Tackling the data challenge in ESG investing

The growing popularity of ESG investing

Investors worldwide are keen to put their investments to greater benefits, which explains the surge in environmental, social, and governance (ESG) investments, in addition to those in exchange-traded funds (ETFs) and sectoral categories such as technology and banking.

Investors’ interest in ESG funds is due to the growing awareness about environmental, social, and corporate governance issues – this offers them the opportunity to be a part of initiatives around ecological protection, social welfare, and good governance.

ESG assets saw significant expansion in Q4, 2021, relative to Q3 with ESG funds following a similar increasing trend. Stocks of companies classified as ESG investments rated highly for their sustainability efforts have shown considerable appreciation. Various benchmarks such as MSCI ESG Leaders Index have also shown increased gains in the past one year. 

ESG stocks are hot, but there are complexities

The lack of data transparency, inadequate availability, inconsistency, and data costs pose significant challenges in ESG investing.

ESG data – ESG ratings and disclosures – helps investors decide how they should invest in sustainability initiatives. However, there are some challenges that need to be addressed, which are: 

• No data standards: The absence of consistent, verified, credible, and widely accepted data standards makes it difficult for investors to compare the ESG characteristics of a potential investment target company against another firm. Often times, data is missing for certain metrics and asset classes, leading to inaccurate investment analysis. 
• Inconsistencies across regions: Certain regions have lesser number of ESG disclosures, which results in fragmented reporting. Moreover, ESG data is spread across multiple sources such as annual report, CSR report, company website, and regulatory filings.
• Lack of data reliability: When it comes to ESG data providers, there is lack of transparency with respect to methodology, scope of underlying data, and review mechanisms. Many firms are looking at developing proprietary, internal ESG ratings to ensure reliable data which is crucial to make sound investment decisions. This, however, may not be economically viable for small- or medium-sized asset managers.  
• Data variance: ESG scores can vary from one ESG ratings provider to another due to differences in frameworks, measures, key indicators and metrics, data use, and qualitative judgement.
• Materiality: Firms can also capture any controversial information with potential reputation impact and financial materiality. Materiality, in the ESG context, refers to the effectiveness and financial significance of a specific measure as part of a company's overall ESG analysis. 

Although ESG investing offers a lot of potential benefits for investors and enterprises, there are a few initial hurdles to overcome for widespread adoption. To address these challenges, it is necessary to look at relevant technology interventions, stakeholder-specific solutions, and regulatory frameworks.

An overview of the stakeholders in ESG investing

Data needs and challenges are dependent on the type of stakeholders.

Given the diverse needs of the various stakeholders in the ESG investing space, it is unwise to follow a one-size-fits-all approach while designing data solutions.

Following are the key stakeholders whose data needs merit consideration during solution design:

• Issuers raise capital and provide ESG information at the request of investors, ESG ratings providers, credit rating agencies, and others.
• ESG ratings providers assess issuers and financial instruments and provide sustainability metrics.
• ESG index providers such as MSCI, FTSE Russell, Bloomberg, Thomson Reuters, and Vigeo Eris construct benchmarks that enable active or passive investments.
• ESG data users such as asset managers, institutional investors, and government agencies consume ESG data for assessment.
• Regulators prescribe standards for ESG reporting.