ESG Data: The Case for Transparency

Joao Sousa Dias, Sales Director

It seems there is nothing hotter in investing today than ESG. While long considered a “tick box” activity, environmental, social, and governance factors have taken centre stage in recent years amid pressure to address issues such as climate change and diversity, as well as societal changes spurred by generational transition. Among investors, though, the catalyst with the biggest impact is the mounting evidence that accounting for ESG factors can improve returns.

“Incorporating ESG analysis into the investment process can add between 50 and 100 basis points per annum to returns,”Arabesque’s Andreas Feiner quantified in an interview with Eagle, adding that it: “imparts a slight reduction in the overall risk”. The numbers support the narrative that impact investors have been making for years. Companies with high ESG standards are likely to be better run, more resilient to changes in regulation, and less susceptible to being fined or suffering reputational issues over the long-term.

That’s the good news for investors. And it helps explain gravitation to socially-responsible investment strategies, as some €19.2 trillion is committed to sustainable strategies worldwide, according to the Global Sustainable Investment Alliance. Europe leads the way in this, accounting for well over half (57%) of professionally invested funds employing sustainable strategies globally. The bad news, however, is that ESG can be a labour-intensive pursuit for firms that don’t have their “data house” in order.

According to the consulting firm Opimas,total spending on ESG data will increase by around 48% in the next two years. Asset managers and asset owners alike are looking to incorporate ESG data to drive both investment decision-making and investment analysis. Furthermore, while ESG factors have traditionally been the preserve of equities, increasingly ESG-based fixed-income indices are emerging. As a result, the demand for ESG data has never been higher and will only continue to grow.

Meeting this demand is easier said than done, however. The availability of data is scarce with vendors playing catch-up as ESG strategies multiply. To fill this void, a range of heterogeneous ESG data services have been introduced, yet standardisation—and, more importantly, standards—have yet to materialise.

This is no great surprise, since the regulatory environment is still developing and ESG measurement is still in its infancy. As Andreas Feiner points out, in the last two years regulators have introduced nearly 300 different rules focused on sustainability and corporate governance. While this is likely to improve ESG reporting—and provide greater opportunity for investment decision makers to identify metrics that deliver outperformance in the longer-term—in the short-term, it holds back standardisation.

Moving Forward, Without Waiting on Consensus
While practitioners would certainly prefer having the expectations outlined, in the absence of consensus, most recognise a need to provide transparency on the criteria used to calculate and explain given ratings. This is essential to avoid ‘greenwashing’ as well as any generalisations.

It’s possible for a company in a decidedly unsustainable sector to achieve a high ESG rating, for instance. A modern coal plant might provide one example. Alternatively, it can be dangerous to exclude entire sectors that some would argue don’t align to ESG principles. Consider the mining space. If the sector is overlooked altogether, it means investors are not acknowledging mining firms with high standards of governance and sustainability.

Some would argue that there has hitherto been too much focus on the environmental factors of ESG at the expense of social and governance considerations. This is not without good reason, as environmental factors are typically easier to measure and standardise. Carbon emissions measurement, for example, can be quantified and tracked over time. Social and governance factors on the other hand can be more nuanced and subjective. For example, what constitutes good ‘social’ standards will vary by country and culture, and what is acceptable in one geography may be forbidden in another. Achieving consistency against this backdrop is incredibly challenging, which is what makes transparency and granularity so important when it comes to ESG data.

The answer, however, is robust data management. It enables firms to understand and compare ratings, provides context around the reasoning behind those ratings, and allows organisations to reliably use more than one data provider to compare multiple points of view. Data management can also provide assurance about the data quality and highlight ways to spot discrepancies. It allows users to slice and dice position-level information on ESG (be it by country or sector); and, importantly, it allows users to roll up this granular ESG data to each level of the classification structure.

Arabesque, which introduces big data capabilities to ESG investors, provides access to over 200 different ESG metrics from over 50,000 sources on 7,000 of the world’s largest corporations. As one of our strategic alliances, our clients are able to access and incorporate this sustainability data into their own investment platforms, providing transparency to support their investment decision-making processes.

The potential for ESG-based investment strategies is huge, with retail and institutional investor demand likely to continue to increase. However, timely and accurate data that can be interrogated and assessed on a granular level to support the decision-making process is essential if the industry is to fully realise its potential.

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