ESG, often misunderstood as divestment, involves complex regulatory and voluntary reporting frameworks, balancing transparency and strategic investment. Our roundtable panel of experts discusses the scale of the challenge.
Participants
- Neill Blanks, managing director, ESG fund research, MainStreet Partners
- James Palman, sustainable investment manager, Gresham House
- Vai Patel, head of responsible investment, Alcentra
- Sam Tripuraneni, head of sustainable investments, Aviva Investors
- Jane Wadia, head of sustainability, core products & clients, Axa Investment Managers
Read the second part of this discussion here
Officially, there are 24 languages spoken in the EU. Unofficially, ‘ESG’ could be the 25th. The divergence of meaning around the subject creates a Babel-like confusion which increases in magnitude the more that ESG becomes politicised.
“Mention ESG and some people presume that means divestment,” noted one commentator at a recent Funds Europe roundtable. The speaker was making reference to certain asset owners that have announced divestment programmes from fossil fuels – the ultimate ESG act.
However, Jane Wadia, head of sustainability, core products & clients at Axa Investment Managers, noted that ESG principles at many firms had integrated into broader investment processes, where ESG is understood by asset managers to serve as a method for identifying financial risks stemming from environmental, social or governance factors. The term ESG is not synonymous with divestment.
The Funds Europe roundtable – called ‘ESG, data & reporting’ – gathered a group of asset management ESG specialists covering both private and public markets asset classes. They tried to summarise the enormity of the data collection and reporting tasks that surround ESG and they discussed the efficacy of so much data for investment decision making.
Benefits from portfolio reporting
Predominantly shaping the ESG reporting landscape in Europe are the EU’s Sustainable Finance Disclosure Regime (SFDR) and, in the UK, the Sustainable Disclosure Regime (SDR). The Corporate Sustainability Reporting Directive (CSDR) also exists in the EU to try and standardise how companies report key data to investors. Other regimes globally have their own regulatory reporting requirements and there are also voluntary frameworks for reporting emissions and carbon footprints.
Fund managers face increasing pressure to meet the stringent reporting requirements established by the EU and UK regimes. As our roundtable met, the industry faced a key deadline of December 2nd in the UK, where the industry has to align sustainable fund naming and marketing strategies with the regulation.
Axa’s Jane Wadia noted that reporting takes various forms, including regulatory reporting at the fund level and client reporting at the portfolio level. Clients were increasingly seeing benefits from the latter, she said.
“While there are regulatory reporting requirements, we have observed a growing importance of portfolio-level reporting and so we have focused on enhancing our client reporting capabilities, which has been well received,” she said.
Helpfully, it is often the case that underlying ESG data does not change. Yet there is still a divergence in how people want the data which, said Wadia, does make reporting a challenge to scale up.
Additional to requirements
Vai Patel, head of responsible investment at Alcentra, a private credit manager with EU-domiciled funds, highlighted that there is a large volume of reporting that is additional to regulatory requirements. Although the ‘periodic’ reporting requirement under the EU’s SFDR requires firms to make certain disclosures regarding commitments of so-called “Article 8” or “Article 9” funds under the regulation, this was often not enough for investors. Some require more frequent updates, typically on a quarterly or semi-annual basis.
“There is a lot of separate reporting on the back of what is required by the actual regulatory reporting regime,” Patel said.
Diverging uses of data
Inevitably, the question arises about if ESG teams are spending too much time on reporting rather than helping portfolio managers create value – let alone helping guide the world to climate adaptation.
James Palman, sustainable investment manager at Gresham House, highlighted that over the past few years the growing volume of ESG reporting had resulted in greater pressure on internal sustainability and ESG teams within asset managers across the industry, particularly smaller firms. This had also created an ongoing tension between asset managers’ ability to focus on investments while also fulfilling regulatory obligations.
“There is a balance between getting the right returns for clients by doing your fiduciary duty, and embedding the reporting requirements,” said Palman. He warned that regulatory reporting for some firms could become overwhelming, where they might find themselves dedicating substantial time and resources to compliance rather than value creation.
