By Rebecca Healey, Co-Chair EMEA Regional Committee and Co-Chair EMEA Regulatory Subcommittee, FIX Trading Community.
The growing requirement for asset managers to evidence how ESG risks are factored into investment decisions has compounded the amount of non-financial data that now needs to be taken into consideration. A few years ago, an overall ESG score may have sufficed in demonstrating adherence to sustainable policies. Now, increased regulatory scrutiny, combined with more sophisticated client demands, are leading asset managers to reconsider the information they need to review and look at the underlying data that makes up the ESG score.
The pandemic also highlighted that a portfolio manager can no longer look at a company in isolation of its supply chain, further expanding the data points that will have to be collated, curated, and analysed.
Forthcoming research from Liquidnet Investment Analytics shows that the growing integration of sustainability factors is leading the buy-side to make significant investments into third-party analytics to uncover alternative sources of information. Whether it is real-time data such as social media sentiment and searching the internet for the latest news on a company, or more historical information, portfolio managers are looking at the data that will give them the edge to build a more thorough understanding of a company and its possible risks.
Not every jurisdiction is at the same development stage when it comes to ESG data. Europe may have led the charge, but other countries such as China and the US are waking up to the challenge. Given the global nature of financial services and portfolio holdings, accessing non-financial as well as financial data on companies lies at the heart of the need to improve ESG standards globally.
The current lack of commonly agreed standards about what ESG entails, as well as existing data fragmentation, make it challenging for asset managers to compare data and evidence their investment decisions, which in turn increases the risk of greenwashing. This is further complicated by the risk of conflicting regulations from one jurisdiction to another, and the myriad of private initiatives that have emerged attempting to define standards for the industry to adopt.
The recent announcement by the European Commission to replace the Non-financial Reporting Directive (NFRD) with the Corporate Sustainability Reporting Directive (CSRD) is a welcome change as it will expand the number of companies subject to non-financial reporting from 11,500 to 50,000. In addition, the decision to use Inline XBRL[1] could be the first step in providing detailed, consistent and comparable data to asset managers, which in turn will help them make more informed decisions.
ESG remains a fluid concept and is characterised by different interpretations of what constitutes a ‘green’ investment. The need to evidence how ESG factors are incorporated into the decision-making process is increasing asset managers’ nervousness of what holdings they should keep and which should be removed from the list of investable assets.
This could soon pose liquidity risks and may inadvertently create an ESG bubble. To prevent this, greater company disclosures can ensure portfolio managers understand the full picture – current and future risks as well as those from subsidiaries and supply chains.
For example:
- Data centres require power to operate. The race to carbon-free electricity is forcing companies to rethink how these data centres are powered by investing in renewable energy such as solar panels[2].
- The procurement cycle will increasingly matter, as consumers look at where and how food products are sourced. In June 2020, 63% of French people highlighted they were ready to consume locally to support the economy[3].
- Social considerations continue to increase as well as how a company treats its employees; one could argue that one of the reasons Deliveroo’s IPO was not as successful as anticipated could be linked to the working conditions of its employees.
These new challenges are more than adequate incentives for investee companies, as well as asset managers, to address how to access more accurate and comparable data. Without this access, asset managers will not be able to fully understand which risks are material to the future performance of an investment. Sustainability should remain focused on the future viability of a business model and, while both quantitative and qualitative analysis are essential, comparable data will be what makes ESG investing successful – and ensure economies become carbon neutral by 2050 in the process.
[1] https://www.xbrl.org/news/big-news-europe-to-get-mandatory-digital-esg-disclosure-using-inline-xbrl/#:~:text=Europe%20to%20get%20mandatory%20digital%20ESG%20disclosure%20using%20Inline%20XBRL,-Posted%20on%20April&text=The%20European%20Commission%20has%20adopted,Financial%20Reporting%20Directive%20(NFRD) [2] https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/beyond-the-ppa-quest-for-24-7-carbon-free-power-is-reshaping-energy-buying-64195343 [3] https://www.ipsos.com/fr-fr/63-des-francais-se-disent-prets-consommer-le-plus-de-produits-locaux-possibles-pour-soutenir
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