Author: FINBOURNE– finbourne.com
Thomas McHugh, CEO, FINBOURNE Technology
This article was written for and first appeared in Data Management Insight 30th March 2022.
With ESG firmly on the global investment agenda, investors are increasingly expecting asset managers to generate sustainable returns across multi-asset portfolios. In developed markets, many are now expecting not just a portion of these investments but a majority of their portfolio to positively impact on the community and the environment.
To date, much of what we’ve seen in sustainable finance has focussed on climate change. The UN COP26 climate change conference, last November, was considered instrumental in aligning the world’s governments to a range of climate-related criteria, as outlined in the Glasgow Climate Pact. It also saw biodiversity emerge as the next ‘ESG frontier’.
Within the Glasgow Leaders’ Declaration on Forests and Land Use, the term is referenced throughout, with point six of the declaration, being most significant for institutional investment:
Facilitate the alignment of financial flows with international goals to reverse forest loss and degradation, while ensuring robust policies and systems are in place to accelerate the transition to an economy that is resilient and advances forest, sustainable land use, biodiversity and climate goals.
And there is good reason for acknowledging the transition risk posed. In a recent report Elizabeth Gillam, Head of EU Government Relations and Public Policy at Invesco, wrote that “whilst the moral imperative to act is clear, the economic imperative is just as clear…According to the World Economic Forum, the value of goods and services that nature provides is estimated at $33 trillion USD a year. Comparable to the combined economies of the US and China.”.
It is no wonder that 100 counties have since pledged to meet the revised biodiversity goals and net-zero commitments outlined in the pact. Including 37 global asset managers, with a total AUM of $9 trillion, who have signed the finance biodiversity pledge.
However the practicalities of gaining a clear view of the market risks and opportunities – including the requisite investment needed to offset deforestation – is becoming increasingly difficult, amid a fast-moving geo-political and financial backdrop. Adding to this, are significant gaps in reporting and numerous ESG ratings providers, all with their own proprietary methodologies and criteria, that are proving difficult to standardise and derive insights from.
Addressing ESG data at the root of investment management operations will be critical in the coming years. So, how do asset managers monitor and respond to climate change and biodiversity risks, and importantly show progress not only against targets, but in generating real change?
The devil is in the data
Despite sustainable finance marching at pace, The reality today is that many asset managers are struggling to aggregate and translate ESG investment data, into a timely and reliable, firm-wide view – with a detrimental impact to both portfolio operations and reporting.
Much of this is down to the high volumes of untypically structured ESG data; from company reports, to satellite imagery, supply chain data and more. Add this to the already burgeoning volumes of investment, market and reference data, and you begin to see why accessing, understanding and controlling investment data, with any real fidelity, is becoming problematic. And at the root of it all are legacy systems responsible for data fragmentation, organisational silos, and subsequently a host of labour-intensive manual workarounds. This, together with the addition of niche ESG bolt-on systems, has created a tangle of systems and interfaces, and accelerated the ESG data struggle.
As a result, the data that forms a central asset to investment management operations is simply not fit for purpose. We know the complexity of this will only grow, as new requirements like biodiversity are introduced and the number of sustainable finance products in the market increases. That puts a very real strain on both the people and processes involved.
In order to meet COP26 goals and regulatory requirements, we need to fix this broken process and address the causal effect of operational pain; mostly timeliness and uncertainty. Removing data silos and achieving high-quality, accessible and secure investment data is now vital. Not only to restore trust in the data responsible for investment decision making but also to demonstrate meaningful progress towards net-zero commitments.
What hasn’t yet been tackled by front-to-back investment management solutions, or even Enterprise Data Models (EDMs), is innately translating unstructured forms of ESG data, and making it usable across the organisation. This is where Software as a Service (SaaS) technology can integrate with existing systems (rather than overhaul them), to make all the difference.
An interoperable platform with open APIs and innate financial sense, can enable asset managers to easily translate and consolidate ESG data, together with mainstream investment data sets across their investment landscape, for a timely and holistic multi-asset view.
Chicken and egg
However, while data management forms a considerable and critical element to the success of sustainable finance, there is one other challenge asset managers face when it comes to meeting the new bioderversity goals. That is the chicken and egg situation of introducing reporting requirements, before the data required is made available.
