The Environmental, Social and Governance (ESG) criteria used to screen investments for sustainability have been around for decades now, making steady progress into the mainstream as time has gone on. But recent years have seen investment managers having to pay more attention to ESG funds and assets – and that need seems like it’s only going to grow.
What’s driving ESG?
The main drivers for ESG come from two places: the investor themselves and government regulation.
Investors have become increasingly keen on putting their money into organizations that are shown to be ESG conscious, even going so far as to introduce the Principles of Responsible Investment (PRI). According to a CNBC article in February 2020, 2019 saw 479 green bonds issued worldwide, up 25% from the previous year. They went on to say Brown Brothers Harriman found that, in five years, almost one in five investors said they would allocate between 21% and 50% of their portfolio to ESG funds, and BBH concluded that ESG “doesn’t appear to be a passing fad.”
According to that same article, Saxo Bank Chief Economist Steen Jakobsen said in his latest quarterly outlook report: “For the first time since WWII we sense a shift in which climate and the environment — not growth — will become the priority of governments and their citizens, as shortages of food, clean water and air become existential questions…”
This appears to be true – on the regulatory side, the EU launched two initiatives in the first half of 2020: The first was on January 13, which established new ESG disclosure requirements for EU funds and asset managers in an effort to “integrate ESG considerations into its financial policy framework and mobilize finance for sustainable growth”. The second was on May 21, 2020, where the EU unveiled “the world’s greenest recovery package” which offers tax incentives and grants for investment in electric cars and charging stations, retrofitting buildings for greater efficiency, and renewables and “green hydrogen”.
In the first half of 2020 alone there have been significant, tangible, and actionable strides to accelerate investment management toward ESG.
How are organizations keeping up?
In response, organizations have invested their own resources into all things ESG. Capital Group hired a new Global Head of ESG this year, S&P Global launched a groundbreaking study into the effects of gender diversity on stock price and profits, and firms are looking to ESG scores from scoring firms to more easily manage and keep track of ESG funds and assets. In simplistic terms, the score tallies up all of the ESG factors that an organization has undertaken, which allows investment managers to match the score according to their investment mandate, which ends up in the portfolio management system.
These scores, however, currently come with their own limitations. In some cases there isn’t enough coverage or there’s a lack of consistency or, for others, firms simply don’t trust the scores – so they want to score the funds themselves. Data vendors are putting together data sets to give firms the raw inputs to create their own scoring systems and methodologies, but in many cases these data sets have hundreds of essential data points. For most buy-side firms proprietary scoring simply isn’t possible, so they’ll likely need to bring in data scores from multiple suppliers, such as larger sell-side institutions, and compare them.
Getting ESG scoring right
ESG scoring is of paramount importance for both investment and regulation, but this data is constantly changing, so what can buy-side firms do to ensure they maintain a robust and flexible mechanism? The most important thing to do is to manage the ESG score properly at the foundational level – that is, at the entity level –within an operational data store.
Tagging the score at the entity level makes it easy to ingest and compare data from multiple ESG feeds in one place and on one screen, which is a huge step toward transparency and auditability, facilitating buy-side firms’ ability to efficiently manage ESG investment on the front end. It also allows an investment manager to seamlessly identify not only the score of the individual firm, but the scores of all the firms that company does business with, and how those relationships impact one another. In volatile times like the COVID crisis, one can expect to see a flurry of corporate actions including mergers & acquisitions, so what are the ripple effects of these actions on ESG scores, and how far reaching can they be?
This brings us to the next point: can I maintain and track the historical ESG data from the merging companies or, more broadly, those of organizations in general? Private equity investors are already voicing concerns about “greenwashing” before independent standards have been set, but there is an expectation that they act now for fear of being left behind. It’s not an entirely unfair point; as ESG benchmarks continue to evolve, what firms are doing for ESG now may not be enough months and years from now – and when regulatory scrutiny and/or government subsidies are on the line, firms need to be able to report on point-in-time scores and the events that lead to change. One such event could even be purely accidental: an operational risk event such as a spill or leak can completely tank a firm’s ESG score whereas, prior to the event, their score was high.
These events can significantly impact investment, and having complete and accurate data is a difference maker. This is where an operational data store shines: feeding all of the data into an operational data store provides the ability to track historical ESG data and the impact of events, but also allows investment managers to track revenue-related trends such how much they are investing, what are the returns, and how have those changed over time. Having this information can put organizations firmly ahead of the pack both from a regulatory and an investment standpoint.
ESG investment is here to stay, and it’s only getting more important – investment managers would do well to ride the wave.