Generic data only part of the solution

Off-the-shelf ESG ratings and estimation models can only be part of the toolbox for asset managers seeking to comply with market and regulatory demands for sustainable investing solutions. “It's key to rely on proxy data to conduct gap analysis, but don't use it as a driver for investment decision making,” said Nikkie Pelzer Impact Manager with Triodos Investment Management. She was referring to the estimation models that are increasingly used in the funds industry to plug the frequent gaps in databases. 
“We just have to accept that there is some degree of subjectivity to this,” said Isobel Edwards a Green Bond Analyst at NN Investment Partners. “Depending on your data provider, you can get a different alignment for the same company, and of course there is a risk with that.” She remarked that, for example, she has seen the same organisation be assigned five different sustainability profiles by five different providers.

Treat synthetic data with respect

“Data providers don't have a magic wand either to fix that,” said Anne Schoemaker, a director with the analysts Sustainalytics. “We do estimation models, and we provide proxies where we see that is meaningful. This is better than having nothing at all, and these are good starting points which give a sense of direction.” 
Ms Edwards agreed: “the general rule is that if you are not sure, do not assume, don't over inflate.” She cited some cases in 2021 of announcements of 100% alignment with the EU taxonomy, but many of these have since been retracted. She noted that mistakes like these are more likely at this early stage of the ESG revolution, but that they need to be eliminated as the market matures.

Use ESG data with care

“Asset managers like ourselves have increasingly turned away from off-the-shelf ratings, and are now assembling our own data in ways that make sense,” said Eric Borremans, Head of ESG at Pictet Asset Management. “You have to treat ESG data as professionally as financial data: that is, by being very rigorous,” he said.
He added that these assessments are then used throughout the company’s investment chain, including by investment teams, researchers, analysts, investment risk specialists, the management company, portfolio oversight, and reporting functions. Even so, these should not be used blindly, with him noting that investment teams bring their own views to these assessments before assembling portfolios.

A manageable challenge

Ms Pelzer agreed that although this is a new set of requirements but that “in the main it actually becomes quite clear over time after you find your way around.” She identified four key steps: screening for positive impact; minimising negative impact; defining areas that are not applicable; and managing the risk. 
Anne Schoemaker pointed to the difficulties posed by “timing mismatches whereby investors are required to report on ESG aspects that companies are not yet required to report on.” She noted that it should help when the Corporate Sustainability Reporting Directive is in place next year. However, this will only apply to large cap European companies. “It won't address that issue for small caps nor for companies outside of Europe, particularly in emerging markets,” she said. She called for greater clarity from the regulators.
We will look in more depth in the next article about how the industry is tackling these challenges.