There’s a plethora of ESG data available to investors, but issues remain over accuracy, relevance and comparability.
It remains hard for investors to access accurate and relevant data from issuers when attempting to factor ESG risks and opportunities into their investment decisions, according to industry experts.
“Investors and their asset managers need to be using all the tools in their toolkits when working with companies and gathering ESG data,” says My-Linh Ngo, Head of ESG Investment at Bluebay Asset Management. “Investors need to go at this with a mixture of carrots and sticks.”
According to global bank HSBC, more than half of investors believe data provided by issuers is not comparable enough to support ESG-driven investing. In its ‘Sustainable Financing and Investing Survey 2020’ report, HSBC identified the five main obstacles to comparability as: quality and availability of ESG data; inconsistency in ESG definitions; financial returns; lack of demand from asset owners; and shortage of expertise.
Demand is rising strongly, but the quality, accuracy and relevance of the data provided by issuers and third-party data providers is more open to debate.
As outlined by the Organisation for Economic Co-operation and Development (OECD) in a 2020 report, the investment industry – investors, asset managers, regulators and policymakers combined – need to be “ensuring consistency, comparability and quality of core metrics in reporting frameworks for ESG disclosure”.
One key challenge, which will be covered in more detail in a future ESG Investor article, is the sheer number of ESG scoring and rating systems, which have different methodologies and can lead investors to different conclusions, therefore producing different data points within the same areas.
But the overarching issue surrounding ESG data is the need for investors and asset managers to access primary data on which they can rely when making investment decisions.
Streamlining ‘E’ data
Climate-related data has been prioritised by many investors as the most urgent requirement from investee companies. This flow has been further enabled by increasing adoption of the disclosure guidelines proposed by the Task Force on Climate-Related Financial Disclosures (TCFD).
Investors expect corporates to be able to disclose their exposure to climate-related risks and provide a detailed strategy for decarbonisation. For example, non-profit organisation ShareAction filed a climate resolution against HSBC to encourage the bank to provide more details on its plans to reduce its carbon emissions.
The surge in climate-related regulations and reporting frameworks has seen a complementary spike in the availability of data. Especially for well-resourced investors, this can assist assessments, but for many the search for accurate and relevant data can prove overwhelming, due to lack of consistency and comparability.
“There is so much ESG-related data out there that it’s like a huge bowl of soup, full of numbers and letters. But, when it comes down to it, there’s not that many pieces of data that actually matter to the investor,” says Sudhir Roc-Sennett, Head of ESG at Vontobel Asset Management.
A recent announcement from the Net-Zero Asset Owner Alliance, noted that the group of 33 global institutional investors has pledged to reduce their portfolio carbon emissions by between 16% to 29% by 2025.
As well as internally analysing ESG data, members of the alliance will be expected to procure data from their fund managers and investee companies and formulate a decarbonisation strategy over the next five years, in order to best reduce their Scope 1, 2 and 3 emissions.
Coordinating the comparability of ESG data
Asset managers are equally under pressure from their clients to ensure portfolios are Paris-aligned, meeting their temperature targets, which Ngo says is easier said than done.
“Investors want to know, very simplistically, whether we are Paris-aligned or not,” she says. “And maybe your portfolio can be positioned to be Paris-aligned. But if nobody else is matching your contribution to decarbonisation, then that’s going to change what your proportionate contribution to global emissions actually is.”
Ngo says that asset managers therefore have a responsibility to continue “managing client expectations”.
“Even if we take issuers at their word in terms of their net-zero commitments, the number of companies that have made these pledges is still very limited, especially outside the EU, compared to the published number of detailed roadmaps that can give us strong confidence around the shape of that decarbonisation pathway,” agrees Gabriel Otto Wilson, Global Head of Sustainability Research at BNP Paribas Asset Management.
To better coordinate the comparability of ESG data from issuers, the International Organisation of Securities Commissions (IOSCO) established a Sustainability Task Force (STF) in April 2020, which is working to both improve investor protection and address transparency around ESG data and sustainability disclosures. In the IOSCO report, respondents noted that “challenges around comparability may result from the different levels of development and maturity in markets, the lack of common definitions and lack of standardised frameworks”.
Future-focused ESG data
More often than not, ESG data streams are “backward looking” says Wilson Otto. Data ages quickly, and data reflecting on the previous year doesn’t necessarily allow for accuracy when forecasting the years ahead.
“If an asset manager is conducting financial analysis and trying to predict the future outcome of how a company is going to perform, typically they shouldn’t rely solely on the historical data a company has reported,” he explains to ESG Investor.
This timeless investor’s maxim causes numerous problems in the ESG era. Wilson Otto highlights the “data lag” between when the data is reported and when it is actually fed into the internal ESG score systems of managers and investors, thus hindering the “predictive power” of ESG metrics.
“Investors and asset managers need to focus on the momentum of ESG progress within companies, and therefore the evolution of those scores,” he continues. “What is their trajectory from here? That way, we can better forecast our own cashflows or outlook for the company.”
There are several initiatives emerging to address this issue. A set of metrics has been developed to assess the future pathway of the emissions of companies and sectors, for example, by the Transition Pathway Initiative, a collaboration between UK-based institutional investors and the Grantham Research Institute on Climate Change and the Environment at the London School of Economics.
This year, Otto Wilson anticipates further developments which will help investors to more accurately predict how companies will change in the future, as well as further encouraging corporates to implement future-focused targets of their own.
Defining ESG terminology and applying the context
The HSBC report noted that 39% of European investors said that “inconsistent terminology” proved to be a particular challenge when working with ESG data.
