The Opportunity in ESG Regulatory Expansion Is Data Mastery

ESG regulation growth creates an opportunity for investment firms

In a 2021 survey, the CFA Institute found that 85% of investment firms consider environmental, social, and governance (ESG) criteria a growing priority in their firm’s overall investment strategy¹. Since then, interest in ESG investing has only intensified, driving parallel growth in regulatory complexity.

And as ESG considerations become a priority for mainstream investors, investment firms must negotiate a more demanding regulatory environment. The proliferation of reporting frameworks and requirements, along with inconsistent metrics and scoring systems furnished by various data vendors, forces investment firms to fight administrative overload.

For many firms, legacy data management processes will struggle to keep pace with the need to ingest and reconcile varying ESG data formats rapidly. They also need to prioritize overlapping, and at times, conflicting, regulations as well as adhere to a large and changing set of demands from investors and regulators alike. As ESG becomes fundamental to investment decision-making, we’re likely to see firms that do centralize their data management enjoy a competitive advantage over their peers.

The evolving ESG landscape

Investors are increasingly choosing companies that demonstrate exceptional ESG performance². These companies offer a more prudent long-term choice for navigating market uncertainty.

In fact, Bloomberg Intelligence expects ESG assets to cross $40 trillion by the decade's end³. To put this number in context, this represents over one-quarter of all projected global assets under management. 

And it isn’t just demand for ESG products that is growing. So too, is the complexity and strictness of regulatory enforcement. Governments and regulatory bodies worldwide are implementing frameworks like the Sustainability Accounting Standards Board (SASB) standards to integrate ESG factors into mainstream financial decision-making.

Under the new SASB standards, which will take effect in 2025, 77 industries will be impacted. Oil and gas companies, for example, will need to disclose metrics regarding water withdrawn and consumed in their areas of operation.

Changes like these reflect the ubiquity of ESG requirements. However, not all investment firms can keep pace with reporting requirements, data formats, and guidelines across jurisdictions. Firms globally must navigate a patchwork of measurement and disclosure rules, making compliance a daunting task.

Suzanne Lupton, Director of Co-Investment at Maven Capital Partners, noted that “disparate and competing reporting standards across the industry” will lead to “onerous” information gathering and reporting⁴.

Related reading: Has ESG Investing Peaked?

Adapting to ESG changes: Challenges for investment firms

Investment managers in the maturing ESG space face several complications.

Multiple standards and frameworks

Various organizations have developed ESG frameworks, such as the SASB, the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD). Each framework has its own focus and criteria, leading to inconsistencies in ESG reporting and assessment.

The GRI is broad and inclusive, covering a wide range of topics, including environmental impact. It allows companies to provide contextual information and report their sustainability practices in detail.

The SASB, on the other hand, is more targeted. It aims to identify sustainability issues most likely to affect a company’s performance. The SASB emphasizes quantitative metrics that enable comparison across companies and industries. Datapoints might include details about a company’s energy consumption, executive compensation, or workforce diversity.

While the GRI, SASB, and TCFD are prominent examples, they are far from the only frameworks in use.

Regulatory fragmentation

Countries and regions each have their own regulatory requirements for ESG disclosures as well. For instance, the European Union uses the Sustainable Finance Disclosure Regulation (SFDR); while the United States has its own SEC guidelines for climate-related disclosures. This can lead to investment firms struggling to identify a unified set of standards amid the regulatory fragmentation.

Data challenges

Collecting, verifying, and reporting ESG data is difficult due to the lack of standardized metrics, formats, and methodologies. The quality and availability of ESG data vary by industry, region, and service provider, complicating efforts to streamline ESG assessment.

For instance, misclassifying an asset as fossil-fuel-free when it is not could expose investors to an industry they’d prefer to avoid. Firms can attempt to monitor their portfolio exposure manually, but the task requires either substantial oversight using spreadsheets or other tools, or costly in-house expertise.

ESG Book, one of the industry’s major data providers, reports on over 100,000 global companies across 490 individual ESG attributes. Attempting to replicate similar coverage in-house would be nearly impossible for most firms. Investment firms don’t just require an overall ESG score but also the ability to see the granular details that comprise the score.

ESG Book is just one data provider. Managers can also integrate metrics from other sources, like S&P True Cost or MSCI, often in various formats. While integrating ESG data from several providers enables a comprehensive view across companies’ scores and metrics, it further complicates data management. 

