Building a green credit score, with Daniel Mclean
As an industry, we've been using scorecards as objective and comparable measures of credit risk for generations. We've used this experience to get more and more accurate in those models, but there are other uses, too, like maybe an objective and comparable measure of environmental risk...
I'm sitting down with Daniel Mclean, Client Partner at 4most, a specialist credit analytics firm that became a specialist analytics firm and went on to win awards for its new "green" credit score - an ESG score that can be adapted and utilised across all regions and tailored to a lender's available data, individual portfolios and unique sustainability goals.
You can find Daniel on LinkedIn https://www.linkedin.com/in/daniel-mclean-351278169/ where you can also follow the 4most page https://www.linkedin.com/company/4most/
But for that, you might want to jump straight to their homepage: https://4-most.co.uk/
There's a page dedicated to all their wonderful insights - https://4-most.co.uk/insights/ - but go even if you're just interested int he rebrand!
Please seek me out on LinkedIn, I'm open to all genuine new connections - https://www.linkedin.com/in/brendanlegrange - please also follow the show's page while you're there.
Meanwhile, my action-adventure novels are on Amazon, some versions even for free, and my work with ConfirmU and our gamified psychometric scores is discussed at https://confirmu.com/ and on episode 24 of this show https://www.howtolendmoneytostrangers.show/episodes/episode-24
And finally, I'm also co-creating a new podcast called hAIghtened senses which will look at the intersection between human senses and technology, especially AI-powered technology. You can already start to follow it wherever you're listening to this one - there's only a trailer there at the moment, but we've recorded some of the early episodes and it's going to be a fun ride!
Keep well, Brendan
The full written transcript, with timestamps, is below:
Daniel Mclean 0:00
Which company or which customer is on a more sustainable path? What's the emissions versus profit versus number of employees etc. Instead of credit risk aspects, it's those sustainability variables that we're bringing into the score.
Brendan Le Grange 0:16
As an industry, we've been building objective data driven scorecards, for what, 40 years now, maybe 60, I should actually know because the very first episode of this podcast is a history of credit lesson with Raymond Anderson.
But let's just say a long time now, and we've built up a number of valuable skills and learnings along the way. And now that everything is data, we can apply those skills to answer different questions. And one of the questions that keeps coming up is how do we measure green credentials?
Or if you're like, how can we build a green credit score? Welcome to How to Lend Money to Strangers with Brendan le Grange.
Daniel McLean, Client, Partner at 4most, welcome to the show.
Daniel Mclean 1:17
Thank you, Brendan.
Brendan Le Grange 1:18
Daniel 4most offers specialist credit risk, market risk data and actuarial solutions, all bespoke and all developed by world class experts. It's the sort of company that I think is very well known in certain sectors, but outside of those maybe not as well known. So before we get into the meat of the discussion, would you mind filling us in on who 4most is and what sort of work you're doing?
Daniel Mclean 1:46
We're an analytics consultancy bond from from credit risk, but we've expanded into other areas, generally focused on banking and finance lending. So the development of models in IRB IFRS9, but also our strategies for application portfolio management for banks and financial lenders. We also work on the validation of those models, and then model risk management. So that's kind of been our core area of focus. That's what we're originally known for, and probably still best known for. But yeah, we are expanding out.
So a few years ago, we launched our insurance practice and recently expanded out into a debt practice which is going really well supporting clients with data governance BCBS 239.
Today, we've worked with over 80 different clients and touching all points of the globe. The team itself is 300 specialist consultants. And they've come from working from tier one lenders regional building society, monoline credit providers, and a range of expertise. So ex-risk directors, decision science leads, to recent graduates.
We originally had an office in London, we expanded that into a satellite office in Leeds, recently opened an office in Dublin. At the end of last year, we opened one in Dubai and a couple of years behind that we opened our office in Bangalore as well. So from when we were founded in 2011, we've really been on kind of an exponential growth to where we are today.
Brendan Le Grange 3:12
Yeah, that really is impressive growth. And you've obviously been there for quite a big part of that. You've been at for most for about eight years now, after a similar time in industry. So do you want to talk a little bit about the work you're doing for 4most, and maybe the career path that brought you to there in the first place?
