To account for the effects of a world in flux, more investors are pursuing strategies that consider relevant environmental, social and governance (ESG) factors, an approach known broadly as sustainable investing. In 2017 alone, assets managed through such an approach increased by 37 percent, according to Bloomberg.
Despite the swell in interest, sustainable investing is by no means a matter of course for capital markets. Key barriers, including well-documented limitations with ESG data, prevent true scaling and mainstreaming.
But what exactly do investors need from the data? To further explore the most pressing needs, we set out to scan the state of the market. After reviewing the latest literature, we held a series of conversations with investment practitioners. We spoke with more than 30 practitioners from 25 firms, including institutional asset owners, pension fund managers, asset managers, investment advisors and data firms, that collectively manage $5.2 trillion in assets. The composition of the sample leaned towards practitioners with a general interest in sustainable investing, making it a group well positioned to consider the key data challenges facing the sustainable investing market.
Through these conversations, which we documented anonymously to encourage candor, we gained a more nuanced perspective on investors’ sustainability concerns and the limitations of existing data. While there is growing attention to getting better data and more robust, standardized company disclosures, it will take a wider set of actions under a multifaceted approach to meet investors’ data needs. This collective effort will be an important step in harnessing the power of markets for sustainable change.
WRI is exploring how to contribute to this effort, and fortunately, we are not alone. Research groups, foundations, associations and forward-thinking asset owners and managers are all seeking ways to solve this challenge.
We hope by sharing our perspective, informed by both our research and our experience as an asset owner, we can help bring more focus on data solutions.
Diving into the Data but Coming Up Short
Just as investors use traditional financial data to evaluate business performance, they use ESG data to evaluate the sustainability context of investments. ESG data include any indicators that shed light into the sustainability context of an asset, facility, company or region, whether historic, current or expected.
Investors, for example, may use ESG data to assess environmental matters like annual carbon emissions, regional water stress or whether a company has an emission reduction target. Under the social umbrella, ESG data covers issues like workforce diversity, gender equity and human rights, while data on governance topics tracks matters like corruption, labor practices and gender composition of the board.
Depending on the investment objectives, this data can inform various stages of the investment process, including asset allocation, security selection, portfolio construction and risk management. The additional layer of information can reveal material risks and opportunities that are otherwise overlooked in investment decisions, helping to identify investments that may lead to enhanced risk-adjusted returns and reduced downside risk.
ESG approaches are most widely applied in public equity assets, though there has been increasing attention in other asset classes, particularly fixed income.
Where do investors get this data?
Most ESG data comes from companies’ public disclosures. Companies disseminate this information through a number of outlets, including annual reports, social responsibility reports and ESG disclosure surveys from data agencies like CDP. Investors can and do get relevant information directly from these sources. Third-party data providers also collect and aggregate these data, along with data from other sources. The providers serve as a centralized access point for data (see chart below), offered through fee-based subscriptions.
The offerings vary widely across providers, with some taking a specialized focus and others covering a range of ESG issues. Providers use their own proprietary methods to process and standardize the data into a suite of metrics, scores, ratings, rankings and indexes to enable easier comparisons among companies.
More than half of the investors we spoke with said they subscribe to multiple providers to benefit from their unique comparative advantages.
The type of data investors use varies according to the investment strategy as well as the internal capacities for sustainability analysis. Those new to sustainable investing often use ESG scores as an entry point. More sophisticated investors may construct their own metrics or analysis using raw ESG data. Indeed, this reflects the evolution of our sustainable investing strategy with WRI’s endowment.
While sustainability data is helpful in informing investment decisions, it is still far from perfect. Investors had a lot to say about the biggest data limitations they face, including:
“The biggest challenge with the data is that information is not reported in a standardized way. It’s better than it used to be, but still not great.” – sustainable asset manager
Poor coverage across holdings: The available data are incomplete, making accurate assessments across a portfolio difficult. Despite overall progress, most global companies still do not publicly disclose data on key environmental issues. One sustainable asset manager notes, “The data from rating agencies only covers 20 percent of our portfolio holdings. We end up having to talk directly to company management or regulators to get the information we need.” Our conversations suggest that the gaps are biggest for fixed income assets, small cap companies, and emerging market companies.
Inconsistent reporting metrics: The fact that sustainability reporting is voluntary makes for messy data. Neither the metrics nor the accounting methods are consistent. This limits comparability across companies and remains one of the greatest limitations to sustainability data.
