Part four of our ESG insight series will be split into multiple instalments, as researching the ESG “RegTech“ market is something we’ve spent a long time doing.
These posts take a look at how technology solutions can be utilised to address common industry problems relating to regulations surrounding socially responsible investing. We are bringing together insights from our recent appointment by a top 5 global asset management firm to research the regulatory challenge and the holistic approach required for financial services firms to remain compliant and competitive in the new age of ESG regulation.
Socially responsible investing (SRI), and incorporating Environmental, Social and Governance (ESG) factors into the investment decision making process are nothing new. Front office professionals such as portfolio managers have been aware of the power of ESG data for many years. Now for the first time, those in the middle and back-office are beginning to take notice – some out of choice and some out of necessity.
As demographics change, investor sentiment is moving towards sustainable and responsible investment and away from being solely interested in profits alone. This in turn has brought around changes in the regulatory and supervisory landscape. The EU Taxonomy and Sustainable Finance Disclosure regulations coming into force in 2021 introduce the “hard” mandatory regulation that the ESG and SRI industries have been crying out for. And global industry standards bodies such as SASB, TCFD and the UNPRI allow firms to voluntarily sign up to best practice guidelines and codes of conduct which can provide a competitive advantage.
Answering the regulatory problem
Historically, challenges related to ESG and SRI have been addressed by teams of expert human analysts, meticulously pouring over reams of data from numerous different and disparate sources. These would be assessed to identify ESG high performers and potential investments that could be incorporated into products and portfolios, and ultimately offered to clients. This scenario is unsatisfactory in today’s modern world, as it relies upon the thoughts and perspectives of a small group of individuals. This creates problems as the relative importance of different aspects of ESG and SRI are entirely subjective and in the eye of the beholder.
Enter the solution – technology. Innovative powerful technology products utilising Artificial Intelligence and Machine Learning are able to aggregate millions of data points in a fraction of a second, providing a level of analysis and insight not experienced previously by leveraging the power of consensus and effectively ‘crowdsourcing’ ESG data. These are now being supplemented by a variety of other solutions which help to address incoming regulatory requirements, such as the suitability assessment now included in MiFID II, as well as products which offer reporting and disclosure aligned to both mandatory regulatory and voluntary industry standards body reporting. Examples of these include the EU Sustainability Disclosure Regulations and UNPRI reporting required of its members.
Clearly more data can only be a good thing for any ESG business operation, but those that implement these types of solutions tap into the world of ‘fast ESG data’ and address one of the primary concerns for anyone involved – greenwashing.
Again, greenwashing is nothing new either, and has been around since the 1980s, initially coined by environmentalist Jay Westerveld in his groundbreaking essay inspired by the “save the towel” initiative implemented by a number of hotels at the time. Whilst the definition of the term has developed over the last 30 years or so, it is generally recognised as the process of conveying a false impression or providing misleading information about how a company’s products are more environmentally sound than they actually are. In reality, greenwashing takes the form of unsubstantiated claims made by investee companies, aimed to deceive consumers into believing that a company’s products and practices are environmentally friendly when in fact they are not.
A number of vendors in the ESG space have noticed the potential market opportunity here, and have begun to align their solutions with specific regulatory requirements. We heard from industry expert Dr Todd Bridges – Head of ESG Research at Arabesque S-Ray on potential ways to address some of these regulatory challenges using technology:
“New technologies are allowing ESG data, research, and advisory businesses to expand their product offerings and innovate to help clients create value through the integration of sustainability or non-financial information. Within Arabesque S-Ray – our sustainability data, research, and advisory business – we are integrating technology to address the changing regulatory landscape and help our clients address new requirements. For example, we are conducting research and development to incorporate new regulations around the EU/EC’s action plan on financing sustainable growth – EU Taxonomy, NFRD, and SFDR. These regulations will be incorporated into new technologies to help scale data disclosure, produce regulatory reporting, and create decision-useful data analytics for companies – which impact corporate strategy, investment processes, or product development. Through our companies, we leverage cutting-edge technology to deliver sustainable, transparent solutions for a changing world.”
It is clear and obvious that without adopting these new technologies, firms will be left in the dust by those that do. Consumer demand and the introduction of hard regulatory requirements will, before long, make the utilisation of ESG “RegTech” products and solutions the norm rather than the exception to the rule. This is clearly reflected in the supply side of the market, as a myriad of vendors – some with clear and obvious, historic ESG credentials and others who have innovative powerful technology solutions alike, all turning their attentions to creating this type of product. Watch this space…
Look out for the next instalment ‘ESG: The Rise of “RegTech”’ where we will analyse further regulatory challenges and obligations, as well as the innovative technology solutions out there that can help to solve those problems.