On June 20, RIMES hosted its Client Conference in Boston. The fourth session of the day was a panel debate on the subject of ESG data, hosted by Andrew Barnett, RIMES’ Head of Product Strategy, with panellists including Diederik Timmer, EVP of Client Relations at Sustainalytics, Edward A. Allen, Head of ESG Client Coverage Americas at MSCI, and Tom Anderson, Director, Performance Measurement and Reconciliation at Fort Washington Investment Advisors. What follows is a summary of the main points raised during their discussion.
The debate kicked off with one of the most important issues in the Environmental, Social and Governance (ESG) data world: standardization. The panellists agreed that while it would be good for the market or regulators to introduce some level of standardization around how companies report on ESG factors, there can be no standardization when it comes to the ratings and signals that emerge from various analyses of the data. There will always be differences in ratings so long as ESG data firms and investment managers apply different methodologies – and this should be welcomed.
Discussion then moved to the core question of the debate: how firms integrate ESG data into their portfolios. One answer to this question lies in understanding exactly what the ESG data is intended to do: profile risk, identify alpha or drive environmental engagement and stewardship with corporates? Each requires its own approach to data analysis and rating.
One thing to emerge from the panel session is a difference in focus between the US and Europe. For the former, investment decisions are still based squarely on fiduciary duty, and ESG ratings are mostly used to understand how environmental, social and governance factors impact risk. A common question asked by investors is what does a ‘Triple A’ ESG score means in terms of generating alpha or securing a high return, and there is a sense that investment managers are still linking ESG performance with financial performance.
In Europe, the focus is more on how ESG factors can provide a complementary basis for financial performance-based investment decision-making. This is changing, however. With new ESG-based fund ratings emerging in the US, and advisors being given the tools they need to work with ESG-based investment decisions, the market will soon be more aligned with Europe.
Are the variety of ESG formats an issue?
The panel then looked at the variance in ESG rating forms and whether this could be a challenge moving forward. Does the fact that one agency rates ESG on a ‘Red, Amber, Green’ system and another on an ‘A,B,C’ scale cause confusion? The consensus was that this is no different to the variety of financial ratings available, and that it is the responsibility of the investment manager to understand whether the factors they use are right for them and their clients. As long as ratings agencies are transparent about what they measure and how they measure, the way they present the rating is largely immaterial.
The future of ESG
Looking ahead to what the future might have in store for ESG investing, the panellists outlined several scenarios. In one, companies will start to lose control over how their ESG story is told. This is because the data about their performance will increasingly come from alternative data sources, rather than the companies themselves. Data quality will decrease, but there will be much more of it, presenting a data challenge for firms, but ultimately a more accurate way of measuring ESG performance.
In a second scenario, the ESG market will have shifted its focus from risk profiling and alpha generation and will be used to feed back to investors exactly how their money is being used to positively impact the world. This is a move being driven by clients: they want transparency, increasingly every bit as much as they want a good return. Indeed, the ability to communicate and provide transparency to clients was singled out as perhaps the only true way to differentiate in the ESG market.
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