ESG Investing: It’s all about the data

Read the article to learn about:

• The geo-political momentum driving greater demand for ESG data
• Why non-standardized ESG data has a detrimental impact to ESG investing
• The critical need for investment managers to retain control of proprietary insights
• How Data as a Service can drive successful ESG data management

Paul Ravenscroft,
Offer Manager, Data Management, SimCorp
Connect with Paul on LinkedIn

The world of ESG investing has undergone a sea change. Once seen by some as a niche strategy, philanthropic experiment or even a clever marketing tool, it has since seen a raft of scientific and geo-political developments, which have shifted opinion on both the magnitude of saving our planet and the role we all play. This has impacted the way industries operate today, including the financial markets, with the introduction of the triple bottom line - people, planet, and profit.

Why safeguarding the secret sauce is critical to ESG investment success

More than ever before, many investment managers are looking to ESG to meet their clients’ needs on several levels: from delivering risk-adjusted financial performance, to creating an impactful platform, where they can take positive action. This renewed sense of corporate citizenship, where asset managers and asset owners are reflecting moral values within their investments, has led to a surge in inflows. According to Morningstar¹, money invested in ESG funds grew 10x between 2018-2019 and has more than doubled from 2019 to 2020, despite the pandemic.

This unprecedented investment momentum has not only driven greater demand for ESG data, supplied by both traditional players and newer, niche ESG data vendors, but has also firmly placed ESG data among the more traditional financial data, used for measuring systemic risk and predicting financial performance.

But while demand and desire are escalating, the capacity of investment managers to process multiple, non-standardized data sets and make coherent sense of it all, is fast becoming unsustainable. Asset management is now facing a classical data management challenge. To understand how this could stall sustainable finance progress, and why safeguarding custom insights and scores (the asset manager’s value add - their secret sauce), is critical to ESG investment success, we first need to look at the nature of available ESG data in the market.

Why standards matter

Today, most firms are getting data from multiple providers, such as data vendors, ratings agencies and analytics and research providers, which has created the unfortunate issue of fragmentation in the ESG data management process. Add to this, the differing formats, standards and methodologies and you begin to get a glimpse of the ESG data puzzle.

If we look at what is out there, much of the data available originates from companies self-reporting within annual reports, and reporting against the UN SDG goals. Since much of this is voluntary and qualitative and could lead to obvious “greenwashing”, data vendors are sought to provide additional sources of data. This ranges from sentiment analysis using social media and news sources, and even alternative sources such as satellite imagery or analysis of supply chains. To get as accurate a picture as possible, investment managers are likely to choose multiple ESG vendors, given each tends to be perceived as a leader in a different ESG specialism, such as social issues or carbon. This patchwork of data sets, all based on differing vendor proprietary classification systems, has become the minimum requirement and that is even before we consider ESG in the private markets. 

But even here, several recent investigations, including one from the MIT Sloan School of Management², have documented the disparity and deviation of top-level ESG ratings between different vendors. This is in contrast to the underlying ESG metrics, which are often based on quantifiable and verifiable company disclosed numbers. This has created an administrative task for investment managers to report on, as well as for their investors to compare products and really understand what they are buying into. Some of this deviation in the top-level ratings may be due to lack of quality and metrics. But there is also another reason. Top level ratings are subjective, just like an analyst’s buy/sell recommendations. They correspond to a specific perspective on ESG issues and with a specific purpose, which can be on a wide spectrum, from pure financial materiality to societal impact.

In short, investment managers have a significant task in standardizing all these different categorizations of data points. In reality, many are turning to manual processes when it comes to typical ESG data management exercises. From data acquisition, to normalization, cleansing and publishing, investment managers are arduously piecing together data to create the big picture, from which they can base their investment decisions. But if anything, this combination of non-standardized data and the manual and error-prone workflows that create that picture and the insights gained from it, are becoming questionable.

We know the sheer proliferation of providers is not going to slow down anytime soon and if and when there is vendor consolidation, as some have speculated, it will be interesting to see how standardization will impact them in the future. One development, which aims to move the needle in the right direction, is the shared taxonomy announced by five global organizations, including the Sustainability Accounting Standards Board (SASB) and the CDP, which also aligns with the Task Force on Climate-related Financial Disclosures (TCFD). While other global initiatives include the CFA Institute’s disclosure standards for investment products and establishing an International Sustainability Standards Board under IFRS. If these aligned frameworks and standards for sustainable finance disclosure and climate-related reporting are universally agreed, then what we may well see is data vendors maintaining their proprietary formats but also reporting natively in this agreed industry standard. Only time will tell.

Adding the SFDR into the mix

But time is one thing investment managers do not have right now and while industry associations and regulators play a pivotal role in driving standardization, there is nothing to suggest any immediate change in the near-term horizon. What is coming however, is the introduction of the Sustainable Finance Disclosure Regulation (SFDR). Perhaps the most comprehensive and ambitious initiative from the European Commission’s 2018 action plan, for financing sustainable growth.

