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Data is the Key to Unlocking ESG Investing Potential

Jeremy Taylor

Head of Capital Markets Business Consulting, EPAM
Blog
  • Financial Services

As any good investment manager knows, data should be at the center of any decision you make—this is no exception when it comes to Environmental, Social, Governance (ESG) investing. But with so many data sources out there, how can financial services firms be sure that they’re focusing on the right data? In the second installment of our series on how ESG investing is reshaping finance and the global economy, we will share how investors can ensure they’re paying attention to the right information and are applying the most suitable models and portfolio concepts in order to making the right decisions. 

The Challenge: A Proliferating Environment

Driven by regulation and social purpose, ESG-related data providers and data points have multiplied, leaving investors with more than 150 rating systems and 10,000 sustainability performance metrics they must now contemplate in their decision-making.

While this explosive growth in information is heartening to see, there are numerous challenges associated with it, including:

  • Lack of data standardization and comparability
  • Competing reporting and measurement frameworks
  • Diverging materiality assessments
  • Inconsistent reporting methods
  • Opaque ESG ratings methodologies
  • High cost of accessing structured sustainability data insights

So, how can financial services firms cope with these challenges? Below, learn the six steps investment managers need to take to make better ESG investing decisions.

1. Understand current regulation, accounting rules and reporting frameworks.

To keep up with current regulations and accounting rules, it’s vital that investment managers understand and follow widely-accepted, non-financial frameworks and certification standards to develop reporting against a set of key criteria. Among the most widely adopted frameworks are:

  • Global Reporting Initiative
  • Sustainability Accounting Standards Board (SASB)
  • Climate Disclosure Standards Board (CDSB)
  • Task Force on Climate-Related Financial Disclosures (TCFD)
  • Climate Disclosure Project (CDP)

In addition to these, the European Central Bank’s (ECB) guide on climate-related and environmental risks notes that financial institutions are expected to disclose in millions of Euros, the amount or percentage of carbon-related assets in each portfolio value and a forward-looking estimate of this amount or percentage over the course of their planning horizon.

Ratings providers, such as Morningstar, have also developed a wide array of ratings data and analytics to assist ESG investment. This includes ratings for both passive funds, such as ETFs or ESG Index Funds, as well as actively managed ESG funds.

Financial disclosures by corporations also need to provide sufficient transparency and harmony as they are an important source for analysts to assess. Corporate Social Responsibility (CSR) accounting standards are aimed at making ESG more transparent in financial statements. The World Resources Institute (WRI) provides accounting and reporting standards, sector guidance, calculation tools and training for businesses and governments.

It’s vital for investment managers to keep up with all of these groups in order to ensure that they are focusing on the right data.

2. Recognize what ESG data is available and where to source it.

When looking at these frameworks and regulations, there is no shortage of data available to investment managers. In addition to the aforementioned rating systems, many businesses are publishing non-financial information in their sustainability reporting, such as water use, carbon emissions and diversity among others.

To further complicate things, bigger firms are deploying Big Data and AI technologies to help sift through un-structured data sources—including news, websites and social media—which can be integrated into the investment process.

While it’s important that investment managers keep an eye on all data available, they need to pay attention to five key data areas in particular:

  • High-quality emissions data and coverage, e.g., temperature rise
  • Future climate-related targets and strategies
  • Convergence around business-relevant climate-related scenarios or transition pathways
  • Social indices and sentiment analysis

An end-to-end governance index relating to third- and fourth-party supplier risks

3. Develop a sustainability investment strategy and establish ESG-based portfolio screening criteria targets.

Once they have identified these crucial data points, investment managers need to develop a set of ESG-related goals and screening criteria to assess their portfolios. Until ESG metrics are defined consistently and standards are harmonized globally, investment managers will need to assess their portfolios against a number of different rating providers and perhaps their own in-house models to average out any bias or outliers. 

4. Establish an internal process for ESG data collection, analysis and reporting.

Once this data has been identified, the complexity—availability or not of data—can create a resourcing overhead in the preparation and calculation of forward-looking metrics. Many firms will require the assistance of external data and methodology providers. This will also lead to the emergence of various states of disclosure and reporting maturities.

5. Offer investment products that promote ESG goals.

It is unsurprising that the push from governments and society, driven by changing attitudes to sustainability, has led to the development of green bonds and social bonds. Green bonds are instruments that fund projects that have a positive environmental or climate impact. Social bonds have aims such as expanding access to healthcare and education.

Several government policies have encouraged the private sector to participate and have led to an increase in market liquidity, which is itself leading to more participants. Some issuers have used their green or social sustainability bond issuance to highlight their environmental and social initiatives. Many of these issuances include innovative features often linked to impact metrics or to the UN’s Social Development Goals (SDGs).

Many investment firms have been developing green portfolios over the last decade, but, in 2021, ESG as a new quasi asset or risk class will become mainstream. ESG considerations will become the norm for investment managers integrating ESG factors into portfolio management decisions.

6. Provide a set of analytics and tools to permit their investment clients to assess ESG factors

Investment managers must also be able to measure and analyze the credentials of green or social bonds and ensure that the proceeds are being used correctly and ethically. It is also important that they assess the overall culture, strategy and direction of any green or social bond issuers themselves.

Analysts at invest management firms and other financial services firms now need to review the nexus of credit and ESG metrics and the use of proceeds. Quantitative and qualitative annual reporting by the issuers and how these compare to the frameworks developed by the TCFD and the EU Taxonomy disclosure requirements.

Data is also key to any quantitative analysis. The reputational risk of inaccurate or incorrect investment guidance can be costly. There is no avoiding the fact that investors need to carry out due diligence and engage directly with companies and industry bodies, alliances and regulators to dynamically improve and contribute to a greener, sustainable society.

In order for investment managers to ensure that their ESG investing is a success, they must understand the data available to them and put use to it correctly in order to maximize the potential of this new area. In our next blog, we will discuss why financial services firms should specifically pay more attention to the social aspect of ESG investing.

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