Speaker 1 3:31
Yeah, certainly. So as you mentioned, I joined 4most about eight years ago, I first started having conversations with farmers a couple of years before that Rob McDowell, who is actually our current CEO of the company, I previously worked with him in credit risk. So I had the relationship a year down the line, I got another call from him just to see if I'd be up for going up going through a meal, and just another catch up.
Speaker 1 3:53
And then he kind of told me that the plans for 4most, the ideas and kind of the work are coming in. And it was really interesting, since joining farmers to work on lots of different projects, so working on regulatory non regulatory modelling for secured portfolios, retail portfolios, corporate and commercial. So it was really, when I sat down having that dinner was kind of the breadth of work that it was telling that I'd be able to do. And that's really what swung it for me. And I think that's the opportunity to keep developing and keep learning and cool and interesting work.
Brendan Le Grange 4:22
Yeah, and speaking of sort of current and interesting work, you were recently recognised in the UAE is green initiatives for a green credit score. You hear a lot of people talking about it. You hear a lot of people asking questions about it. But you don't often hear people answering those questions and really putting out a product that fits in that ESG space. So set the scene first for us this green credit score, what does it look like? What's it doing? And how did it end up being so well received in the UAE?
Daniel Mclean 4:57
The project itself kicked off a few years ago in the UK, so We're supported by the innovative UK Small Business Research Initiative. And we're effectively looking to bring something to market. That helps categorise kind of sustainability via ESG for lenders, that the market itself is new. So the supervisory statement, SS 319, was released back in 2009, which kind of give the the overview of how lenders just start to think about climate risk in terms of the strategy, the governance, the disclosures, etc.
And what we effectively were looking to do is how can we bring something to market using the skills that we have the knowledge that we have to be able to support lenders being able to implement this and manage their portfolios, the scorecard itself, it looks and feels like a traditional scorecard that people will be used to seeing. So you'll have a number of variables, they will have points associated, they will aggregate up and then you will get a score. It's a structured process to try and enable SME experts within an institution.
So you will say that there's lots of ESG scores out there that can be a blackbox, the company will be given a score, but you don't necessarily know that the Inklings behind it.
What we're bringing with our green score is effectively that transparency, bringing in SME climate experts for a single institution and try to build that score around what their views are and how they view it and align it to their pathway to net zero or ESG, or climate risk within within their institution.
Brendan Le Grange 6:24
Yeah, because I think that's what's been missing. And as I said, I'm no expert. I'm sure there are other models out in the market, they do take that sort of very structured and transparent approach. But from the outside, it feels like that's been missing that credit scoring expertise, that mindset, I think, is that step in bringing it to a place we can measure and manage much better going forward. I see in building it, you've also created an approach you call the knowledge elicitation process. What what does that mean?
Daniel Mclean 6:55
One of the beauties of working for 4most is that lots of investment that goes into internal development and research on the knowledge elicitation process was effectively a process that was built for low default portfolios. So obviously, the key for modelling is to be able to model against something, which typically in the credit industry is an account going into default. Yeah, what the knowledge elicitation process does, when you don't have that information effectively allows to bring the characteristics that a customer may have. And that allows the experts within this institution to be able to look at a comparison between those two.
And effectively what the probability of one account going by this versus the other, you do kind of a paired view of over a number of maybe 150 different customers profiles, and effectively that brings you almost a synthetic data set, which you could then use the to more of your traditional modelling rather than people kind of thinking this one's better than that one construction into a loved one. And you're able to implement that quite easily into a into a beer your day to day process.
Brendan Le Grange 7:53
Yeah, we've spoke about the input or the build process being inspired or built upon your knowledge from credit scoring, in terms of the output. What sort of score is this? Is this a measurement score that tells us how well we doing? Or is there an element of predicting in there
Daniel Mclean 8:10
It's that prediction element, similar to look for getting that expert judgement, see what the probability of that account going into default versus another one, going back versus another one, the idea is to look at him information and say, which company or which customer is on a more sustainable path.
