Lack of higher quality ESG data becomes pressing issue for investors
Lack of consistent reporting standards for ESG data is a major barrier to sustainable investing as putting unstructured data into easily consumable format remains a challenge
The Hong Kong Monetary Authority recently introduced a series of key measures on sustainable banking and green finance, supplementing the Securities & Futures Commission’s recent Green Finance Strategic Framework and HKEx’s updates on its environmental, social and governance (ESG) disclosure requirements.
Despite the uptake among many professional money managers, the lack of consistent reporting standards for ESG data presents a major barrier to the increased adoption of sustainable investing. This hurdle forces investors to expend excessive effort trying to standardize and interpret unstructured data, slowing down investors and inhibiting new entrants.
The challenge of standardizing data
Businesses are under pressure to satisfy increasing demand for more and better ESG data, which is especially challenging given the plethora of reporting platforms and requirements and lack of consistent reporting standards for sustainability performance.
As a result, different data points may be reported across companies in the same sector and even the same company may report different data points from one year to the next. The inconsistency creates challenges for investors, adding to the confusion and level of effort required to make sense of how companies are creating or destroying value.
Despite these inconsistencies in the data, organizations such as the Sustainability Accounting Standards Board (SASB) and Global Reporting Initiative (GRI) have made immense progress in creating reporting standards.
SASB for example recently released 77 industry-specific accounting standards, adopted by a dozen major international companies, that help investors understand how material sustainability issues can impact a company’s financial performance. While standardization benefits analysis, it also creates more information to sort through and putting all this unstructured data into an easily consumable format remains a challenge.
Another challenge is that some ESG information is only partially measured and accounted for. For instance, one company may report the carbon emissions of its entire business, while another firm may only report the carbon emissions for its headquarters only.
Demand for customizable data
ESG scores, which provide a single metric by which to evaluate companies on a range of ESG issues, have been in vogue in recent years, proving to be a useful metric for easily grading and evaluating investments. However, even these scores are now falling out of favor with investors due to their lack of transparency, among other issues.
In part, this is due to the opinion of analysts who generate such scores, but also their one-size-fits-all approach that disproportionately weights certain factors towards a company’s overall ESG score. In fact, for nearly two-thirds of all securities in the Russell Global Large Cap Index, fewer than 25% of the data items used to calculate their ESG scores are even considered material, according to a Russell Investments study.
These inconsistent standards are why scores can vary wildly among well-known ESG rating platforms. Many of these discrepancies result from not just the specific scores awarded to each component (E, S or G), but also how each platform chooses to weight each score to determine the cumulative ESG ranking.
Recognizing these shortcomings, sophisticated investors today increasingly prefer raw ESG data to ESG scores because it allows them to customize the datasets for their needs and assign their own scores to public companies. This enables investors to weight factors based on their values and the issues they believe will have the greatest financial impact on a sector-, industry-, or company-specific basis.
This is why asset managers are increasingly integrating individual ESG factors into their traditional credit and equity research and portfolio management processes. In particular, quants have shown a great interest in incorporating ESG data into their models since they commonly rely on historical datasets to back test their investment models, allowing these firms to make better-informed investment decisions.
Data that caters to all investors
As ESG grows and expands in the asset management industry, forward-thinking investors want to take a more sophisticated approach. Sustainability-focused investors no longer want to rely solely on outside recommendations and ESG “scores,” while those new to the space are wary of greenwashing. For the sustainable investing movement to continue to grow, it is critical that all parties work together on improvements in the quality, quantity and accessibility of ESG data.
Brad Foster is the global head of enterprise data content and David Tabit is the global head of equity data at Bloomberg.
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