The metrics of a sustainable future

However, 84 per cent of institutional investors are experiencing challenges in obtaining consistent environmental, social and governance reporting across asset managers and asset classes, with 55 per cent calling this a “major challenge”, according to Bfinance.

“The market has become inundated with ESG data service providers,” says Gary Vaughan-Smith, chief investment officer at SilverStreet Capital.

He adds that while the “breadth and coverage of ESG data has increased considerably”, issues of standardisation, transparency, methodological differences have risen to the fore — factors that can be influential in the investment decision-making process. 

Making metrics matter

Maria Nazarova-Doyle, head of pension investments and responsible investments at Scottish Widows, says the first hurdle to overcome is for schemes to select a data provider that can demonstrate both “quality and coverage”.

Greenhouse gas emissions data is a “very important starting point when reviewing pension investments”, she says, and recent regulatory changes have driven schemes to make more robust environmental disclosures. 

“The Department for Work and Pensions has also set good-quality metrics for pension schemes to use in their [Task Force on Climate-related Financial Disclosures],” Nazarova-Doyle says.

“We actively use these metrics in our own reporting, including those of ‘absolute carbon emissions’ and ‘carbon footprint’ — an intensity measure calculated as carbon emissions divided by portfolio value.”

But the quality and standardisation of some carbon metrics have been criticised. Research published by the University of Hamburg and WWF Germany found that metrics for scope one and two emissions — direct emissions from owned or controlled sources, and indirect emissions from the generation of purchased energy respectively — were generally consistent. 

However, scope three emissions, which represent the indirect emissions that occur in a company’s value chain, are harder to calculate, making results more inconsistent. 

In light of these discrepancies, the researchers concluded a “universally accepted” approach to standardise carbon emissions is required.

Creating a new standard

One metric that would appear to assess sustainable investment opportunities are ‘ESG scores’. These are a value placed on a company’s sustainable qualities by a data aggregator, such as MSCI or Sustainalytics, yet inconsistencies across ratings companies are seen as a barrier by more than half of institutional and wholesale investors, according to Capital Group.

“Industry standardisation is necessary to facilitate the disclosure of comparable, consistent and reliable ESG information,” says Joe Cappitelli, general manager at Dow Jones.

“It would also enable investors to compare more effectively across companies and over time, to assess the link between ESG risks and opportunities and the financial performance of a company.”

While Vaughan-Smith agrees there is a need for standardisation, he is doubtful as to whether a useful standard “that can be applied consistently to all companies in every sector” can be achieved. 

“The data provided by ESG vendors is inconsistent with each other and this is a material issue that is not easily resolvable, probably impossible. These scores can be very misleading,” he says.

Defining data

In many jurisdictions, policymakers are recognising investors’ complaints about ESG data and attempting to fill the standardisation gap. 

Cappitelli points towards the EU’s Sustainable Finance Disclosure Regulation as a seismic step forward, while in the US, policies that require investors to be more informed on the ESG activities of the companies in which they are investing have been introduced by the Biden administration.

“However, the regulations we’re seeing are, by nature, more geographically oriented and can focus on a narrow subset of sustainable business practices, like climate change,” he says. 

Looking ahead, the planned International Sustainability Standards Board should help provide “globally consistent, trusted, non-financial reporting that is as robust as financial reporting today”, Cappitelli adds. 

“I’d like to see the regulators take a more holistic view across sustainability categories, as well as a framework that incorporates more robust, accurate and timely data.”

ESG is a vast subject not restricted to climate change. Concerning all areas of the environment, as well as social and corporate issues, there is a requirement for metrics that also cover these.

Similar data challenges occur here. Nazarova-Doyle says there is a pressing need to “rapidly develop our tools, rules and understanding of other ESG areas outside of strictly climate-related concerns”, such as venturing into biodiversity or social taxonomy, and develop appropriate metrics and data-handling methods that can facilitate their use by investors. 

Alongside this, innovative ways of obtaining and processing ESG metrics are set to become commonplace.

Vaughan-Smith points to the use of satellite data to search for fires, deforestation, industrial emissions, and other harmful factors. “These can be linked to precise locations and thus to companies,” he says.

“Real-time monitoring should be able to keep an accurate track of some key ESG issues such as this and make companies more accountable.”