Alpha-Centric ESG Research

Kyle Rudden

<blockquote><p><strong><em>Cybercrime is the greatest threat to every company in the world.</em></strong><br>                                                                    – Ginni Rommety, CEO, IBM</p></blockquote><p><em>Note: There is a pronounced ESG angle to this report but the underlying subject – i.e., cybersecurity as investment risk – is relevant beyond the ESG context. This also applies to future reports in this series.</em></p><div><div>Phishing, data breaches, ransomware, malware, DDoS attacks, and Armageddon-esque scenarios of global cyberwarfare, cascading blackouts, descent into anarchy, and rampant cannibalism.</div></div><div></div><div>But let's be realistic.</div><div></div><div>What matters to investors f<span>alls somewhere between a data breach and doomsday, at some rational intersection of probability and materiality. O</span><span>ne thing is clear though: Cyber-risk is a big deal.</span>
</div><div></div><p>Cybersecurity has emerged as a top ESG concern for institutional investors – and in some cases as <em>the</em> top ESG concern, ranking higher than even the most quintessential of E, S, and G topics.</p><div class="content-remarks"><p>In a recent <a href="https://global.rbcgam.com/sitefiles/live/documents/pdf/rbc-gam-responsible-investing-survey-key-findings-2019.pdf" target="_blank" rel="noopener">survey</a> by RBC Global Asset Management, institutional investors ranked cybersecurity as their number one ESG concern – ahead of ESG mainstays like climate change, diversity and equality, and anti-corruption.</p></div><p>In fact, cybersecurity is rapidly permeating the ESG ecosystem including reporting standards, ESG products (e.g., data, ratings, indexes), and ESG disclosure guidance by stock exchanges.</p><p>There's good reason for all the fuss.</p><p>ESG aside for a moment, cybersecurity is first and foremost a major source of general investing risk since cyber-attacks often result in serious business, financial and capital markets consequences.</p><p><span>We already knew that though.</span></p><p>And cybersecurity has been in the ESG lexicon for a while.</p><p>What's new is a palpable sense of urgency, coupled with a more sophisticated view of cybersecurity and how it fits into the overall ESG context. Salient summary points are as follows:</p><ul>
<li>An evolving cyber-threat landscape is pushing cyber-risk beyond familiar idiosyncratic risks – i.e., beyond the data breach – to include more abstract, complex, and malicious <em>systemic</em> risk.</li>
<li>For investors, greater levels of systemic cyber-risk, which is notoriously difficult to predict and manage, means more overall risk and a shift in its balance from security- to portfolio-level.</li>
<li>Certain kinds of systemic cyber-events, especially those affecting critical infrastructure sectors, can have dire Environmental, Social, and Governance impacts well beyond the affected issuers.</li>
<li>Cybersecurity Governance has been thrust into the ESG spotlight; from an obscure operational extra to a starring-role as a strategic concern demanding executive- and board-level oversight.</li>
<li>Not only is cybersecurity increasingly prominent on ESG agendas, but non-ESG organizations are looking at ESG reporting as an ideal framework for general cybersecurity disclosure.</li>
</ul><p>In short the cybersecurity/ESG story is one of: 1) issuer cyber-Governance, and 2) the societal ESG impacts of systemic cyber-events. It's a story best told through a series of sector-specific Insights.</p><p>My plan is to, periodically, cover systemic cyber-risk associated with critical infrastructure sectors (CIS), each in turn. The most imminent is on Utilities, with a pronounced Asia regional focus.</p><p>This report can stand on its own, but is intended as a contextual foundation for future reports.</p>

