Martijn Groot is VP Strategy at Alveo, responsible for steering the company’s strategy for corporate development, innovation and communications. Here he shares his thoughts on the rise of sustainable investing and how asset managers can best prepare for an ESG future.
Investment is now increasingly being shaped by ESG criteria. At the top of the agenda for asset managers is the need to devise ESG strategies that both meet business requirements as well as investor demand for sustainability and green practices. While such strategies are still in their infancy in a growing market, ESG-related requirements are set to expand as regulations begin to be introduced, and asset managers need to be ready.
Developments are on the horizon. Alongside the EU’s strategy to drive sustainable finance growth, asset managers and asset owners need to follow the Sustainable Finance Disclosure Regulation (SFDR), which covers ESG disclosure obligations. While the SFDR initially focused on fund classification to prevent investment products being ‘greenwashed’, the next phase will mandate for the principal adverse impacts (PAIs) of investment decisions on sustainability to be revealed and will come into play in June 2023.
In addition to the SFDR, the Corporate Sustainability Reporting Directive (CSRD) has also been proposed. This will require larger organisations to disclose details about their sustainable initiatives, while the EU Taxonomy maintains a list of environmentally sustainable economic activities, with CSDR requiring organisations to disclose activities against it.
The pressure on businesses is being applied from both sides, as along with the increasingly complex regulations being introduced, investors born in the millennial and Generation Z era are more likely to consider sustainability as a key factor in investment decisions when compared to their Generation X and Generation Y counterparts.
To ensure that effective reporting is communicated to customers, as well as compliance with these strict regulations, asset managers and other buy side firms will need to leverage large volumes of ESG data. Such ESG requirements will include screening, asset allocation and research, to regulatory and client reporting. The question however remains: how can all the relevant organisations and parties actually gain visibility of the ESG data they require in what is an expanding market and an increasingly diverse ESG data provider landscape?
In this area, there are three different types of data that are most relevant. The first is corporate disclosure data that can be brought together from annual reports, investor relations or other meetings and offered in a common format. Ratings forms the second type of data, and Morningstar, MSCI, FactSet and other similar companies can devise sustainability scores based on information sources and input from experts. This however can be problematic as expert opinions can differ, due to ESG being such a wide spectrum, while ESG scores can sometimes be devised from planned actions or future goals, as opposed to what organisations have already achieved. The third type is sentiment data. This involves using social media posts, press releases, employee surveys and the way that the company is reported in newspapers and television and radio broadcasts to calculate its current standing in terms of ESG. The required selection of data out of the entire ESG universe will depend on the use case and investment strategy.
Making sense of the data
With various options on the table, it’s a tricky task for asset managers to select which ESG data sets they need. Records can frequently be incomplete as some relevant data is withheld, and data needs to be gathered from several sources. A comprehensive approach to ESG data management is required. Asset managers need to be able to effectively source and integrate where needed to enable the data to be delivered to different stakeholders. A professional in external reporting will require factual data from corporate disclosures, while a portfolio manager will need granular data in order to choose investable assets and potentially sentiment data for short term trades.
Companies, therefore, need to source data from varying channels but also document how that information was retrieved. With a lot of organisations outside of Europe not reporting certain data, this may include the estimation of missing fields via specific proxies or sectoral benchmarks or gauging missing fields using external expert opinion or an internally produced model value. Mapping to a common format, interpolating and covering reporting bases and units of measurement to a standard will also be useful for data standardisation. To ensure transparency and differentiation between data sources and also between facts reported by a company, third-party opinions or internal estimates, tracking data lineage will also be needed.
An optimised ESG data management solution will include processes to onboard, inspect and complete data sets, alongside integration with business applications and other information on issuers and financial products. To improve overall data quality, data quality metrics can act as a feedback loop to optimise sourcing, while data cataloguing and browsing helps provide clarity to professionals across the entire investment process on available data and the basis for any decisions made. Practices that have previously been used in data provisioning for performance measurement, valuation and investment operations can help refine ESG data management requirements. While these requirements can certainly be complex due to varying data sources, business rules and quality metrics, data management solutions are in place to help investors to achieve their goals and objectives.