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Building a new investment paradigm

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    Time was the financial community would have turned a blind eye to sustainability or societal impact when considering where to invest. Now, however, taking into account the environmental, social and governance aspects of investing is becoming inevitable. At BNP Paribas, such ESG considerations feature largely in investment decisions.

    The new awareness emerged some 10 years ago with the creation of the BNP Paribas Asset Management Sustainability Centre, whose maiden mission was to manage what were a limited number of sustainable investments.

    As global consciousness of the need to take better care of our planet grew, BNP Paribas group management took a magnified view of its ESG policy and in 2018 made a landmark commitment: From then on, sustainability would be a strategic consideration —not only within BNP Paribas Asset Management, but for all BNP Paribas businesses.

    For BNP Paribas Asset Management, in a single stroke, the remit of its Sustainability Centre broadened out massively, requiring it to build a global framework that would enable the assessment of the ESG performance of more than 12 000 companies and 200-odd countries.

    ESG scoring equals quantitative research

    “It was a whole new world,” says Thibaut Heurtebize, responsible for ESG research in the Quant Research Group. QRG was quickly called in to help the Sustainability Centre develop an ESG scoring model to rate all companies and countries fairly. The model, which must be neutral as regards a company’s size, location or industrial sector, necessarily depends on large amounts of data. He adds, “That’s where quantitative research comes in.”

    Thibaut Heurtebize explains that the BNP Paribas Asset Management might have opted simply to use the services of one of the many existing independent ESG rating agencies. It decided instead to develop its own assessment models.

    “We want to devise our own models to clearly link our ESG strategy and our investment ratings for each company or country,” he explains. “This way we can explain to clients why we engage with one company differently from another company, and we can explain to each company, or country, how they can improve their score.”

    For example, Thibaut Heurtebize points to ‘board diversity’ as one indicator to assess the quality of a company’s governance. A company receives a score of zero if there are no women on its board of directors and a maximum score of 100 if the board contains more than 30% women in line with BNPP AM’s own diversity best practice.

    An ESG scoring model for a fair and balanced rating

    The QRG team ultimately aims to develop three distinct ESG assessment models for the Sustainability Centre.

    Model 1 – the ESG scoring model. This is now implemented fully in the investment processes. It is designed to determine how a company is doing relative to peers from the point of view of its environmental and social impact as well as from the point of view of its governance. The model assigns each company a score based on its ESG performance.

    This was a challenge, says Thibaut Heurtebize. Unlike a classic credit model, which always uses the same criteria to measure companies’ probability of default, for example, the ESG model needs to link a variety of non-homogeneous ESG practices to a common ESG rating. “This exercise is much more complicated because the measurement criteria differ for each industry and region assessed, but the model must render a fair and balanced rating.”

    A challenge: ESG issues vary from one business to the next

    Whether the model assesses a global French rail transport company, a Japanese company specialising in optics and imaging products or a major US company specialised in computer software and services, it rates different ESG challenges for each of the three different business models since the same challenge cannot be applied to all three companies.

    As for the ‘external stakeholders’ measurement, which falls under the social pillar of the ESG model, each of the three companies would be rated according to its biggest external stakeholder challenge. For the rail transport company, it would be its Quality Management System. For the optics company, the biggest challenge would be supply chain management. Data privacy would be the main challenge for the software and services company.

    Linking climate change events and carbon emissions to business

    Model 2 – the physical risk model. This links environmental risk to a company’s financial performance. That is, the model assesses the correlation between physical risk such as earthquakes, radiation, rainfall, temperature and wind speed, and financial performance. Due to be implemented by the end of 2021, it will be applied primarily to the three business sectors with some of the greatest environmental exposure – utilities, retail and insurance.

    Model 3 – the ‘carbon emissions extrapolation model.’ Due for implementation by the end of this year, the model uses artificial intelligence to help establish a link between business predictors and carbon emissions.

    “Taken together, these three quantitative ESG models constitute a new investment paradigm for BNP Paribas Asset Management,” says Thibaut Heurtebize. “They demonstrate that BNP Paribas is paying close attention to the things that matter most.”

    Also read

    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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