The tech industry’s reliance on offshore software developers – some of them working in “dimly-lit third world offices” – could become an ESG issue for fund managers who buy their services, says Abbey Shasore, chief executive of Factbook.

A dam bursting in South America, killing hundreds and flattening communities, will trigger a wave of ESG protest at funds investing in the dam’s owners. ESG is a cultural phenomenon creating derision for asset managers investing in firms with poor ESG ratings.

I argue that asset managers may need to anticipate growing criticism regarding their use of third-party providers, too. Significantly, this includes software vendors on whom the buy-side is so heavily reliant.

The software industry employs teams of offshore developers, some of them beavering away in crowded, dimly-lit third world offices. This may come under increasing scrutiny as the ripple effect of the ESG phenomenon extends from the initial impact zone.

We have witnessed a comparable pattern emerging in asset management supply chains before. In 2013 the Financial Conduct Authority in the UK became very interested in the systemic risk and interdependencies between custodians, third-party administrators and other outsourcing firms that asset managers use. An ensuing Thematic Review on resilience and oversight risk eventually led to more detailed scrutiny of the vendor market and the publication of “guidance for firms outsourcing to the ‘cloud’ and other third-party IT services”.

The flow of inquiry in any supply chain is most often downhill. Anything that comes to the front and centre of the investment management world will eventually require ‘look-through’. For example, the regulators never say: ‘Are your data protection procedures sound?’; they always say, ‘Are yours and those of your dependent suppliers sound?’ There is always another level of look-through.

Many vendors or managed-service providers have long-established development and/or operational teams in eastern Europe and the Indian subcontinent. It’s a labour-cost arbitrage.

So, it is not unrealistic to suppose that investors will eventually require their asset managers to ‘look through’ to their suppliers’ social impact arising from the possibility of questionable practices.

There is, of course, also the environmental perspective. If software firms are taking a closer look at where their servers are and how their servers are power-managed, then firms may need to start encouraging data-centres they use to be more environmentally-friendly.

And governance questions could also be levelled at vendors – questions about money laundering, data protection, conflicts of interest, HR compliance, mitigating key-person risk or even awareness among staff of internal IT policies. These are all in scope should the practice of offshoring come into question from a particularly ESG-led perspective.

But if a sort of ‘ESG index for software vendors’ were to emerge (whereby vendors are benchmarked on their ESG proficiency and given a rating), who would establish it?

If it was the vendor community itself, the obvious conflict of interest might be seen as discrediting. On the other hand, self-governance – usually the best form of regulation within asset management – avoids the imposition of rules that none of the market participants can sustain.

The perennial story with journalism and privacy laws has always walked that tightrope between what we know we can abide by versus the public that might expect a tougher set of standards. If the software community itself does not grasp this particular ESG nettle, there is the likelihood that regulation will be imposed from the outside – regulation that could be far more detrimental to those vendors.

The focus on supply chains has pervaded so much of our society already. Fast-food chains are no longer just telling us how tasty their burgers are; they now tell us burgers use ethically-sourced beef and sustainable ingredients.

Asset managers today may perceive that their vendors are sometimes ‘creative’ in their answers to ESG-related examination, but that is not the point. The point is, have you thought about it and do you have it written down somewhere? If it isn’t, it might soon need to be.

By Abbey Shasore, CEO of Factbook

@FactbookCompany

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Original article appears in funds europe here