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In recent years, images of environmental disasters and social injustice have become all too familiar. Melting ice caps, ravaging wildfires in Australia and California, record-breaking heat waves across the world and political and social turmoil are now a mainstay of people’s lives. It is in this context that ESG has taken centre stage. And now – with the EU’s Sustainable Finance Disclosure Regulation (SFDR) – there is a concrete regulatory framework to cement ESG standards and reporting as one of the most important operational processes for all firms.
The immediate problem for investment managers and corporates alike is that there is still lots of uncertainty around SFDR, in particular around what is considered ‘materially harmful’ and how this should be categorized. For example, there is no agreement yet on how much carbon emissions are considered harmful and how this affects a company’s ESG rating. Also, while the 32 principal adverse impact categories of SFDR pale in comparison to the number for MiFID II, they are broad and cover much of what is considered ESG finance, which is continuously evolving. Additionally, unlike MiFID II, there’s a significant issue in that there is no standardized approach to understanding and categorizing the required data.
Even with a lack of standardization and specifications currently in-flux, investment firms need to be in a position to publish their strategy by the 10th of March in order to be aligned operationally to implement the RTS – level 2 of SFDR – in January 2022. However, firms should by no means see this deadline as an end point. On the contrary. In fact, this initial step should be seen as a foundation that underpins a longer-term view of ESG and its role in asset management in driving investors’ risk decisions.
Firms could, as a bare minimum, capture, analyse, identify and report just enough data on a yearly basis in order to meet the specifications of the regulation. Or they could instead go many steps further by collecting and providing greater amounts of granular ESG data to their investors, covering different asset classes, sectors, regions, historical analysis and so on. By doing this, fund managers put themselves in a position where they can educate and inform, with a view to increasing their investor base and fund inflows. In order to achieve this, though, firms will need to access multiple data sources that will provide the breadth and depth of information currently available.
It’s also worth considering that, as usual, the EU is leading on this regulatory battleground, but is unlikely to be the only region to introduce specific requirements around ESG reporting. With a solid foundation, firms can expand their data collection and reporting process to include North America and APAC, which are almost certain to follow suit.
Instead of looking at this other new regulatory requirement as a hurdle, investment managers should see this as an opportunity to communicate ESG concerns effectively with investors by providing more regular updates than SFDR requires, but with data that will help to cut through the considerable noise that surrounds ESG. However, as is always the way with these things, firms will need to establish their SFDR framework that can adapt to the changing metrics and classification of this relatively new field of investing. Only with a solid foundation can the investment world hope to provide monthly, daily, or event-driven reporting of ESG metrics.