With the first deadline of the EU’s Sustainable Finance Disclosure Regulation (SFDR) fast approaching on 10 March 2021, is your organisation data ready for compliance, what data management challenges are you facing, and how can these be overcome? Still more, how prepared is your organisation for the next deadline on 30 June 2021, and the final deadline to complete implementation of the regulation by 1 January 2022?
To assess the current situation on data and data management for SFDR, consider longer-term implications of the regulation, and weigh up whether the regulation will be a burden or benefit for financial market participants in scope, we talked to Environmental, Social and Governance (ESG) experts Mark Davies, partner, and Tim Fox, senior associate, at data consultancy Element22. As well as advising asset managers on ESG compliance, Element22 is developing a product for ESG data reporting.
Essentially, by the 10 March 2021 SFDR deadline, asset managers must meet a ‘comply or explain’ requirement, either complying with the key transparency element of the regulation by being able to demonstrate how they are using ESG data and factors internally in the investment process, or explaining why sustainability risks are not relevant to them.
The 30 June 2021 deadline, sometimes overlooked as organisations work towards final implementation of all the EU’s SFDR Regulatory Technical Standards (RTS) by 1 January 2022, is equally important and provides no stay of execution as it ends the ‘comply or explain’ option for all asset managers with more than 500 managers.
Challenges of compliance
The challenges of SFDR compliance are many in a fragmented landscape with a number of voluntary standards and data vendors with their own interpretations of ESG products. SFDR is also the first mandate on ESG investing. While it seeks to implement ESG standards in line with the United Nations’ Sustainable Development Goals (SDGs) and avoid greenwashing by identifying criteria for ESG products, it does not line up with voluntary standards and is prescriptive about data points and how ESG data calculations are made.
Considering the challenges, Fox notes the level of consistency in ratings, saying: “The correlation of ESG ratings across the market is low at 60%, compared to 90% correlation in the credit ratings world. This inconsistency results from a lack of standards.” He describes most ESG data as ‘exceptionally unstructured’, often information prised from CSR and annual reports, and the requirement for all metrics to follow European reporting formats. For example, all financial numbers must be published in Euros, adding the challenge of currency transformation. ESG data must also be rolled up to issuer level.
Looking at data sourcing for SFDR compliance, Davies says: “Many firms struggle to source data when a new regulation asks for information for the first time.” With SFDR there are problems such as investees not being public companies and thereby making it difficult for asset managers to source ESG data about them. “Each firm must address what ESG data is provided by existing data vendors and find solutions to bridge gaps ahead of reporting. ESG technology will help here.”
Large fund managers are expected to use vendor data for underlying data points – of which there are about 50 – and manage their own ESG calculations and modelling. Smaller firms are likely to be more dependent on data vendors across the SFDR reporting process.
How to gain business benefit from compliance
While the data management challenges presented by the regulation are significant, compliance could be beneficial to the business. Davies says: “This is an opportunity in the market. Proactive firms that create ESG master data sets, bring ESG into the core of their business, and manage it as an asset will gain competitive advantage.”
While SFDR is the first regulation covering ESG investing, it certainly won’t be the last with the UK post-Brexit planning similar and maybe more challenging regulation – and potentially causing dual ESG reporting requirements. Other countries are sure to follow.