The Long and Winding Road for ESG

A series of heartening stories about ESG efforts from the inner workings of European investment managers has hit the headlines of the industry’s media outlets of late, covering the hiring of new team heads and a material bias toward ESG products, with a major investment manager reporting over half their AUM in ESG funds.

As the European investment industry welcomes these milestones, a shadow looms over the landscape, revealed in a recent survey by Ignites Europe, where three-quarters of surveyed investment professionals were found to be suffering from “ESG burnout.” Demoralised teams are struggling with the sheer volume of reporting requirements for regulators, clients, and industry bodies, with some leaving the industry to seek roles that provide “more personal fulfilment.”

The EU's Sustainable Finance Disclosure Regulation (SFDR) has been both an administrative and compliance burden for asset managers as they attempt to draw new governance and reporting frameworks into their operating model.  In Europe, Germany’s BVI has publicly stated this month that EU regulation for sustainable funds “burdens smaller fund providers disproportionately." In the UK, this has been compounded by mandatory reporting to the Taskforce on Climate-related Financial Disclosures (TCFD). Also, with the Financial Conduct Authority's SFDR Requirements and the EU's Corporate Sustainability Reporting Directive due to come into effect this year, we can expect that additional transformations will have to be made.

When protecting the environment and the client’s interest, heightened regulation is not a bad thing. But when coupled with an operating model insufficiently flexible to accommodate ESG compliance, one can only wonder whether feeling powerless in relation to such a massive challenge is a factor in the retention issues faced by ESG teams.

Empowering ESG agendas with data

As always, data plays a critical role in supporting asset managers. But in this context, one question arises: do existing operating models have the flexibility to accommodate ESG integration?

1.    Take a stand and own it

Firms land somewhere in between seeing ESG as woven into the very fabric of their investment process and dismissing it as a well-intentioned nuisance (if not a cynical, all-out power grab). However, after assessing market and client demand, especially with grassroots research that may contradict what is said in public, managers should form an ESG strategy based exclusively on their capability to deliver on it.

This is likely to go beyond relative security weightings and potentially involve screening, activism, and scrutiny of a company’s connected entities, such as suppliers, lenders, and other enablers. The strategy should reflect a commitment to act according to stated principles, which, given recent guidance in the UK on stewardship, require investors to actively seek changes in the way a company operates. These need not be too complex—indeed, simplified principles can make these strategies more actionable. 

2.    A data conundrum: Little correlation, lots of subjectivity

The market for ESG data has yet to fully mature. Start-ups, mid-sized firms, and major blue chips are all vying to stake their claim as the go-to provider for ESG data. Furthermore, data on biodiversity, shipping traffic or other items not related to commodities or companies is not necessarily targeted at the investment industry. Investment managers may struggle to find a suitable mix of data, but this is just as likely to be on account of an ambiguous strategy as a perceived gap in the market.

ESG ratings and rankings are a mixed bag that, much like other lists that seek to find the “best” in a complex and subjective field, may favour large players seen as dominant in their sector that can dedicate resources to public relations. The acquisition and application of ESG data will not work in the same way as instrument reference or other market data. Investment managers will need to spend time and resources reading between the lines on ESG data and researching what the data omits.

3.    Value in intelligence on private investments

Recent transactions in infrastructure investment firms have highlighted the need for larger firms to actively explore areas that previously were deemed immature or poorly aligned with conventional investment strategies.

While large, listed companies fall over themselves to burnish their ESG credentials, competing to showcase their commitment to sustainability, private companies—often at the forefront of climate change innovation—demand a different approach from investors. Instead of adhering to the trope of merely reassuring the broader market that they’re doing their best not to exacerbate issues, these companies frequently concentrate on implementing tangible, innovative solutions to actively address ESG challenges.

Acquiring expertise in managing private asset portfolios may prove more efficient than building it from scratch—a path that may be exclusive to top-tier investment managers, considering the associated costs. 

4.    Embrace unstructured data

The capabilities of emerging technologies to process many types of data could enable investment managers to distil indicators, sentiment, and statistics from many sources with fewer resources. This allows investors to dig far deeper into information that may correlate with market trends, establish greater custom strategies and influence investment decisions. This shift calls for a more open data model, offering flexibility in storage, resolution, maintenance, and classification.

While investment managers’ move to up their game in integrating ESG into their operating models, challenges persist. Addressing these considerations is crucial for a future where ESG becomes an essential component, even amid employee exhaustion. The journey toward clarity in operating models requires thoughtful navigation through the evolving landscape.