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Analysis & opinionSeptember 8 2021

ESG commitments: words are good, but data is better

No matter how committed a firm is to enshrining sustainability into their business, the easy part is saying it. The harder part is proving it. 
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ESG commitments: words are good, but data is better

“Words, words, words.” A famous line from Shakespeare’s Hamlet, when the frustrated Danish prince suggest that words representing thought, but not concrete action, are meaningless.

The modern version is ‘actions speak louder than words’, and these phrases continue to come to mind when considering the raft of environmental, social and governance (ESG) commitments released globally by various market participants from banks to asset managers, from regulators to governments.

No matter how committed a firm might be to enshrining sustainability in their business, the easy part is saying it; the hard part is proving it. By ‘proving it’, I mean backing up qualitative public ESG statements with quantitative data-based evidence: cold, hard facts, numbers, scientific calculations to build an irrefutable body of evidence to back up assertions.

Defining metrics

Building trust and legitimacy regarding sustainable business practices requires a shift towards facts, not opinions. The very concept of sustainability is not new, and until recently companies generally operated their own proprietary programmes, defined their own terms and marked their own homework.

There also remains a glut of competing global ESG standards to measure against, and this fragmentation continues to increase as new regulators or industry bodies look to join the ESG bandwagon. As such, it is increasingly difficult to compare one firm against another, like for like.

At the same time, ESG data scarcity remains the biggest obstacle to financial service firms’ ambitions to make a more positive contribution towards addressing climate change risk and achieving a more inclusive and just society.

The EU has tried to address the fragmentation issue by setting its own all-encompassing rules, rolled out across a major part of its financial services legislation and regulation. This ambitious policy mandate is underpinned by political support as a pillar of the European Green Deal. Three major regulations underpin the EU ESG agenda; each is extremely data hungry and demand a huge degree of complex data to be disclosed across a range of sustainability criteria. They are:

• EU Taxonomy Regulation

• Sustainable Finance Disclosure Regulation (SFDR)

• Corporate Sustainability Reporting Directive

These regulatory requirements add some new acronyms to the EU’s already lengthy list, but they also require regulated financial firms operating in Europe across the entire spectrum to start thinking about science-based approaches to their ESG promises and commitments. They are full of data-driven requirements and compel banks, asset managers and insurers, as well as stakeholders in the supply chain of financial services, to publicly disclose data on non-financial measures of success previously not considered or demanded.

These EU ESG rules retain a mixture of quantitative and qualitative disclosures on the surface, but what is published in summary terms in a product disclosure document or website will need to be underpinned with a second layer of evidence and verified data to back up the words and promises made to clients. The rules will also have vast extra-territorial impact beyond the EU’s borders because the EU firm will be required to report the ESG data on any issuer or supplier they engage with, regardless of where that counterpart is based.

Strict data rules

The EU’s approach also means that even if a firm already operates to globally recognised standards, such as the UN Principles for Responsible Investment, Task Force on Climate-Related Financial Disclosures or Sustainability Accounting Standards Board, and so on, they must recalibrate and align to the dataset required under the new EU ESG rules, which are more detailed, more complex and more data-hungry than any previous standards of sustainability measurement. Being generally ESG-aligned is no longer a valid statement in Europe: you must be SFDR- and Taxonomy Regulation-aligned. This will drive consistency and comparability over time, but it poses several obvious challenges.

By way of example, the use of a highly prescriptive scientific data approach means the risk of ‘greenwashing’ is reduced, but also means that the flexibility of a principles-based approach is removed. It is also a ruleset that moves ahead of current generally accepted market practices. Many of the prescribed data points in the Taxonomy Regulation are currently either undisclosed by issuers or are inconsistently disclosed.

The availability of data to fully comply with the EU ESG requirements is far from complete. Even larger publicly listed firms disclose some, but not all aspects of climate, diversity or social impact metrics required under SFDR and the Taxonomy Regulation. Data scarcity becomes even more of a problem as one moves into private market activity, smaller companies or, indeed, issuers outside the EU who are not legally mandated to provide these disclosures. The extra-territorial impact of the rules remains significant.

I challenge readers to research the Scope 3 emissions calculated according to the Greenhouse Gas Corporate Protocols for any firm currently listed on any of the major emerging market mid-cap indices and argue that ESG data scarcity is not an issue. Data questions will dictate whether financial firms can truly assert they are ESG-compliant, or if promises and commitments already made are merely words, words, words.

Adrian Whelan is global head of regulatory intelligence at Brown Brothers Harriman.

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