The implementation of the European Union’s Sustainable Finance Disclosure Regulation (SFDR) has been anything but smooth, with warnings of greenwashing, waves of reclassifications, and growing investor complaints even triggering a review by the European Commission. 

Yet while much of the attention has focused on the ever-shifting Article 9 landscape, investment firms have also had to grapple with the task of producing principal adverse impact (PAI) reports. 

This year, for the first time, firms that fall under SFDR had to publish a document detailing the impact of their investment decisions on a series of sustainability factors.

Investors were required to produce an entity-level report quantifying their impact on 14 mandatory indicators across environmental and social topics, as well as two additional indicators chosen from a separate list. 

In the first of a new series, Responsible Investor looks at how investors have found the process, as well as prevailing data troubles and varying approaches to overcoming them. 

Only a slice of the PAI 

The variance in data availability was – alongside data gaps generally – resoundingly the biggest issue flagged by asset managers in the 30 PAI statements reviewed by RI.

Summing up the view of many investors, Pia Gisgård, head of sustainability and corporate governance at Swedbank Robur, tells RI that there are “still a lot of uncertainties” regarding the reporting and how the requirements should be interpreted. “The data quality and availability differ substantially between the PAIs and between service providers.”

In its report, Legal & General Investment Management stated: “The accuracy of the data sourced, researched or estimated cannot be fully guaranteed. The availability and quality of data are still very limited across many adverse sustainability indicators … For certain indicators, data coverage was below 10 percent.” 

The UK investor said there were several reasons for this, flagging in particular poor issuer disclosures resulting from a lack of regulation compelling reporting of relevant data. Meanwhile SEB’s report flagged that availability is low for certain PAI indicators as only some sectors are covered. 

“The data quality and availability differ substantially between the PAIs and between service providers”

Pia Gisgård
Swedbank Robur

Elizabeth Lance, assistant chief counsel at ICI Global, says the industry group’s members have broadly flagged poor coverage, even among mandatory indicators. Anecdotal reports suggest that for some this is as low as 3 percent.  

Almost half of reports in RI’s sample flagged tonnes of emissions to water and unadjusted gender pay gap metrics as having poor coverage, while the hazardous and radioactive waste ratio was also a common concern. 

Other issues highlighted included concerns around data quality in emerging markets, data time lags, indicators being too narrow in scope, challenges in setting targets without coverage, methodological issues, and accuracy concerns surrounding the use of estimations to address gaps. 

Unsustainable reporting

BlackRock noted that fluctuations in AUM or asset value may mean PAIs improve or deteriorate without any change in actual sustainability performance. It added that a “significant proportion” of the data it receives is still estimated. 

The US group, which had to produce reports across five national entities, also raised concerns that ESG data reporting may lag relative to financial data, with firms only reporting annually and a delay between the disclosure of data and its inclusion in data sets.

A figure at one data provider said the fact that dates used for portfolio holdings differ from those on which enterprise value including cash (EVIC) is taken, and that both differ from the “typical time stamp” of ESG data itself, was also causing issues for investors. 

Markus Høiberg, a senior analyst at KLP, tells RI: “For the more obscure indicators like hazardous waste or emissions to water we have really low coverage, so we are estimating based on a really small amount of reported data. So that is a big challenge for the quality of the data.”  

Lance says that ICI Global’s members are looking for more granularity from data providers about where information comes from and what methodologies are behind it, as well as “more transparency about estimates and assumptions”.  

Given data uncertainty, she says: “There are concerns around whether we’re coming to this in a consistent way that’s actually going to tell us something important, or whether we’re just generating things to fulfil the regulatory reporting requirements.” 

She also questions recent comments by Patrik Karlsson, a senior policy officer at ESMA. During a hearing on proposed SFDR reforms put forward by European regulators, Karlsson appeared to suggest that investors should make assumptions about negative impacts even where they are not disclosed.

Asked about the discrepancy between mandatory reporting for investors and voluntary reporting for companies on certain indicators under the European Sustainability Reporting Standards (ESRS), Karlsson acknowledged that availability of data was important. 

At the same time, he said: “Presumably there is some kind of adverse impact even if the company doesn’t disclose it. It doesn’t seem to us at least that the legal requirement or obligation to disclose your adverse impacts is limited to where the company happens to inform you about them.”

Lance says this seemed excessive. “From a regulator, steering people towards making assumptions where there is no reported impact I think makes them uncomfortable. To have a regulator say that when there isn’t any information you need to assume there is a negative impact, that’s a little extreme.”

Filling in the gaps 

Managers have taken diverging approaches to dealing with the various issues around PAI reports. Some, such as Northern Trust, have chosen the “explain” route, holding off on reporting until data coverage improves. 

The firm said it would look at product-level reporting first and consider a whole-entity approach at a future date “when data availability, reliability and consistency has vastly improved”.

