The impact of ESG data beyond regulation

Companies wanting to categorise funds accurately under SFDR need to be more stringent with their data and disclosure

The discussion around ESG data has exploded of late, with seemingly every newsletter or homepage having some mention of ESG above the fold. Much of the conversation makes mention of Sustainable Financial Disclosure Regulation (SFDR) and the spectre of future regulation, but what about those companies that aren’t required to comply with SFDR standards? Why should those companies care about managing ESG data and delegate its integration to their data operations teams?

It should be said, first and foremost, that few companies will be exempt from complying with some aspect of SFDR, even indirectly. Any company marketing into the EU is obligated to do an SFDR disclosure, so if your company is, or is planning to, expand into the European markets, the regulation will affect you. Beyond this, however, it is important to take a look at how ESG data impacts your business.

According to a report by the CFA institute, one of the main drivers of ESG integration is risk management, specifically on the governance side. Historically, good governance criteria and metrics have proven to result in good Return on Equity (ROE), and companies that put good governance standards into practice see returns that are notably higher than their peers.

The traditional risk factors of size, value, and momentum are direct evidence that a given instrument tends to give investors a higher return. Because some, but not all, ESG characteristics fall into these categories, some people may not consider ESG itself to be a factor by the preferred nomenclature – however, big players in the ESG agency space are determining their ESG metrics as risk categorizations and assessments. Bank of America also found that with better ESG data and lower ESG risk, firms can generate alpha.

ESG data that do meet these criteria can be incorporated in signals alongside more traditional financial data to create portfolios with high returns but that are also more ESG friendly. Investors, though, will want to be able to combine various types of ESG stocks/bonds (e.g. by filtering using the hundreds of fields available now for ESG) with the time-series data that is used as the basis for developing factor investing strategies.

For firms, it is clear that data and disclosure must evolve and improve if funds are to be categorised into SFDR accurately. The issue at hand is that regulators are becoming increasingly strict on the criteria that qualifies a fund for both Article 8 and 9. If this pattern continues, we can expect the regulatory framework to become even more stringent when it comes to disclosure and compliance.

While the delay to SFDR has offered firms more time to comply with reporting requirements, data providers have already invested heavily in coming up with enhanced data sets geared towards these guidelines. In this process, multiple sources are taken into consideration for deciding on and calculating what one is going to disclose on a fund level.
 
Investment firms and banks should be prepared to collect, compare, evaluate and manage ESG data, regardless of what threshold the regulators set for compliance with ESG principles. The SFDR framework for Principal Adverse Impact Statements in the RTS part of SFDR will always be valid, even if specific provisions end up being changed.

Natalie Kenway

Natalie is global head of ESG insight for ESG Clarity. She won Editor of the Year at the Aviva Investors Sustainability Media Awards 2021. Winner of Aegon Asset Management's Institutional Journalist of...