Evaluating corporate ESG performance

Martijn Groot at Alveo describes how the lack of corporate disclosures forces asset managers to cast a wide net for ESG

 

ESG disclosure  refers to the disclosure of data by corporates relating to their organisation’s environmental, social and governance performance. In a world where investors increasingly weight ESG metrics in their investment decisions, corporates increasingly understand the rationale behind making such disclosures.

 

Reporting on their ESG practices, performance and plans helps these businesses to develop better sustainability and governance practices. It also caters to regulatory and shareholder information requirements. The data revealed in such reports can help organisations align their purpose, strategy, and operations to ESG metrics.

 

For example, the European Union introduces the Corporate Sustainability Reporting Directive (CSRD) which requires certain companies to disclose information on the way they operate and manage social and environmental challenges. Not every company is covered though.

 

Overall, on a global scale, there are still many challenges to overcome. Not every jurisdiction has specific rules on ESG disclosures, and across the world much guidance still focuses on best efforts or best practices rather than being mandatory. Consequently, corporate disclosure is spotty.

 

There is also a serious problem with a lack of standardisation. Recent analysis by financial consulting firm, Duff & Phelps revealed that nearly half of valuation experts think the lack of a standardised and recognised measurement system is the biggest threat to effective ESG disclosures for businesses.

 

Gaps and inconsistencies in corporate disclosure records force asset managers to cast a wider net for ESG data. Recent research commissioned by Alveo found that more than seven out of ten (71%) of executives working for investment management firms across the UK, US and Asia say their organisation uses more than five ESG data sources. The most common response in all three regions is to have between six and ten ESG data sources.

 

The research reveals that corporate disclosures are the least common data source cited. The most common source is ESG ratings provided by third parties most: just under three-quarters (74%) of respondents said that their organisations were using these ratings.

 

To deliver these ratings, Morningstar, MSCI, FactSet and other data companies create sustainability scores based on information sources and input from experts. This can be problematic, however. Expert opinions often differ, largely due to the number of aspects underlying ESG criteria and the different weights rating firms put on them. In addition, ESG scores are sometimes also based on planned actions or future goals, as opposed to what organisations have achieved already.

 

Another category of ESG data that organisations engage with is sentiment data which involves gauging the perception of the company’s ESG performance from a range of sources including newspaper reports, television and radio broadcasts, social media posts, press releases and employee surveys.

 

Making sense of the data

With all these options available, it’s often difficult for asset managers to know which ESG data sets to opt for. Records are often incomplete as relevant data is withheld, and data invariably needs to be gathered from a wide array of different sources. A comprehensive approach to ESG data management is needed.

 

Asset managers must be able to effectively source and integrate, where needed, to enable the data to be delivered to different stakeholders.

 

A professional engaged in external reporting will need factual data from corporate disclosures and will need to conform to regulatory reporting standards.

 

A portfolio manager will require more granular data to create custom metrics to choose investable assets and potentially sentiment data for short term trades. They will also need to be able to cross-reference to a comprehensive data model that covers regulatory information and underlying data sets and that links ESG data to pricing and reference data. In addition, they must achieve transparency as to which sources and what types of data are leveraged, the business rules used and any manual intervention.

 

So what’s the ESG data management solution? From the outset, a way of overcoming data quality issues is needed. This requires a process that seamlessly acquires, integrates and verifies ESG information. Apart from that, a data management function should facilitate the easy discoverability and explainability of information and effective integration into business user workflows.

 

In short, data management should service users from the use case down, not from the technology and data sets up: for example, investment managers should be able to cross-reference taxonomies and condense information. There may be a requirement for indicators that serve as selection thresholds or performance KPIs. Or reporting may have regulatory requirements such as principal adverse impact ("PAI”) indicators, as per the EU’s sustainable finance disclosure regulation (“SFDR”).

 

ESG data management capabilities should facilitate the easy roll-up of information from instrument to portfolio and blend ESG with pricing and reference data sets, so it becomes an integral part of the end-to-end investment management process. Data-as-a-Service models, where a supplier manages the sourcing and integration but also quality management of required ESG data, emerges as the preferred service model from Alveo’s research.

 

Data derivation capabilities and business rules can spot gaps and highlight outliers, whether it concerns historical patterns or outliers within a peer group, industry or portfolio. Additionally, historical data to run scenarios can help with adequate risk and performance assessment of ESG factors.

 

Having these capabilities in-house is good news for all users across the investment management process. Drawing on the services of an expert solutions provider and adopting Data-as-a-Service models may prove to be the best route to address these challenges.

 

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Martijn Groot is VP Marketing and Strategy at Alveo

 

Main image courtesy of iStockPhoto.com