The International Regulatory Strategy Group (IRSG) have recently released their ‘ESG Ratings and ESG Data in Financial Services – A view from practitioners’ report. We welcome this as it is strongly aligned to many of our own views. For those of you that follow, you will know that for some time we have been posting on the inadequacies of ESG ratings and data and indeed what some of the solutions should look like.
Let’s recap for a minute. ESG has become a hugely important investment class and its now central to Board level strategies across all Financial Services firms (asset managers, but also banks, insurers and private finance). Commensurate with its importance, ESG performance is starting to be measured and recognised in a way that just a few years ago was largely unimaginable. And while there are an increasing array of ESG data sources, they remain, opaque, inconsistent, sometimes inaccurate and difficult to use at scale to calculate value and risk. The IRSG report acknowledges these issues and starts to look at how, as an industry, we move to a better place – principles of consistency, collaboration and coordination, transparency, data standardisation and investor protection are identified along with recommended actions.
As the authors note in the foreword, this poor state of ESG ratings and data creates a real risk that the potential to ‘green’ corporate behaviours and financial markets is eroded. Because the signals are so mixed and unclear, the market cannot properly price ESG performance and the steps required to improve ESG performance are similarly unclear and contradictory. We agree with this assessment. Until there is more consensus around what ‘ESG good’ actually means and how it is measured and reported, these problems will persist.
The report, consistent with its mandate, focuses on actions at an industry, regulator and policymaker level and while that is good and will improve the situation for market participants, the question remains what can individual organisations do right now in order to manage their way through this? As we will shortly be outlining in a new collaborative article to be released in March with Google, there are ways by which we can close the disconnect and get much closer to an objective version of the ‘ESG truth’.
The good news is that progress is being made – the International Sustainability Standards Board is to develop a comprehensive global baseline of sustainability related disclosure standards, The World Economic Forum are discussing how to bring consistency to ESG metrics and the World Business Council for Sustainable Development has a vision for consistently measuring emissions and environmental metrics.
No doubt, this search for consistency helps, but we also need new curated ESG data sets. And we need new methods to verify and validate that ESG data and the ability to react rapidly to changes which the traditional historic data can never capture in a timely way. Some of this data exists, but its not always easy to get or convenient to sift through. Good examples are the vast public data sets and the private data collected by a growing range of institutions and local and geospatial data. Its out there, you just need to know where to look and how to use it, which is where new technologies and tools come into play. Equally it’s important to be able to spot where new data-driven solutions are amplifying the risky characteristics of the data or analytics processes that produce them. There is no silver bullet, but data indexing, semantic modelling and analytics, machine learning, artificial intelligence, natural language processing, workflow automation – and many more – all have a role to play.
The key is to keep an eye on the prize. Closing the data disconnect not only resolves the regulatory challenge, but also mitigates risk and unlocks opportunity. As understanding of the financial performance of businesses has become more sophisticated, strategic decision-making has become more insightful – and delivered better outcomes. With continued focus, ongoing collaboration and a collective ongoing commitment across the impacted stakeholder groups, improved understanding of ESG performance can drive the same dividends.
If you would like to discuss the IRSG report further or understand the impact on your organisation, please reach out to a member of the team.