Environmental, social and governance (ESG) investment has risen in popularity over the last few years within the retail, wealth and institutional arenas, but when it comes to data transparency and comparability, there’s a lot of work still to be done.
European regulators have had ESG principles in their sights for quite some time and last week’s consultation paper by the European Securities and Markets Authority (ESMA), the European Banking Authority (EBA) and the European Insurance and Occupational Pensions Authority (EIOPA) on the subject set forth the pan-European regulators’ proposals for establishing more transparency for the investor community in the region.
I’ve long had an interest in ESG and, in particular, have enjoyed working with individuals engaged in the ‘G’ bit of the industry throughout my career. Governance teams tend to be more gender diverse than other functions within the buy-side such as trading, for example, and I haven’t yet met a governance person I haven’t enjoyed talking to! The addition of the ‘E’ and the ‘S’ components to the mix reflects the increased awareness of issues such as sustainability, climate change, diversity and social welfare within the public consciousness overall. These are all important issues that must be considered by all industries and capital markets is no exception.
As always, it’s a fine balancing act to make compliance requirements sufficiently robust for investors and simple enough to comply with that even the smaller buy-sides are encompassed. To this end, the long tail of smaller European asset managers may struggle to cope with the more onerous obligations in the paper and this could be detrimental to their performance and overall transparency in the market.
The intent of ESMA and its two European counterparts is sound – to ensure that investors are not misled by vague documentation and misinformation such as intentional “greenwashing”, where products are labelled as ESG but they aren’t actually environmentally friendly. It’s in keeping with investor protection goals and given the rise in popularity of ESG, the consultation paper is timely – though some might say a little late. The challenge however, is that there are very few best practices in the ESG realm and data vendors and index providers are all calculating ESG scores on the basis of markedly different inputs and methodologies. Moreover, buy-sides are taking these various data sources and applying their own individual scores. Moving from this level of disparity to a regulatory-mandated regime is always going to be painful.
ESMA and co desperately need input from the buy-side if they are to ensure their approach is correct. Too onerous and the industry won’t comply to the detriment of the sector and investors, too high-level and no real progress will be made in addressing transparency and comparability of data.
The challenges the regulatory community has faced in establishing common data standards for reporting under MiFID II and EMIR prove that without the right inputs at the start, some degree of chaos can ensue. You just need to look at the MiFID II time-stamping debacle for a concrete example. The industry can do without the ESG rules following suit.
The paper still has a lot of blanks to fill in when it comes to formats for data provision – there’s a heap of annexes that we’ll have to wait for – but it does provide three different levels of proposed transparency for the Level 1 text, ranging from the high level down to the prescriptive. A significant challenge in gathering feedback on the correct approach is that three different pan-European regulators are asking the same question of three different industry demographics across all EU member states. Consensus is hard enough to achieve at the level of one industry – how can we expect insurers, pension funds, asset managers and banks of varying shapes and sizes and from various countries to provide a consensus on anything? That rarely works out well.
There’s logic in having basic underlying principles that are the same across these sectors, but in building one ring to rule them all? No, bad idea. It’s a miracle that the three different regulatory bodies themselves could come to some form of agreement – I suspect that may be the reason why it has taken a while to publish the proposals in the first place.
The industry should certainly take the opportunity to provide as much feedback to ESMA as possible before the start of September, but I hope they decide to break the approach down into sector-specific regulation rather than some giant directive across all sectors.