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The downside of the data game
The downside of the data game

The downside of the data game


The explosion of data and environmental, social and governance (ESG) information is met with questions around accuracy, methodology and transparency

We live in an information age:

90 per cent of all the data ever created is said to have been generated in the last two years

Source: IBM Marketing Cloud

The growing use of big data, artificial intelligence and machine-learning is one of the defining megatrends of our time, and in the financial sector it is starting to interact with another – the increasing importance of ESG issues to investors as they start to understand the value and materiality of such information.

On the one hand, this data explosion is a boon to companies and investors because it shines a light on how companies operate, the risks they face and the challenges they can exploit. Almost three quarters of analysts take ESG issues into account in their investment analysis and decisions, with governance being the most common issue they consider, according to the Chartered Financial Analyst (CFA) Institute[1].

“This explosion of machine power and speed means that we are still learning about the potential of data,” says investment fund Arabesque[2]. “We have scaled up our understanding and application of data science to cope with the new size and usefulness of the data being collected around us. And with the gap closing between the size of data and our ability to master it, investors are now able to produce real insight using correlations across big pools of complicated data sets.”

There is pressure on companies to find ways to collect more data and release it, and more providers are enlarging their data offerings, adds Florence Fontan, head of Asset Owners at BNP Paribas Securities Services.

On the other hand, the picture that the light reveals is often out of focus because much of the available data is not ordered, standardised or comparable with other data, meaning that it is of little use. “The quality of ESG data is at around 10 per cent of where it will be in five years’ time, but it is increasing all the time,” Arabesque asserts.

"To make data meaningful, there will have to be a focus on the methodology"

Trevor Allen, product sales specialist, BNP Paribas Securities Services

In addition, it is massively incomplete: while there is a great deal of data about companies based in the industrialised world, particularly North America and Europe, in other parts of the world there is much less information to go on.

The CFA Institute’s latest survey found “evidence that the ESG market is maturing, but with significant variation by region”.

We need to understand what we are measuring, says Trevor Allen, product sales specialist at BNP Paribas Securities Services. “If you have a portfolio that is heavily invested in emerging markets, it can be quite difficult to get information.”

According to the CFA Institute, the three factors that most limit organisations’ ability to use non-financial information in investment decisions are: a lack of appropriate quantitative ESG information, a lack of comparability across firms, and questionable data quality/lack of assurance.

A paper[3] by researchers at New York University’s Stern Center For Sustainable Business in the Journal of Environmental Investing says: “ESG data are not going to meet financial quality standards because companies do not use one standard to report their performance. Companies can choose to report on material or immaterial ESG factors, on their own operations or the entire supply chain, on clear targets or on general policies. They can choose to use a globally accepted ESG standard such as the Global Reporting Initiative (GRI), or they can follow their own criteria. They can choose whether or not to have their ESG reporting audited by a third party.”

The researchers identified more than 150 providers of ESG research, ratings, rankings and indices following more than 50,000 companies. These include the market data providers such as Bloomberg, FTSE Russell, MSCI, and Thomson Reuters, which have branched out into ESG data; ESG-exclusive data providers such as Arabesque, Covalence, Oekom and Sustainalytics; and specialised data providers, which provide information on one or more aspect of ESG. CDP, for example, focuses on climate change and water, Trucost analyses environmental risks such as natural capital, ISS has an emphasis on governance and RepRisk focuses on reputational risk.

“For ESG data to meet its potential to help investor (and management) decision-making, ESG metrics need to be standardised, ESG data providers need to adopt a common code regarding their methodologies, and financial performance related to ESG investments needs to be tracked and monetised,” the paper says.

Allen agrees. “When it comes to data, we are experiencing growing pains,” he says. “As big data develops, demand for information will increase because it will be easier to get hold of. This will bring increased transparency but to make this transparency meaningful, there will have to be a focus on the methodology used to compute the data, to ensure that that there is the same comparability as there is in accounting.

“The industry is just starting to work on standardising methodologies. At the moment it’s important to check the accuracy of the information that is available.”

BNP Paribas’s own ESG report uses multiple data providers “so that we can compare the information we receive and increase the reliability of what we do”, says Fontan.

One way that information is becoming more standardized is through consolidation – the sector has seen a number of takeovers in recent years. Another development has been the advent of open source datasets and tools. The 2° Investing Initiative[4], for example, is developing such tools and offering them to market participants for free. “A lot of providers are using this information to enhance their offering,” says Jean-Philippe Hecquet, investment risk and performance specialist at BNP Paribas. “If you have an open dataset, you can create standardisation.”

Initiatives such as the Sustainability Accounting Standards Board, the GRI and the Global Compact encourage a certain amount of convergence, while stock exchange requirements on sustainability disclosures are also helping. The International Integrated Reporting Council provides guidance on how companies can go beyond providing ESG data in a siloed fashion and incorporate ESG data into financial reporting to develop a cohesive value creation story.

The Taskforce on Climate-related Financial Disclosures provides guidance on how companies – and investors – should report climate-related information in their financial filings, focusing on governance, strategy, risk management, and metrics and targets.

When the framework was released, Philippe Désfosses, chief executive of French pension scheme ERAFP and vice-chair of the Institutional Investors Group on Climate Change, said: “The more companies report effectively on climate-related risks and opportunities, the easier it becomes for investors to allocate the substantial amounts of capital required to implement the Paris Agreement and to work on their own climate risk disclosure.”

It also allows investors to hold companies to account on their climate change impacts and align their portfolios with the targets of the Paris Agreement, to keep average temperature rises well below 2°C. For example, Mirova, an affiliate of Natixis Investment Managers, recently announced that it had reduced its carbon footprint on its consolidated equities portfolio from 3.5°C to 1.7°C and that it is also now within the 2°C threshold across its asset classes.

This is an example of how ESG data can drive positive change, even though the field is still emerging. As the amount of data grows, technology helps us to process it more effectively and it becomes more standardised, ESG analysis will become more important to investors everywhere.

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