The breadth of this field is where the challenge lies for the Buy Side. Climate change has a solid set of metrics to reference – more than 900 in MSCI’s methodology alone. Whereas, despite goals having already been agreed, a measurement system has yet to be established for biodiversity.
To bridge this gap in reporting, the Taskforce on Nature-related Financial Disclosures (TNFD) was launched in June 2021, in the same vein as the 2015 Taskforce on Climate-related Financial Disclosures (TCFD). Its aim is to minimise the risk to nature by better aligning corporate reporting, and prompting a shift from negative to positive investment screening e.g. proactively supporting investments that benefit biodiversity, rather than simply divesting from those that cause harm.
While TNFD is a positive step in the interim, the issue of available and agreed-upon data remains significant for asset managers, particularly those who have pledged to meet the pact’s biodiversity goals. Combined with growing market and regulatory demands for firms to delve deeper into holdings and correctly categorise products, the new commitments have added further complexity to an already resource-strained process.
And that is before we get to the dizzying number of rating agencies blending quantitative and qualitative data and commentary. With many using proprietiary methodologies and criteria, the onus is on the asset manager to make sense of it all. The output of which, directly feeds into the data that is reported to both regulators and investors – each with their own unique reporting requirements and varying frequencies.
Meeting these demands and aggregating information in an acceptable and timely format remains elusive at best – and problematic at worst. And until we start to see the introduction of global standards for ESG scoring, broadening the scope to include biodiversity, will almost certainly result in additional legwork for asset managers.
An interoperable path forward
To address this painful process and really make sense of ESG investment data in all its forms (the piece that is missing today), firms need an open and interoperable, SaaS platform that delivers both a fully-auditable data repository and a real-time translation service. Delivering this ‘Rosetta Stone’ for ESG investment operations, powerfully resolves the pain points of timeliness and uncertainty, bringing transparency, trust and accountability to the data.
- SaaS data management empowers asset managers to optimise resource-intensive ESG data workflows, such as aggregating ESG scores, by leveraging emerging technologies like machine learning and Natural Language Processing (NLP).
- Asset managers can add climate change and biodiversity metrics, on top of traditional financial metrics, for reporting as well as garnering deeper analytical insights from disparate data sources e.g. rooting out underperforming companies and seeking undervalued ones, to create alpha opportunities.
- One of the game-changing SaaS-enabled features that can critically benefit asset managers is native bitemporality. This enables firms to see data effective at any given point in history, as-at any point in history. With significant impact to regulatory reporting, it provides firms with data fidelity – easily rewinding and viewing data lineage, for complete reproducibility.
- Bitemporality also benefits portfolio management. For example, firms can create a risk weighting based on certain biodiversity criteria, and re-run their portfolio against it, to better manage constituents and ultimately, their risk and exposure. The performance can be measured along two timelines – as it was before (pre-risk weighting) and after a given risk weighting has been applied, to deliver granular insights for future decision-making.
It is clear that the move towards a more sustainable investment ecosystem is going down a one-way street. Rather than a blip or temporary concession, what we are seeing today is a fundamental shift within the financial industry, and the world at large. The investment case for sustainable investing has moved beyond altruism, to plain survival.
With asset managers reporting across new and evolving ESG metrics and net-zero commitments, there is greater emphasis on demonstrating timely progress, delivering transparency to the investment process and creating meaningful change to the planet.
This will not only open up new investment opportunities but enable firms to manage the inevitable climate and biodiversity-led volatility, that is just not possible within the confines of the current infrastructure many operate in.
Given the severity and urgency, it is now time we evolved as an industry. For the buy-side, this evolution applies directly to data. To make sustainable finance a success, asset managers must turn to a new interoperable approach to ESG data management. One that achieves greater access, understanding and control of ESG data, while enabling the adoption of emerging technologies, to future-proof operations.
Earth’s biodiversity is the result of over four billion years of evolution. It is only right that the Buy Side evolves beyond its legacy infrastructure, and only right that it accepts its responsibility in shaping our future.
 Fund technology, data & operations, Europe 2022, Clear Path Analysis January 2022