Watch our webinar with ESG Book and J.P. Morgan: ESG 2.0: The Future of Regulation, Data Integration, and Sustainable Investing

Consequences of inadequate ESG data management

Failing to streamline ESG data collection and analysis can expose firms to regulatory penalties and legal liabilities — not to mention reputational damage.

An investment firm may be at risk of reporting ESG data based on outdated or incomplete information about a company's ties to the tobacco industry, for example. This could lead to sanctions and fines. Or, their ESG data system might fail to flag a portfolio company’s environmental violations. The investment manager could face fines from the SEC and reputational harm.

Poor data management can also erode trust as investors increasingly demand transparency and accountability in ESG practices. Morningstar’s proxy voting database saw a 33% rise in the number of shareholder resolutions in the United States between 2018 and 2022 aimed at aligning investment strategy with investors’ personal ethics⁵.

Inconsistent ESG data management can also hamper strategic decision-making. Without a comprehensive view of ESG exposure across their portfolio, investment firms could find themselves unintentionally overconcentrated in a particular sector.

Lack of visibility can lead to suboptimal investment decisions, affecting returns and investor satisfaction. Imagine:

• An investment manager may overlook environmental risks, leading to investment in a company facing regulatory fines or operational disruptions.
• Without accurate social data, an investment firm might invest in a company with unethical labor practices, inviting negative publicity and boycotts.
• Inconsistent governance data could lead an investment firm to miss signs of problematic corporate governance, such as conflicts of interest, which could lead to investment in a company navigating an embarrassing internal scandal.
• Incomplete ESG data may prevent an investment manager from spotting a company leading in sustainability practices, resulting in a missed strategic investment opportunity.

When legacy systems are insufficient

Despite the importance of efficient ESG compliance, many investment firms continue to rely on legacy systems that are ill-equipped to address the reporting demands of today’s clients and regulators.

Often built on previous-generation technology or even Excel workbooks, these systems do not efficiently ingest, integrate, and analyze fragmented and inconsistently formatted ESG data from diverse sources.

Legacy systems often operate in silos, with different departments like marketing or investment strategy — or even different geographic regions — managing ESG data independently. A firm with separate ESG data oversight for its European and Asian operations may be unable to consolidate and reconcile data for global reporting purposes efficiently.

Moreover, legacy tech systems typically lack the flexibility to adapt to evolving regulatory requirements. As ESG regulations multiply, investment firms need a way to address new standards.

And those who fail to modernize their data management systems may find themselves at a competitive disadvantage.

Despite this, a recent Bloomberg survey found that only one-third of firms take a holistic, firm-wide approach to evaluating, implementing, and rationalizing ESG data⁶.

Gaining an edge with centralized ESG data management

Like public markets, private markets are experiencing an uptick in the popularity of ESG-focused investments. In 2017, ESG-focused private funds held less than $20 billion in assets under management. By 2022, that number crossed $100 billion.

The benefits for investment firms who adopt centralized data management are manifold. Even the world’s largest private market players recognize them.

In 2021, Blackstone, the world’s largest alternative investment firm, acquired data management company Sphera for $1.4 billion⁷. Sphera allows clients to identify and manage ESG risks in their portfolios.

Centralized systems provide a single source of truth, ensuring consistency and accuracy in reporting — an advantage some firms are willing to invest in.

But luckily for most investment firms, adopting centralized, holistic technological solutions is not yet widespread, leaving an opportunity for those looking for an edge.

Efficient data management has emerged as a key factor in gaining advantage, and those who embrace centralized data management will be better equipped to navigate the complexities of regulatory change and capitalize on the opportunities it presents.

 Sources:

1. ESG Criteria: Global Asset Managers Expand Their Embrace CFA Institute, September 7, 2022

2. Why ESG performance is growing in importance for investors, EY, March 9, 2021

3. Global ESG assets predicted to hit $40 trillion by 2030, Bloomberg, February 8, 2024

4. Can private equity meet public responsibilities? Financial Times, October 11, 2023

5. In Whose Best Interest? Why Investors Are Demanding More Transparency on Companies' Lobbying Activities, Morningstar Sustainalytics, September 12, 2023

6. Bloomberg Survey Reveals Increasing Demand for ESG Data but Data Management Challenges Persist, Bloomberg, August 23, 2023

7. Blackstone to buy ESG software provider Sphera in $1.4 bln deal, Reuters, July 6, 2021