Our report echoes what is clear in the market – that there is an increase in ESG activity and there are issues with ESG data.
According to Paul Elflain, Head of Asset Management, Europe, at Linedata, it is important to appreciate the subjective nature of the ESG market and to accept that different firms will use the same data for different means. For example, says Elflain, some firms will use ESG scores and ratings to decide whether they divest from certain assets or companies, whereas others will use that same data to inform their ESG risk.
There is also a challenge for asset managers to integrate that data into their own systems and their own ESG framework, whether that is to meet compliance obligations or to validate their own ESG strategies and mandates.
This may lead to a rise in hybrid data models where an internally developed methodology is used to define a firm’s ESG strategy and then external data is used to validate that strategy. “You have to retain the flexibility to be able to score things in different ways,” says Elflain.
The most likely development is that standardisation will be focused on the raw data and the definitions and taxonomy rather than a prescriptive standard for ESG ratings and scores. “There is a place for methodologies,” says Elflain. “But you have to be able to prove to the market that you are doing what you say you are doing.”
The hope is that, in the longer term, the SFDR and the Non-Financial Reporting Directive (NFRD) will provide more transparency and credibility to the vast array of ESG scores and encourage them to improve their sustainability credentials.
However, one of the critical short-term concerns regarding the SFDR is the associated data cost, says Elflain, especially if these costs prove too high for the smaller boutiques.
This is where data management vendors have to pick up the slack, he adds, so that ESG does not become the sole domain of the larger and well-resourced asset managers.
“We are looking at how we can make standardisation easier and develop a subscription-based model for firms so that they do not have to do so much of the heavy lifting,” says Elflain.
There are numerous implications if the industry fails to address these data challenges, he says. Firstly that they will lead to more greenwashing – that is, firms using ESG branding to promote their products without necessarily adhering to ESG principles. Secondly, if investors find that they are unable to compare different ESG funds or understand and assess the different methodologies at work, the ESG sector will lose credibility.
However, despite the fears over greenwashing, there is less cynicism towards ESG from the people most closely involved, says Elflain. “The vast majority of ESG managers believe in these concepts and believe that ESG scores are not as important as their overall objectives – to try and change corporate behaviour for the better.”
Our survey shows that some form of NAV oversight is in place for all but a small minority of firms. However, it also shows that there is plenty of room for improvement in how this process is performed. Firms are using systematic NAV oversight and spreadsheet checks in equal measure and more comprehensive measures like full shadow NAV and contingent NAV are not widely used.
These figures suggest that we are at the start of a trend.
The survey also highlights three drivers that are making the case for better NAV oversight. Firstly, there is the pandemic. The funds industry adapted commendably to the move to remote working and proved that mass adoption of digital technology can be achieved. The case for automation accelerated and the adoption of digital processes grew massively.
The pandemic also raised the importance of contingency. Although the market proved to be remarkably resilient to extraordinary changes, the pandemic has shown that high-impact/low-probability events can happen and the right contingencies have to be in place – be that enhanced cyber security for home workers or back-up provisions for NAVs in the event of system outages, business interruptions or unprecedented market volatility.
A critical component in the rise of NAV oversight is technology. The pandemic has proved digital technology can work at an enterprise level and has made it harder to justify the use of spreadsheets and manual workarounds in all but the rarest of instances. Cost is also less of an issue as technology becomes more accessible.
There is also greater regulatory focus on valuations and oversight. The likes of the FCA and the SEC are putting new rules in place to ensure accurate valuations and fair value.
And we have witnessed greater investor interest in validation and data. This is most clearly seen in the rise of sustainable investing and ESG. A lack of standards around the multitude of ESG ratings and scores is making it harder for investors to compare funds and failing to prevent so-called ‘greenwashing’.
If asset managers are to compete in markets like ESG and attract a new breed of demanding and socially conscious investors, they will need to prove their ESG credentials and demonstrate, through accurate and transparent data, that they can validate their mandates.
Taking all of these factors into consideration, we can reasonably expect the adoption of cost-effective options like contingent NAV to grow in increasing numbers in the years to come.
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