Asset managers’ data problems are compounded by conflicting ESG taxonomies, as well as the national identifiers established by individual governments, particularly given that ESG spans both financial and nonfinancial worlds. Different frameworks often use contrary definitions — does nuclear energy or carbon capture constitute “green” investments, for example? Despite efforts at standardization, these challenges are set to continue.
In addition to the EU taxonomy, China, Japan, Singapore and Canada are now developing their own taxonomy versions and a UK Green Technical Advisory Group was established on 09 June 2021 featuring ESG experts to review EU Taxonomy metrics to ensure they are appropriate for the UK market. Asset managers, who typically make more cross-border investment decisions than banks or insurers, will be troubled by inconsistent definitions for the foreseeable future, as a single globally recognized standard in ESG reporting and transparency does not exist.
Though there is a multitude of market data providers and specialized ESG ratings companies, the majority of these only offer a partial solution to the sector’s data headaches. We see, however, that data providers are trying to match these ESG reporting needs by developing a suite of solutions for their clients. Nowadays, it’s not unusual for large asset managers to use various ESG data providers, brokers and academic research feeds.
EY analysis of 62 of the largest asset managers worldwide shows that most asset managers use between 2 and 5 different providers and some even use up to 10 different third-party vendors to cover their ESG data needs. Looking ahead, it’s possible that ESG data providers could fall within the regulatory perimeter set by EU. That would fundamentally change how nonfinancial data is accessed and could trigger a wave of consolidation among providers.
In short, nonfinancial disclosures are not yet sufficiently accurate, consistent, appropriate or timely enough for asset managers to use them as often or as effectively as they would like.
How asset managers are investing in their ESG capabilities
Faced with these continuing challenges, many asset managers are seeking to develop their proprietary ESG capabilities. The industry is also working to improve its own disclosures — a process that should be given further impetus by measures such as the SFDR. Demonstrable ESG leadership in this area will be a valuable source of differentiation, but no single strategy is without its drawbacks. Let’s look at the three different ways in which asset managers are seeking to tackle the ESG investing challenge:
1. One approach is to develop in-house research expertise, enabling asset management firms to generate their own ESG ratings and project these into the future. However, only the largest firms can make the necessary investments in talent and technology. Internal ratings can also create problems, for example, when financial and nonfinancial ratings contradict each other or when E, S and G ratings tell a different story, or when some of the components (e.g., S or G ratings) are unavailable.
2. Screening techniques are another area of focus. Positive screening is seen as the “gold standard”, but objective quantification is exceedingly difficult. Negative screening is easier to execute, but its use by itself is limiting, as the process may not be sufficient to classify a product as “sustainable” according to some regulators. The survey shows that 23% of asset managers expect oil companies to be affected by exclusions over the coming year. But, with many major fossil fuel providers now investing heavily in renewable energy, this strategy faces questions over its usefulness.
3. A third area of potential differentiation for asset managers is the analysis of nonfinancial data from alternative sources such as satellites, drones or social media. Deriving actionable insights from this data typically depends on the use of data analytics and scenario modeling using artificial intelligence or machine learning. In both cases, the ability to work with external vendors and service providers is vital to success.
The described three approaches are different ways through which asset managers are seeking to rise to the ESG investing challenge. We believe that asset managers need at least a minimum of in-house research expertise, as well as sophisticated screening techniques. The application of data and analytics is expected to become a trend in the future, and is fundamental to the successful integration of forward-looking and alternative data for scenario analysis and risk modeling.