The Vital Role of Technology in ESG Investing
As ESG initiatives dominate organizational agendas within the wealth management industry, getting beyond common challenges is essential for effective implementation.
Overcoming data quality issues is key to progress with environmental, social, and governance (ESG) investing initiatives. Ashley Longabaugh, senior analyst, Celent, discusses how the appropriate technology can help wealth managers overcome challenges standing in the way of ESG initiatives – and meet clients’ needs.
Environmental, Social, and Governance (ESG) concerns are growing rapidly. So is interest in ESG investing. As ESG initiatives dominate organizational agendas within the wealth management industry, getting beyond common challenges is essential for effective implementation. The key to embracing this promising and complex market is overcoming data quality issues.
Data will be the differentiator that helps investment managers implement and make the most of ESG initiatives. Without robust ESG reporting and data control software systems to mitigate data challenges, wealth managers will be hampered from augmenting their ESG programs and embracing opportunities in the ESG market.
A Growing Focus on ESG Investing
Various cohorts—activist investors, non-governmental organizations (NGOs), and certain regulators—have demonstrated long-standing interest in ESG initiatives. Today, the public’s awareness of and focus on ESG-related issues is heightened. Historically, ESG growth was centered in Europe. That’s changing, with the United States driving growth in recent years.
Wealth managers see increased client demand for ESG-driven products and portfolios. Two predominant forces are behind this. Investors are looking to use their investment opportunities to drive positive social impact; the COVID-19 pandemic accentuated this mindset. This is paired with the wealth management industry’s efforts to find alternative growth for assets under management (AUM) in light of subpar growth.
Responses to this demand have varied. Some companies addressed ESG issues diligently, advancing their sustainable practices. The responses have been frequently limited, perhaps an exclusive function of investor/analyst relations departments.
See More: 5 Ways Organizations Can Improve Their Green Footprint in 2021 and Beyond
ESG Challenges
As interest in ESG investing grows, so does the importance of addressing challenges to implementing ESG initiatives. Data quality, accountability, and transparency are top among these.
The lack of a standard definition of ESG complicates regulatory work. While the individual E, S, and G components correspond with United Nations Sustainable Development (UNSD) goals, the dominant framework comes from the Sustainability Accounting Standards Board (SASB). The SASB’s “universe of sustainability issues” focuses on five sustainability categories that cover a wide range of topics: business model & innovation (e.g., materials sourcing, physical impacts of climate change), environment (e.g., air quality, water and waste management, ecological impacts), human capital (e.g., labor practices, employee diversity and inclusion), leadership & governance (e.g., business ethics, critical incident risk management), and social capital (e.g., human rights, community relations, customer welfare).
Additional guidelines further complicate regulatory work. The framework established by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD) has gained traction and robust international support across the Americas, Europe, and Asia-Pacific, making it the leading approach for addressing climate risk and opportunity. ESG initiatives must also keep pace with the U.S. Securities and Exchange Commission, including the SEC’s recent announcement mandating climate-impact disclosures, which necessitates robust reporting software systems.
Data challenges present the weakest link in fully integrating impactful ESG investment strategies. To deliver on their goals, wealth managers must be able to move beyond common data challenges. These often relate to issues such as:
- Transparency: Data standardization, which impacts issues such as methodology and frameworks, is necessary to execute ESG initiatives. Similarly, the data must also be timely and timestamped.
- Ratings correlation: Wealth managers must be able to benchmark their activities against industry-wide ESG scores, disclosures, and regulatory standards.
- Greenwashing: Certain data practices, such as subjective assumptions for modeling or self-reported data, may contribute to greenwashing, in which a company promotes environmentally conscious activities that may not actually deliver the purported benefits. The industry as a whole needs to take proactive measures to remedy the damaging consequences of greenwashing.
Presently, most assets are held in less mature screening strategies, such as exclusion. But as investment strategies shift towards impact and thematic investments, data and reporting metrics will also need to mature. This is part of an overall adjustment that considers and prioritizes forward-looking engagement metrics rather than the somewhat short-sighted view that’s been common to date. More powerful technologies—including comprehensive data reporting software—are required to succeed.
Technology to Address the Challenges
Fortunately, investment managers can turn to technology-driven solutions to overcome data issues. Opportunities are present for technology to solve ESG data challenges. By adopting well-suited technology solutions, wealth managers can improve data:
- Sourcing, through reliance on alternative data sources with specific, ESG-related metrics (including, but not limited to, NGO reports or social sentiment trackers).
- Capture and processing, using methods such as natural language processing (NLP) that can ingest large amounts of unstructured data and integrate data from multiple sources.
- Validation available from quantitative methods that leverage multiple large data sets and artificial intelligence and machine learning (AI/ML) technology.
Taken together, improved sourcing, capture and processing, and validation yield enhanced reporting. The value is significant as it offers the potential to reinforce relationships between a financial institution (FI) and its clients by better demonstrating how investments align with clients’ ESG considerations. The frequency and customization of reports can be fine-tuned to highlight ESG impact in greater detail.
To optimize this work, investment managers will need to develop ESG portfolio engines that scale. When they face the decision to build or buy appropriate solution(s), essential prerequisites will be to have clarity into how their data will be used and into reporting goals. This information is essential for effectively evaluating the technology vendors who are solving ESG data challenges.
A Transformational Opportunity
As more clients are focused on sustainable practices, investing with a focus on Environmental, Social, and Governance implications can be a catalyst for positive change within financial services. Ultimately, the ability to better deliver on clients’ priorities can fortify ongoing relationships.
Being able to tailor ESG investments better not only improves the value delivered to clients. It helps strengthen the meaning of the ESG acronym; solidify the overall value of Environmental, Social, and Governance investment initiatives, and harness the power to deliver on these collective goals.
How well wealth managers can meet clients’ requests for ESG investments depends in large part on the technology architecture in place to automate semi-customized portfolios that satisfy individual ESG values, preferences, and priorities. Look ahead to technology’s role in ESG investing to capture this important and rapidly growing opportunity.
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