Initiatives such as the long-awaited EU Taxonomy aim to provide further clarity around what constitutes as ‘green’, giving corporates a baseline of acceptability when it comes to emissions levels and other sustainability metrics.
But the process is fraught with difficulty. Responses to the draft delegate acts called for the European Commission to better follow science-led data.
Inconsistent terminology is an important issue to identify when analysing data, experts argue. Engaging with corporates and third-party vendors to better understand their terminology and its application in reporting processes and scoring methodologies will allow asset managers and investors to align their own analysis accordingly.
Roc-Sennett adds that science-led data should be used alongside present day context, as scientists consider a 30-year data timeline to be “short-term”, compared to an average short-term investment timeline, which spans closer to five years.
“We can’t just blindly follow data models; we need to try and more deeply understand their methodology – and that includes understanding terminology and how it might differ,” he says. “Investors and asset managers should always question the data process. Not because they’re wrong, but I do see a lack of discussion around the issue.”
Understanding the business context around the data will help both asset managers and their investors to make better-informed decisions, Bluebay’s Ngo agrees.
“To what extent has their board thought about ESG issues? To what extent do they have a coherent strategy in E, S and G areas? How are they currently performing in these areas so I can understand the extent to which there are ESG risks to their business? To what degree can I gain comfort that a company is mitigating risks appropriately and will be able to adapt and be resilient in the future? There needs to be a compromise between the data you get and the holistic nature of the framework in which you put this data together in order to form a clear picture,” Ngo continues.
‘E’ data shouldn’t be the only priority
Undoubtedly, the debate around ESG data has largely focused around climate-related risks and opportunities. However, the quality and availability of social data remains “poor” according to Martin Buttle, Head of the Good Work Programme at non-profit organisation ShareAction. Buttle adds that investors have been “slow” to realise the materiality of ‘S’ data, something he hopes to see change as Covid-19 propels social issues to the fore.
“Corporate disclosure of meaningful data in ESG in general is poor, but particularly on the social side,” he says. “There are some really glaring gaps, particularly around workforce-related data which goes beyond direct employees – such as at an operational and supply chain level.”
Despite relatively lacklustre engagement with social data from investors up until this point, ShareAction has seen an improvement in engagement with companies on workforce reporting, with 141 companies responding to its Workplace Disclosure Initiative (WDI) in 2020 – a 20% increase on the previous year.
Buttle goes on to add that modern slavery statements made by corporates are also inadequate, and that investors seem to be satisfied with a “generic statement that will cover risk but not really cover the spirit of legislation”.
“I would like to see companies better disclosing against modern slavery and really interpreting what their risks are and sharing this with investors, as they have a right to know,” he says.
Time to better regulate ESG data?
Alongside investor demand for ESG data, regulators and policymakers have a key part to play in the evolution of data relevance and accuracy. A key ongoing discussion centres around the standardisation of data and reporting frameworks, covering both the primary disclosures of issuers, but increasingly also the services of third-party data providers.
“Rapid standardisation of metrics and calculation methodologies would be a huge boon,” Wilson Otto says.
A standardisation – or harmonisation – of data reporting processes would allow corporates, managers and investors to more clearly understand the “reporting perimeter”, he explains.
The International Financial Reporting Standards (IFRS) Foundation released its ‘Consultation Paper on Sustainability Reporting’, which proposed the widespread adoption of TCFD guidelines and the implementation of a Sustainability Standards Board (SSB). Although widely accepted by industry, the proposal isn’t perfect. Asset manager DWS responded to the paper and called for the Foundation to centre a global sustainability reporting standard on double materiality.
Standards-setting bodies, known as ‘the group of five’, took this proposal one step further and launched a climate-related financial disclosure prototype, based on the four pillars of TCFD reporting and including proposals outlined by the IFRS Foundation. The five bodies have urged corporates to begin using their prototype now, rather than waiting for further developments from the likes of the EU Taxonomy and the IFRS consultation.
Two financial market regulators, France’s Autorité Des Marches Financiers (AMF) and the Dutch Autoriteit Financiële Markten (AFM), released a joint paper last year which advocates for more of a regulatory focus on data methodology transparency, governance and market innovation. They further called for a regulatory framework for ESG data services which would require supervision from the European Securities and Markets Authority (ESMA).
The European Fund and Asset Management Association (EFAMA) expressed its support of the regulators, but noted that the rising costs of ESG data could be “particularly detrimental to smaller firms which have less resources and bargaining power, and to end-investors who ultimately foot the bill”.
In theory, this is all highly positive and “a material step in the right direction”, Wilson Otto notes, but, in practice, it will be much harder to deliver.
“It needs buy-in from so many different entities,” he says. “If we’re looking at one niche area which is seeing broader acceptance and is the best place to start in terms of standardisation, then reporting under the TCFD framework is the way to go.”
Standardising reporting across sectors will present challenges, Ngo counters. To get the fairest overall picture of performance, asset managers need the same data points from companies in each sector.
“There’s a size bias around the availability of data,” she says, “as well as a sectoral bias and a regional bias. Data doesn’t always account for the different nuances we encounter within our assessments, and therefore doesn’t always allow for a level playing field.”
If there is to be a true harmonisation in reporting standards, then the issues surrounding primary data need to be addressed.
“In order to facilitate a globally standardised level of disclosure, we need to see more high-quality data from our data providers and issuers in order to best report on the characteristics of our portfolios,” says Wilson Otto. “I think this is why investors need to treat ESG scores as the start of a further investigation into performance – not the end result.”