynamic, forward-looking analytical tool for scaling up the assessment of sustainable development. “Our goal is to collect, process data to paint a comprehensive view of our world without losing any of its complexity. We are not interested in providing a single linear figure or rating that tells us very little about the dangers facing our world,” Lips da Cruz explains.

    The Path to INNORBIS

    According to Lips da Cruz, INNORBIS has been on the back of her mind for the last 20 years. “Back when I worked for Citi Bank in London, I was in charge of creating a new internal Debt Rating Model (DRM) platform for the European Autos and Industrials Citibank Investment Banking portfolio,” she recalls. “We needed to collect and check all the information we had to model the price of syndicated loans, with guarantees among other securities. We needed to identify the complete risk and to understand what kind of collateral we needed to provide this business with funds.”

    “My experience helping ABB deal with their problems with Asbestos years ago set the tone for my understanding of the hurdles facing the financial industry and the world. At the time, we worked together to integrate the hidden risks posed by this harmful material into our pricing models. However, one of the issues we faced was explaining to auditors how this risk mattered. Their focus was on the P&L. We had to engage with them to clarify the relevance of this problem.”

    According to Lips da Cruz, INNORBIS seeks to go beyond the limits of the DRM she helped develop all those years ago, to provide a fuller image of the world and the risks facing our societies.

    The Need for Financial Stability

    “The world runs on trust and trust requires predictability and stability. Where there is no trust business cannot flourish. Financial crises disrupt this trust and directly affect people’s standards of living. Suppliers go without being paid because liquidity disappears from financial markets. However, companies still have bills and salaries to pay. People still have to eat. Stability sets the rules that allow us to do business, so that we can take care of the planet, its people and our collective and inclusive prosperity.”

    Lips da Cruz find the state of the global economy and financial markets ripe for instability. “History tells us that the present state of affairs is no going to last. I find the market capitalisation and the debt structure of the US quite troubling. I can’t say where it is heading, but there is clear financial instability. We know from previous experience that the market will eventually experience corrections,” the Lips da Cruz warns. “One reason it has not crashed already is that central banks are pumping money and pushing interest rates into negative territory.”

    Beyond these concerns, Lips da Cruz also worries that the world is turning a blind eye to the dominant concerns of our day. “According to the World Economic Forum, the issues most concerning the world are migration, state collapse, water and war. Alarmingly, the traditional financial sector is not really considering any of these. Some of these are long/term problems while others are more immediate,” she adds regarding this blind spot.

    Integrating ESG Risks and Rating Problems

    Looking at the world with ESG eyes, INNORBIS’ CEO is alarmed by the situation. “Technology has facilitated an enormous increase in productivity. My smartphone has made me much more efficient than I was 20 years ago. But what about income distribution to workers and income inequality,” Lips da Cruz says reminding her audience of the social factor of ESG and the tenth UN Sustainable Development Goal (SDG).

    “Since the financial crisis of 2007-09, the S&P500 has increased by 300%. However, these returns have not been fairly distributed between shareholders, managers and workers. Consider Amazon, an enormously successful company that has outperformed the S&P by orders of magnitude. It is famous for the poor working conditions it offers its employees,” she says. “How can we hold a company like that accountable and responsible for the way it treats its workforce?”

    “There’s a fine line between doing harm and having the right sort of business,” Lips da Cruz warns before discussing the issues of corruption and governance, the other ESG factor. She illustrated the difficulty that companies often face between maintaining integrity and overcoming hurdles to breaking into new markets both in developed as well as in emerging markets. The workshop participants also discussed concrete examples of corrupt customs officers in Brazil, corrupt local officials in China, and the importance of strong governance structures to mitigate these and other risks to companies.

    However, governance problems can be subtler. “INNORBIS was able to see the drop in Facebook’s capitalisation because it was clear they were not prepared for GDPR, and they had grown faster than they had matured.  We could see they did not understand the importance of regulation. Even Elon Musk breached the agreement with SEC as CEO after the SEC found his behaviour was not aligned with what the CEO of a listed company ought to do. That is the cost of bad governance and the consumer protection for fair trade.”

    Given the importance of ESG, the next problem Lips da Cruz flags is the inconsistency of ESG ratings. “Two years ago, the Japanese pension fund highlighted that the ESG ratings across providers are not consistent or correlated. There’s a reason for that. Rankings are not useful to state how much more or less sustainable the transformation and transition processes and policies that companies are undergoing. It’s a myth that ordinal scores can tell us anything on whether things are progressing or improving and reaching goals.”

    INNORBIS seeks to solve this problem. “Our methodology is grounded in the scientific approach. It is not about whether I believe or you believe. We are trying to overcome the subjectivity introduced by some of the rating agencies, which causes so much of the disparity in assessments.”

    INNORBIS’s Solution

    Ultimately, Lips da Cruz acknowledges that policy decisions moved her to action. “The creation of INNORBIS was triggered in 2016, following the European Commission’s 2015 decision that large corporations should report their CSR. That policy decision led me to believe that massive amounts of data would become available.”

    Time proved her right. According to Lips da Cruz, she had to reach out to data specialists in the industry to find ways to handle the vast quantities of data and information now available. “We then started to gather, string together and clean the data. It required us to develop reference tables that combine CSR data with traditional financial data because the ESG data is spread out and in different languages.”

    Returning to her seminal experience at Citi 20 years ago, Lips da Cruz explains the value-added her company seeks to provide today. “Innorbis is a much more complex tool to analyse risk and opportunities, and investments. After we clean the raw data, such as CO2 emissions, we take that data point, and we transform it to determine how difficult it is to shift a fossil fuel infrastructure, or a product, towards renewable energy. We are then able to compare with high reliability among the companies as well as with macroeconomic indicators across countries’ sustainable transformation. That’s what we measure at INNORBIS.”

    “Our method allows us to identify which companies are further along in this transformation. We can see patterns, which we believe is better than focusing just on benchmarks. Even with minimal information, our tools allow us to see whether the evolution of a company fits the pattern of transformation, whether they are stagnant or going forward. There is also no distortion comparing between a small company and a large company, which is important because large companies have more resources and report more information. So we have a strong reliability factor.”

    “The financial sector is operating in the dark. To my surprise, the reliability of existing ESG rating systems was 0.1. In comparison, INNORBIS’ Industry scenario has a reliability of 0.94, and a standard deviation of 144 and we work with uncertainty. The Sharpe ratio of our index is 1.84, which is rather good. The comparable ratio for the STOXX600 is much worse.”

    “As the Sharpe ratio suggests, sustainability is not a trade-off,” Lips da Cruz concludes.

    Image © NordSIP

    Filipe Albuquerque
    Filipe Albuquerque
    Filipe is an economist with 8 years of experience in macroeconomic and financial analysis for the Economist Intelligence Unit, the UN World Institute for Development Economic Research, the Stockholm School of Economics and the School of Oriental and African Studies. Filipe holds a MSc in European Political Economy from the LSE and a MSc in Economics from the University of London, where he currently is a PhD candidate.

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