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.