The shift towards sustainability in finance has accelerated. Climate change and other socioeconomic risks have moved front of mind across the financial sector. In order to pursue a clear sustainable agenda within Capital Markets consistent, coherent and comprehensive data is essential. While significant progress has been made in terms of non-financial reporting the field remains relatively new. Notably however, advances in data analytics and data capture are laying the foundations for a better understanding of, and more structured form of, ESG data.
Without this focus on materiality and industry specifics, we won’t be able to have significant or relevant data that’s used by financial players.
In the past, companies have used a number of standards, including the GRI, TCFD and SASB, when issuing sustainability reports. According to Ashraf Ammar, Consulting Director at PwC Luxembourg, this has led to ESG data on the market being inconsistent. However, upcoming EU regulations, such as the Taxonomy and Non-Financial Disclosure Regulation, aim to harmonise the data that is reported. Laetitia Hamon, Head of Sustainable Finance at the Luxembourg Stock Exchange, believes this a step in the right direction and will help identify which activities contribute to environment objectives, but that it will still take some time.
Hamon notes that, in the search for consistency and comprehensiveness, it’s encouraging to see players report in a scientific-based manner. New products, such as Sustainability-Linked bonds for example, require companies “commit to Sustainability Performance Targets and KPIs to be reached within a set deadline that are ambitious, measurable and externally verified and around which the level of reporting is expected to be robust,” according to Hamon.
However, coherency cannot be forgotten in the search for consistency and comprehensiveness. ESG data cannot, and should not, be the same for each industry. In order to be able to truly map sustainability risks, the data must be granular and material. Ammar asserts that “without this focus on materiality and industry specifics, we won’t be able to have significant or relevant data that’s used by financial players.”
Producing this data is also becoming more complicated as investors become more aware of the data that is available to them. Hamon sees forward-looking sustainability-related data as one of the next steps the industry is examining, however she notes that it remains in its infancy given the difficulties in accurately modelling for this type of data.
To comply with EU regulations related to sustainable finance, you will need far more granular details and ESG ratings or scores alone will no longer be enough.
From a social perspective, increasing issuance of social bonds is contributing towards a shift towards social impact data. This long-term data is critical in order to assess the impact on communities. To Hamon, this sort of data is however difficult to report, as companies are required to “judge scenarios and stress test around social data and social scenarios in order to assess how a project might benefit the community as a whole over the long-term.”
Further, the overwhelming number of ESG ratings agencies is not helping matters. With well over 100 ratings agencies, using a variety of inconsistent methods, this presents large challenges to players looking for consistent data. Given the important role ESG scores or ratings used to play in determining whether funds purchase a stock or how lenders structure loans, this adds another layer of complexity into the mix. Ammar notes that “this is a challenge and even a threat; to comply with EU regulations related to sustainable finance, you will need far more granular details and ESG ratings or scores alone will no longer be enough. On top of this ratings agencies in the market have different methodologies and materiality data.”
Long-term data is critical to judge scenarios and stress test around social data and social scenarios in order to assess how a project might benefit the community as a whole over the long-term.
Hamon states however that rating agencies obviously have their advantages, but that firms must do their homework and “understand how they work, the type of data that is put out and the type of methodologies used.” Sifting through this information and understanding the underlying methodology can be time consuming and costly to players and the methods of determining ratings can favour large firms who are prolific in terms of disclosure.
While comprehensiveness in data is difficult to truly achieve, large data gaps make the holes in sustainable finance data particularly noticeable. However, expanding regulations within the EU and increased reporting requirements, as well as growing investor awareness, mean that corporates, data vendors and AI-based startups are beginning to plug the gaps. According to Ammar, “the gap will never be 100% closed, but it will at least be reduced.”
The LGX Datahub provides a level of granularity in the market that cannot be found elsewhere, allowing for data comparison, extraction and analysis, even for post-issuance information.
While this certainly bodes well for investors and asset managers, Ammar notes that the increasing regulations related to reporting and sustainability risk could mean that European asset managers face becoming less competitive in terms of global investments. “Managers in Europe might struggle to get the level of detailed reporting from corporates based in the US, Latin America, Asia or Africa, where local regulation does not have the same requirements as the EU.” To Ammar, this highlights the advantage that private equity has in this space, given that these firms are able to “put pressure on the assets and ensure that reporting meets your requirements.”
In order to meet growing data requirements, the Luxembourg Stock Exchange recently launched the LGX DataHub. This database provides investors and asset managers with a variety of data points related to green, social and sustainability bonds, at a bond, project and impact indicator level. According to Hamon, the LGX DataHub provides a “level of granularity in the market that cannot be found elsewhere, allowing for data comparison, extraction and analysis, even for post-issuance information.”
Capital markets firms continue to struggle to incorporate meaningful sustainability aspects into their investment decisions, leading to capital often being allocated to projects or corporates that are considered unsustainable. In order to rectify this a number of actions must be taken, but data lies at the heart of many of these. Consistent, coherent and comprehensive sustainability data is critical to ensuring the sustainable allocation of capital and the future of sustainable development.