As demand for ESG (environmental, social and governance) investing grows, the lack of consistent and robust data remains among the biggest challenges for 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:
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 consistency, quality and accessibility of the ESG data available on the market.
More than half (53%) of surveyed investors say the lack of consistency in ESG scores from ratings firms is a stumbling block when incorporating research data into their investment process. It appears regulators may soon take up this issue. Officials with the U.S. Securities and Exchange Commission (SEC) have warned about ratings inconsistencies. And the United Kingdom government announced in October that it is considering a plan to put ESG rating agencies under the jurisdiction of 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 quality 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. 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 U.K., are moving toward 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 quality and consistency.
Nearly half (45%) of investors surveyed say harmonizing 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
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 harbor 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 organization to raise its ESG focus.
The U.S. Department of Labor proposed a rule in October that would clear a path for ESG funds to be more widely included in retirement plans. But even with fewer regulatory hurdles in the way, it does not appear institutional investors will be swayed to invest in ESG funds by vague assertions or abstract predictions. They want proof rather than promises that ESG will generate alpha.
But proving that ESG alone is driving returns can be challenging. Many factors — such as geography, market capitalization, quality or value — can affect returns, and it can be difficult to assess how they 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.
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 global 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 U.S. has lagged somewhat on the ESG front.
Best ways to tackle greenwashing
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 SEC Chair Gary Gensler in July suggest the SEC also may be considering a crackdown on fund labeling. But, as noted above with ESG disclosure rules, it remains to be seen how fund labeling standards will jibe 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.
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