With reports of Environmental, Social and Governance (ESG) investing on the rise amid a drastic drop in oil prices, ESG data is facing scrutiny both from investors and regulators. Market participants are therefore looking to artificial intelligence (AI) to assist in data management.
“As investor demand for more clarity on ESG grows, an increasing number of companies are providing detailed information on their ESG policies, data and actions. Most ESG data, however, is self-reported and often lacks transparency and comparability,” said John Cushing, CEO, mnAI, an AI-powered M&A deal-flow search engine, in an email.
“Many businesses still use ESG factors in a box-ticking way or offer up data only on metrics where they perform well.”
The move towards data standardisation is currently industry-led, with standards such as the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-Related Financial Disclosures (TFCD) leading the way. But while these bodies set standards, they cannot provide verification of data.
SASB creates standards based on consultations with investors, companies and academics to determine whether an ESG factor is both of interest for investors and ties into conventional financial value drivers, making it financially material, according to Jeff Cohen, head of private investments, SASB.
“I think that any data, in the absence of it being third party verified or assured should be treated with some level of scepticism. This is not to suggest that any company that goes about self-reporting ESG data is not doing so with the best intent in mind, but ultimately there is a cherry-picking phenomenon that exists in the absence of mandated and regulated disclosure,” says Cohen.
“Data for data’s sake doesn’t really add a lot of value – data is meant to inform decision making. And I think [standards] remove a lot of barriers to turn the data into decision-useful content that creates action.”
Pressure for more precise ESG data management arises from upcoming changes to the Second Markets in Financial Instruments Directive (Mifid II) which will require advisers to incorporate ESG considerations into their suitability requirements. A study by Square Mile Investment Consulting and Research found that 47 percent of advisers were unaware of the change, and that advisers are seeking clarity of ESG data from asset managers.
More and more bodies, including Morningstar and Bloomberg, have in recent times began to offer market data and rankings. Scepticism towards ESG data and funds has prompted calls from the US’s Securities and Exchange Commission (SEC) in March to more closely scrutinise the data, with proposals to eliminate misleading fund names. Cohen believes the ESG industry will see a combination of the market leading the charge in standardisation, with regulators eventually responding.
According to Cushing, the vast amount of data and data providers available creates confusion.
“With no standardised agreement on scoring ESG metrics and with so many different methodologies from a growing number of providers, views on the same company often differ. It is therefore vital that investors also look for information elsewhere to make sure companies are doing what they’re saying,” said Cushing.
A combination of data-driven processes is needed to measure ESG data, said Cushing. He believes AI tools are integral to the process in order to analyse and present the data in an organised way to investors.
On April 20, Morningstar reported that companies with the highest ESG rating outperformed their peers in February and March. There has been speculation that the current oil crisis is attributing to increased ESG investment, though Cohen stresses that negative oil prices are only one factor.
“The fate of ESG factors into investment strategies I don’t think is going to be dependent entirely on or largely on what oil does. Certainly it is a factor and I think it’s going to influence how investors think about sector based allocation in the future, but ultimately this is about factors that are relevant across multiple industries – oil and gas and extractors included – that are managed well from an investment standpoint or assess well upfront, which can lead to outperformance irrespective of the industry you invest in,” says Cohen.
Haresh Patel, CEO at Mercatus, a data platform working with SASB, agrees.
“The oil industry has continued to suffer as we know, and it’s just one more data point for investors to say ‘It used to be a good money machine, now I need to change my asset allocation and now I need to worry about ESG.’ It’s just one more straw on the camel’s back.”