On Monday, I attended the Future of ESG Data conference in London. Among the rehearsed keynotes and panels there were moments of real insight, and also a brief moment of honesty that highlighted a major dissonance between climate science and capital allocation.
Here is a summary of what I gleaned from the day’s events.
The elephant in the room
One part that stood out both for its honesty, as well as its stark contrast to climate science, was the climate change scenario modelling panel.
On this panel, Craig Mackenzie, Head of Multi-Asset Sustainability at abrdn, began joking that he didn’t “want to do a Stuart Kirk” before describing the scenario analysis carried out at abrdn and the conclusions about climate risk that his team had come to.
Stuart Kirk left his role as Global Head of Responsible Investing at HSBC after being suspended for his now infamous speech at the FT Moral Money Summit in May 2022. Shocking the responsible investing world, Kirk stated that “There's always some nut job telling me about the end of the world.”
Ironically, Mackenzie then found himself sat beneath a Q&A screen displaying the words “you just did a Stuart Kirk…” in an anonymous audience comment.
Mackenzie explained that for the majority of his funds, climate risk isn’t material, as something that happens in 2050 (for example, sea level rise in Florida) is negligible in terms of the majority of his client’s interests. As such, he said that he finds endless TCFD reporting tedious as “half of his team” is working on something that “isn’t material”, retracting from “more important ESG work” they could doing.
This moment of honesty was perhaps risky for Mackenzie but also important in opening up about how asset managers are assessing climate risk and allocating capital.
The current system is a self-perpetuating cycle. If, as Mackenzie says, the vast majority of investors are only considering risks over the next five to 10 years (and as such, viewing climate risk as negligible) then they are falling into the trap of the “tragedy of the horizon”. This in turn makes something like 3°C of warming by 2050 more likely as capital is allocated in a business-as-usual fashion. Does this then become the climate scenario that is most appropriate to model for, even when taking a long-term view, in turn driving investment decisions towards this eventuality?
Short-circuiting the system
Mark Carney suggests two ways to solve this. One is allowing companies to set net zero targets themselves (which should include scope 3 emissions). In theory, this would reduce emissions at the company level. However, we find very few net zero targets are credible. In fact, as we reported in our Initial Insights report (available for clients here and by request for non clients here, only 11% of LevFin companies had committed to setting a net zero target aligned to the Science-Based Targets initiative (SBTi) and none had these verified. Without stricter net zero standards and mandatory engagement, it’s hard to see this approach having much real world impact.
The second suggestion is a carbon price that reflects the global impact predicted by climate science. Currently, the average carbon price around the world is $2 - $4 per metric tonne. In order to short circuit the above system and reboot us towards a 1.5°C world, the price needs to be around $75 - $100 per metric tonne. As Carney points out, this would take an immense global policy and regulatory effort. Which brings us to COP 27.
Data — what’s useful in 2022?
The general consensus at the conference was that people now trust ESG data more than in the past. Quality and coverage are improving and we actually have some widely accepted frameworks so issuers and investors are no longer saying ‘what are we meant to be doing?’
Now the question is more like ‘how are going to do this, and where are we going to find the resource?’.
Investors are increasingly seeing value in the data, and of having multiple data sources to aggregate and compare. Even if you’re not BlackRock, and can’t buy all the data, a few different carefully selected feeds is better than one. Quality is key here. There is no limit to the amount of data available but some is mass produced with minimal thought gone in (which can be useful as long as you know what you’re getting), and some is more niche but carefully sourced and analysed.
9fin’s of course, is the latter.
Assurance came up a lot. Third party audits are not yet required for ESG data but we should be looking for verification where we can. This is something the 9fin team has in the pipeline for its v2.0 dataset.
Timing was another concern. David Hickey, UK Head of Sustainability at BlackRock, stated that data is often pulled through to to models only to find out that it’s 18 months out of date.
Other conference participants said that there was too much focus on reporting backward looking data. Now that we have better quality data, we should be looking past reporting and towards tangible action, the panel conversation went.
External scores — help or hindrance?
As always, there were mixed opinions on whether ESG scoring is helpful or not. Analysis needs a conclusion — invest or not? Which fund to allocate to?
When describing how an ‘E’ score is balanced against an ‘S’ score to achieve an overall rating for a company, Sylvain Guyoton, Chief Rating Officer at EcoVadis, quipped “you can blend bananas and carrots together if you want, and you’ll end up with a nice smoothie … people want one score at the end so we give it to them, even when it makes no sense.”
Some panellists suggested that scoring makes sense when talking about specifics, like water stress, while everyone agreed a score that tries to reconcile two different ESG factors has little relevance. While third party opinion is invaluable, the final score or decision should be that can be supported with in house knowledge and reasoning.
Interestingly, the room was split on predicting the regulation of ESG ratings, with roughly half the room thinking that ESG scoring will be regulated in the next 3 years, according to an audience poll.
90% of the value is in the opinion
Despite the focus on complete, consistent and comparable data, a more nuanced understanding of data is prevailing. A number of speakers and delegates alluded to the importance of the qualitative element, and the analysis done on top of the data. The consensus was that subjective opinion isn’t bad, and in fact it holds 90% of the value. But transparency over how this opinion has been formed is important, as is challenging this opinion with multiple sources of information.
The materiality debate
Some panellists sheepishly stated that financial materiality is all that matters, while others took a more impact-driven approach, referencing SDGs within their internal frameworks.
One of my favourite moments was when Mark Manning of the UK’s Financial Conduct Authority suggested that the way ESG risks are viewed may be too “stark”.
Our view is that when analysing ESG risk, there is a large overlap between what is financially material and what is material to planet and people. This is an opinion we shared in our recent webinar.
Regulation: written for regulators
Despite numerous iterations and supporting notes, there is still a fair bit of confusion surrounding The Sustainable Finance Disclosure Regulation (SFDR). Some complained that it wasn’t simple and seemed to be written in a language only regulators understood. Others complained about the focus on companies themselves, as well as the difficulty in knowing which companies are appropriate to put in any given fund. “One man’s article 9 fund is another’s 8”, one delegate mused.
Keep an eye out for our piece on SFDR next week, as well as our SFDR-focused webinar in November.
