ESG Data, Regulation and the APAC Fragmentation Challenge

Panellists at Regulation Asia’s ESG Tech & Data event discussed the need for methodology transparency and better company reporting.

The use of ESG ratings and data products has grown considerably in response to mounting interest from investors in companies that take sustainability into account in the way they run their businesses.

As the role and influence of ESG ratings and data providers have grown, questions have emerged about whether they are adequately regulated, and whether the ESG data being supplied to the market is adequately relevant, reliable and comparable.

Last month, IOSCO (International Organization of Securities Commissions) issued a set of recommendations for securities regulators to consider when developing frameworks to supervise and oversee ESG ratings and data providers.

The report highlighted, among other recommendations, the need to promote greater transparency around the methodologies and information sources providers use in developing their ESG data products.

Inherent biases

According to Gabriel Wilson-Otto, Director of Sustainable Investing at cInternational, understanding the methodology used is critical, because of the inherent biases that get built into ESG scores purely by design.

“Some of these [biases] will be intended because they reflect the way you invest and the way you operate. They’re deliberate decisions, but it’s always a trade-off. It’s critically important to be able to understand which trade-offs and decisions have been made by any underlying provider.”

Speaking at Regulation Asia’s ESG Technology & Data Asia 2021 conference on 25 November, Wilson-Otto highlighted the importance of enabling investors to pick data providers that are aligned with their own investment processes, based on their operating jurisdiction, where they invest, and their preferred asset classes.

For instance, providers that use a sector relative scoring framework would not penalise individual sectors, so this separates sector allocation decisions from ESG decisions. On the other hand, an absolute scoring methodology would make it harder to invest in sectors with fundamentally higher risk profiles.

Such differences can cause a “disconnect” between investment strategy and the ESG ratings investors use if they are not aware of the characteristics built into the framework they are adopting, Wilson-Otto said.

“It’s really about ESG scores being fit for purpose. What we’re increasingly seeing is a lot of asset managers – Fidelity International included – starting to develop their own in-house ratings, where they take underlying raw data from providers and use that to fashion a score which is consistent with the way that they believe ESG should be integrated.”

Data diversity

Speaking on the same panel, Eugène Goyne, APAC Financial Services Regulatory Leader at EY, said increasing regulation around risk management in Asia requires financial intermediaries to assess their data needs, as well as ensure the data they use to run their risk management systems are fit for purpose.

“Are the data and ratings providers you’re seeking to use right for the needs of your business? Right for the needs of the particular climate risk exposures that you’re exposed to? That’s really the focus in Asia at the moment for regulation of financial institutions.”

Goyne said the diversity of ESG rating agencies and data providers, the categories of ratings they issue, and the uses to which they’re put can be vast. “It’s very important to understand the purpose of that rating, what it is measuring, and to what uses it should be put.”

Michelle Cameron, APAC Head of Sustainable Finance at LSEG, likewise said it is “imperative” for ESG data providers to provide transparent, complete, and accurate data – to enable investors to make sustainable investment decisions.

Refinitiv, an LSEG business, approaches ESG data using a “quantitative lens”, she said, adding that it provides full transparency around how it captures data and the associated reporting mechanisms, and applies materiality to differentiate companies in different industry and sector groupings.

Incomplete picture

But, Cameron said, Refinitiv is also conscious that company reporting is not always going to be a complete picture, as it is “curated” for public and investor consumption. “It’s the company’s own view of their operations they’re putting out into the world.”

To address this, Refinitiv provides controversy scoring overlays and sentiment analysis functionality, by using AI (artificial intelligence) to scrape social media and news sites to establish whether a given company’s operations or other ESG-related considerations should raise investor concerns.

While Refinitiv would welcome regulation of ESG providers, Cameron pointed to the broader issue of addressing fragmentation in the way different geographies, sectors and companies report. “The challenge we face as a provider is that we only can report what is published [by companies].”

For investors to be able to assess climate risks and opportunities, they need climate data that is complete and presented in a way that is comparable and comprehensive across industries and countries, she said, also pointing to gaps in areas like emissions data that need to be addressed.

Governments and regulators are increasingly introducing ESG and sustainability reporting and disclosure frameworks, Cameron noted. However, there is a need for a move away from voluntary and comply-or-explain approaches towards mandatory reporting requirements.

“This will certainly drive change,” she said. “As a provider of data we’re constantly wanting to absorb more data so that we can generate more insightful findings.” Private companies present a particular challenge, however, given the difficulty of data-gathering in the private sector.

Fragmentation challenge

In Asia specifically, Cameron said the fragmentation challenge is much more pronounced. The region has a relatively higher volume of smaller markets with large exposures to environmental, societal and governmental challenges.

Asia also does not have a harmonised, overarching regulatory body like in the EU, and the socioeconomic demographics are vastly different across jurisdictions. “We’ve got a mixture of developed and developing countries, where some of the biggest economies are reliant on fossil fuel industries and a large amount of our developing countries, face very real and impactful social challenges.”

“Supporting the transition to standardising regulation is part of the challenge that, as a region, Asia faces in a more pronounced way than EMEA or the US,” Cameron said. “But I do think that there’s real cause to be really optimistic. Across Asia we’ve gone from being a bit of a laggard historically to really turning the tide with increasing adoption rates and regulatory pushes.”

Indeed, five years ago, only a small number of Asian countries were adopting ESG. Today, countries across the region have been increasingly pushing for higher standard reporting and regulations and being much more aggressive in their timelines.

“It’s really exciting to witness that we’re starting to move the needle on a reporting and disclosure perspective and getting Asia well and truly on the global map.”

Listen to this panel on-demand to hear more from Fidelity’s Gabriel Wilson-Otto, EY’s Eugène Goyne, and LSEG’s Michelle Cameron.

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