After a few delays, the European Sustainable Finance Disclosure Regulation (SFDR) was finally launched this week, regulating ESG disclosures of all EU financial market participants.
While this might not be good news in micro-view, as most companies are unprepared to cope with, yet again, another piece of 'regulatory reporting' across a complex data set, the macro-view offers a brighter future, one in which ESG and sustainable investment reporting is moving towards unified, standardised and free of “greenwashing”.
But the standardisation of ESG reporting hides greater benefits than the above, and the biggest one is the underlying opportunity for alpha.
How can firms capitalise on this opportunity?
2020 was the year where ESG investments really shined with global ESG bond volumes reaching a record high at over $489 billion.
Deloitte forecasts that ESG-mandated assets could make up to half of all managed assets in the US alone by 2025 due to an ongoing uptick in investors’ demand for social and sustainable-aware investments.
To meet this client expectation and to capture a greater share of this growing allocation to ESG, Deloitte suggests that firms should be “utilizing emerging technologies for incorporating quality ESG data into the investment decision process”.
This component of collecting and integrating high-quality data into investment processes seems to be the biggest challenge for investment managers when pursuing alpha through ESG data, with data inconsistency being main barrier.
An MIT Sloan School of Management working paper published in August 2019 found that in a dataset of five ESG rating agencies, correlations between scores on 823 companies were on average 0.61. For comparison, credit ratings from Moody’s Investors Service and S&P Global Ratings are correlated at 0.99.
So, what is a firm to do?
Investment management firms around the world have already increased their spending on ESG data while looking at emerging technologies such as AI to aid with advanced data analytics, but analysis capabilities alone are not sufficient when developing and building scalable ESG investment strategies.
You can look at ESG as just another data layer, but to be able to properly integrate this layer into your investment and decision-making processes, you’ll need to have:
An ESG data provider that does not rely on ‘black boxing’ the complexity of sustainability data into aggregated scores but rather provides a transparent and 'easy to use' ESG dataset.
ESG and regulations like SFDR provide significant opportunity for both investors and managers. However, the value you will be able to extract from this is determined by how well you can manage it.