Despite all the vendor sources available today, the challenge most often cited by investment managers is lack of data coverage from the invested companies, themselves. This will be particularly tricky in the short term, for firms subject to the SFDR, which applies to any funds which are environmental and socially promoting (Article 8 funds) or have sustainable investment as their main objective (Article 9).

The challenge is that these funds will need to adhere to the SFDR next year, when the regulation that requires companies to report their ESG figures - the Corporate Sustainability Reporting Directive (CSRD), will be enforced later. This creates a difficult interim period, where investment managers will need to press companies for more information but there will at least be some clemency. In a recent SimCorp Journal interview, Theodor Christensen, Head of Sustainable Finance at the Danish Financial Supervisory Authority, commented that “From a supervisory point of view, we understand there may initially be a chicken and egg situation when it comes to methodology and data. We therefore see 2021 as a transition year, where firms should really try to do as much as is possible, on a best effort basis. From 2022 onwards however… we expect firms to have much more data and report more rigorously.”

The takeaway here is that SFDR will by no means be the end of ESG regulation, nor will it be confined to the EU. It is expected to have global impact, not only because global investment managers offering ESG funds in the EU will have to adhere to it, but also because companies outside the EU, which have been invested in by those EU funds, will now be asked to provide ESG information. It will also spur further legislative efforts from regulators in the UK, US, and in Asia, so that the data management problem outlined will only be compounded by a future filled with a multitude of data mapping and regulatory reporting requirements. And while this may deter some firms from offering ESG investment products altogether, it will raise the bar significantly for what does constitute an ESG product. That transparency is both vital for investors and for the planet.

Safeguarding the secret sauce

While the current data situation is a mess, many investment managers have found a process to derive their own scores. And many see this as a value-add or the secret sauce of inferred data. For example, there are firms who have an active interest in examining companies that have divergent scores, between vendors and their own custom-built insights, as this might suggest the company is either over or under-valued from an ESG perspective and hence a potential investment opportunity.

While, other firms, even those not creating ESG funds, will use the history of ESG data, to analyze how a firm’s performance is trending from a risk management perspective - with a view that bad governance is historically well correlated to catastrophic drops in share price. Though this is all advantageous, there is another way of safeguarding these insights without having to go through the trouble of acquiring and managing it all.

Changing the game in ESG data management

The present reality tells us that there is a very real need for safeguarding the value-adding capability for Asset Managers to derive their own scores, while removing the arduous workarounds that form ESG data management today. Investment managers can no longer continue to spare their resources struggling away with deeply manual processes like cleansing and reconciliation, and that too at a scale that will only increase with time.

Firms have a clear need to retain governance and control of proprietary insights, while being able to outsource the operational burden. Even if we reach an eventuality where there are only a handful of converging data vendors to manage, we believe service providers can play a significant role in taking on the operational responsibility, with enhanced services that will drive successful ESG data management. Given the current options, there is certainly a need for this, and already a number of software providers, including SimCorp, are universally turning to a service-delivery approach to offer more value.

ESG is a classic use case for Data as a Service which flexibly delivers both a service and an interactive solution. At its core, the managed service needs to enable investment managers to keep 100% control of their data, while taking the pain and risk out of the process. It does this by fully automating the in-bound ESG data a firm receives, while ensuring its validity to create an accurate and ready to use single source of truth for the entire organization.

This game-changing service not only adds transparency, but also offers advisory through industry experts that can help investment managers navigate and implement the run of future regulations, including the SFDR. By leveraging a data-driven approach to ESG investing, where one source of reliable and accurate truth acts as a solid foundation for the whole organization, firms can spend more time creating proprietary insights from ESG data, and reliably act on them to enhance their ESG investment decisions.

If we consider EDM as the beginning, then Data as a Service is most definitely a valuable, future-proof solution, reinforcing firms with the agility needed to respond to markets, as they evolve. Furthermore, by digitalizing demanding processes, it also opens the doors to the adoption of innovation that can optimize and scale operations in the future.

Ultimately, with ESG becoming mainstream, the ability to scale and drive business critical outcomes is now essential. Central to this is addressing the status quo of inefficient ESG data management, to protect and augment the secret sauce that will successfully drive the future of sustainable finance. Especially so, with standardization still a way off and pressure mounting from regulations like the incoming SFDR. With Data as a Service available to address this conundrum and deliver the means to ESG investment success, the question investment managers must ask is: What harm are we doing to the firm’s success, as well as to people and the planet, by not taking action now?

For more information on Data as a Service, including an interview with Zurich Insurance Group please click here or contact Paul Ravenscroft.

¹ A Broken Record: Flows for U.S. Sustainable Funds Again Reach New Heights, Morningstar (January 2021) 
² Aggregate Confusion: The Divergence of ESG Ratings, MIT Sloan, (August 2019)