This, he said, throws into sharper focus the question of the utility of ESG data.
“We often find ourselves pulling in diverse sets of data and this can lead to some uncertainty about whether all this data meaningfully influences investment decisions,” Palman said.
This view was reflected by other panellists, including Vai Patel at Alcentra, who warned that the emphasis on regulatory reporting could overshadow strategic investment decision-making.
Sam Tripuraneni, head of sustainable investments at Aviva Investors, said that some asset owners themselves can also experience a disconnect between sustainability efforts and investment decisions.
“There may be cases where the data generated is not needed by the investment team of the asset owner at all. However, I can completely understand why a sustainability team would want as much data as possible, even though the data may not inform the investment side.”
Difficult to scale up
Tripuraneni emphasised the challenges of scaling up the reporting process to encompass various asset classes and client segments. Automation has emerged as a crucial strategy for streamlining compliance, data checks, and delivery for both SFDR and SDR disclosures. However, Tripuraneni said: “While automation helps quantify sustainability objectives consistently, this approach doesn’t always work across different funds and asset classes, especially for sustainable Article 9 funds, where qualitative judgment plays a bigger role.”
Article 9 funds carry the highest sustainability commitments under the SFDR.
James Palman of Gresham House, said: “Internally, our team is tasked with creating and inputting data to enable reporting at scale. While managing individual fund-level reporting is straightforward, automating the process for regulatory compliance poses a significant challenge.”
Despite these hurdles, Palman emphasised the importance of regulation for enhancing transparency and improving investor access to information.
“Is it a challenge? Of course. It’s a huge change project that happens internally. But it is good and proper because it allows investors greater access and more transparency regarding what a fund does.”
Referring back to investment outcomes, in private markets, Vai Patel pointed out that while obtaining data from end borrowers can be challenging due to the sometimes limited resources of privately owned companies, private market investment managers can still leverage sustainability data effectively.
“We take the data and embed ESG KPIs [key performance indicators] into sustainably linked loans, which form part of our lending strategy. Putting KPIs in loan documentation can actually force a company to decarbonise,” he said.
Third-party providers
Jane Wadia, of Axa IM, shared her perspective on the importance of understanding the nuances of data, not only from internal sources but also from third-party providers. “It’s crucial for us to be expert users of the data and understand its intricacies,” she stated, emphasising the need for understanding data methodologies when making investment decisions. “It’s less about producing the data and more about being careful with how we use it for our clients.”
Neill Blanks, managing director, ESG fund research, at MainStreet Partners, echoed this sentiment. “Different asset managers use various approaches to ESG integration as well as reporting, and it’s essential to understand each fund’s methodology rather than applying a one-size-fits-all evaluation approach.” He also said there is frustration in the market at reliance on a limited number of key third-party ESG data providers.
“There’s a monopoly in the market for ESG data, and this is something that needs addressing,” he said. Due diligence in selecting data providers is a necessity, he said, pointing out the UK’s Financial Conduct Authority recognised the necessity of understanding methodologies behind ESG data.
Palman, at Gresham House, acknowledged the strides made in obtaining ESG data, emphasising the positive shift in recognition from both companies and investors. However, he pointed out the challenge smaller managers face in affording high-quality data solutions, which can exacerbate resource disparities between large and small firms.
“There’s a bit of a divide between larger managers and smaller managers,” he said.
Looking ahead: a more consistent future?
Reflecting on the future of reporting, Vai Patel expressed hope that the implementation of the CSDR in the EU will lead to a more standardised approach to reporting.
“I think we will hopefully get to a point where everybody is reporting hard data on the same basis,” he suggested. This would require managers to interpret and assess the data effectively, adding value through their unique insights.
Sam Tripuraneni of Aviva Investors emphasised the ongoing challenge of systematising sustainability within the investment process.
“As active managers, we are paid to make judgments based on all available information but interpretation is important. The reporting should not reduce our decisions to a simplistic set of binary data points,” he said. The tension between qualitative assessments and quantitative reporting metrics remains a significant challenge for the industry.
