Grappling with ESG’s evolving landscape
It has been one year since the introduction of the EU’s Sustainable Finance Disclosure Regulation (SFDR), and there appears to be little added clarity for asset managers large and small still grappling with lack of definitive guidance and industry agreement on comprehensive, quality data around environmental, social and governance (ESG) investing.
“What has become more challenging is that we went from little data a decade ago to now a proliferation of data, which is great, but then how do you use it?” commented a senior executive at one of the world’s largest asset managers, BlackRock, last fall. “It’s being disclosed, but not from a regulatory lens and there is not much consensus.”
Asset managers, hedge funds, and wealth managers of all sizes and strategies understand the importance of active and effective participation in this important market. ESG adoption is strong while barriers remain: 67% of asset managers have prioritized ESG integration into their portfolio while 23% cite data integration and cost as an obstacle, according to Linedata’s latest Global Asset Management Survey. It’s no surprise that 31% cite lack of industry standards as a headwind.
Most ESG data providers only cover a selection of securities, which can lead to data gaps. ESG regulations such as SFDR should be helping to improve this. We do see increased demand from corporates as well as investors and, data coverage is improving. The challenge remains for asset managers in easily accessing and integrating data and scoring into their workflows.
So a year on from SFDR, how can asset managers separate the signal from the noise when it comes to ESG data integration?
SFDR and greenwashing
One of the primary goals of the SFDR framework from the EU was to protect investors from greenwashing, requiring that managers disclose sustainability levels in their portfolios and investment process. But the general market consensus is that there is no consensus: the subtlety of greenwashing is not easily definable or entirely preventable. Separating the marketing hype from reality in ESG is heavily debated today.
Despite this, record demand has fueled the increase in the number of ESG funds, and those that have been classified as Article 8 or Article 9 have commercially benefitted.* This has in turn increased the number of ESG data providers and measures available within the market.
Measuring the flow into ESG funds
But does this mean the asset management industry is seeing a ‘real’ increase in ESG funds? Bank of America research found that 4 out of every 10 dollars globally went into ESG-focused equities in 2021, up 135% on 2020. And according to data from Morningstar, Article 8 and Article 9 funds reached €4.05 trillion at the end of December 2021, which represented 42.4% of all funds sold in the European Union.
Additionally, Morningstar’s research found more than half of all new fund launches in the EU were Article 8 and Article 9 funds, accounting for nearly 200 in Q4 of 2021. These funds will all be required to extensively report on their ESG products and will be impacted by data challenges.
Categorizing funds gets more complicated
But have these definitions changed based on criteria from regulators or other metrics like AUM? In February of this year, Morningstar announced that it had removed 27% of the funds on its “sustainable” list following the implementation of SFDR rules. The culling represented more than 1600 funds with $1.2 trillion in AUM. Many were Article 8 self-identifying funds and confirmed many in the industry’s fears about the prevalence of greenwashing.
This represents complexity for the industry, besides the fact that funds get categorized further into two categories, Article 8 and 9, under the regulatory technical standards (RTS) of SFDR. This is very limiting as well—clearly it cannot also represent the full spectrum of ESG funds and the range of data available.
Additionally, the rise of the Gen Z and millennials in both the workforce and as influential investors has built momentum around the “Social” and “Governance” in ESG. Millennials invested $51.1 billion in sustainable funds in 2020, compared with less than $5 billion five years ago. Nearly one-third of millennials exclusively take ESG factors into account, compared with 19% of Gen Z, 15% of Gen X and 2% of baby boomers, according to a CNBC poll. While “Environmental” has largely been the focus for most asset managers, Covid and the events of summer 2020 have highlighted both the need and challenge around incorporating social data into analysis.