A Strategic approach to ESG Data and ESG Fintech solutions
According to J.P. Morgan, “Over $500 billion flowed into ESG-integrated funds in 2021, contributing to a 55% growth in assets under management in ESG-integrated products.”1. The governance and infrastructure to support this growth, have been sub-optimal, partly due to deficient enterprise level strategies in identifying ESG Data and ESG Financial Technology solutions that enhance the investment process.
We have identified three key reasons why this has happened:
- The rush to meet market demand for sustainability focused products
- Infancy in the ESG Data and Financial Technology
- Regulatory requirements and client expectations
Exploring these reasons in detail:
1. The rush to meet market demand for sustainable investment products
The rapid increase of inflows towards sustainability focused products resulted in some investment managers sacrificing parts of their product governance processes to gain a market share of the growing ‘green revenues’. There was also limited comprehension of ESG issues across business teams supporting the investment process, and this will likely have impacted the effective governance of sustainability products. How do you ensure effective understanding to challenge and monitor data? Knowledge of sustainability issues continues to improve across all teams and this will be important as managers look to identify ESG solutions that can add value to their investment processes.
2. Infancy in the ESG Data and Financial Technology market
The availability of data and advancement in technology capabilities typically respond to demands from clients, asset owners, investment managers and regulatory requirements amongst other groups. The rapid increase in supply of sustainability products, and in the absence of embedded regulations, meant data and technology firms are still playing catch up as they seek to address data and system capability deficiencies. As a result, many investment managers are consuming ESG data from multiple sources so they can meet their data requirements as best they can. Whilst this may meet short term business demands, in the long term, subscribing to multiple providers may not be the most cost effective when considering the license fees and the internal cost of supporting these platforms. Managers are now looking to consolidate ESG data and platforms to drive costs down and improve efficiency.
In the last year alone, there have been significant improvements in the Data and Technology market. Some solutions providers are now providing data and metrics to assess the impact of companies' activities in biodiversity. Data quality and transparency has also improved driven by regulatory disclosure requirements and companies partnering with independent sustainable industry bodies and disclosing voluntary ESG information to obtain certifications to demonstrate sustainable investing. There are also multiple ESG financial technology firms providing data normalization services for those managers looking to utilise data from multiple sources but consumed via a single feed. Have the advances in this market translated into an improvement of your own investment process?
ISOCO adds additional colour in their Final Report on Environmental, Social and Governance (ESG) Ratings and Data Products Providers2, published in November 2021:
"Recommendation 7: Financial market participants could consider conducting due diligence on the ESG ratings and data products that they use in their internal processes. This due diligence could include an understanding of what is being rated or assessed by the product, how it is being rated or assessed and, limitations and the purposes for which the product is being used."
3. Regulatory Requirements
Through the Sustainable Finance Disclosure Regulations (SFDR) and EU Taxonomy, the EU may have set a precedence on how other jurisdictions may shape sustainability regulations. There is still significant debate by investment managers about how to define thresholds for article 8 products i.e. those that promote environmental or social characteristics, and article 9 products i.e. those that have a sustainability investment objective. The relevance of thresholds is that they set the minimum ESG metrics that need to be integrated, processed, and measured. The Sustainability Disclosure Requirements (SDR) being introduced by the FCA will have higher thresholds for the equivalent article 8 and article 9 products. Managers will need to consider their regulations exposure to ensure their can streamline their approach to product creation and classification.
Another consideration is for managers who have multiple manufacturing entities, or products that have been created for particular markets. When the UK SDR is effective, will your article 8 product meet the higher bar for a UK label? There are currently over 8,000 funds registered for sale into the UK and the proposed UK SDR divergence from the EU SFDR may cause concern for managers going forward.
Identifying and embedding ESG Data and ESG Financial Technology solutions
There are many ESG Data and ESG fintech solution providers in the market, all with different capabilities and focus. Investment managers offering a diverse suite of products will likely need to consume services from multiple ESG solution providers. A diligent and thorough study of the market is required to ensure that the solutions they integrate into their businesses are optimal. The three steps below will guide you with your strategic approach to ESG Data and ESG Financial Technology solutions.
- Perform a thorough enterprise data and technology requirements gathering exercise
- Understand the breadth of the ESG solutions market and maintaining market insight
- Shortlisting, selection and ongoing monitoring
ESG solutions enterprise requirements definition
Your firm’s stance on a range of sustainability issues, and the commitments you sign up to, will be the starting point of your data requirements. This will be complemented by the sustainability issues addressed by your products, your client information requirements, and the various regulatory requirements you are exposed to. Whilst European Securities and Markets Authority (ESMA) has led the global funds industry from a regulatory perspective (through SFDR), it remains imperative for investment managers with a global focus to keep track of regulatory developments in other markets. The technology capabilities you will require will also be influenced by the metrics you need to process, analyse and report. There are many different ESG technology firms in the market whose capabilities include portfolio management, compliance, analytics, reporting and stewardship amongst others. Investment managers therefore need to ensure that they award appropriate focus in defining their requirements so they can get a clear understanding of the ESG capabilities they need to integrate into their investment process. How have you defined your ESG solutions requirements and are you comfortable that this has been performed well?
Understand the ESG solutions market
The ESG solutions market is dynamic and continually has new providers entering the market, and providers that are constantly enhancing their services and forming new partnerships. Some technology firms can only support data feeds from certain vendors and other are agnostic to where the data is coming from. Investment managers need to understand the market so they can identify solutions that enhance their investment process. The challenge often cited by many investment managers is that there are many ESG solution providers which makes reviewing this market a very time intensive and expensive process. Furthermore, solution providers do not utilise a common taxonomy making it difficult to make meaningful comparisons. Therefore, how can you perform a robust due diligence exercise that considers a wider pool of solution providers in such a market? What is the value of performing such an exercise?
Shortlisting, selection and ongoing monitoring
It’s critical that your approach to shortlisting is robust to ensure you can identify solutions providers that add value to your investment process. Your ability to effectively compare services from different solutions providers and rate them against each of your requirements is crucial. Any service shortfalls identified will add risk to your investment process which will need to be managed. Understanding the solutions providers’ product pipeline should be factored into your shortlisting or selection. Not only is it good governance to continually understand substitutability, the European Banking Association (EBA) Guidelines on outsourcing arrangements also require managers to understand substitutability and the associated mechanics to effect. Can you demonstrate how you selected your solutions providers, who the good substitutes are and how you maintain awareness of the market?
How Devlin Mambo are helping our clients
We understand how challenging and time intensive it is to navigate this complex market as you look to identify and maintain awareness of solution providers that can complement your investment process.
Supported by a common taxonomy, our DM ESG Insights platform consolidates our market research on the many ESG Data and ESG fintech solutions and structures the output into understandable and comparable information. Our platform has a strong reporting and vendor assessment framework allowing for a well governed and demonstrable approach to selecting and maintaining ESG solutions partners. Our platform will assist you in demonstrating good due diligence on solutions providers aligned with IOSCO recommendation 7.