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Change and Consolidation: The Coming Year in ESG

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Last year saw some potentially game-changing developments in the ESG data and technology space, especially with regards reporting standards and regulations. It was also the year that ESG became a political football, prompting some investors to review their commitment to sustainability.

In many ways, ESG came of age in 2023. The concentration of responsibilities within the International Sustainability Standards Board (ISSB) was a major step towards the formation of a universal data disclosure framework. The rise of Generative AI (GenAI) opened new possibilities for research and analysis. And the creation of the Taskforce for Nature-related Financial Disclosures (TNFD) cemented biodiversity’s position as a topic of almost equal importance to climate change.

So, how will 2024 to play out? ESG Insight asked a panel of experts to look ahead and make some prediction for the coming 12 months in ESG.

Regulations: The Snowball Continues

Volker Lainer, Head of Connections, ESG and Regulatory Affairs at GoldenSource: Many challenges with reporting and standardisation remain, with a newfound focus on climate and nature requirements set to take up more time in 2024. Carbon emission methodology has come a long way and now appears virtually a given – especially with its uniform meaning applied across regulatory regimes and disclosure frameworks globally.

**Till Jung, Managing Director, Head of ISS ESG, the sustainable investment arm of ISS STOXX:**Regulation will remain a key ESG driver for investors in 2024. To name but a few regulations beyond the EU that will shape the discussion in 2024: the expected ISSB adoptions globally, the Securities and Exchange Commission (SEC) fund-naming rules in the US, the UK sustainability disclosures requirements (SDR), the climate reporting requirements in New Zealand and Australia and the PRI signatory requirement for Japanese pension plans.

Jan Ahrens, Chief Executive, SparkChange: The most closely watched regulation will come from the SEC and its announced ESG disclosure rules, which are scheduled for release in spring. If adopted, they would mandate US listed companies to publish reliable, standardised ESG data, which includes scope 3 carbon footprint data. Furthermore, businesses would be required to conduct climate “SWOT” analysis to disclose risks and opportunities arising from the transition. At the same time, the ISSB disclosure standards might be adopted into law in several countries, including the UK, Canada or Japan, which would establish similar reporting requirements like the SEC rule.

Alexandra Mihailescu Cichon, Chief Commercial Officer of RepRisk: We’re going to continue the trend of companies being focused on regulations, companies upskilling, when it comes to regulations, and the patchwork of regulations around the world coming together. The Taskforce for Climate-related Financial Disclosures (TCFD) had a quick adoption in various jurisdictions around the world for climate risk and opportunity reporting – will the same happen with the TNFD with biodiversity?

Martina MacPherson, Head of ESG Products at SIX, Chair of the Board at FoSDA: We will see a closing of the loops in the regulatory value chain. Creating regulation in certain jurisdictions versus either normative or no-framework frameworks creates even more fragmentation and an aggregate confusion. We need to create a global sense check and we need to build more alignment around the frameworks we are building and the interoperability we are creating.

Till Jung: The challenge for ESG data providers is to constantly update solutions according to the different requirements globally. This requires ongoing commitment to innovate, a robust speed to market with quality solutions and the ability and willingness to constantly invest. Further, regulation now hits a much wider circle of financial market participants than before, and banks especially will be in the spotlight in 2024. Regulation also includes the “self-regulatory” requirements that come with investors joining industry initiatives and commitments:? Net Zero pledges, Climate Action 100+, Biodiversity commitments, PRI and others all require members to report, engage or vote in a certain way and we expect that they will keep turning to us for support in the years to come.

Alexandra Mihailescu Cichon: If we want ESG to be about bringing change, then you must look at what the potential adverse impacts are on people and on planet, which is not part of the equation of single materiality [on which the ISSB’s frameworks are built]. The bottom-line implications are what companies understand and single materiality addresses the bottom line. But it’s not a holistic view – adverse impacts on people and planet also have bottom-line implications.

Technology and AI: Overplayed or Undervalued?

Volker Lainer: The adoption of internal large language models (LLMs) is set to become more widespread to help both firms and vendors handle the depth and breadth of ESG data more efficiently. AI could be used to trawl through existing reports and return with the reasoning as to why a specific KPI – such as a decrease in carbon emissions – has changed over the last year. Nonetheless, the whole ecosystem requires transparency, and AI is no exception. It is incredibly important to be clear about exactly where and how firms engage with it. I’m sure this will occupy the minds of the regulators next year.”

Till Jung: Focus will remain on a useful application of AI-based solutions, although many investors seem to be reappraising excessively high expectations in some areas and now see AI-empowered analysts as more reliable for robust ESG understanding than stand-alone algorithms.

Martina MacPherson: We ****know that GenAI, for instance, is a very good source if you need to get a summary on a specific topic that you pre-specify but is it the single source of truth? Can you eliminate analysts interpreting information and maybe building secondary opinions? I don’t think so. We’re not yet at that stage. We need to take everything with a pinch of salt and that’s what we’re seeing, that’s what we’re hearing. We need to be very much aware that now there’s more information out there that we start really building the mechanisms, means and tools to interpret the information to help with navigating the complexity jungle.

Data and Data Management: Rising Demand

Leila Sadiq, Global Head of Enterprise Data Content at Bloomberg: 2024 will see an unabated demand for high-quality and interoperable ESG and climate data that firms can rely on to make investment decisions and use for regulatory reporting. Another trend is the growing frustration with managing disparate ESG data point solutions across providers. Reconciling this data can be extremely time consuming and complex. I expect to see more consolidation in this space and the use of data management solutions.