So what we'll try to do is bring that information through. So it might be scar permissions that we've been able to calculate the annual disclosures, or it might be something by with pi to be able to bring in that information, we can then obviously, then calculate some intensity metrics over the back of it. So what's the emissions versus profit versus number of employees etc? We can ask questionnaires to customers on kind of an annual review to try and understand what's their plans on being a more sustainable business going forward? Do they have any, instead of credit risk aspects, it's that sustainability variables that we're bringing to.
And then again, it's using those expert judgments to view what do we think is a more sustainable company, which one do we think is law on that path going forward, and that allows you to then obviously, rank that information and then you can then use that on a going forward basis to understand it. The advantage of those Scott is obviously you can run this, of course, your full portfolio and you can start to try and tailor it to what your puppy is, what your goals are, what your risk appetite is in that area to understand the business profile and how that's going to merge and potentially where, and it concentration risks are in the portfolios away maybe need to speak to some of the lenders to understand maybe they need to review their plans for you to continue effective lending report. The idea is that it tackles a number of different areas that are aligned to sensibility.
So we spoke about emissions and emissions intensities, but also what our company's plans to be able to manage a transition to net zero be more sustainable. So typical questions that you might look to us the company times with the management attitudes towards adapting business model for a transition to a low carbon economy. And do you think those are achievable as well? Is there a plan in place to help
But they can manage that whether the business is already implementing green activities and taking into consideration climate risks. So if you've got an automotive kind of company or they're looking to invest in EVs, are they still working on carbon combustion engines? Those questions can be different across different sectors, one for those potentially more vulnerable to climate change, which is agriculture construction
Brendan Le Grange 10:23
And who's answering those questions. So if I'm the lender, and I've got a portfolio of 1000, SMEs, am I sampling from those SMEs? And they're having them answer the question, or do I answer it on their behalf?
Daniel Mclean 10:37
Ideally, you would turn on annual reviews, we would have a structured questionnaire through and we would get information that is publicly available we'll get through. So we might be able to look at annual audits to understand what they're if they've got any kind of sustainability plan, sustainability goals, scope, permissions, etc. But yeah, any kind of gaps that could be addressed through questionnaires. And ideally, to kind of tie them that annual review.
And there is the expectation from the PRA that lenders are having these conversations with their clients and their customers. You
Brendan Le Grange 11:08
I can envisage a world where like we have the credit bureaus, essentially, you could have these comparative matrix across an industry and through industry, so we can start to really understand who's doing well.
On the outside, you'd often you would ignore things that don't affect you about climate goals. And kind of the the wish that we all move in more sustainable directions means that this is a score that is of interest to everybody. So really fascinating to see where that goes to talk to me about the implementation side of it.
Daniel Mclean 11:43
The take up side of it is new to markets, where we are going out to speak to lenders now about kind of implementing this, I think, as the market becomes more aware, and looking to implement solutions in this space, I think it's become more obvious to lenders where they can use it and how they can use it. But as you can see it it's almost regional agnostic to how it can be done born from the bomb from the UK or why did in the UAE?
Brendan Le Grange 12:05
Yeah. And Daniel, I got two questions in terms of people who maybe want to learn more. First is a you mentioned here that we can implement it at a portfolio level, who should be engaging with you? Is it normally a specialist sustainability department from a lender? Or is this something that you know, a normal lending department could start talking about and understanding? And second link to that? If they want to learn more about this? Who or how should they get a hold of for most,
Daniel Mclean 12:33
For those lenders that are focusing on the SME lending in that area that are looking to set targets and understand how they can make that portfolio sustainable or how sustainable that portfolio is or isn't.
I think that's the key market and the key area that it would be able to support lenders today
Brendan Le Grange 12:50
When they see that score, is that score then applicable to their portfolio? Or can does it roll down to the customers can they even pass some of that on to the borrowers within the portfolio that they might see X or Y SME is doing a great job,
Daniel Mclean 13:08
They could pass that information on to the customer. So the idea is obviously you would score not necessary portfolio but it'd be those customers within that portfolio. And you could get into kind of maybe an average via which you understand how that portfolio is and then you might be able to set targets off that actually, we think this isn't necessarily sustainable portfolio.