Similarly, Credit Suisse argued that it would not be able to meet its “high transparency standards” if it produced a report.  

In a bid to address the various data gaps and challenges, several investors have utilised multiple data providers.  

These include Robeco, which adopted what it calls a “best of breed” approach for data sourcing, “combining what we deem to be the strongest provider for each category of information”. The firm used six data providers across all indicators. 

“When you think of biodiversity, you can imagine that when corporates define how material biodiversity is to their entire operations, it will be limited”

Dennis Hänsel
DWS

For Dennis Hänsel, global head of ESG advisory at DWS, multiple data providers are necessary for two reasons: better coverage and data availability, and a second opinion on indicators with outliers or deviations in the data.

For every PAI, DWS looks for where coverage is best and then decides whether to average or take the worst number for the indicator. 

Echoing this, Candriam’s report stated that differences in providers’ coverage, methodologies and culture may lead to discrepancies in views and final ratings. “These different assessments provide our ESG analysts with a more holistic view of a company.” 

Despite taking a multi-vendor approach, Hänsel notes that there are still data challenges for indicators such as biodiversity. “ESRS for corporates gave the decision of materiality to the corporates so they can decide if any issue is material to them, and if it’s not material they don’t have to provide information around it. And when you think of biodiversity, you can imagine that when corporates define how material biodiversity is to their entire operations, it will be limited.

“So even in the near future, there will not be information directly from corporates, and then you go to the rating agency, which will currently have coverage of around 15 percent.” 

Multiple downsides

Other investors warned against the use of multiple vendors. APG argued that appointing multiple data suppliers would not result in a material expansion of data coverage of the invested universe and would risk introducing internal inconsistencies.  

Danske Bank AM used ISS as its core vendor for all but one indicator. “That has implied that potentially for some of the indicators, we might have a lower data coverage than if the guiding principle had been we should just select the vendor for each indicator that provides the best coverage,” says Stine Lehmann Schack, head of responsible investment frameworks and governance at the bank.

She says Danske was very conscious of the risk of cherry-picking. “We do not want to end up in a situation where investors or others might believe that we have chosen the vendor that carries the best result for the report.”  

Given these issues, Amundi’s statement warned that despite best efforts to mitigate, there is a “possibility of a substantial margin of error in our calculations”. The French manager added: “We encourage stakeholders to exercise caution and consider this potential margin of error when interpreting and utilising the provided information.” 

Similarly, LGIM warned that it “would be prudent to exercise caution in relying on the data as accurate representations of principal adverse impacts”. 

Anne Schoemaker
Anne Schoemaker, Sustainalytics

The UK investor also noted that, given the range of data sources and methodologies used, comparability of data across reports published by different financial market participants will be limited. 

Anne Schoemaker, director of ESG products at Sustainalytics, agrees: “Comparability is impossible for now. Although investors will be able to use PAIs to scrutinise strategies and commitments of an individual financial firm once historical comparison is possible, comparability between investors will depend on whether further regulatory guidance makes approaches converge further.”

Data outlook

Many investors predicted that data coverage and quality will improve as corporate disclosure become mandatory through regulations such as the EU Corporate Sustainability Reporting Directive (CSRD), and as the volume and quality of voluntary issuer disclosures improve.  

However, Kamil Zabielski, head of sustainable investments at Storebrand, warns of a “Catch-22 dilemma” if requirements for portfolio companies under CSRD are not aligned with investor disclosure requirements.  

Going further, Lance says: “Even if the EU were to require everything from everybody in the EU, it’s still only going to settle a minority of the data challenges out there.”

Meanwhile KLP’s Høiberg suggests that indicators should be made more precise and cut down to sectors where they are more relevant. 

On the value of entity-level reporting, Zabielski notes: “You can question whether an entity-level statement really says something of value for an investor, especially since it’s difficult to compare with others, when everyone is using different data providers and has different approaches to investing.” 

He adds that looking at PAIs at fund level rather than entity level may add more value in showing the sustainability performance and changes in product offering of investors over time. 

Investor opinions were not universally negative, however. DWS’s Hänsel expresses support for entity-level statements. “It gives people an understanding of the inside-out effect of what we’re doing. As an asset manager, even with the difficulties to disclose what we do in funds, I believe this exercise provides a useful guideline to share this very important information to portfolio managers, distribution partners, and external stakeholders on an entity level.” 

Danske Bank AM’s Schack also praises the strictness of mandatory indicators. “Often when you start reporting, the first decision to make is what metric would be relevant to evidence performance. This regulation provides a really good tool to ensure we have consistency and alignment across various asset managers.” 

ICI’s Lance, however, is unconvinced by the case for entity-level reporting. “If they were to do away with it, I don’t think our members would feel sad about that.

“Investors invest in a particular product. They don’t invest in an asset manager, and asset managers can have a variety of products that are looking at a variety of different things. So when you aggregate these impacts up to an asset-manager level, what is that really telling anyone?”