Measuring What’s Critical – The Need to Improve ESG Data

Anna Sophie Herken, Business Division Head at Allianz Asset Management and a “40 over 40” Germany 2020 Alumna, knows there is more to be done when it comes to protecting our planet. In this episode of our series Questions on Finance, she emphasizes the urgency of improving ESG data

by Anna Sophie Herken | 06 Dec, 2022
Anna Sophie Herken Questions on Finance

“You can’t improve what you can’t measure,” the economist and management thinker Peter Drucker once wrote. In business, nowhere is this observation now more relevant than in the field of sustainability.

Fueled by real-world concerns, especially the ever-growing threat of climate disaster, companies are increasingly adopting sustainability in their business processes. However, one problem is that ESG (the term that includes sustainability) is notoriously difficult to measure in a consistent and standardized manner. The consequence is a relative lack of comparable, standardized, and reliable data relating to environmental, social, and corporate governance (ESG) topics.

“The term ESG is less than two decades old, but it may already be coming to the end of its useful life,” the Financial Times, sagely opined in June of this year. Its reason? The fine line between flexibility and ambiguity means some companies and investors are using the loosely defined ESG term to “greenwash,” or make unrealistic or misleading claims, especially about their environmental credentials.The Economist joined the pile on. In ‘A broken system needs urgent repairs,’ in July, writer Henry Trick contended that, from impact to measurement to disclosure, much of ESG is still flawed. There are three fundamental problems, he wrote.

First, because it lumps together a dizzying array of objectives, it provides no coherent guide for investors and firms to make the trade-offs that are inevitable in any society. Second, it is not straight about incentives claiming that good behavior is more lucrative for firms and investors. Finally, ESG has a measurement problem.”

But despite the criticism, Trick concluded that “for all its pitfalls, it may be better to overhaul than to bin ESG.” He acknowledged that at the core of ESG is a quest for something increasingly crucial in the battle to improve capitalism and to mitigate climate change: making firms and their owners accountable for their negative externalities, or the impact of production or consumption of their products on third parties, such as the atmosphere.

What’s the Challenge With Data and ESG?

The challenges are multi-dimensional, especially for a financial services firm seeking reliable data on which to base investments. First of all, there is hardly any global consensus on many ESG related issues such as what can be considered sustainable, on common definitions, on ESG risk, etc.

There are also specific challenges in the different elements of E, S, and G. While it is easier to measure carbon emissions scientifically or diversity in a Board, it is far more difficult to quantify a positive social contribution of an economic activity. That leaves room for interpretation regarding a company’s ESG risk profile, for example.

Also, there is no standard methodology that rating agencies follow. This situation was highlighted in a recent study on six leading rating agencies by researchers from MIT Sloan School of Management in the United States. The agencies used 709 different metrics across 64 categories, but only ten categories were common to all.

Second, there’s a potential conflict of interest stemming from doubts about ESG data in the rating process and questions about the transparency of the rating process have been raised. And even when ESG data is available, it is almost always backward-looking, making it only a snapshot of a firm in the past, not its present or future activities.

Finally, the whole process of data gathering can be complicated and resource intensive. A wealth of data already exists for publicly listed companies or those with long histories, which makes it easier for issuers of securities to assess them. However, in a greenfield infrastructure project, for example, all required data must be captured through extensive due diligence. This can make it costly and time-consuming to assess, document, and quantify all the environmental and social impacts.

Did you know …

72% of European asset owners that receive ESG-related reports from asset managers would prefer standardized reports across managers, yet only 18% are currently able to do so.

The ESG Data and Analytics market is expected to grow at 25% annually until 2024 and reach a market size of $1.7 to $2.3 billion. (Source: McKinsey)

Worldwide there are around $30 trillion worth of invested assets that rely on ESG information.

Preserving the Planet

Many investors feel that the lack of robust and transparent data is a critical concern with ESG. However, while acknowledging the challenges and risks of incomplete and imperfect data, we cannot allow this to get in the way of preserving our planet and its inhabitants. Keeping in line with the mentioned importance of improving and measuring, companies are now turning to the power of digitalization to shed light on the unseen.

Firms are transforming business processes with big data, inexpensive sensors, and the power of artificial intelligence (AI) and other advanced technologies. Companies are now trying to tap into the extensive real-time functionality of these technologies to help set and achieve ESG goals and share progress with stakeholders. This potential is yet to be proven, but it would allow the ESG credentials of issuers to be analyzed without having to wait for standardized and accessible data.

More data providing greater insights will enable investors to make better decisions, regulators to steer companies more effectively, and to create a shared understanding of sustainability.

Saving the World We Live In

Despite the many challenges, generating ESG data is essential for the future of our planet. More data providing greater insights will enable investors to make better decisions, regulators to steer companies more effectively, and to create a shared understanding of sustainability.

ESG is not about to disappear. It is tackling some of the most critical concerns facing the future of our planet today: climate change, biodiversity loss, human rights violations, inequality, pollution, and many more. Many of these problems are interrelated and becoming more acute, so financially more relevant to investors and the people whose money they manage.

This all points to the urgency of collecting more data relating to ESG. Human imagination and diligence have worked wonders before, and with active collaboration between regulators, scientists, standard setters, and technology providers, we will also overcome the ESG data challenge.

Tighter regulatory oversight will help make ESG more credible. This is coming, particularly in Europe. More global regulatory pressure to make ESG information more accurate would be better for the long-term future of companies and the world in which they operate. With the right disclosure requirements and regulatory scrutiny, it could help direct capital where it is most needed.

Through such efforts, capital markets may eventually “internalise externalities,” that is to reward companies for reducing their carbon footprints through higher asset prices and a lower cost of capital. This blend of climate concern and capitalism could represent the best chance we have to actually improve sustainability measures and save our planet.

This article reflects the personal views of the author.



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