Download a PDF of this article

ESG investing has, in a relatively short time, gone from being a core investment tenet among a relatively small subset of the global investment community to being one of the most discussed global investment trends in recent memory. The strategy, which has undergone several iterations, all of which had limited market reach, has taken off over the last couple of years due in part to increased concern over climate change and the impact of a global pandemic. Like any investment trend that catches on quickly, ESG has caught the attention of global regulators who are proposing new ESG regulations that improve ESG transparency and provide better insights into how ESG-focused investment decisions are made.

ESG has been the catalyst for a host of new investment products – global ESG assets now total over $40 trillion, according to Pensions & Investments – by leveraging metrics on how companies align with ESG standards and deliver ESG outcomes. EU and Australian regulators were first out of the gate to raise concerns about the potential “greenwashing” of ESG investments, or the risk that funds would be marketed as more sustainable than they are in reality.  As such, regulators in both regions have led the charge to pass rules requiring asset managers to integrate sustainability risks into their internal processes and estimate the potential impacts of climate change on their balance sheets.  

In March, the U.S. Securities and Exchange Commission (SEC) formed an enforcement task force to look closer at ESG regulation, with a special focus on developing initiatives to identify ESG-related misconduct. And more recently, the Financial Conduct Authority (FCA), which regulates the UK investment community, put ESG investors and ratings providers on notice, promising to bring new ESG transparency requirements by January and warning that “if there is insufficient evidence of active stewardship to advance environmental and social goals, we will consider further regulatory action.” The move followed recent guidance from the International Organization of Securities Commissions urging tighter controls, so we should anticipate other regulators to follow suit.  

All of this means that to stay out of the regulatory crosshairs, asset managers must be able to empirically prove their commitment to ESG compliance and the integrity of their evaluation processes. Beyond the legal considerations, nearly 3,000 asset managers have signed the UN-supported Principles for Responsible Investment (PRI), which seek to offer a menu of possible actions for incorporating ESG issues into investment practice and comes with a requirement to report on impact and outcomes.

Yet conversations with some asset managers reveal that they would be incredibly limited in their ability to disclose their process if PRI or any national regulator were to initiate an audit. As with many internal functions, the process of evaluating investment vehicles through an ESG lens remains highly manual and fractured, with critical information residing in disparate locations on the network drive, including user-owned, unshared spreadsheets, and direct communications with the companies in question. Collecting and compiling this information – and presenting it in a way that satisfies an auditor – can mean weeks or months of frustrating data collection and validation as well as a sense of uncertainty that no business wants to bear.

This transparency and accountability challenge with respect to ESG-focused funds was corroborated by our recent Investor Survey, in which 72 percent of institutional investment professionals said it was difficult to illustrate to investors the impact of ESG considerations on company sustainability practices. That challenge is made more difficult as ESG research workflows and analysis are often siloed from core research conducted on holdings within investment portfolios. The majority of investors (72%) told us that this lack of a unified view is the most challenging aspect to incorporating ESG considerations into the investment process.

Despite the lack of enforcement to date, the regulatory rumblings around ESG suggest that it is only a matter of time before the auditors come knocking. This means it is imperative that asset managers begin to look beyond spreadsheets and shared drives to house their ESG-focused research content and implement a more structured approach to capturing ESG data, analysis, management team engagement, and investment considerations alongside their organization’s core investment research.

Solving for this industry challenge was the primary reason we worked — in collaboration with our investment management clients — to develop ESG Scorecards, an end-to-end ESG research workflow toolkit that centralizes and streamlines the selection, monitoring, and reporting process for ESG-focused investment portfolios.

Demand for solutions like ESG Scorecards is on the rise because they add structure, control, and transparency to the relatively unstructured set of data and workflow requirements involved in the scoring, monitoring, and reporting on ESG-focused investments.

To illustrate, picture an ESG analyst making a buy recommendation on a company with a particular ESG rating based on details from a management meeting about how supply chain enhancements will reduce the company’s climate risk exposure while lowering the cost and complexity of taking their products to market.

With ESG Scorecards, that unstructured information is now captured and available within the research management system (RMS), displayed next to the company’s preferred third-party ESG ratings data, their internal ESG scoring system, and all of the core fundamental research being conducted on that company by other analysts on the team. And should the decisions be called into question by investors or regulators, it can be easily retrieved from the RMS with a few clicks or through a custom ESG report.

Toolkits like ESG Scorecards go beyond merely facilitating the capture of ESG data. ESG Scorecards streamlines investment workflows, enables the ability to compare internal and external scoring models in real time, provides direction and focus during management meetings, and drives regulatory compliance through improved auditability and accountability. That transformative functionality contributes to improved ESG-focused investment outcomes and more transparent reporting on ESG-related investment decisions to investors and regulators alike.

Heightened regulatory scrutiny following a rapid rise in investor demand for a popular investment angle or strategy is not a new thing. When a trend achieves liftoff, regulators inevitably begin to take a closer look. With ESG-focused investments, responding to growing investor and regulatory pressure for transparency is achievable with organizational focus and the use of intelligent new tools that are purpose-built to deliver added structure and control to the investment process.

While there does not yet appear to be many documented regulatory actions for ESG-focused fund managers, regulatory regimes the world over are clearly laying the groundwork, and asset managers that take a leading role in adding structure and transparency to their ESG investment process will be in a far better position to weather the storm when the other shoe drops.