Key ESG Data Challenges
In the world of asset management, quality data is the foundation of all good decision-making. Yet challenges in ESG data reporting mean that asset managers often have to work with data that’s at best inaccurate – and at worst misleading.
These ESG data challenges can lead to skewed results, misled stakeholders, wasted resources and poor ESG investment decisions. So why is this still happening?
For a number of reasons…
1. The ESG data pool isn’t big enough
The more data you have, the bigger the pool you can draw from. But the fact that only larger public companies are required to report ESG data, published via their annual reports, means that the data pool that ESG researchers have access to is limited to what these larger companies decide to self-disclose.
2. Lack of consistent regulation
Although various guidelines exist, the lack of a single regulatory framework around ESG reporting is cited by valuation experts as one of the biggest ESG data issues. Some of the most popular ESG frameworks include Global Reporting Initiative (GRI), Sustainable Accounting Standards Board (SASB) and Task Force for Climate related Financial Disclosures (TCFD), and the EU Taxonomy. But without a single, universally accepted ESG reporting framework, there is plenty of space for different interpretations of how and what to report against ESG factors.
3. No universal system to verify reported ESG data
One of the biggest challenges in ESG reporting is a lack of auditing, which undermines and limits the reliability of ESG disclosure reports. This results in public reports tending to highlight only the positive contributions to ESG, while underplaying or omitting negative factors in reporting. This is the very essence of greenwashing and it is being made easier for businesses to achieve as a result of ESG data challenges around auditing.
4. ESG rating providers use different criteria to score
This is perhaps the biggest of the challenges in ESG data reporting, because it renders ESG ratings scores an impenetrable black box. Without regulation governing the assessment of sustainability requirements and performance – and every ESG ratings provider applying its own methodology – it is questionable whether any of the results they provide are truly accurate.
Let’s explore this final point in a little more detail.
When MIT’s Sloan School of Management compared the scores from various ESG rating providers, they found that the correlation was just 0.61, on average. This lack of correlation is, in large part, owing to the widely different methodologies these agencies use.
The differences in approaches among ESG ratings providers ranges from the data sources they use to the weightings given to certain considerations and the criteria against which they assess ESG factors.
Some providers like MSCI ESG Fundamentals draw from sources like financial data and, sustainability reports, while other agencies like Sustainalytics use mostly primary research and publicly available data. Meanwhile, there are other agencies that use proprietary data sources like surveys, questionnaires, and interviews.
The weightings that ESG ratings providers give to different factors also vary wildly, with some providers giving more weight to environmental factors, while others lean more towards social or governance factors.
ESG rating providers also differ in their use of the specific criteria used to assess ESG factors, with some directing focus towards a company’s carbon emissions, while others emphasise a company’s labor practices or political lobbying. This comes back to the fundamental question about what risk assessment is: risk to the environment and society, or risk to the financial health of a company?