Alexandra Mihailescu Cichon: Data providers should be able to explain the purpose of what their data set is and they must be transparent. They owe that transparency to the market and to their users. Without that, how can you meaningfully apply data if you don’t know what it’s for and how they build it? And I think the regulators will address that. Regulations for data providers will come through. I think it’s going to perhaps create a separation between the existing data providers – who’s going to make the cut, who is going to be able to take that step to be to be transparent in their processes and in their methodology, what changes to the business will need to be made to avoid conflicts of interest?

Patricia Torres, Global Head of Sustainable Finance Solutions at Bloomberg: A big theme is assessing exposure to physical risks like extreme climate events. This type of analysis relies on large amounts of geospatial and climate data to effectively account for the uncertainty inherent in future climate projections.

Till Jung: Investors’?consumption of data will keep diversifying and ease of access will be key – from the use of data providers’ platforms through to feeds via aggregators and cloud solutions – or a combination of the above. Automatic report generation to cater to reporting requirements from taxonomy, SFDR and other regulatory initiatives are a requirement to simplify workflows.

Alexandra Mihailescu Cichon: ESG has become anything that’s sustainable. But it’s so broad and so ambiguous, that to some extent the phrase has become everything and nothing. That’s the risk; it’s muddled. But I think we will slowly move to a disaggregation of ESG. Investors and data providers are in many cases disaggregating their data. The rating providers are providing more raw data because clients and users want to see the disaggregated data. It also doesn’t hurt from the political or the regulatory side too because you see regulations are also disaggregating – there’s human rights regulations, biodiversity, there’s climate change, and so on. There’s been pressure on data providers to be transparent to avoid conflict of interest and to have a variety of mechanisms in place to allow for just transparency in their overall processes and methodology, and that trend will continue

Ratings and Analytics: Watershed Moment

Till Jung: The ratings field will likely be dominated by the EU ESG rating regulation that is currently being discussed in Brussels. The current reading points mostly at transparency and good governance requirements. At the same time, ESG ratings will be facing an ever more nuanced user base. We experience that the materiality approach of our ESG rating helps cater to both impact- and risk-focused investors and the ratings “absolute” approach that looks at corporate performance versus needs to address global challenges adds an important element of understanding to investors’ analysis.

Jens Ahrens: In 2023 we might have seen the beginning of the end of ESG ratings as we know them. However, there are more niche ratings establishing. As companies look to navigate the quality issues around voluntary carbon markets, offset quality ratings from BeZero, Sylvera or others have grown significantly and will likely do so in 2024. At the same time, investors increasingly look at integrating financial risks from the transition into their conventional risk metrics, so that there is increasing need for long-term physical risks and short-term carbon price risk analytics. It looks like 2024 might be the year where ESG metrics evolve from “marketing” metrics in sustainability reports to financial metrics on the balance sheet, and rightly so!

Till Jung: The appetite for raw ESG data will increase as institutional investors are under pressure for more transparency and accountability. This will result in investors disaggregating ratings’ components as well as (re-) assembling raw data and indicators based on an investor’s specific preferences and weighting to reflect their own DNA. Further, simple data-aggregation solutions to quickly grasp ESG risks and impact for the retail market will see further demand.

Alexandra Mihailescu Cichon: I do think we’re approaching a watershed moment for providers that have operated in a pretty free, self-regulating operating space over the last 10-15 years. And that’s changing quickly. In particular, I want to see who is going to publish their methodologies next, who is going to take the next step forward.

Investment Themes: New Topics

Patricia Torres: Biodiversity and impact investing are emerging as big themes for our customers. As regulation around biodiversity and sustainability tightens and investors search for datasets to help them identify companies at the highest risk, we remain steadfast in our commitment to provide our customers with the data they need to pursue their investment strategies.

Martina MacPherson: Nature-related themes have risen up the agenda quite quickly. I’ve commented on quite frequently, as well, the need for more and better data here. And we absolutely need more and better high-quality, high-integrity data together with TNFD, who are really pushing the needle here right from the start in order to really get access to as much information as possible. To aggregate, to normalise, to standardise – that’s where I see the role of us as data and information providers of the future.

Till Jung: The area of biodiversity will likely see a tipping point of uptake by the market and Net Zero will keep trending. In addition, the datasets that help navigate the current global polycrisis – data on Global Sanction, on weapons, on Energy and Extractives or Modern Slavery – will likely still be in high demand in 2024.

Politics: Time for a Rethink

Alexandra Mihailescu Cichon: ESG advocates must reframe ESG because most people agree on the substance of ESG, all the things that fall under that umbrella. Most of those are non-political issues that most people agree on. Climate change is a unique one that has been politicised to some extent. But other issues, whether its nature preservation or good labour standards or clean water, those are not political. So, I think there needs to be a reframing of ESG as good business and as good risk management. Once you do that then it’s clear that it’s part of fiduciary duty and part of a company’s core expectations.

Martina MacPherson: The political agenda has been used and abused to move away from say, Paris Agreement trajectories and development goals. That is not serving the right purpose. I think by focusing and emphasising more on the scrutiny around disclosures, also from the side of the data providers and the wider market here – which are part of the value chain – and not just issuers and investors. I think that will bring back some of the credibility momentum we need. We need clarity, comparability, consistency – the three C’s – to continue with this momentum and scale.

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