30 November 2020

Data dilemmas impacting ESGs

As featured on financederivative.com

It’s been well documented over the past few months that the COVID-19 pandemic has had a positive impact on ESG funds. ESG funds are typically portfolios where environmental, social and governance factors have been considered as part the investment process. Research from Morningstar shows that globally investors poured $45.6 billion into sustainable funds in the first quarter of 2020. In comparison, the overall fund industry saw outflows of $384.7 billion.

This trend is predicted to continue. Worldwide, attitudes are changing and a younger crop of ‘conscious investors’ with strong ethical views are now increasingly influential. Today, you’re less likely to see someone invest in an oil company. Instead, they are looking for innovative technology companies which fall under the ESG bracket, and more companies are entering this space. For example, United Nations Principles of Responsible Investment, which launched in 2006 with 100 signatories, now has more than 3,000 supporters, with a combined $100 trillion of assets under management.

With data now playing a fundamental role in the way funds, both ESG and typical, are managed, what role will data play in accelerating growth in this space? Although ESGs are doing well, we are seeing a critical issue which will determine their future growth – and it stems from data.

Across the board, ESG scores vary, and despite increased regulations from the UN, EU and individual countries’ regulatory bodies, there is no unified definition on what constitutes an ESG. This is why you’ll occasionally see oil companies pop up in an ESG fund. Tied into this, the way a lot of companies analyse data is biased toward larger companies who publish more data about themselves and are therefore likely to score higher in a fund manager’s ranking.

It’s clear changes need to be made to make it easier for fund managers to convert the interest investors are expressing in ESGs into proactive investments. The first change to be made is better sustainability reporting from companies. The second is improving data measurement and reporting. By making changes to these areas we will be able to accelerate the growth of investment in ESGs.

Let’s start with what we need from companies. Currently, most reporting on sustainability is aimed at stakeholders such as NGOs, which isn’t most relevant to investors. However, data management platforms can dissect and digest these reports to provide a reliable assessment of ESG performance. The state of play is rapidly improving, for example there are various EU directives and UK laws that require companies of a certain size to report non-financial information on an annual basis, but is this enough to attract conscious investors, driven by a sustainability motive?

Currently, many companies are missing out on potential investment from a host of conscious investors. To make themselves more desirable as a viable ESG option there are several steps that they can take to improve their reporting. Recent research from Harvard Business Review recommended the following:

  • Articulate your purpose: Companies should demonstrate their purpose within a society, not just their profits. When reporting they should clearly explain how they produce profits by providing a solution to problems people and the planet face. The easiest way to articulate this is by producing a Statement of Purpose
  • Improve engagement with stakeholders: Company reports should include an analysis that identifies the ESG issues that affect financial performance. Such a report is an effective way to demonstrate to shareholders and other stakeholders that the company recognises its role in society
  • Improve measurement in reporting: Investors want to know how ESGs affect society as a whole and are committed to investing in these impacts. However, most companies aren’t demonstrating the positive impact they’re having. For some, this will be because of a lack of framework available to report this. The UN’s Sustainable Development Goals (SDGs) provides a reliable list of objectives that companies should recognise when preparing stakeholder reports. The SDGs recognises 17 goals that the UN identified as necessary for a sustainable future, including eradicating poverty and hunger, ensuring responsible production and consumption, and promoting gender equality.

We are also seeing moves toward data standardisation when it comes to ESG reporting. Standards such as the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-Related Financial Disclosures (TFCD) leading the way. The European Commission has also blazed trail here, in pushing for the standardisation of ESG data, from the Non-Financial Reporting Directive, which entered into force in 2017, to the EU Action Plan on Sustainable Finance, which will impose ESG reporting obligations on European investors from 2021.

However, it will take time – possibly years – before we see more companies begin reporting around ESG in a structured and standardised way. Until then, fund managers wanting to satisfy the increasing appetite from investors for ESG, will need to find ways efficient ways to make sense of disparate pieces of information and spot ESG opportunities for their clients.

Tech and innovation needs to be at the forefront of how reporting platforms support fund managers so they can effectively advise their clients.

A combination of data-driven processes is needed to measure and analyse the complex and unstructured ESG data that is available today. Technologies such as artificial intelligence and expertise in handling Big Data make it easier to analyse ESG data. In addition, machine learning and natural language processing (NLP) allows for algorithms to infer context as they sift through a variety of sources, such as annual reports, NGO reports, academic papers, regulatory and legal disclosures to assess a company’s sustainable credentials and performance. Furthermore, using these technologies removes biases and allows fund managers to review a much broader range of sustainable funds available to them.

It’s clear that ESG growth is going to continue to rocket as investors across the world become more conscious of their impact and look for ways to invest money more sustainably way. Smart fund managers will augment their own skills with the right data management platforms so that they and their clients can ride this wave of growth.

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