Cybercrime is the greatest threat to every company in the world.                                                                     – Ginni Rommety, CEO, IBMNote: There is a pronounced ESG angle to this report but the underlying subject – i.e., cybersecurity as investment risk – is relevant beyond the ESG context. This also applies to future reports in this series.Phishing, data breaches, ransomware, malware, DDoS attacks, and Armageddon-esque scenarios of global cyberwarfare, cascading blackouts, descent into anarchy, and rampant cannibalism.But let's be realistic.What matters to investors falls somewhere between a data breach and doomsday, at some rational intersection of probability and materiality. One thing is clear though: Cyber-risk is a big deal.
Cybersecurity has emerged as a top ESG concern for institutional investors – and in some cases as the top ESG concern, ranking higher than even the most quintessential of E, S, and G topics.In a recent survey by RBC Global Asset Management, institutional investors ranked cybersecurity as their number one ESG concern – ahead of ESG mainstays like climate change, diversity and equality, and anti-corruption.In fact, cybersecurity is rapidly permeating the ESG ecosystem including reporting standards, ESG products (e.g., data, ratings, indexes), and ESG disclosure guidance by stock exchanges.There's good reason for all the fuss.ESG aside for a moment, cybersecurity is first and foremost a major source of general investing risk since cyber-attacks often result in serious business, financial and capital markets consequences.We already knew that though.And cybersecurity has been in the ESG lexicon for a while.What's new is a palpable sense of urgency, coupled with a more sophisticated view of cybersecurity and how it fits into the overall ESG context. Salient summary points are as follows:
An evolving cyber-threat landscape is pushing cyber-risk beyond familiar idiosyncratic risks – i.e., beyond the data breach – to include more abstract, complex, and malicious systemic risk.
For investors, greater levels of systemic cyber-risk, which is notoriously difficult to predict and manage, means more overall risk and a shift in its balance from security- to portfolio-level.
Certain kinds of systemic cyber-events, especially those affecting critical infrastructure sectors, can have dire Environmental, Social, and Governance impacts well beyond the affected issuers.
Cybersecurity Governance has been thrust into the ESG spotlight; from an obscure operational extra to a starring-role as a strategic concern demanding executive- and board-level oversight.
Not only is cybersecurity increasingly prominent on ESG agendas, but non-ESG organizations are looking at ESG reporting as an ideal framework for general cybersecurity disclosure.
In short the cybersecurity/ESG story is one of: 1) issuer cyber-Governance, and 2) the societal ESG impacts of systemic cyber-events. It's a story best told through a series of sector-specific Insights.My plan is to, periodically, cover systemic cyber-risk associated with critical infrastructure sectors (CIS), each in turn. The most imminent is on Utilities, with a pronounced Asia regional focus.This report can stand on its own, but is intended as a contextual foundation for future reports.

Leading Independent Investment Research, Morningstar, Inc.

Morningstar

Leading Independent Investment Research

Morningstar, Inc.

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. We offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors. 

Morningstar provides data on more than 500,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 16 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries, with more than $180 billion in assets under advisement or management as of June 30, 2015. We have operations in 27 countries.

Download the Morningstar Fact Sheet : http://corporate.morningstar.com/US/documents/MarketingFactSheets/AboutMorningstarFactsheet.pdf

Thematic (Sector/Industry)

