ESG Data Challenges & How Investment Firms Should Solve Them



Only a few years back, “sustainable” or “green” initiatives were assumed to be a prerogative of the manufacturing industry. Now, even investment firms have come under the scanner. While the financial sector may not directly contribute to the carbon footprint, it does have a role in financing companies across multiple industries. In addition, firms are no longer scrutinized based on their environmental impact. Instead, investment firms must comply with all the ESG (Environment, Social, and Governance) factors, social influence, and governance structure. This concept seeks to promote sustainability, but it also imposes numerous challenges, the biggest one being – “How to incorporate ESG data into the existing investment operations?”

Why do firms need ESG data?

While the mandate from the regulators has not been stringent, guidance has been provided to firms. For example, International Organization of Securities Commissions’s (IOSCO’s) recommendation on ESG reporting suggests how firms should look to enhance the quality of ESG data by liaising with third-party data providers. The SEC is also mulling the introduction of rules that would bring greater transparency among investment firms on their sustainability reporting. Most financial institutions have already started treading in this direction, and one can expect a regulatory framework to emerge within a few years.

ESG investing is an emerging trend in the investment world. Therefore, firms should look to convey the strategy to investors so that any change in investment makes sense. Take the example of an investment firm that is doing well but is heavily concentrated in the oil and gas sector. To improve its ESG rating, if the firm looks to allocate capital in the renewables sector, the investor may not view this change favorably. Therefore, it is imperative to report this change considering the impact on ESG, which would make it more acceptable to the client.

As investments in the ESG theme grow, more companies are looking to exploit this opportunity. For example, a traditional automobile manufacturer is exploring opportunities in the Electric Vehicle (EV) segment. Access to reliable ESG data would enhance the decision-making capabilities of investment firms. Firms with reliable access to such data can devise advanced analytics to seek investment opportunities and manage their risk better in this new niche. Conversely, the lack of ESG data would not make it feasible for the firm to achieve its goals. Furthermore, an ESG strategy formulated at the executive level will not be easily executed by the relationship managers or investment advisors if there is no data to make the process more objective. ESG data is a way of defining the parameters that should be monitored and would eliminate much of the subjectivity in the investment process.

While the need for ESG data is inevitable, one cannot overlook the challenges companies face in utilizing this data. Some of these challenges are discussed in the next section.

Current challenges

Reliance on external data providers

Most firms do not have a well-established framework for maintaining ESG data. They rely on external vendors for this information. To add to the problem, these firms must integrate ESG-related inputs from multiple vendors with their own templates. To compound the challenge, some investment firms are already grappling with archaic data systems, thus adding another layer of data integration would create more problems. While the data vendors have developed their APIs to automate the integration process, the inputs may not be relevant to the investment firm. The repository of ESG data from these providers is very generic and may not be dynamic enough for use by the investment firm. The following example should make the problem clearer. Based on historical data, an automobile company should have a low ESG rating since cars are run on fossil fuels. The ESG data feed may not consider that some automobile firms like Tesla, manufacture only EVs. In addition some companies that used to manufacture only cars running on fossil fuel have now also entered the EV space. Therefore, it is logical to ask, “How does the ESG data account for these changes?”

Another problem is the internal models adopted by firms for reporting ESG data. Regulatory guidance allows firms to choose whatever they deem fit for reporting ESG-related information. A unique model for each firm would not only make the output inconsistent, but it would make the task of data providers more challenging. The format of the ESG data shared would have to be customized to meet the needs of each firm. This would make ESG reporting costly and ironically unsustainable. Moreover, the lack of standardization makes comparing two investment firms difficult. The obscurity in the model also allows for tweaking the process to obtain favorable results for the firm.

Possible Solutions

As previously mentioned, regulatory bodies have been providing guidelines for reporting ESG numbers. The SEC is looking to tighten the reporting guidelines lid, especially with the increase in the number of ESG funds. The ESG assets are expected to reach $50 trillion, constituting a third of the total assets under management. So, it only makes sense for investment firms to establish a dedicated framework for managing and reporting ESG investments. A part of the framework should address the data governance of ESG investments and instruments. By doing this, any form of manipulation would be reduced if not eliminated. A framework would also guide investment firms as they incorporate ESG into their businesses. The existing models seeking inputs from ESG data should also be reviewed and updated.

Another big problem for investment firms is the existing IT infrastructure. While data providers are looking to standardize their offerings, banks and investment firms have faced numerous challenges. The downtime related to adopting new systems is something the financial industry finds hard to accept. It is one of the reasons why several of these companies still rely on archaic systems for managing the business. However, this should not be an excuse for the inability to present ESG data transparently. The accountability for investment firms should be high because their investments would shape the future of sustainable financing. These firms can adopt cloud-based platforms offered by data providers. These cloud-based solutions are flexible and enable smooth integration with investment firms’ financial systems. The data providers have consistently upgraded their ESG data repository to enhance their data warehouse, thereby ensuring that the data points relevant to financial companies are available to these firms.

Data for different industries and instruments is now readily available. API-based integration is also another way that firms can extract information from data providers. Investment firms can use the services of external vendors to customize the information provided by data providers. Customizing the information would eliminate the need for company to revamp their existing infrastructure. Adopting new technologies is also critical for firms to enhance their business intelligence. Most solutions come with advanced business analytics that enriches data visualization and improves decision-making capabilities. How a firm handles, its ESG data could influence its performance in the near future.

One way to ensure proper ESG data management is by providing adequate training to employees. The concept of ESG investing is relatively new, and investment managers need to understand the consequences of this change. By implementing the necessary training, they would be able to convince their clients of the strategy that is currently being pursued. This is relevant across all funds (not limited to ESG funds) because of the opportunity that ESG investing presents. By ensuring every employee is aware of the concept, the firm would be able to capture accurate data at the transactional level. If the input data is reliable, the reports and analytics on this data set would be more accurate. A well-informed employee base would also make the firm compliant with any regulations targeting ESG investing. In the past, financial firms have been levied huge fines due to a lack of compliance with regulations related to Anti-Money Laundering (AML). Part of the problem was the lack of awareness among employees whose primary goal was to generate more business for the firm.

Key Takeaways

There have been several industries related to ESG that have been growing exponentially. Governments across the globe have backed up sectors like renewable energy and electric mobility. It is only appropriate for investment firms to target such industries and prepare for any regulatory requirements imposed on their investments. ESG data would be a critical factor in determining the success of these firms. How firms seamlessly integrate this information into their existing infrastructure could profoundly impact business performance. Investment firms should be proactive in seizing this new opportunity by adopting new solutions and using them to improve analytic capabilities.

The goals and responsibilities of managers should be clearly defined, and adequate training should be provided. Firms must also realize that failure to comply with the ESG regulatory requirements could draw the attention of investors and other stakeholders. We have seen ESG models transform various industries, and it is only a matter of time before investment firms see the benefits of a robust ESG data infrastructure.