Calls are growing for accurate high-quality ESG data that is assessed under a global standard. Otherwise sustainable investing has no foundation for achieving what the world is expecting from it.
(An earlier version of this article appeared on WealthBriefing. We republish it here as the issues here are global in scope, and we hope readers find this of value.)
For all the enthusiasm and claims behind ESG, the data supporting it is neither clear nor unified. Standards are still voluntary and are often reported in conflicting ways. This makes it hard for the most well-intentioned asset manager to apply investment decisions with any confidence, without fearing that they are contributing to greenwashing, especially in a market that is redhot for sustainable products.
Research shows that asset managers are increasingly using third-party analytical tools and dashboards to uncover alternative ESG data from social media sentiment to engagement with universities.
As an industry agnostic, Rebecca Healey, who co-chairs the EMEA regional committee and regulatory subcommittee at the FIX Trading Community, recently highlighted the level of nervousness about falling foul of ESG disclosure demands.
“This extends well beyond the immediate financial risk to the hidden risks that may impact future performance as well as the risks from subsidiaries and supply chains,” she said.
As for what constitutes good ESG capital allocation, she used a number of examples to highlight just how tricky is the terrain.
Take the future risk of water shortages for clothing companies. Planet Tracker cites 740 listed companies that are subject to $66 billion of risk that is not currently fully priced in.
In a discussion yesterday hosted by UBS, industry specialists spoke about the difficulties clothing brands face sourcing their supply chains, where fiber level transparency is very low but critical for recycling efforts.
Another example is soya beans. The crop is now recognized as the second largest cause of deforestation in tropical countries after cattle. ETF indices hold 380 publicly listed companies linked to deforestation, largely still hidden from investors, according to research from the CDP.
Even more sensitive, how do fund managers look objectively at company labor practices? If there is an anti-slavery policy on a corporate website, what does that practically mean?
Healey cites a report from the Australian government that suggests Chinese Uighurs are working in the factory supply chains of at least 82 well-known global brands.
The German government has been active in passing legislation demanding due dilligence on human and environmental standards in supply chains. Fines for non-compliance could reach 2 per cent of average annual sales for companies making a minimum of €400 million ($486.8 million) annually.
From the impact end of the investment spectrum, it is argued that pursuing ESG goals, with its surrounding hype and confusing metrics, might even be hindering progress.
"Some people are questioning ESG as a solution to solving the problems we face," said Daniela Barone Soares, CEO of impact investment firm Snowball. "ESG is just a risk assessment. It does not take into account the product, the service, the solution, and the negative externalities."
Barone Soares said that it took her firm a full year to review equities' providers to see which ones "were really serious" about going beyond ESG and pushing companies to go further. "It is hard because even when fund managers have created the culture, and some are serious and really good about it, they often have little leverage because they are not big enough and don’t own enough of a company to say, 'Hey look, this is how I am going to vote.'"
My concern is that the movement to ESG makes people feel good about themselves and a way to ratify the status quo a little better. But that is not enough for what we need to do by 2030," she said.
Healey at FIX says the industry and regulators obtaining accurate data and applying it under global standards will determine ESG’s success.
The non-profit work with stakeholders on regulatory and other issues affecting multi-asset global markets, focused on standardizing disclosure reporting, increasing transparency, and reducing risks and costs for market participants.
Coalescing on standards
Last weekend's G7 summit of finance ministers saw some progress on this front, with the group agreeing to make climate disclosure mandatory. By whose standards and by when remains unclear. The International Organization for Standardization (ISO) is one of the main independent bodies developing new standards relevant to climate change disclosures and other ESG priorities to automate sustainability-related processes. The Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD) is widely used by fund managers to report climate-related financial information.
The European Commission is working on the Corporate Sustainability Reporting Directive (CSRD) to give firms a more even reporting system.
CSRD “aims to create a set of rules that will – over time – bring sustainability reporting on a par with financial reporting.” Its new mechanism, in the simplest terms, will require companies to digitally tag sustainability information, making it machine readable and comparable, whereby data can be passed seamlessly across the investment lifecycle.
The promise is more meaningful, comparable information for investors and other stakeholders, giving currency to the saying that you can’t manage what you can't measure.