Poor quality, immaterial: Investors have substantial doubts about the quality of sustainability data. Most disclosures come through as check-box yes-or-no responses, generic boilerplate language or tailored narrative, rather than robust quantitative performance indicators, such as metrics on energy intensity or water consumption. These types of disclosures are weak indicators for how the ESG issue impacts business performance.
Inconsistent evaluation with limited transparency: The ESG scores, ratings and rankings from data firms are of questionable validity. The methodologies for normalizing the reported data carry different assumptions about what is material. As a result, there is low correlation between company evaluations across providers. One firm, for example, ranks Tesla at the top of its industry while another ranks it as the worst, as each considers different factors in the scoring process. In many cases, the firms use sustainability metrics that have little correlation to financial materiality, meaning they do not impact a company financially. As another sustainable asset manager explains, “Rating agencies often assess companies on the quality of disclosures, or whether they have policies in place, rather than on actual performance.” It is hard to know which, if any, scores indicate material performance.
Paving the Way for Better Data
While sustainability data is far from perfect, its trajectory is one of rapid improvement. A critical mass of data, experience and interest continues to emerge. Some even go so far as to suggest we are amidst an ESG data revolution.
In response to investors’ growing interest in sustainable investing and demands for sustainability disclosures, among other drivers, there has been movement towards more consistent disclosure.
Frameworks developed by the Global Reporting Initiative (GRI), the most widely used sustainability reporting standard, and the Sustainable Accounting Standards Board (SASB), which exclusively targets an investor audience, have been fostering a shift towards more standard disclosure. SASB in particular has gained traction with investors because of its focus on materiality.
Within this movement, climate change is a rallying point. An early milestone was Article 173 of the 2015 French Energy Transition law, which requires institutional investors to disclose climate-related risks facing their portfolios. Then in December 2015, 196 countries adopted the landmark Paris Agreement, which calls for increased investments in low carbon and climate resilient development.
“By helping generate more comparable information, the TCFD recommendations will enable investors to more accurately assess the climate risks facing investments.” – pension fund manager
Further, a number of investor-led initiatives have since popped up, calling for increased climate disclosure in line with the TCFD recommendations. Among these, the Climate Action 100+ stands out, having gained commitment from 310 investors with over $32 trillion in assets under management.
The momentum towards improved sustainability accounting has been further bolstered by the adoption of the Sustainable Development Goals (SDGs), a new framework for global sustainability. Forward thinking private sector actors have rallied around the framework and are beginning to shift business activities and capital allocation to align with the goals. While they were not designed to guide company disclosure, they are beginning to encourage it as investors demand clarity on how business activities contribute.
Collectively, these initiatives are facilitating improved reporting on sustainability, which is becoming standard practice. In 2017, 85 percent of S&P 500 Index® companies published sustainability reports, up from 20 percent in 2011. Reporting rates at a global level are not far behind. And while not all companies use standard frameworks, more are beginning to. Already, 74 percent of the world’s 200 largest companies use The GRI Standards for sustainability reporting.
This represents a flood of new information, with more to come. In theory, better disclosure leads to better data for investors. And indeed, reporting with the GRI framework produces better quality data. But is this enough to meet investors’ data needs?
Perhaps in some areas more than others. While most investors we spoke with see climate change as a significant concern and are using the TCFD recommendations to prioritize issues, this may not be the norm. According to an HSBC commissioned survey, only 8 percent of issuers and 10 percent of investors are even aware of the TCFD. And few companies that report climate-related information according to TCFD recommendations report the implications of the risks for their businesses.
The new web of standards and frameworks can also be overwhelming for investors struggling to navigate these issues. Some argue that investors need a streamlined and regulated data and reporting system to truly enable accurate sustainability accounting.
Clearly, there is a long road ahead for improved climate disclosure and effective use of this information.
But beyond improved disclosure, are more data advances needed to bring sustainable investment into the mainstream? We explored this question through the lens of climate change.
Climate Change Concerns Raise More Questions than Answers
Climate change is expected to have widespread impacts on the global economy. Under business-as-usual emissions scenarios, an estimated $2.5 trillion or more of global financial assets are at risk from a changing climate. The recent historic wildfires in California, which are expected to become more common and more extreme, are the latest example of the destructive cost of climate change.
“Investors are struggling to figure out what to do about climate risk.” – traditional asset manager
In October 2018, we got a sense of the urgency and scale of efforts needed to combat climate change with the release of the IPCC’s 1.5 degree C report, so called because of its message that global temperature must be kept to 1.5 degrees C (2.7 degrees F) above pre-industrial levels to avoid the most damaging effects of a changing climate. The message was clear: everyone, including investors, needs to step up their contribution to a low-carbon transition without delay. Doing so will both limit negative impacts and facilitate more equitable and prosperous growth.
