At the beginning of March, the Sustainable Finance Disclosure Regulation (SFDR) was implemented by the EU, causing many firms to rush as they try to collect data to meet the requirements. One solution to this is the integration of Environmental, Social and Governance (ESG) data into asset managers’ workflows, as this would free up time and resources for firms affected by the new regulation.
Sourcing data for compliance and integrating it to fit the new regulations being introduced in 2022, are proving to be the biggest issues faced by firms. One strong view on the importance of ESG data being integrated into asset managers’ products comes from Paul Elflain, Head of Asset Management at Linedata.
With over 25 years of experience in financial services, Paul shares his views on ESG data compliance:
Earlier this month, the ESG movement got a major regulatory push with the implementation of the EU’s Sustainable Finance Disclosure Regulation (SFDR). This standardises disclosure requirements and will bring much-needed transparency over the makeup of sustainable and ethical funds. Yet, the real deadline asset managers will be prepping for is January 1, 2022, when new ESG reporting requirements come into effect. An ESG data race is now in full swing, as managers get ready to comply with these new regulations and further their investment strategies. Playing in this new world is not just about access to ESG data, but integration into existing workflows, meaning ESG must be a digital revolution as well as one for sustainable finance.
The number of conversations surrounding sustainability has snowballed over the past year, exacerbated not only by the new regulations, but also by US President Joseph Biden’s commitment to climate change policy, and the global pandemic has put a spotlight on the very real threat of non-financial risks. This, alongside growing acknowledgement that portfolios that include ESG factors generally perform better, has had an immediate impact on investing. From January through November 2020, investors in mutual funds and ETFs invested $288 billion globally in sustainable assets – a 96% increase from 2019.
New generations of investors are increasingly demanding that ESG criteria are factored into their portfolios and that these are legitimately implemented rather than just ‘greenwashed’. SFDR and the increased transparency it will bring to this burgeoning market will help address this. But while regulation will be the catalyst for driving industry change, it will also be driven by technology. Much hard work must now be done behind the scenes to integrate this valuable ESG intelligence to place it at asset managers’ fingertips.
The First Hurdle: Sourcing ESG data
The initial challenge now presented by the impending January 2022 deadline is the collection of necessary ESG data and the individual scoring of financial products. Asset managers will need to start periodically reporting whether their products meet their specified objectives or classification based on a minimum of 32 sustainability metrics.
Now fund houses have a clear choice in front of them: build up teams in-house to evaluate and score stocks by ESG criteria or outsource this to technology vendors and ESG data providers.
When weighing up their options, ensuring the credibility of the ESG positions while doing so in the most efficient way possible are the most important factors for managers to consider. Many smaller firms simply won’t have the capacity to build this capability internally and working with an independent provider helps demonstrate the impartial scoring and prevents further fragmentation across the industry. This means a partnership approach is likely to win through as the most popular option to access ESG data.
The Second Hurdle: Integration
While sourcing ESG data and scoring products is a challenge, it is made much harder by the need to integrate the new processes and data into existing workflows and the technology that underpins these. Workflows that cannot be quickly adapted to respond to new regulations present an underlying issue for many asset managers. For those who still use on-premise servers and legacy technology, the process of integrating new rules into software can be a slow and costly task.
The direct integration of ESG data and scoring with existing software is important as it gives managers a key competitive edge in creating and marketing ESG investment products, complying with regulatory reporting and monitoring, and positioning their firms as sustainable and ESG friendly. This enables new investment strategies and in turn, will boost competitiveness by differentiating the firm’s offerings to the market. Cloud technology is a vital enabler when collecting and scoring the ESG data; cloud-based data lakes can break down data silos and scale up and down quickly, and it is easy to layer new analytics on top.
How Asset Managers Can Get Ahead
For firms tackling data collation and scoring in-house, SFDR compliance presents a mammoth task and it can be hard for these firms to see past the due diligence to the opportunity presented by the new regulation. For firms that have the option, partnerships with ESG service providers is the fastest and most cost-effective way to ensure compliance. A partnership with a service provider that already has access to the necessary data vendors means cutting down the number of required vendors dramatically, freeing up resources that can be channelled into bringing new products to market. This also reduces time spent ensuring regulatory and investor reporting requirements are met and running ESG-specific compliance at both an asset and fund level. For those considering partnerships, it will be important to consider whether their solutions are cloud-based as this will affect not only speed of implementation, but also scalability – crucial for funds looking to expand internationally.
The asset managers who can create reliable ESG products quickly and take these to market will find themselves in the lead in an increasingly competitive industry. They will have the freedom to enhance portfolio strategies and be able to make informed decisions ahead of their competitors, regarding which well-performing companies they should include in sustainable and ethical funds. The race is on, and time is of the essence.