How do we then manage that through and then you can use a scorecard for when you applicants come in through? Are you doing those annual assessments, if you're then setting your targets and how you want to kind of achieve a more sustainable longer term portfolio, you've got that rating system, which effectively allows you to review customers not just from a credit risk aspect, but also from that sustainability aspect and feed that through into the decisions and maybe the lenders you're doing,
Brendan Le Grange 13:48
you'll see stories in the paper that X or Y big bank is being pressured to stop financing fossil fuels. And that's about the level at which we can really talk about it is we can see big bank A is lending to big oil producer B always financing new oil exploration here or there. And we can pressure them not to do a $10 billion deal. But everything under that is essentially invisible. It's invisible to us as customers and stakeholders. It's also probably invisible to them.
But all of a sudden we have this tool that can understand the same forces all the way through down to small businesses. They've got something more than just saying oh, we don't lend for oil exploration, they can now actually say hey, we give better deals to more sustainable companies. We do this. On the positive side we avoiding X or Y in the sub sectors that we've been you don't talk about which suddenly allows you to really backup further talk. So instead of ESG being this thing that happens in the financial reports and you've turned the page and carry on, it's actually becomes a lever for strategy. And I think that is going to be exciting. Yes. For people in the ESG teams,
Daniel Mclean 15:05
certainly that I think that is that is bringing that that that theoretical view of ESG. And like you said, the broad brush rules that people might implement to try and bring it more into that day to day view in the day to day lending and have achievable targets and kind of show how you're managing that through and then the conversations relationship managers can have with the companies that they're lending to, and hold them up versus their portfolio and what they think they might be able to do.
Brendan Le Grange 15:31
And so yeah, if if anyone listening, I guess, essentially, in any market is interested in seeing this and how it works. Getting closer to the details. How do they get in contact with 4most, is that the 4-most.co.uk Website?
Daniel Mclean 15:47
Yeah. So they come through the website. So we've got an email up for foremast, and then reach out to me, me direct, I'll be happy to have the conversations with anyone perfect.
Brendan Le Grange 15:57
I'll put links to you on LinkedIn and things in the show notes as well. But yeah, their roots are 4most are in credit risk.
And that's kind of where most of the audience to the show lives. I was having a look at that for Dash most.co.uk website last night looking at some of the articles you've got up there. And I saw you've published one recently on the current state of affairs in terms of IRB, talking about whether the PID approach which I've only just learned this point in time, whether or not it is kind of a solution for us in keeping the IRB happy, probably an episode on its own. But what what was that article about? And what are your thoughts within this very changing world we're in we're where we're standing in terms of IRB modelling.
Daniel Mclean 16:43
This is predominantly focused in the UK. So the consultation paper released at the beginning of 2023, which was looking for the implementation of the Basel 3.1 or Basel 3.4, as some might call it, and the new regulations, the industry itself has just gone through a very rocky path.
Traditionally, IRB rating systems have been a point in time or through the cycle methodologies. The aim is then to move towards kind of this hybrid approach, which is what the secured world has been going through over the last two, three years. In the UK. As I mentioned, there's been a rocky path, lenders are starting to see the light at the end of the tunnel, as Focus starts to move away from the secured world. With those hybrid PD submissions. The focus is obviously then moved on to kind of the unsecured portfolios, if you go back to what a rating system is.
So the through the cycle effectively, it kind of assumes not percent cyclicality. So the risk rates that are used to define capital requirements are not really influenced by customer behaviour or economic change, it's typically through the risk appetite of a bank, whereas a point in time rating system is pretty much 100% cyclical.
And it's measuring those accounts as expected default performance of accounts in the next 12 months during downturns are coupled to requirements going up and in the good times, is going down. And the way that lenders would typically do is to apply the capital, they would have a point in time plus buffer a porch or a point in time variable scaler. And that effectively just adds a little bit of contingency on to that payday to merchant other adequately capitalised at any time in the consultation paper last year that the PRA effectively outlawed the use of a variable scalar. Which then the client, what does that mean, that point in time approach is still applicable?