In fact, bold climate action could create an additional $26 trillion in economic gain through 2030, according to the New Climate Economy report. That trajectory would unlock unprecedented opportunities for investors.
Investors have gotten this message. “Climate change,” one sustainable asset manager explains, “brings real threats to companies and drivers for opportunities. It is central to our investment thesis.”
Other sustainable asset managers take a more urgent perspective. As one manager said, “Climate change is global, it’s getting worse and it’s not going to be fixed overnight. No matter what the investment is, it’s going to face climate-related risks.”
Most investors we spoke with are taking initial steps to manage climate-related risks and opportunities within their investment strategies. Certainly, it is a welcome development to see climate change in the spotlight and investors pushing for action. But can the existing data formulate a clear picture of the full range of risks and opportunities?
Evidently not. “It’s one thing to disclose carbon emissions, as is required now in France,” a representative of a traditional asset management firm explains. “But making the transition to understanding the material climate risk to the portfolio is much more complex and challenging.” Much of this challenge stems from information gaps. Our discussions revealed several areas in particular that limit investors’ ability to account for these issues.
Let's Get Physical: While investors are concerned about both transition and physical risks related to climate change, most in our conversations are not managing for the latter, since they do not have the necessary data or tools to do so.
“Physical risk is a very complex equation, and it is something that investors persistently underestimate and underprice.” – sustainable asset manager
The TCFD has suggested a set of metrics for reporting physical risks, but there is a lack of standard measurement methods and available data to account for them. Given these limitations, it is challenging for investors to assess vulnerability to risks like extreme weather events or sea level rise, and to then convert them into financial terms.
As another sustainable asset manager explains, “Accounting for physical risks requires mastering a new discipline. You need to know where the companies’ assets are, how vulnerable they are to the risk, and what the implications are for financial performance.”
Consider for instance, how relatively straightforward it is to use a company’s reported carbon emissions (developed using the Greenhouse Gas Protocol) to measure and quantify the impact of a carbon price on business performance. To do so, an investor would use the disclosed carbon emissions and a carbon price to quantify the dollar expense of the company’s carbon emissions. They would then factor this expense into the income statements to understand the impact of the carbon price on broader, corporate financial performance.
This is in stark contrast to how an investor would measure and quantify the impact of increased frequency of extreme weather events, given both the large range and scale of possible events, their uncertain timing, and the ambiguity surrounding the financial impacts they may have on a company.
As a representative from a family foundation simply states, “We don’t understand physical risks. This is massive question and it’s always changing.”
Fortunately, the assessment of physical risks in investment portfolios will become easier if there is broad adherence to the TCFD recommendations. This, however, assumes the disclosures would be measured with consistent methods, which do not yet exist for physical impacts. Without these disclosures, evaluation requires knowledge of asset location, which is not readily available to most investors.
There are exceptions. Plenty of investors are already tracking and managing physical climate risks such as water stress, floods, wildfires and sea level rise. Aside from insurance companies, this is most common among investors that manage or directly invest in fixed income assets like municipal bonds, or real assets like real estate or farmland, where asset-level data is inherently more accessible.
Mind the Data Gap: While assessment of physical risk may be spotty, investors are actively managing for a variety of other climate factors. For a number of these issues the data is still incomplete or of poor quality. Some of the gaps pertain to factors at the company or asset level. These include Scope 3 carbon emissions, methane emissions, energy consumption, water management and climate scenario analysis disclosure.
There are also gaps in data to help put the company or asset level metrics in context. Such data gaps are noted for issues like local water stress, global carbon prices by region and jurisdictional environmental regulations, among others. This information provides a necessary reference point when interpreting company disclosures to evaluate performance on relevant metrics.
Understanding What the Future Holds: One of the key TCFD recommendations is for organizations to disclose forward-looking analysis of how climate change will impact business operations. These so-called climate-related scenario analyses test businesses, strategies and financial performance against a set of potential climate-related scenarios, each based on a series of assumptions about climate impacts and market shifts.
For most companies, climate-related scenario analysis is a new exercise. While numerous reference scenarios are available, there is no standard method for completing the analyses. Companies must therefore make a number of assumptions to inform the analysis. This leads to concerns about the quality of the results. Without the use of consistent assumptions and metrics, or at least greater transparency into those used, the analyses will not be comparable across companies, greatly limiting the utility in informing decisions.
“There is a lot of confusion among companies – even the big ones – around scenario analysis.” – sustainable asset manager
Not surprisingly, in our conversations with investors, perspectives on this concept ranged from skeptical about the value, to interested but unsure how to use them for decision-making.
