Accelerating sustainability: modefinance's ESG Automated Score

Over a year has passed since the approval of the document “Aspettative di vigilanza sui rischi climatici e ambientali” (lett. “Supervisory Expectations on Climate and Environmental Risks”) by the Bank of Italy, regarding the need to integrate climate and environmental risk factors into corporate culture, strategy, risk management, and disclosure to banks and financial institutions. Not to mention the EU Taxonomy, considered the reference system for identifying economic activities that make a "substantial contribution" to at least one of the six environmental objectives.

The latest news, dated June 9th, comes from the European Commission, which has released for consultation the draft of a preliminary delegated act for the official adoption of the European sustainability reporting standards (ESRS). It is expected that the final text of the ESRS could be applied as early as January 1st, 2024, which marks the beginning of the first reporting period stipulated by the Corporate Sustainability Reporting Directive for listed companies and other public interest entities. Today, these and numerous other existing regulations place particular emphasis on the operations of eco-friendly companies. As a result, the growing awareness of the impact of business activities on the environment, society, and administrative choices has prompted companies to consider adopting increasingly sustainable practices.

One of modefinance's main goals is to align with European and international institutional directives in order to support companies in adopting a responsible and conscious approach to the impacts their actions can have on the planet and society, as well as the numerous opportunities that will make them more competitive on the market.

In response to the proliferation of increasingly regulated global norms and the growing demand for fast and reliable solutions for sustainability assessments by companies and banks, modefinance has developed the proprietary model of "ESG Automated Score".

The ESG Automated Score is a quantitative and automated model that quickly and automatically provides a sustainability score, taking into account a company's activity from an environmental, social, and governance factors point of view.

In this context, one of the main challenges in ESG evaluations is the collection of necessary data for an accurate analysis. Therefore, modefinance has addressed this issue by developing a system that automates both data collection and the final evaluation. This approach allows for faster and more efficient results, eliminating the reliance on questionnaires and interactions with companies.

In fact, the ESG Automated Score model is not based on surveys or any form of interaction with the analyzed subjects, but rather utilizes information automatically retrieved from internal and/or third-party databases, primarily linked to the company's VAT number – which includes all statistical information about the business (sector, geographic location, etc.) – along with statistical benchmarks.

The ESG Automated Score is integrated within modefinance's patented Tigran platform but can also be made available to users through API, ensuring greater flexibility and adaptability to individual preferences. Within the platform, the final evaluation is divided into three steps corresponding to the three pillars of sustainability: E (Environment), S (Social), and G (Governance). Each pillar is assessed on a scale ranging from S1 to S7. This synthetic approach provides a comprehensive and detailed analysis of corporate sustainability.

The environmental pillar is analyzed starting from the company's VAT number through a process divided into three steps:

1. The physical risk model begins with the identification of all strategic assets of the company (storage and production sites), assigning 13 possible extreme risk events (e.g., storms, volcanoes, fires, landslides, etc.) to each asset;

2. In the second step, based on the company's coordinates, these risk events are aggregated using an appropriate weighting function to avoid unreliable results. The analysis goes beyond a simple average and applies a weighted average. For example, if at least one event exceeds a certain risk level and falls within the red zone, the high-risk zone, the average of the results is calculated only for the events that exceed that threshold. On the other hand, if all events are green except one that is red, a regular average would give equal weight to all events, leading to unreliable results. Furthermore, it is also possible to exclude an extreme physical event if it is considered irrelevant to the company's activities

3. The third step involves a materiality analysis, which identifies the ESG factors that are most relevant for capturing risks/opportunities arising from the company's specificities (e.g., industry sector) and the operating context. Materiality analysis operates on a scale of 4 classes: negligible, low, medium, high. Consequently, the output of the analysis is a materiality factor.

The final result of the analysis of Pillar E is the physical risk index, representing the overall physical risk mediated across all events and assets on a scale ranging from S1 to S7. Additionally, within Tigran, it is possible to visualize the geographic location of the analyzed asset. Below is an example of how the physical risk model is displayed within Tigran.

The social pillar within the ESG Automated Score is based on big data analysis, which includes all publicly available data from Italian companies over the past 10 years. It considers the investment that a company makes for each employee, not only in terms of salary but also in training expenses and other benefits. Consequently, the model aims to determine whether the analyzed company adopts better or worse wage policies compared to its benchmark. The variable compared with a reference group is obtained from the ratio between employee expenses and total company expenses. Within the analysis, companies are segmented based on various criteria such as industry sector, size, and geographical location.

Regarding the governance pillar, the model evaluates various aspects of corporate governance by considering data available in the business register. The Governance score takes into account two main aspects:

• Administrative structure, which includes:

1. Number of administrators
2. Percentage of administrators who own shares or stocks in the company. This aspect is important to assess the separation between management and control within the company. For example, if a shareholder, as an individual, is also an administrator, they have the power to manage the company, which could compromise good corporate governance. Therefore, data on the percentage of administrators with share ownership helps to understand whether or not there is a separation of these roles. However, it cannot be generalized that the lack of separation is a negative aspect as it depends on numerous factors, including the company's size. Therefore, for appropriate weighting, the evaluation is based on statistical grounds, considering the legal form of the analyzed company (LLC or joint-stock company) and its size in terms of turnover
3. Presence of technical figures, external to the governing body, providing support to the administrative body, such as attorneys.

• Control body structure: the presence and type of control body, as well as the potential assignment of the statutory audit function to an external entity:

1. Sole auditor
2. Audit firm.

The regulatory landscape focused on sustainability and the growing awareness of companies regarding the impact of their activities on the environment and society demand reliable and fast sustainability assessments. modefinance's ESG Automated Score model offers an automated and quantitative evaluation of corporate sustainability, easily accessible for banks, financial institutions, and investment funds to swiftly and comprehensively assess their portfolios. As the model does not rely on the completion of a qualitative questionnaire, this evaluation occurs automatically, providing a rapid and comprehensive ESG score. The model is available within modefinance's proprietary credit risk management platform, Tigran, or through API, ensuring flexibility and adaptability to user preferences. This tool enables businesses to adopt a responsible approach to sustainability, enhancing their market competitiveness, and aligning with increasingly regulated global standards.