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Buy-Side Focus: The ESG Jigsaw

Data fragmentation is not new in ESG but the pressure is mounting to find a solution as inflows skyrocket into sustainable funds, writes Lynn Strongin Dodds.

Despite all the regulation, initiatives and working groups, gathering the right data remains one of the biggest hurdles to sustainable investing for buyside firms. This not only makes it difficult for asset managers to assess a company’s environmental, social and governance credentials but also hinders their ability to report their own efforts in being ESG compliant.

While these data challenges are far from new, the problems have been magnified due to the exponential growth of sustainable investing. ESG assets are on track to exceed $50tn by 2025, representing more than a third of the projected $140.5tn in total global assets under management, according to Bloomberg Intelligence’s (BI) latest ESG 2021 Midyear Outlook report.

Buyside focus: The ESG jigsaw

In many ways, asset owners, feel as if they are swimming upstream with a torrent of regulation and industry and peer pressure,” says Mark Austin, head of the UK for Northern Trust’s institutional investor business. “The majority rely on asset servicing firms, and investment advisors for information but the problem is that there is no clear standardised and consistent data across portfolios for measurement and investment decisions.”

This is borne out by several recent studies. In the summer the Index Industry Association (IIA) polled 300 US and European asset managers for its Measurable Impact: Asset Managers on the Challenges and Opportunities of ESG Investment report. It identified a lack of reliable corporate data about companies’ ESG data as a pervasive challenge to asset managers seeking sustainable investments.

Equally as important it noted that there was a wide range of philosophies on how ESG performance should be evaluated. The survey showed, 61% pointed to the absence of meaningful metrics as a major or moderate challenge to ESG implementation for fund and asset managers.

This was mirrored in the BNP Paribas ESG Global Survey 2021 published in September and canvassed 356 institutional investors, with an estimated $11.3tn in assets under management. Drilling down, just over half found social data the thorniest compared to 39% for environment and 27% for governance. The latter two have better data sets because they have been areas of interest for much longer. By contrast, social is a relative newcomer, having come to the fore during the pandemic and the move to remote working.

Data providers step in

Increasingly, buyside firms turn to third party providers and ratings agencies. This is reflected in the recent Clearwater Analytics report on European Union’s Sustainable Financial Disclosure Regulation (SFDR) and ESG transparency initiatives. It showed that 95% of asset managers subscribing to at least one, averaging five, with 60% aiming to increase this number over the coming year. All asset managers are creating their own ESG data, with over 75% creating both scores and company engagement data.

Buyside focus: The ESG jigsaw

One of the main problems is that there are gaps, according to Fraser Hall, Head of Global Product Management – FinReg Adenza. “In many cases, the necessary information is captured only at the high level and there are too many estimated values. There needs to be much more granularity across the board.”

While it is natural for divergent views to emerge on materiality, measurements and underlying calculation methodologies, it is much wider than traditional research providers. Research from MIT Sloan Sustainability Initiative shows a correlation of just 0.61 among prominent ESG data providers. It is around 0.3 in the ratings world compared to 0.99 in the credit space between ratings agencies by S&P and Moody’s.

Buyside focus: The ESG jigsaw

The result is that “it is complicated and difficult to compare apples with apples based on different data sets,” says Clare Vincent Silk, partner at Sionic and lead author on the Clearwater report. “Asset managers need to pull the appropriate data sets together and ideally put their own interpretation on it across all the holdings for analysis.”

Buyside focus: The ESG jigsaw

Tom McHugh, CEO and Co-founder, FINBOURNE Technology, agrees, adding that one of the main constraints for asset managers is aggregating and translating data from multiple systems and interfacing into one language to provide a real-time, whole office view.

“When you add high volumes of unstructured ESG data to this, e.g., company reports, satellite imagery, supply chain data etc., you begin to see why achieving timeliness and scale become difficult,” he adds. “All of this is making it difficult to reach the nirvana state many firms are trying to get to with their data, which is accessing, understanding and knowing where the data came from. Achieving this, increases your trust, control and use of investment data, immeasurably”.

Regulatory push

Although it will take time, many believe the catalyst for a more uniformed approach will be regulations. “Regulatory requirements will evolve over time, the volatility of information will change, and disclosures must be renewed annually,” says Karan Kapoor, Head of Regulatory Solutions and RegTech at Delta Capital. “There will be pressure on firms to certify that data stays relevant and that internal frameworks are built to adapt to regulatory changes. Firms must therefore have a system in place that collects data in a way that is readily available for regulatory reviews and for investors to easily interpret at any time.

Buyside focus: The ESG jigsaw

On the regional front, Europe is way ahead with three key pieces of legislation on sustainability disclosure the EU Taxonomy, the Sustainable Finance Disclosure Regulation and the Non-Financial Reporting Directive. One reason is ESG, and sustainable investing is much more ingrained in the fabric of the European society. In fact, the SFDR is said to be inspired by Article 173 of the Energy Transition for Green Growth Law launched right after COP21.

The regulation which came into effect in March 2021 to establish a common standard for reporting on financial products in European countries. There are 3 main articles – 8 which covers funds that “promote environmental or societal characteristics,” 9 focusing on “a sustainable objective”, and 6 for funds that are classified as neither.

“Standardisation is a big goal for regulators and extends to issues further up the food chain,” says Andy Pettit, director of EMEA policy research at Morningstar. “I am optimistic about the SFDR because it puts quantifiable information around not just the environment but across the spectrum. It is a reasonable step in the right direction and outs more pressure on asset managers to substantiate their claims. Although there are data challenges.”.

Volker Lainer, VP of product management and regulatory affairs at data management solutions provider GoldenSource is also positive about SFDR. “Based on our conversations with clients, there really is no one-stop-shop in that asset managers will need three to four different data providers and a platform that can deal with multiple sources,” he adds. “Fund managers will have to revamp their products to meet Article 8 or 9. However, at the end of the day, ESG data is really reference data and an important part of SFDR is to roll that up at the fund level.”

Although SFDR will be time consuming, there is also a host of global initiatives that are or have made their way through the pipeline, most notable the Taskforce on Climate-related Financial Disclosures which aims to develop consistent climate-related financial risk disclosures for use by companies, banks, and investors in providing information to stakeholders. Its offshoot, the Taskforce on Natural Financial Disclosure aims to do the same for nature and biodiversity risks.

Equally as important is the International Financial Reporting Standards (IFRS) proposed International Sustainability Standards Board (ISSB. As ratings agency Fitch Ratings notes this could prompt consolidation in the disclosure of financially material sustainability information by corporates and financial institutions within a globally accepted framework.

The proposal sees the ISSB sitting alongside the International Accounting Standards Board (IASB) to ensure interconnectedness between accounting and sustainability-related requirements. The sustainability standards will aim to capture financially material information about companies’ sustainability-related risks and opportunities, and their impact on enterprise value, with an initial focus on climate-related risks.

Buy-Side Focus: The ESG Jigsaw first appeared on Best Execution, a Markets Media Europe editorial platform.