Can you still do that point in time approach? Or can we do a long run similar hybrid type approach to building models, when you're looking to do this unsecured debt or have a longer economic cycle, if you think about how insecure products have kind of changed over the last even over the recent years, but over the longer term, so credit card balance transfers, money transfers by now per letter, it's quite easy to be applicable, that actually unsecured product doesn't necessarily look the same today, as it does historically. So you might not have that representative sample. So therefore, I think that that does potentially leave the option open for a point in time before approach. From a modelling perspective, it's certainly easier and simpler to build it build a point in time easier to manage, easier to validate through.
So I think there is pros and cons. In the article you mentioned that that pretty much just covers up what those those pros and cons. It's very much a theoretical piece. So the results of that consultation paper knocked you out till the end of q2 this year, which is obviously very much coming upon us. But lenders are starting to kind of pull that data together to be able to make sure they're compliant for when they will regulations come in. So is a response to questions we will get in
Brendan Le Grange 19:35
Yeah, well, I think it's pros and cons of work no matter what way the regulator goes to be thinking through what these implications are from the different approaches and internally kind of what makes more sense. I think just in general, that, you know, that idea of the history of unsecured lending is something we need to deal with in every model we build and every strategy we create going forward. Yeah, how applicable is that history, new products have entered the market. There's debit and credit and where spend is going. There's also obviously COVID, and huge changes in interest rates and cost of living, we really need to be careful. When we build a model, we build any strategy based on the past.
Now we've got a good sense of how we are taking that into account. Yeah, that that article is on the website, as are many more I saw just like a real wealth of posts coming out across that new, expanded span or for most work, but it also saw their in person quarterly economic updates. So in London and in Leeds, yeah,
Daniel Mclean 20:37
so certainly, so the Economic Forum's that we have Keefe church are headed economist here for who and does do so it's quite a base.
And it's just to give a view to our clients, but lenders that aren't our clients as well, what we think is going to be happening over the quarter, how does that look versus what we had in the previous quarter. But it's really good as well, just as you said, get those face to face meetings and gatherings are people from in the people in the industry can kind of just come and have a chat share for you share opinions and even just just get to see all colleagues and potentially haven't seen for a while, the way that we we work with clients is we don't just come in to kind of just deliver a solution.
And then then just leave knowledge sharing is kind of one of our key elements. So I've recently started a project myself, which is working for a client that is focused on the commercial space, but they're looking into the consumer space. And they're asking lots of questions of how can we train up? How can we get the knowledge I have in this area. And that was how well through this project, one of our key goals will be to make sure that we're bringing you along in that journey, you're understanding what we're doing, why we're doing it, you're inputting into some of those key decisions as well.
So we're not just making those decisions for you. So that when it comes to then about, you should be able to understand what we're delivering the models that we've delivered. And then again, you should be able to implement a mechanism changes in house yourself going forward. Yeah,
Brendan Le Grange 21:55
there's some consultant firms that were worse at this than others. But they're the bad old days when companies were known for trying to just continuously keep the hours built. But as a consultant, you want to have your next project building on the first one, you want to be doing something new and unexpanded. And if you are not bringing the company along with you next time, even if they are engaging you in two years, it will be to do the same work over and you know, that's not great for the team.
So yeah, I've been a big fan of 4most, I've been great pleasure to have you on and to learn about the screen credit score in particular, it's a tool that allows us to really make big strides, a start of something that I can see becoming very big and very interesting. Yeah, that's what we're certainly hoping for. And yeah, very happy to have had a chance to speak to you today.
Daniel Mclean 22:42
You too. Thanks, Brendan. Thanks for the time. And
Brendan Le Grange 22:45
And thank you all for listening.
Please do look for and follow the show on your favourite podcast platform and share the updates widely on LinkedIn where lending nerds are found in our largest concentration. Plus, send me a connection request while you're there.
This show is written and recorded by myself Brendan le Grange in Brighton, England and edited by Fina Charleson of FC Productions.
Show music is by Iam_wake, and you can find show notes and written transcripts at www.HowtoLendMoneytoStrangers.show and I'll see you again next Thursday.