<p>Blockchain is full of promise. Investment in the space totals billions of dollars. Large corporations, venture capital funds, and initial coin offerings are funding projects. The activity is not completely misguided; blockchains have the potential to disrupt economic activities ranging from simple payments to the structure of a corporation as it currently exists. We see three broad categories of applications for the technology: financial transactions, data management, and marketplace activity. Companies that engage in these functions are seemingly at risk, as blockchain technology can potentially lower transaction costs as well as the costs of recordkeeping. However, we've identified some narrow- and wide-moat companies that will be less vulnerable to the blockchain threat. These companies provide value-added services along with simpler transaction processing and recordkeeping functions. Then, we point out that the early-stage technology still suffers from a handful of technical issues, including problems with scalability, privacy, and leadership.</p><h2>Key Takeaways</h2><ul><li>Ideally, a blockchain is trustworthy, transparent, and decentralized. These features provide most of the technology's appeal, allowing businesses to solve problems related to trust, recordkeeping, and transaction costs.</li><li>Blockchain technology provides a way to decentralize three important economic functions: financial transactions, identity and data management, and marketplaces. Decentralized solutions could disrupt companies that create value by centralizing such activities.</li><li>The financial services sector abounds with companies that serve to centralize financial transaction activity. Blockchain technology removes the need for a trusted third party and lowers transaction costs.</li><li>Centralized control of data and identity management is increasingly creating security and privacy issues. Blockchains allow individuals to maintain control over their own digital identities.</li><li>Marketplaces such as <a href="https://www.smartkarma.com/entities/409" target="_blank" data-smartkarma-citation="entities:409:1">Amazon.com Inc (AMZN US)</a> and <a href="https://www.smartkarma.com/entities/6669" target="_blank" data-smartkarma-citation="entities:6669:1">Expedia Inc (EXPE US)</a>, which serve as intermediaries between buyers and sellers, have arisen in numerous sectors. Marketplace activity can conceivably migrate to a blockchain, removing the need for a corporate intermediary.</li><li>Corporations exist to lower transaction costs and solve problems of trust. Blockchain technology therefore can also enable entirely new forms of economic organization.</li><li>Moats arising from network effects and cost advantages are, on the surface, most vulnerable to a technology that decentralizes activity and reduces transaction costs. Moats arising from switching costs and intangible assets are less vulnerable.</li><li>Blockchain technology removes the need for a trusted third party and potentially lowers transaction costs, but cost advantages are seldom the only variable in play. Many intermediaries provide value-added services in addition to commoditized transaction processing and recordkeeping, and companies often benefit from multiple moat sources. Even in commoditized lines of business, incumbents often benefit from massive economies of scale.</li><li>Blockchain technology is in its infancy, with major technical hurdles to overcome before reaching mainstream viability. Scalability and cost are primary concerns, as are privacy issues, despite the security inherent to encrypted, distributed ledgers. Decentralized control can exacerbate differences, slow progress, and lead to balkanization. Ironically, private and permissioned blockchains might better balance the benefits of decentralized ledgers with those of centralized systems. In this case, the benefits of blockchain technology could accrue to incumbents or their customers.</li><li>Narrow- and wide-moat companies serving as trusted intermediaries in several industries are trading at significant discounts to fair value. <a href="https://www.smartkarma.com/entities/916" target="_blank" data-smartkarma-citation="entities:916:1">American Express Co (AXP US)</a>, <a href="https://www.smartkarma.com/entities/18151" target="_blank" data-smartkarma-citation="entities:18151:1">Mckesson Corp (MCK US)</a>, <a href="https://www.smartkarma.com/entities/4668" target="_blank" data-smartkarma-citation="entities:4668:1">Anixter International Inc (AXE US)</a>, <a href="https://www.smartkarma.com/entities/16449" target="_blank" data-smartkarma-citation="entities:16449:1">Tripadvisor Inc (TRIP US)</a>, and <a href="https://www.smartkarma.com/entities/665" target="_blank" data-smartkarma-citation="entities:665:1">Facebook Inc A (FB US)</a> are some of our top current picks among these companies.</li><li>Utility token demand rests on 1) the ability of an individual token to add value for users, and 2) the lack of viable alternatives to its use. We believe that value creation in the token world will depend not only on networks of users and developers, but also durable competitive advantages over both decentralized and centralized competitors.</li></ul><p><em>Analysts: Jim Sinegal, Joshua Aguilar, Rodney Nelson, Brian Bernard, RJ Hottovy, Matt Young, Michael Wong, Ali Mogharabi and Dan Wasiolek</em></p>

