Author: Finbourne – finbourne.com
This story first featured in Finextra as part of a COP26 special, on Friday 12th November.
Christopher Farrell, COO of FINBOURNE Technology, explores the current challenges buy-side firms face with ESG data, highlighting the need to establish a new standard for ESG data management to make sustainable finance a success.
With COP26 coming to a close, there has been much discussion, debate and pledging on how we can decarbonise, to create a net zero world. And while the G20, which accounts for 80% of the world economy must set the lead, it is clear that every country needs to take action to mitigate its own impact, including those with the biggest carbon footprint, if we are to make this target a reality.
While phasing out fossil fuels and creating mainstream use of renewables is critical to reaching the desired global temperature of 1.5°C, sustainable finance also plays a significant role, providing necessary investment in adaptation technologies across biodiversity, resilient infrastructure and clean energy.
However, it is not without its challenges. Gaining a clear view of the market opportunities and risks are becoming increasingly difficult, as the parameters for sustainable finance continually evolve. The environment in which buy-side firms and the companies within their portfolios operate in, is becoming increasingly hard to navigate. Adding to this, are significant gaps in reporting and numerous ESG ratings providers, offering conflicting methodologies and criteria, that are difficult to standardise and create value from.
To date, organisations such as the Taskforce on Climate related Financial Disclosures (TCFD) have tried to improve climate-related reporting, helping the buy side to better assess risk and allocate capital. Regulation such as the EC’s Sustainable Finance Disclosure Regulation (SFDR), has similarly endeavoured to create a level playing field, delivering greater transparency. And during COP26, there has been much buzz around Chancellor Rishi Sunak’s plans for the UK to be a net zero finance hub, which will see publicly listed companies disclose their climate metrics by 2023.
But for capital markets allocations to really contribute to net zero ambitions, firms need to do more than divest in non-ESG friendly companies. Real change requires both investing in technologies and infrastructure to develop and scale them, but also turning around industrial age and carbon-heavy companies to create greater impact.
To help achieve this, we must address the data management processes at the root of institutional investment operations, putting in place technology that can manage climate-related risk and volatility, seek emerging opportunities, and importantly show progress not only against a firm’s targets, but in generating real change.
The perfect storm: data, technology and regulation
While buy-side firms are not in the business of data management, there is no denying that data is central to investment management operations. The reality today is that many firms are struggling to aggregate and translate their ESG investment data across multiple systems and interfaces, into a timely and reliable, firm-wide view. At a recent industry event, we found the joining of disparate data sets formed the biggest data challenge for asset managers today (56%), with ESG data management (22%) forming the second largest data issue.
Much of this is down to high volumes of unstructured 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 buy-side firms are dealing with, and you begin to see why accessing, understanding and controlling investment data, with any real fidelity, is becoming problematic.
One of the reasons behind the growing ESG challenge is the existence of duplicate and legacy systems over the last 20 years, which are at the root of data fragmentation and organisational silos, and subsequently a host of labour-intensive manual workarounds. In our recently commissioned whitepaper – The Buy Side and System Consolidation – Grasping the Nettle – we found more than half (57.7%) of the 52 global asset managers surveyed, use a mix of proprietary and/or legacy and third-party-developed platforms to manage their mission-critical functions. With (76.9%) of respondents experiencing multiple silos across the company, multiple formats across the various systems, or having to manage multiple vendors and interoperability challenges.
It is therefore no surprise that only 9.6% of respondents are confident that their data is clean, transparent and reliable. The data that forms a central asset to investment management operations is simply not fit for purpose. With a large majority of respondents already using ESG data to some extent, we know the complexity outlined will only grow, as the number of sustainable finance products in the market increases. And that puts a very real strain on both the people and processes involved.
For sustainable finance to really take off, we need to fix this broken process and address the causal effect of pain, mainly timeliness and uncertainty. Removing data silos and achieving high-quality, accessible and secure investment data is vital. Not only to restore trust in the data responsible for investment decision making but to demonstrate meaningful progress towards net zero commitments.
Front-to-Back investment management solutions and even Enterprise Data Models (EDMs) have provided some respite by consolidating investment data, but what hasn’t been tackled, is making the divergent and unstructured forms of ESG data, usable and interactable across a firm’s operational landscape. Here, technology that can integrate into a firm’s operations, including existing service providers (rather than overhaul them), can make all the difference. Using open interoperability in the form of APIs, enables buy-side firms to aggregate their ESG data with mainstream investment data sets, from across their investment landscape, for a more holistic view.
But to really make sense of investment data in all its forms, the piece that is missing today, firms need a platform that not delivers a fully-auditable data repository, but also a real-time translation service, that allows its people to see ESG data in the language they need. Delivering this Rosetta Stone for investment operations, crucially resolves the pain points of timeliness and uncertainty, bringing transparency to the process, and trust in the data.
As asset managers are finding themselves in the perfect storm, and managing increasing volumes of data, escalating regulation and transparency demands from investors, will only compound as sustainable finance matures. This will no doubt add significant pressure on firms using legacy technology but it also puts them at risk. There is the very real threat of penalties from regulators, dissatisfied over data lineage or uncertainty over calculations, which simply can’t be reproduced.
Achieving value and purpose from ESG data
Given both the seriousness and urgency, it is essential that firms look to cutting-edge technology that can work with their existing landscape and create iterative change, demonstrating value at a faster time to market. This is why we built LUSID. Serving a broad range of financial organisations, our platform delivers a real-time, financial data repository that ingests, aggregates and translates multi-asset class investment, market and reference data, across the existing operational stack and wider ecosystem.
Native bitemporality is particularly critical for investment management, enabling firms to see their data effective at any given point in history, as-at any point in history. This has a significant impact for regulatory reporting, enabling firms to demonstrate data fidelity, by easily rewinding data and viewing its complete lineage, for reproducibility.
Bitemporality also benefits portfolio management. For example, where a portfolio is concentrating on carbon footprint, firms can create a risk weighting 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 e.g., as it was before (pre-risk weighting) and after a given risk weighting has been applied, to deliver deeper insights for future decision-making.
As touched upon earlier, one of the challenges that buy-side firms face with sustainable finance today, is trying to use subjective ESG vendor data. This is proving increasingly difficult, due to the overwhelming lack of standardisation within the ESG scoring methodologies and criteria that exist in the market. Machine learning can take some of the manual work out of this but comparing apples with apples and garnering analytical insights that can create alpha opportunities, requires a big effort.
Aggregating scores across differing ESG data vendor methodologies and criteria is crucial, as is consolidating them into one real-time data store. By doing so, firms can more easily create value, by adding their own metrics, to root out underperforming companies and seek undervalued ones. While this can be a game changer for ESG data management, it requires firms to start unlocking data from their organisational silos and systems first.
Setting the course for the future starts here
With operating margins already squeezed, the cost of inaction is considerable, both to a firm’s reputation and bottom line. Our hope is that the commitments set out in COP26 and the increasing regulation in this space, will provide the impetus the Buy Side needs, to finally address data at the root of their investment operations.
Making sustainable finance a success, requires a new standard for ESG data management. One that achieves greater access, understanding and control of ESG data, and can future-proof operations. This will not only open up new market opportunities but enable firms to manage the inevitable climate-led volatility, that is just not possible within their current operational landscape.
As some have coined it, this may be the ‘last chance saloon’ but it also presents an incredible opportunity for the Buy Side to demonstrate net zero accountability, deliver greater transparency to the investment process and meaningful change for our planet.