The coming of age for ESG data
By Dan Mistler; Luke Wilcox, ACA Group
Published: 20 November 2023
Environmental, social, and governance (ESG) data has been around as a consumable product since the early 1990s. The first ESG index came in 1990, and its initial company risk data arrived at the end of the decade. The biggest players of today began over this timeframe, and the ESG data product ecosystem took nearly 20 years to begin to ramp up, which happened in earnest in the late 2010s.
While the explosion of ESG data over the last five years has garnered both enthusiasm and criticism from different corners of the investment community, the wild west character of the data environment is fading – giving way to a market that is more robust, reliable, and regulated. The crucible of interacting investor demand, regulatory scrutiny, industry competition, and stakeholder (insert your favorite politician or pundit) criticism is giving ESG data a facelift. Investment professionals are getting more purpose-built data products that fit their investment use cases.
In the early days, investment professionals were less accustomed to data usage implementation methodologies, and as such, there was frequent volume buying across the industry. Managers would purchase suites of data and figure out how best to use it as a later step. Many large managers would build their data solutions by constantly adding new datasets to achieve the broadest possible coverage universe.
Managers and other consumers of ESG data, such as Limited Partners (LPs), have become more sophisticated and directive in their usage of ESG data. They are also facing increased regulatory and investor pressure to implement and monitor ESG data across multiple strategies. This has led to more specific use cases, such as deeper climate physical risk data, coverage of private markets, and solutions for fixed income and alternatives.
Until recently, data quality programs have been focused on internal research procedures. Data providers could only focus on assuring quality in procedures they have control over. However, the most important quality issue for any data customer is whether ESG data accurately reflects reality for any underlying name.
The vast majority of ESG data, particularly for public issuers, consists of voluntarily reported information – and data providers have only been in the position to accept this information, with limited ability to check the data’s veracity.
With improved data from sources other than firms (such as geospatial/satellite), AI-based data collection and validation, an increase in independent data auditing, and improved statistical modeling across ever-growing datasets, providers and consumers alike are empowered to measure and control the quality of ESG data.
Financial regulators in multiple jurisdictions have zeroed in on ESG practices for enhanced scrutiny and rulemaking over the past three years, and this regulatory pressure is creating rules of the road for ESG data providers and users.
Aggressive regulation in the EU, and more recently the UK and Asia, have shown the US to be the laggard in this space. While the SEC has heightened its ESG focus in recent exams and is currently deliberating over potential rulemaking for the US, regulatory bodies in states across the country have attempted to take their own stands on the implementation of ESG data and analysis in how their state’s money is managed, creating quasi-regulated environments.
This is in contrast to current and proposed regulation in the EU, such as the proposed legislation on the transparency and integrity of ESG ratings activities, announced in June of this year.
Several undercurrents in the ESG ecosystem have created misleading conclusions about ESG data. For example, detractors of ESG data frequently cite the lack of correlation in ESG scores between data providers as evidence for the idea that ESG data is somehow inherently flawed. In fact, it is precisely the wide variety of investment and research use cases that makes ESG data both useful to many managers and other consumers of ESG data, and difficult to compare.
The data being compared (such as scores from different ESG data providers) are made up of different constituent parts for different audiences with different goals, and thus will continue to struggle to correlate. Scores that focus on physical climate risk will not correlate well with scores that focus on controversy or reputation risk, for example, but both are useful in different contexts.
Similarly, vocal critics of individual ESG scoring methodologies can misunderstand, and as a result misinterpret, ESG scores (as seen most notably in tirades on ESG from certain public intellectuals in the news), thus amplifying false characterisations of ESG data (and indeed of ESG more broadly). Despite the opinions of pundits, investors everywhere are consuming ESG data to improve investment decision-making.
Over the next five years, we can expect to see the following developments in the ESG data market:
- Given the constant need to improve data sources and methodologies, we will continue to see innovation in data sourcing, reaching universal data coverage and expanding data types. While climate tech investing in PE/VC slowed over 2023, the pipeline for data technology remains strong and will likely continue to grow.
- The trend of combining directly measured data with voluntary disclosures will accelerate. For certain types of companies, there will always be a dearth of information. As methodologies to measure ESG directly without contacting the company improve, the data picture will continue to fill in.
- Data assurance will create another inflection point for the industry. The majority of data in use today is not assured, and demand for assured data is nascent. However, a vended data assurance system is the finish line for ESG criticism, and the market will get pushed there over time. When it does, it will usher the Big 4 and other assurance players, significantly increasing the market size and distributing additional costs across the system.
- The association between regulations and data will weaken in proportion to investor demand. The sense that regulations create the market for data (see recent developments in Europe) will fade, as we will see softening of proposed regulations in the EU and UK and possibly no significant regulation in the US (the net effect of political pushback, the coming 2024 election, inflation, and continued elevated interest rates).
Taken in combination, it’s clear that ESG data is established, maturing, and here to stay. Firms can benefit from working with third parties that can help leverage their data in a new way to help develop and monitor their ESG programs to mitigate risk, make informed choices, combat greenwashing, and grow profitably and sustainably in the process.
But where does it go from here?
While the turmoil of the last two years may have called ESG’s longevity into question, it appears to have instead worked to improve the ecosystem. Reporting consumers (investors) have focused demand over time, data providers have developed better sources, methodologies, and tailored products, and data users (asset managers) are finding better ways to monetise the analysis. Only time will tell just how big it will get.