ESG data refers to information surrounding sustainability and the ethical conduct of an organization or country. This information can be used by asset managers for investment decisions, defining investment strategy and compliance.
Fund managers have started spending more on ESG data than ever before, with costs projected to reach $1 billion by 2021. Currently, asset managers’ spending on ESG data is projected to be around $554 million a year. For asset managers looking to incorporate an ESG framework, there is a need for some methodology to understand and assess these factors.
To better understand the framework of each factor, they are divided into separate issues and then mapped to various metrics for measurement. Some of the issues under each of the factors are as follows:
- Environmental: Issues surrounding GHG emissions, air quality, energy management, water and wastewater management, etc.
- Social: Issues involving customer privacy, data security, product quality and safety, labor practices, etc.
- Governance: Issues around board accountability, executive compensation, etc.
The Impact of ESG
Assessing and predicting financial performance of investments requires understanding the drivers of expected risk and return. While there are traditional financial metrics that capture some aspects of risk and return, there are some issues that affect this that cannot be directly linked to monetary terms.
The Volkswagen emission scandal and the Enron scandal are two examples where traditional valuation models failed to capture the risks these companies faced. In hindsight, understanding aspects of governance within these companies would have exposed some of these risks and could have averted losses for many of the investors.
As per research, risk adjusted returns of portfolios where ESG factors were given importance tend to be higher as compared to portfolios where there was no allocation for an ESG factor-based selection of equities. In addition, ESG-compliant firms have greater transparency, leading to a lower cost of capital and risk premium.
Need for Mastering ESG Data
While ESG data can be synthesized internally through checklists and other mechanisms by asset managers themselves using their own internal criteria and metrics, there are multiple providers who maintain ESG data in varying degrees of coverage. ESG data may be required in a variety of applications. Order management systems might require ESG data to check for compliance prior to the execution of a trade. There might be a need for alerts or flags of the held securities that breach an ESG threshold. Reporting tools might also require ESG data to check the current state of compliance at multiple levels ranging from portfolio, strategy or analyst levels.
1) Some asset managers might want to create a checklist for the internal computation or assessment of ESG metrics. This will require a solution with native capabilities to permit users to master data.
2) Each of the applications may be managed by different teams. Each of these teams will eventually maintain ESG data in the format, volume and quality as they will require, leading to a lack of standardization and integrity.
3) Each of the applications may try to retrieve data for their own set of requirements, leading to a redundant increase in the number of data requests and retrievals.
4) ESG data will become inconsistent over time across applications, especially if they work in silos.
5) As the fund grows, the amount of ESG data required to be sourced will also increase in proportion to the issuer of the securities and corresponding countries. There might also be a need to increase the number of ESG issues being considered, which will amount to an increase in volume. While there are some dataflows that will require automation, there will be also some dataflows that will require tracking and monitoring.
ESG Data Mastering Solution: IVP Security & Reference Master
IVP Security & Reference Master, with a configurable data model, allows users to master ESG data as per their requirements without the need for customization of the application. This configurable data model allows asset managers to maintain and change customized ESG checklists as per their requirement without the reliance on the external IT team. IVP Security & Reference Master also has native capabilities to support sourcing from multiple ESG data sources, produce a blended golden copy of ESG data, store ESG data at both the issuer and at the country level, and distribute the copy of ESG data to multiple applications for their consumption. This solves a multitude of problems related to a lack of standardization and redundant data retrievals as it maintains consistency across applications and allows asset managers to scale at ease. The growth and adoption of ESG data is going to continue as managers seek new opportunities. Managers must continue to examine their data management capabilities to ensure customization, continuity and scalability once in use.