Climate-related Social Impacts: Taking a step back from our conversations, we notice what was left unsaid about climate risk: the social impacts of climate change as an investment concern. But these impacts carry risks and opportunities for business. These include:
Conflict: Departures from moderate temperature and precipitation patterns are expected to systematically increase interpersonal violence and intergroup conflict. The SASB Materiality Map™ indicates that this is a likely material risk for companies across multiple sectors.
Food security: Not only will global crop yields of major staple foods decline with temperature increases, but higher concentrations of atmospheric carbon dioxide will decrease nutritional value of food crops. Global efforts to combat the growing threat of food insecurity may open new investment opportunities in the development of innovative technologies and sustainable agriculture.
Health: Unabated, climate change is expected to increase a range of health risks, while improved air quality from a broad transition to a low-carbon economy would reduce chronic disease burdens and premature deaths. This is an important consideration for investors as employee health, safety and wellbeing is a material issue for companies across most industries.
Labor: We can expect to see extensive growth in green jobs as we shift to a low-carbon economy, even as some jobs in high carbon sectors would be lost. If temperatures continue to rise, a decrease in labor productivity can be expected in many regions. Companies’ labor relations and fair labor practices—a material factor for a number of industries—will be relevant in shaping the outcomes.
Inequality: Marginalized communities are not only more susceptible to the negative impacts of climate change, but have less capacity to cope and recover from the damages. This pattern will reinforce and intensify existing inequalities. The World Economic Forum ranks rising income and wealth disparity third among leading drivers of global risks in the next decade.
In some cases, these climate-related social issues can present systemic risks for the wider economy, raising particular concerns for universal asset owners that manage large, diversified holdings representative of global capital markets. The financial returns for these portfolios depend not just on the performance of individual investments but on the stability and health of the economy.
While the TCFD recommendations may give the impression that climate-related risks and opportunities mostly play out in the E and G pillars of ESG, social issues are clearly in the mix as well. In acknowledgement of this common blind spot, the Principles for Responsible Investment (PRI) has recently released a new guide to help investors link their strategies on climate action with inclusive growth and sustainable development. Efforts to improve data and disclosure on relevant social dimensions will be an important aspect of facilitating this expanded focus.
Filling in the Gaps: Data and More
After reviewing the landscape of available data and gathering input from investors, we see several key advances that can facilitate more accurate accounting of climate-related risks and opportunities in investment decisions. Interestingly, though our conversations focused on data needs, many investors suggested resources beyond data alone.
Standard Approaches to Measure Impact
The TCFD recommendations and the SASB Standards are important resources to help improve disclosure of climate-related risks and opportunities. What’s missing are the underlying methodologies for measuring and reporting on the recommended metrics, especially for metrics related to physical climate risks. Without this critical piece, companies and investors will be hampered in their efforts to implement the new disclosure recommendations. The success of the GHG Protocol in advancing the reporting of greenhouse gas emissions could serve as a guide for developing measurement and reporting standards for other areas, including physical risks.
New Methods to Estimate Costs
Investors are grappling with how to think about the risks from physical climate impacts. They note a lack of existing research and data that shows how exposure to climate stressors may affect business revenue or profit. New research demonstrating how recent climate events have affected business performance across various sectors, and new methods for calculating the impacts in financial terms would make existing disclosures more meaningful. This could also inform projections of climate impacts on business performance.
Guidance and Tools for Scenario Analysis
Climate scenario analysis can help facilitate a much-needed shift among investors towards forward-looking assessments. But there is still a lot of confusion about how to conduct and interpret scenario analysis and how to leverage the information in a practical way. It will likely be one of the biggest challenges public companies and investors face in reporting on the TCFD recommended disclosures. More resources and guidance on scenario analysis are needed to overcome the challenge.
Better Ways to Track Economy-wide Impacts
Sustainability data is generally output-based: carbon dioxide emissions, water withdrawal, the number of women on the board. These metrics enable comparative assessment across companies or portfolios, but fail to benchmark performance against a specific outcome, such as meeting the global carbon budget, staying within ecological thresholds or achieving the SGDs. For investors interested in tracking the economy-level impact of investments, often material in the long term, more research or metrics are needed to link corporate or investment outputs to broader risk or impact thresholds. For emissions issues, linking investor-friendly data with Science Based Targets would be a good starting point.
More Data to Account for Poor-quality Disclosure
Company-disclosed data on natural resources often lacks adequate context about the physical environment where companies operate. While reporting frameworks urge contextual reporting, there is not much guidance on how to do this, so context has been widely missing in corporate reporting.
