As sustainable finance disclosure regulations bring focus on ESG data and analytics, more data is becoming available for investors to assess companies’ performances. This in turn is placing additional pressure on firms to produce accurate reports at a greater and greater scale.
Institutional asset managers, fund administrators, custodians, third-party providers – essentially any firm with high portfolio volumes or that handles complex performance calculations – must now have a solid foundation of ESG capabilities that integrates with existing risk and performance analysis and monitoring.
Regulatory requirements in this area are in an early, embryonic stage. New regulations are being introduced across jurisdictions, such as the European Union’s Sustainable Finance Disclosure Regulation. Firms need to stay in compliance even though existing ESG data contains ambiguities and gaps. Technology has a major role to play in ensuring data is accurate, offers clarity, and gives investors the best information possible to make better decisions.
Sustainable data challenges
Consistency is paramount in accurate reporting. The same methodology and language need to be used across companies, funds, portfolios, and benchmarks. There must be a simple way to compare data from the main providers of sustainable fund metrics such as Trucost, Morningstar and ECPI. The two most serious challenges that stand in the way of consistent reporting is missing data and inconsistent reporting methods. Without a solve for these challenges, it is impossible to meet the expanding data and analytics needs of the industry.
Firms range in size and maturity in terms of ESG and data. Some have long-standing ESG histories with strong core ethos and governance built around sustainable investing and eco-green credentials. ESG is integrated into everything these firms do, and they know how to communicate this with the markets. On the other hand, smaller firms, or those just entering the ESG space, struggle with the volume, breadth, and depth of information they need to disseminate to different people, entities and regulators with parallel regimes emerging.
A key practical challenge is the lack of talent in asset management companies that can analyze and understand the data, along with the methodologies behind the analytics. Firms are struggling and finding it increasingly difficult to manage the growing number of datasets.
There’s also challenges associated with the interpretability and subjectivity of datasets, especially when given the complexities of company screening. Asset managers also need to factor in ESG strategy indices, which include principles such as market representation, transparency, independence and objectivity, and sustainability.
At the same time, sustainability data has certainly challenged technology. Bringing in the vast amount of data, especially unstructured data, into technology solutions can be difficult for firms to do on their own.
The importance of KPI frameworks
Firms need to ensure that investors can “look under the hood.” This goes beyond a top-level number or rating but being able to understand the key performance indicators (KPIs) that are being captured and the intention of their framework. This allows investors to reconcile any differences in a meaningful way. Investors must know whether risk is being measured as it relates to the company from an ESG lens, focused on risk related to society, or a combination of the two.
With many different frameworks, it's hard for a private or public company to understand where to start. Establishing a good framework of what can be realistically measured is an obvious challenge due to widespread self-reporting. The goal is to encourage more convergence between the different frameworks and define ESG risk versus ESG impact. This way, there is a common understanding and transparency, rather than yielding different results in different places.
ESG KPIs or ratings are playing significant roles in liquidity events, structuring of bonds, and IPOs, with investment banks leading the way on focused ESG KPIs. This is helping companies narrow down what they can be thinking about most.
We’re seeing a proliferation of market indexes that are setting inclusion or exclusion criteria based on the KPIs that they think are most important. This offers more guidance and transparency to companies around that disclosure.
Integrating ESG into your process
As ESG becomes more embedded into the different use cases and value chains, some asset managers have implemented and integrated ESG into their fund and portfolio management processes.
Some firms are already well advanced on their journey towards full integration of ESG are leveraging data into their portfolio management, risk and performance analysis platforms with data fully integrated into a ready-to-use tool.
When it comes to providers, being able to take raw data and aggregate, contextualize and normalize it, and offer additional meaning while filling in the gaps with estimation models turns the data challenge into a robust set of intellectual property.
Use case: ESG-enhanced risk and performance analysis
A European fund administrator was looking to improve its front- to back-office workflows and enhance the way their team screen investments, build and monitor portfolios, and report on them to the investor, distributor, and asset owner community.
The firm added ESG capabilities to its risk and performance analysis platform. The company now integrates ESG profiles of fund ESG analysis based on a range of criteria, and ESG data from multiple sources. The fund administrator benefits from flexible communication and distribution solution with highly accurate performance measurement and multi-model risk analytics, through one comprehensive solution for all regulatory, risk and ESG monitoring and oversight. They can create better, more specific risk management policies, enabling the construction of a consolidated map that identifies valuable areas of opportunity with better decision-making approaches.
Making ESG part of your ecosystem
This shows the importance the investment community is placing on ESG and how increasingly firms are engaging with ESG to further manage portfolio risk exposures and drive capital into positive areas of impact. Communicating financial performance accurately with flexible attribution is key to staying competitive and growing in today’s environment.
Making strategic investment decisions to create a more diversified and socially responsible portfolio can boost returns and align investments with investors’ ESG goals. Analyzing the relationship between social pressure, corporate responses and financial performance through ESG factors can maximize returns and minimize the downside risks associated with investments.
Producing accurate and timely portfolio performance results is critically important. But the process is labor- and data-intensive and error-prone, leading to delays and poor-quality results. With technology that embeds ESG into the entire risk and performance process – through integrated ESG data, intelligent workflows, and connectivity – firms can increase productivity and massively scale while catering to clients’ specific needs and quickly delivering performance results to stakeholders.
Market participants who make ESG a valuable part of their investment process have an opportunity to optimize efficiency and control across their investment lifecycles with smart, automated solutions that remove all manual processes and operational risk.
Disclaimer: The information contained in this communication is for informational purposes only. Confluence/StatPro is not providing, legal, financial, accounting, compliance or other similar services or advice through this communication. Recipients of this communication are responsible for understanding the regulatory and legal requirements applicable to their business.