ESG data quality tops list of investor concerns in 2020

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Investors have continued to sound the alarm over the quality and fragmentation of ESG data in 2020, yet the market has exploded with providers offering data sets on every sustainability trait imaginable. So what gives?

First, not all ESG data is created equal. At company-level, the gold standard is still information which is disclosed directly by firms. A recent study on corporate carbon emissions, a commonly used data point, found that self-reported data is 2.4 times more accurate than estimates provided by third parties. Researchers concluded that the current reliance on estimated emissions in some cases made investors highly susceptible to greenwash.

This is a problem. Only a fraction of companies choose to report sustainability information, and the rules governing the topic are loose in most jurisdictions. This is a sore point for investors who complain that companies are exploiting the lack of regulation to evade scrutiny – particularly in areas where little progress has been made, such as ethnic diversity, waste management, labour rights or the transition away from fossil fuels.

Some players are taking things into their own hands, instead of waiting for regulators to introduce stricter self-disclosure rules for companies. In April, tech and investment titans Microsoft and BlackRock brought their collective might to bear, announcing joint research grants to improve ESG data quality. One month later, State Street said it planned to bring together a “critical mass of asset managers” to work on climate data.

Observers like 2° Degree Investing Initiative have been calling on investors to develop alternative data sources, rather than relying on self-disclosure. On this, there have been signs of movement this year: Dutch investment house Robeco, for example, has become an early adopter of ‘spatial’ information, which integrates satellite data and machine learning to physically observe the environmental performance and risk of a company’s operations in real-time.

Others see collaboration as the most pragmatic route. A group of investors and service providers, including Allianz and S&P, are establishing a new platform offering free-to-access, open-source ESG data and analytics. Additional licensing rights will be available for a fee.

Regulation

For their part, regulators across the world are hunting for ways to improve the quality of raw ESG data. The European Commission is in the middle of a comprehensive overhaul of the rules which govern corporate sustainability disclosures, the Non-Financial Reporting Directive. The revised regime is set to be announced in March.

In the meantime, the Commission has put the onus on fund companies and asset managers to provide granular ESG data for investment products, in a bid to avoid greenwashing and increase transparency. We’ve seen industry groups reacting coldly to the proposals so far, arguing that comprehensive corporate disclosures need to be in place before investors can provide sufficient information at fund level. Without this, they would be forced to pay for expensive third-party estimates to plug gaps, leading to a “lock-in on the side of data purchase”, industry groups warned in May.

In September, the Commission addressed some of these concerns by promising to give investors “seamless access” to financial and sustainability corporate information through the creation of a dedicated platform. The announcement mirrors a move made by the Canadian Government to provide a central hub for climate data.

And today has seen perhaps the most ambitious push for regulation. In a joint statement, French and Dutch market authorities proposed a new regulatory framework to govern ESG data services in the EU, including mandatory authorisation from EU regulator ESMA and specific requirements for internal controls and governance. The proposals would address conflicts of interest and greenwash, the authorities said.

In the US, the Securities and Exchange Commission (SEC) has been dragging its feet on ESG disclosures and broader sustainability issues, taking its cues from outgoing President Trump. Still, the SEC has been coming under increasing pressure from its own committees to standardise ESG reporting (its Asset Management Advisory Committee has suggested in recent weeks that the regulator mandates ESG risk disclosure with the same weight as generally accepted accounting principles); and with Joe Biden entering the White House, big developments could be on the cards in 2021.

Despite the fledgling attempts at convergence, there is a feeling among ESG data firms that unified disclosure standards are a long way off. The CEO of one ESG data provider told me this year that, while she saw why people wanted standardised information, “having a diversity of providers and approaches helps the discussion mature at this early stage, and gives us more of a chance to get it right eventually”. Going too fast could result in poor policy, she warned, and not every investor wants to use the same data as everyone else.

ESG Ratings

The developments haven’t just been on the side of raw ESG data this year. The ratings and scores that third-party providers develop using such data continue to have a major influence on investor decision-making.

This has been seized upon by a number of emerging markets that see improved coverage of domestic firms by ESG data providers (and better scores) as crucial to attracting foreign capital. At least three countries – Taiwan, Thailand and Malaysia – have inked agreements with global ESG firms to make their ratings freely available in domestic markets, in a bid to encourage disclosure and engagement by local firms.

The same view lies at the heart of the Asian Infrastructure Investment Bank’s ambitious strategy to develop regional Asian capital markets. Over the next few years, the development bank’s managers, Amundi and Aberdeen Standard Investments, will establish climate and sustainability data sets for companies in the region, which they will use to inform two new investment strategies.

ESG data firms are also moving to ‘free up’ their top-line ratings, seen as a response to longstanding criticisms regarding the lack of convergence in ESG ratings between providers. MSCI, Vigeo Eiris and Sustainalytics are among the big names driving the trend. But, since only high-level ratings are being reported and not the underlying data, it is unclear whether the move will impact the perceived transparency of ratings.

There are questions over whether, with governments and regulators under pressure to provide raw ESG data freely to enable investors to comply with the flurry of new disclosure rules, and with most of the big ESG providers making their ratings free in 2020, there will be anything left for them to sell. But with Bloomberg entering the space in 2020, mainstream players continuing to snap up dedicated ESG data houses, and big names being drafted in to help position companies as leaders in sustainability data, there are no signs of a slow down.