As demand for ESG (environmental, social and governance) investing grows, the lack of consistent and robust data remains among the biggest challenges for institutional and wholesale investors globally.

That’s according to Capital Group’s new global survey of more than 1,000 institutional investors and financial professionals to identify the key factors that are influencing how they integrate ESG into their operating models and the challenges that they are encountering. The results show there are still numerous barriers to widespread ESG adoption and highlight a set of issues that may soon be in the crosshairs of global regulators.

Here are three top issues that financial professionals want to solve:

 

1. ESG data and ratings need to be improved

As investors gather increasing amounts of information for their ESG decision-making, they are encountering challenges on multiple levels. Survey respondents expressed frustration with the ESG data available on the market.

More than half (53%) of surveyed investors say the lack of consistency in ESG scores from ratings firms¹ is a stumbling block when incorporating research data into their investment process. It appears regulators may soon take up this issue. Officials with the US Securities and Exchange Commission (SEC) have warned about ratings inconsistencies. And the UK government announced in October that it is considering a plan to put ESG rating agencies under the jurisdiction of the country’s financial regulatory body, the Financial Conduct Authority (FCA).

But the survey shows many investors are not waiting around for regulators to act. A significant number of those surveyed indicated they are looking beyond scoring systems to focus on fundamental analysis and rigorous risk management. This may also help explain why three-quarters (75%) of respondents use active investment decisions to ensure ESG factors are integrated into their funds.

Investors are also growing frustrated with the robustness of the ESG data being reported by companies, the survey shows, as well as the difficulty they encounter in accessing that data. To try to fill in the gaps, investors are increasingly relying on multiple data providers to gain a more holistic view of their portfolio.

More than half (53%) of respondents now use two to five data providers compared to fewer than a quarter (22%) two to three years ago. This multiple-provider strategy is set to become more entrenched, but it brings about a new set of challenges.

The current global ESG regulatory framework represents a patchwork of rules overseen by different bodies. US President Joe Biden signed an executive order in May calling for officials from the Treasury Department to start working on a plan for climate risk disclosure standards. Numerous countries, including the UK, are moving towards mandating corporate climate disclosure aligned with the Task Force on Climate-related Financial Disclosure (TCFD) framework. Europe rolled out its own broad corporate sustainability reporting directive in April. And private groups like the International Financial Reporting Standards (IFRS) Foundation are working to develop new ESG disclosure standards that could improve data robustness and consistency.

Nearly half (45%) of investors surveyed say harmonising global ESG standards, classifications and metrics should be the top ESG priority for national regulatory frameworks in their respective countries. But it remains to be seen how rigorous many of these new standards will be. It is also not clear how much of the ESG space they will cover. Most, at this point, focus mainly on climate.

Greatest challenges when incorporating ESG data, ratings and research into investment decision-making²

2. Performance: Investors want proof, not promises

Overall, only about three in 10 (28%) global investors who responded to the survey believe ESG factors do not directly improve investment results. But while these respondents are in the minority, more than half of institutional investors surveyed say the potential for sacrificing returns presents the biggest barrier to greater ESG adoption.

This may create a difficult hurdle for the asset management industry. Yet, while institutional investors harbour stronger fears about investment results, they are also more inclined to put such concerns aside if presented with research demonstrating a clear link between ESG and returns. Nearly half of institutional investors surveyed (46%) say that more convincing academic evidence showing a positive relationship between ESG and returns would encourage their organisation to raise its ESG focus.

But proving that ESG alone is driving returns can be challenging. Many factors can affect returns and it can be difficult to assess how those factors may interact with ESG issues. The inability to split correlation from causality is an ongoing debate and challenge. Long time frames associated with some of the ESG themes, such as the transition from fossil fuels, also make it difficult to prove how investment results tie back to ESG.

 

3. Greenwashing: The importance of disclosure and transparency

The rise of ESG investing has been accompanied by growing concerns over greenwashing, where companies embellish their green credentials to enhance their reputation or gain more business. Overall, almost six in 10 investors (57%) reported they think greenwashing is prevalent within the asset management industry.

This issue holds outsized weight in North America, where almost two-thirds (63%) of those surveyed say greenwashing has become widespread. Such misgivings perhaps explain why the US has lagged somewhat on the ESG front.

Best ways to tackle greenwashing³

More transparent fund reporting is seen as the most potent weapon in the fight against greenwashing. The survey results highlight the need for asset managers to provide comprehensive fund literature that details specific ESG investments and spells out how they will be monitored.

Regulation is seen as another major key to solving the greenwashing issue. Nearly half (47%) of investors who responded to the survey say setting minimum regulatory standards for sustainable investment products and services would help tackle greenwashing. Europe, which enacted its Sustainable Finance Disclosure Regulation (SFDR) in March 2021, is arguably setting the pace on the regulatory front. But recent announcements of two possible new environmental product categories by the European Securities and Markets Authority show that even plans many years in the making may require adjustments. Comments made by US SEC Chair Gary Gensler in July suggest the SEC also may be considering a crackdown on fund labelling, whereby it would require asset managers to explain the standards they use for classifying funds as environmental, social and governance-focused. But, as noted above with ESG disclosure rules, it remains to be seen how fund labelling standards will harmonise across jurisdictions.

To dig deeper into these topics and more (such as how automated analysis tools, like artificial intelligence, may help ESG investors) check out the full survey.

 

1. An ESG rating is a score assigned to an individual entity according to how it is perceived to be performing on a range of ESG topics. ESG ratings agencies have different systems in place for assigning a score to an entity.

2. Source: Capital Group ESG Global Study, June 2021

3. Source: Capital Group ESG Global Study, June 2021