Blockchain is full of promise. Investment in the space totals billions of dollars. Large corporations, venture capital funds, and initial coin offerings are funding projects. The activity is not completely misguided; blockchains have the potential to disrupt economic activities ranging from simple payments to the structure of a corporation as it currently exists. We see three broad categories of applications for the technology: financial transactions, data management, and marketplace activity. Companies that engage in these functions are seemingly at risk, as blockchain technology can potentially lower transaction costs as well as the costs of recordkeeping. However, we've identified some narrow- and wide-moat companies that will be less vulnerable to the blockchain threat. These companies provide value-added services along with simpler transaction processing and recordkeeping functions. Then, we point out that the early-stage technology still suffers from a handful of technical issues, including problems with scalability, privacy, and leadership.Key TakeawaysIdeally, a blockchain is trustworthy, transparent, and decentralized. These features provide most of the technology's appeal, allowing businesses to solve problems related to trust, recordkeeping, and transaction costs.Blockchain technology provides a way to decentralize three important economic functions: financial transactions, identity and data management, and marketplaces. Decentralized solutions could disrupt companies that create value by centralizing such activities.The financial services sector abounds with companies that serve to centralize financial transaction activity. Blockchain technology removes the need for a trusted third party and lowers transaction costs.Centralized control of data and identity management is increasingly creating security and privacy issues. Blockchains allow individuals to maintain control over their own digital identities.Marketplaces such as Amazon.com Inc (AMZN US) and Expedia Inc (EXPE US), which serve as intermediaries between buyers and sellers, have arisen in numerous sectors. Marketplace activity can conceivably migrate to a blockchain, removing the need for a corporate intermediary.Corporations exist to lower transaction costs and solve problems of trust. Blockchain technology therefore can also enable entirely new forms of economic organization.Moats arising from network effects and cost advantages are, on the surface, most vulnerable to a technology that decentralizes activity and reduces transaction costs. Moats arising from switching costs and intangible assets are less vulnerable.Blockchain technology removes the need for a trusted third party and potentially lowers transaction costs, but cost advantages are seldom the only variable in play. Many intermediaries provide value-added services in addition to commoditized transaction processing and recordkeeping, and companies often benefit from multiple moat sources. Even in commoditized lines of business, incumbents often benefit from massive economies of scale.Blockchain technology is in its infancy, with major technical hurdles to overcome before reaching mainstream viability. Scalability and cost are primary concerns, as are privacy issues, despite the security inherent to encrypted, distributed ledgers. Decentralized control can exacerbate differences, slow progress, and lead to balkanization. Ironically, private and permissioned blockchains might better balance the benefits of decentralized ledgers with those of centralized systems. In this case, the benefits of blockchain technology could accrue to incumbents or their customers.Narrow- and wide-moat companies serving as trusted intermediaries in several industries are trading at significant discounts to fair value. American Express Co (AXP US), Mckesson Corp (MCK US), Anixter International Inc (AXE US), Tripadvisor Inc (TRIP US), and Facebook Inc A (FB US) are some of our top current picks among these companies.Utility token demand rests on 1) the ability of an individual token to add value for users, and 2) the lack of viable alternatives to its use. We believe that value creation in the token world will depend not only on networks of users and developers, but also durable competitive advantages over both decentralized and centralized competitors.Analysts: Jim Sinegal, Joshua Aguilar, Rodney Nelson, Brian Bernard, RJ Hottovy, Matt Young, Michael Wong, Ali Mogharabi and Dan Wasiolek

United States

IHS Markit Ltd. is a global diversified provider of critical information, analytics, and solutions. The Company offers next-generation information, analytics and solutions to customers in business, finance and government, improving their operational efficiency and providing deep insights. IHS Markit serves business and government customers worldwide.

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IHS Markit (INFO US)

Cybersecurity and ESG: Beyond the Breach

Cybercrime is the greatest threat to every company in the world. – Ginni...

Kyle Rudden

Disruption by Decentralization?

Blockchain is full of promise. Investment in the space totals billions of dollars. Large corporations, venture capital funds, and initial coin...

Morningstar, Inc.

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