Five years ago, ESG data aggregation and impact investment research was a cottage industry with fewer than 1,000 specialists worldwide. Fast forward to 2021; there has been a seismic shift in the volume of people with an ‘ESG’ job title.
Over the next five years, we predict that:
- Ever increasing ESG information requirements will thwart standardization plans.
- Market forces and regulations will generate demand for investment-grade ESG data.
- CFOs and CIOs will appoint powerful heads of ESG.
- Asset managers will increasingly be proactive in engagement and voting activities.
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Let me walk you through our thinking for these predictions.
In the sustainability echo chamber, a narrative about impending global standards for ESG disclosures has gained significant traction. This expectation is very unlikely to be fulfilled in the next five years. Instead, Verdantix predicts that there will be more diversification as multiple putative standards compete for air time with issuers.
Further ESG disclosure divergence is demonstrated by Governments around the world actively bolstering their own mandatory ESG disclosure requirements with varying requirements. The EU’s SFDR regulation, the UK’s roadmap to TCFD economy alignment and the USA’s impending mandatory ESG framework are all different.
Expectations that the IFRS Foundation will impose a single harmonizing framework that provides data definitions and a taxonomy to respond to the CDP, the UK Financial Conduct Authority, European Securities and Markets Authorities (ESMA), Fitch Ratings, FTSE Russell, the GRI, the Loan Syndications & Trading Association (LSTA), Moody’s, SASB and the SEC – to name just a few – are extremely hopeful.
The current clamber of Governments and policy makers to improve ESG disclosure is in order to provide ‘investment grade’ data to investors, data categorized as accurate, auditable, complete and timely. This is not the current situation. Credit and equity analysts struggle with the value of self-serving voluntary sustainability reports designed around flaky materiality assessments and data sets with weak assurance guarantees.
As ESG disclosures migrate from voluntary to mandatory and parts of the mandatory disclosures become embedded in regulated financial reports – issuers and fund managers will need to invest in digital systems to provide investment-grade data which reflects the liabilities of financial misstatements.
ETF fund marketers and green bond underwriters are already preparing for a crackdown in the EU and UK on the mislabeling of ‘sustainable finance’ products. The requirements from financial institutions to tackle greenwashing will cascade down onto issuers who will benefit from higher ESG ratings by investing in technology stacks from providers such as Envizi and Project Canary, who gather data from operating assets on an ongoing basis, which provides traceability and auditability.
The rapidly evolving ESG landscape in the last two years has led boards to increasing ask, “what are stakeholders expecting from a corporate on climate change and ESG?”. Seeking answers, board members are turning to advisers at accounting firms and law firms to bring them up to speed on what their duties are now and are likely to be in the future on climate change and ESG. Board-level scrutiny of executives is just one driver behind the creation of a fully resourced financial ESG team.
The incredible pace of change on ESG issues across investors, lenders, rating agencies and regulators requires a core team who can keep track of market developments. This team also needs the authority to impose new ESG-related procedures internally, such as moving funds away from an EU SFDR Article 6 classification, meaning there are no sustainability considerations in the investment process.
Gone are the ex-NGO sustainability leaders from CSO roles. Many issuers are now hiring ex-Big Four partners as their Chief Sustainability Officers. In financial institutions there is a war for talent when it comes to finding people with genuine experience in the ESG strategies, concepts and issues.
Asset managers are also adapting to the increased importance of ESG, with a transitioning approach to engagement activities. Traditionally, asset managers have been passive participants in driving change at investee firms. Voting has been led by proxy advisor policies, and further interaction has been largely due to reaction to shareholder proposals. Since the start of 2020, prominent asset managers have begun adopting a proactive stance by leading policy initiatives focused on ESG issues.
It is quickly becoming apparent that the ESG trend represents more of a permanent shift in the prominence of ESG in stakeholders values. Over the next 5 years, firms that fail to grasp the full extent of ESG presence will be left lagging behind – while companies placing ESG at the forefront of their strategy have an opportunity to prosper.
Verdantix Industry Analyst