Temperatures rising faster than banks can get ESG data
Financial institutions are not moving quickly enough on data challenges to meet decarbonization goals.
The financial industry’s ability to wrangle environmental risk data is not keeping pace with rises in global temperatures.
A slew of corporate disclosure rules, and the ways to measure that information, continue to emerge, supposedly giving banks and investors important tools to facilitate companies’ shift away from fossil fuels.
There has been progress in terms of standards and increased familiarity with data. In some ways, the industry has come a long way over the past few years in terms of having the ability to manage data and incorporate it into analyst views, banking terms, and investment products.
But the climate crisis is moving faster than human institutions. On Monday, March 20, the Intergovernmental Panel on Climate Change (convened by the United Nations) issued a report that dramatically moved forward dates by which global average temperatures are expected to rise 1.5 degrees Celsius to the mid 2030s.
The report, approved by 193 countries, says human burning of coal, oil and natural gas is on track to blow through the limits set in 2015 in the Paris Accord. That deal laid out net-zero carbon emission targets out to 2050 with the aim of keeping global temperature rises limited to 1.5 degrees. By allowing temperatures to rise even faster, humanity is putting our weather, agriculture, and health at greater risk.
To avoid calamity, the IPCC says we must cut greenhouse gases in half by 2030, and stop all new carbon-adding activities before 2060. Yet the world’s two biggest polluters, the United States and China, continue to add new carbon-emitting projects.
Governments mostly prefer to rely on the finance system to influence companies and get them to transition out of carbon emissions – as though the free market can be used to address a problem of gross market externalities.
Standards coming together…
Nonetheless the energy transition will continue to drive financial institutions, largely driven by regulations.
One of the biggest problems with disclosure rules may be getting solved. Each country or region has pursued its own sets of disclosures and definitions of that information.
The International Sustainability Standards Board (ISSB), a division of global accounting-standards groups, will soon release an integrated set of standards and rules, says Hiroshi Komori, a member of ISSB. This will harmonize reporting across major markets.
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He relates his previous role as head of ESG at Japan’s Government Pension Investment Fund, which with ¥190 trillion ($1.4 trillion) is the world’s largest institutional investor.
“Investors have well-known challenges,” when it comes to data for ESG (environmental, social and governance) factors, including data governance for information originating from many sources. “Plus there is the issue of the correctness or the data itself,” he said, speaking last week at a conference hosted by the Asia Securities Industry and Financial Markets Association (Asifma).
Investors will combine information disclosed by listed companies or asset managers with other types of data to get a better view of a company’s carbon footprint. “Disclosure isn’t just a number,” Komori said. “It is a strategic tool for companies to explain their value creation to long-term investors.”
…While disclosures lag
For now, however, too few companies are volunteering such information.
Helena Fung, head of sustainable finance and investment for Asia at the London Stock Exchange Group, notes that among the largest companies included in FTSE Russell indices worldwide, 42 percent still don’t disclose even basic emissions.
Miwa Park, head of ESG analytics at BNP Paribas Securities Services, says disclosures in Asia Pacific remain insufficient. She cites the ASX300, the 300 biggest companies listed in Australia, noting that 20 of them disclose nothing.
“It gets worse when you look at small caps, mid caps, and emerging markets,” she said.
Unlisted companies are not obliged to report anything, which is a problem because while they may not be listed on a stock exchange, they may issue bonds. Asset managers and banks can only make crude estimates of those companies’ ESG risks.
Even when companies do disclose fully, they may do so at a consolidated group level, obscuring information at the operating-company level.
A host of data analytics companies now exist to make estimates of these companies’ emissions. “But any two estimates can vary up to 200 times for the same company,” Park noted.
It is not all bad news. Park says banks and investors are converging on certain measuring sticks, judging companies based on enterprise value (cash, equity, and debt, minus interest), so at least investors can have an apples-to-apples idea of what a company’s emissions average ought to be.
Trial and error
Regulators are also learning to fine-tune their information requirements – or simply bludgeon companies with expanded disclosure rules.
Chris Faint, head of the Bank of England’s climate hub division, said, “We want to ensure the system we regulate is collecting the information needed to understand climate risks.”
One of the challenges is that historical modeling doesn’t work: rising global temperatures has no precedent in human history. Authorities such as BoE are now asking companies to provide data that companies historically never monitored. And the exercise feels like a moving target.
“Even if you are able to collect the data today, how do you ensure you are forming a view of how that will change in the future? We know climate change will arise, but it’s not clear what path it will take, so we can’t predict any combination of risks.”
BoE and other regulators are working the banks and investors to try to figure out the risks embedded in companies. It’s trial and error, although Faint is optimistic the industry is getting smarter. “Firms are getting an increasing body of data which is leading to a better understanding of risks.”
Exercises in the UK have helped companies get better at knowing what data they need and how to manage it. “We’ve also realized how big a gap in data there is,” Faint noted. “Financial institutions need to get this from their clients, but sometimes when they ask for it, the clients don’t know the answer.”
His conclusion: along with the energy transition, “we need a whole-economy data transition.”
The steady stream of new accounting and disclosure requirements is urgent, but large companies argue that forcing them to rush things only leads to bad data.
Mark Harper, head of sustainability at Swire Group, a Hong Kong conglomerate, says new rules – from the stock exchange and from the government – require companies to build the internal capacity to source the appropriate data and integrate it into their reports.
“If we are given only six to nine months to comply with new rules, you won’t get anything of value back,” he said. Overlapping demands by different local and global authorities adds cost, but it also muddies the waters. “Instead of a single line of comparison for investors, it’s a mess,” he said. “We need a sense of realism.”
That said, he says new data rules bring benefits. “The data does provide us with value,” he said, noting a favorable report can lower the corporation’s cost of capital via green-finance methods. “Today 35 percent of our financing is green, such as issuing sustainability-linked loans,” Harper said.
That suggests that data disclosure can work: companies are finding they can pay cheaper interest rates if their ESG metrics score well.
From data to product
For asset managers, though, turning data into good products has a ways to go. ESG can be a good branding exercise, but firms also need to offer funds that perform well.
Jessica Ground, global head of ESG at Capital Group, says product innovation remains difficult. ESG themes work in equities but not very well in fixed income, where there’s relatively little demand among customers.
“Performance is a barrier. The lack of robust data is a problem,” she told the Asifma audience. “Investors have concerns about greenwashing. We need transition finance that can scale, but we also need transparency. People need to understand what this looks like, what’s the impact. We’re seeing the strongest growth in Asia, but it needs product innovation, transparency, and to scale up in fixed income.”
Overall, banks, asset managers, and standard-setters have made a lot of progress when it comes to the data aspects of ESG. The industry is taking steps to demystify information, create reliable ways to make comparisons, and increase the scope and depth of data. When done right it can help allocate capital to sustainable investments, or nudge companies to decarbonize faster.
But it also looks as though more urgency is required. Everyone needs to improve their data game, because we have even less time than we imagined to achieve a global energy transition.