Areas likely to be flooded by 0.5 and 1.5 meters of sea level rise. Source: WRI
In the absence of better disclosure, geospatial data can help fill this context gap by providing important insights into physical climate risks. But to use geospatial data to understand risk exposure and inform investment selection, investors need the other piece of the puzzle: asset-level data. For some sectors, asset-level data enables a highly granular analysis of environmental risk. However, investors still face barriers to accessing asset-level data for physical risk assessment. Bloomberg has dipped into this space with its new product, Bloomberg MAPS, though the scope and coverage of is still evolving.
Forward-looking Data on Mega Trends
Investors know they have to change with changing times. To determine whether management strategies are positioned to thrive and create value in the face of social, economic, and environmental upheaval, investors need information on emerging systemic trends.
They will need to track broad demographic shifts like population growth and migration, economic shifts like increased spending on infrastructure and changing costs of low-carbon technology inputs, and policy changes like national and subnational strategies for climate action, energy transition and sustainable growth. Investors also need to track the changes in the status of natural resources, including water, agricultural and forest land, and air quality, as well as physical climate impacts.
The Way Forward
In the face of sustainability challenges of unprecedented measure, the cost of inaction is high. At stake is the wellbeing of billions of people, the health of global ecosystems and trillions of dollars in reduced economic growth and lost assets.
Investors are starting to recognize this and are looking to protect their assets and strategically deploy their capital to solutions. But they are struggling to make informed decisions with substandard data. To accelerate the flow of capital towards a sustainable future, we need rapid improvements in sustainability data.
In the previous section, we described a range of climate-related data solutions that investors told us they want.
At WRI, we will use the insights from these conversations to inform work on our Sustainable Investing Initiative, which seeks to empower institutional investors to pursue sustainable investment approaches. We will not try to tackle all the needs at once. But we have some relevant work already in motion and are exploring other new projects to help address different needs.
On the research front, we are conducting a study to quantify the financial impacts of water stress on electric power-generation companies. The research applies historical income statement analysis and tests a new methodology for forward-looking analysis to illustrate how different climate scenarios could affect the power sector.
On the data front, our team is working with colleagues from across WRI to explore ways to translate the Resource Watch platform for an investor audience. Our investor conversations suggest an opportunity for WRI to tailor the functionality and curate the data outputs towards investors’ needs, providing broad cross-sector coverage of relevant geospatial sustainability data. We have also joined the Asset-level Data Initiative (ADI), whose mission is to make accurate, comparable, and comprehensive asset-level data tied to ownership information publicly available across key sectors and geographies.
For decision-making tools, in the next few months we will conduct a scoping exercise around developing a Physical Resilience Protocol. The protocol would seek to address the lack of globally accepted methods for measuring and reporting on the physical risk-related indicators and metrics put forward by the TCFD and SASB, in the same manner as the GHG Protocol is used to measure and report on greenhouse gas emissions.
WRI’s efforts alone will not meet all the current data needs. It will take broader efforts by different groups.
To begin, research organizations should continue to develop analytical and data solutions to inform smarter investment analysis and engagement on sustainability. This is particularly needed in areas where commercial service providers do not have strong incentives to act. Foundations can help advance this innovative work to address data and information gaps by providing increased grant funding.
Data and services providers, in turn, should consider developing a set of harmonized baseline methodologies for ESG scores. This would provide a foundation for comparability, improving investor confidence in scores, while still leaving room for providers to layer on proprietary assessments.
Lastly, forward-thinking investors should partner with organizations that are trying to support and build solutions. Together they should continue to engage with companies and managers to demand consistent and meaningful sustainability disclosures.
While there are distinct roles and opportunities for each stakeholder group, coordination and collaboration will be key to fostering continued improvement in data quality and harmonization and, ultimately, market wide buy-in and uptake of sustainability reporting and integration.
Together, these efforts to improve the quality, availability and functionality of sustainability information and resources should help ensure that the ESG data revolution and the sustainable investing boom drive meaningful change in capital deployment.
The authors would like to thank our colleagues Lihuan Zhou and Jack McClamrock for their research contributions; Lawrence MacDonald, Leonardo Martinez-Diaz, and Janet Ranganathan for their guidance and strategic advice; and Billie Kanfer, Wil Thomas, Romain Warnault, and Deborah Zabarenko for their assistance with graphic design, layout, and editing. We also wish to thank Bank of America for supporting the Sustainable Investing Initiative’s data efforts and the Ford Foundation for providing core funding to the Initiative.