Why data remains the biggest ESG challenge for asset managers

The latest EY Global Institutional Investor Survey which polled 62 of the world’s largest asset managers, shows that financial institutions’ interest in ESG has become virtually universal - but there’s a profound disconnect between the environmental, social and governance (ESG) data asset managers need and what’s available to them.

Working with ESG data is no longer optional as stakeholder demands are driving asset managers’ ESG focus. As a result, asset managers, banks and insurers are all moving toward a more disciplined and rigorous approach to evaluating companies’ non-financial performance.

The asset management industry has a long history of stewardship, but it’s indisputable that the evolution of principles-based regulation is a crucial driver of ESG scrutiny.

Arguably, the EU Sustainable Finance Disclosure Regulation (SFDR) which came into effect in March 2021 has initiated significant changes for asset managers, given its strict “ESG” and “sustainable” labelling requirements and the disclosure burdens it imposes on funds and managers. The regulation applies to all financial market participants and financial advisors in the EU, as well as market participants with EU shareholders, and those marketing themselves in the EU.

Recent proposals by the SEC (The US Security and Exchange Commission) to enhance disclosures by certain investment advisers and investment companies about ESG investment practices demonstrates the importance of validating ESG claims.

Ultimately, investor demand and competition are significant drivers of asset managers’ interest in ESG performance. This is illustrated by high-profile fossil fuel divestments made in recent years by end investors ranging from Nordic sovereign wealth funds to US pension funds. 

Data remains the sector’s greatest challenge.

Unfortunately, asset managers’ desire to focus on ESG performance is not always matched by reality. When it comes to investment decision-making, asset managers are more dependent than banks and insurers on publicly available sources of non-financial data. Historic in nature, the data from these public sources are only disclosed once or, at most, twice a year. Our survey shows that this presents an additional challenge for the sector:

1. Privileged data

Asset managers need to model future earnings, but the EY survey shows that 50% of asset managers see a lack of forward-looking disclosure as limiting the value of ESG reporting, compared with 31% of insurers and 25% of banks.

This is because banks and insurers have more sources of privileged forward-looking data such as loan businesses, mortgages and trade finance.

2. Real-time data 

Asset managers need to take day-to-day decisions in response to fluctuating market risks and prices, but this is at odds with the frequency of public non-financial disclosures. The survey shows that 46% of asset managers view the lack of real-time information as a limitation on the value of ESG data, compared with 41% of insurers and 35% of banks. 

In addition to these shortcomings in underlying data, asset managers face structural obstacles to using non-financial information. Much of it is presented in either narrative or unstructured form. Asset and wealth management firms still struggle with developing and maintaining a “golden” copy data architecture of investible instruments — a single source of the truth. In contrast, repositories of client risk information are central to the core activities of banks and insurers.

Data accessibility affects smaller and more specialised institutions more, as they typically rely on third-party data vendors for critical information, such as ratings. Bigger firms often have access to in-house research and are able to calculate proprietary ESG scores.

Taken together, these limitations have an inevitable effect on asset managers’ ability to perform frequent, rigorous analysis of non-financial disclosures.

The survey revealed that while the use of non-financial disclosures in investment decision-making is becoming more frequent, asset managers are lagging other sectors. For example, 55% of asset managers use non-financial data occasionally and 37% frequently. In contrast, 49% of insurers use non-financial data frequently and 42% occasionally.

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 non-financial worlds. Different frameworks often use contrary definitions. For example, does nuclear energy or carbon capture constitute “green” investment? Despite efforts at standardisation, these challenges will continue. 

In addition to the EU taxonomy, China, Japan, Australia, Singapore and Canada are now developing their own taxonomy versions and a UK Green Technical Advisory Group was established in June last year featuring ESG experts to review EU Taxonomy metrics to ensure they are appropriate for the UK market.

On 1^st April, National Treasury also launched South Africa’s first national Green Finance Taxonomy. Investors, issuers, lenders and other financial sector participants can use the taxonomy to track, monitor, and demonstrate the credentials of their green activities in a more confident and efficient way. South Africa’s approach is aligned to the European taxonomy but for market participants ensuring the systems that are put in place to address expectations work across geographies will be important. 

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 recognised standard in ESG reporting and transparency does not exist.

Though there is a multitude of market data providers and specialised ESG ratings companies, the majority of these only offer a partial solution.

We see, however, that data providers are trying to match these ESG reporting needs by developing a suite of solutions for their clients. It’s now not unusual for large asset managers to use various ESG data providers, brokers and academic research feeds. Our analysis shows that most asset managers use between 2 and 5 different providers and some even use up to 10 different third-party vendors. 

Non-financial 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. Hopefully the convergence in global sustainability standards will help to fill this gap though the timing of implementation and the coverage of requirements will probably still present challenges. 

On the upside, the survey suggests that financial institutions worldwide see asset owners and asset managers as better placed than regulators or international bodies to close the gap between the non-financial disclosures made by issuers and the transparency desired by investors.

 Companies should start their sustainability migrations now because the speed of change and expectations of stakeholders should not be underestimated.