The European Union’s wide-ranging ESG regulation has imposed in financial institutions, huge data gathering responsibilities, many of which are a challenge to meet. But the requirements of the Sustainable Finance Disclosure Regulation are expected to actually help solve some of the challenges that currently make compliance difficult.
In particular, SFDR is seen as a galvanising force in generating more ESG data to fill yawning gaps in corporate sustainability record. That’s especially so for data from smaller businesses – information that will be key in enabling financial firms to disclose the ESG impact of supply chains on the companies in which they invest. Adrian Whelan, Senior Vice President and Head of Regulatory Intelligence for Investor Services at Brown Brothers Harriman, said SFDR had become a “lightning rod” for asset managers and that he was confident the regulation would help fill those gaps.
“Investors, and where we want to put our money, are actually shifting the dial,” Whelan told A-Team ESG Insight’s most recent webinar, which discussed how firms were marshalling their data to comply with SFDR. “Every investor wants or needs non-financial information. That’s why we’re going to drive this forward quickly.”Such is the demand for sustainable assets and financial products, said Whelan, that investors “can’t invest or continue to invest” if they don’t have the data.
Regulatory Requirements
SFDR, which came into force last year, requires financial firms to report on their ESG performances. To do that they need data about how their own activities affect the environment and society as well as that of their investee companies. Linked to SFDR is the EU green Taxonomy, which provides firms with the framework against which they must benchmark their sustainability.
Its introduction triggered what Anyve Arakelijan, Regulatory Policy Advisor on ESG and Stewardship at the European Fund and Asset Management Association (EFAMA), said has been an evolution in the market for sustainable investment products. More and more funds with a sustainability theme have been created since the regulation’s formulation. Indeed, Bloomberg estimates that the mushrooming industry will be worth more than US$50 trillion by the end of the decade.
Nevertheless, data gaps remain a challenge to companies.
In particular, explained Arakelijan, the lack of high-quality, standardised ESG data on investee companies remains the number-one issue that asset managers are grappling with notably for the reporting obligations under the SFDR Level 2 templates. For example, PAI indicator reporting remains challenging as there is not always a dataset available.
This could leave asset managers and manufacturers of financial products vulnerable to accusations of greenwashing – making unsupported claims about an asset or a fund’s sustainability record – she said.
“Greenwashing is not necessarily caused by deliberate misconduct by asset managers, it can happen as well if the investment decisions are based on sustainability data that is incomplete or insufficiently standardised, which is currently often the case unfortunately,” Arakelijan said.
Patchy Coverage
Exacerbating the problem is the patchiness of data availability worldwide, with less available in emerging markets and those with weaker regulatory frameworks for ESG, said Franita Neuville, Research and Portfolio Management Sales Director for Northern Europe at Refinitiv, an LSEG business. There are also sectoral differences, with the preponderance of information readily available for climate change and environmental impacts and less so for social and governance factors
But the panel heard that there are other reasons to be optimistic.
Greater standardisation of reporting frameworks and better data availability is expected to come with the full implementation of the Corporate Sustainability Reporting Directive (CSRD), an SFDR for non-financial companies, which is expected to yield far more information from smaller companies, panellists agreed.
And there will be inducements for those companies to report too. Failing to offer the proper information could leave corporates wanting for credit and capital from investors who are increasingly screening out non-compliant issuers. Making it easier for corporates to report, then, has become an opportunity for vendors and technology developers, which they are taking advantage of by creating self-reporting products, said Neuville.
Another encouraging development is that a greater number of financial institutions are seeking raw data as well as aggregated ESG scores, which have been criticised for their inconsistency. These firms are using the information to create their own scores. Such has been the shift in demand that two-thirds of firms are now asking for raw datasets, Neuville explained.
Despite pushback from some politicians and executives, ESG is now firmly rooted in the fabric of the global financial system, the panel agreed. And that’s unlikely to change for many reasons, not least because investors see value in the market. ESG may be expensive to implement, but the benefits become apparent quickly, the panel agreed.
To ignore ESG would be reckless and costly, concluded Whelan, depriving firms of a critical competitive advantage.
“The ESG train has only just left the station,” he said. “So you’re either on that train and put in these upfront costs and efforts or you don’t and you get left behind.”
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