Making sense of ESG data
How do we assess reporting around ESG?
Making sense of ESG data
We know that everyone is looking for the easiest way to assess the environmental, social and governance (ESG) characteristics of an investment. However, ESG data can be complex and not always reliable.
In our first of two videos, SEI’s Sustainable Research expert Aruran Morgan discusses how we consider ESG data, metrics and reporting.
S: Hi, I’m Sarika, and I’m part of SEI’s Institutional Group. I’m here again with Aruran Morgan, who is our Head of Sustainable Research. In our last video segment we talked about the challenges around ESG ratings. Today we will discuss in detail how to think about carbon data.
S: As we know one of the most important ESG topics in asset management right now is climate change. Can you share your thinking on climate-related data and what investors should know?
A: The first thing I’d say is that we believe carbon data are getting better. There a lot of forces driving this, including regulation (most notably in Europe), investor engagement and client interest in the topic.
When the industry talks about carbon data, they often break it down into Scope 1, Scope 2 and Scope 3. Scope 1 emissions relate to direct emissions from sources that are controlled or owned by an organization, such as company facilities and company vehicles. Scope 2 emissions are indirect emissions from the generation of purchased electricity used by an organization. And Scope 3 emissions relate to upstream and downstream emissions that occur throughout a business value chain – everything from raw-material sourcing to employee travel to consumer use. We’re starting to see much better disclosure of Scope 1 and 2 emissions by companies which gives us more comfort in this data, with some countries beginning to require it from listed companies. Scope 3 disclosure is less robust. The methodology for calculating it is less standardized and quite frankly there are some real challenges to actually capturing supply-chain data given suppliers for large companies can be very small, geographically diverse, and have multiple tiers. And I’d add generally that, when it comes to disclosure in the ESG space (both carbon and other metrics), small companies tend to report less data than large ones.
S: Is there a concern that some companies are ‘greenwashing’ or deliberately not counting their Scope 3 emissions?
A: I’d separate the two issues. I think greenwashing, the idea of a firm overstating its sustainability credentials, is definitely a challenge. There is often an incentive for companies from both a financial and reputational standpoint, if they can get away with it, to greenwash by drawing attention to a few sustainability issues while ignoring the most material impacts of their business. Similarly, asset managers are racing to label products as “sustainable,” even when the portfolio hardly looks different than the index.
On the Scope 3 emissions side, I think it’s a slightly different issue. It’s an important metric and at times, for sectors like the banks, Scope 3 emissions can make up over 95% of the total carbon footprint of a company*. But it’s so hard to measure and any calculations have a number of assumptions associated with them that we may just have to accept that we’re not there yet in measuring these types of emissions. A further challenge for Scope 3 emissions in the asset management industry is that one company’s Scope 3 emissions are another company’s Scope 1 or 2, and vice versa. Scope 3 reporting for a diversified portfolio may result in double-counting emissions.
S: It sounds like, alongside quantitative metrics, understanding carbon emissions is a mix of art and science. How does SEI use ESG data?
A: SEI’s investment process starts with manager research, and so much of the data we use is proprietary and based on our in-depth ESG due diligence process. Beyond that, we subscribe to ESG data sets from a few different third-party providers and use them in several ways. One is to ensure funds with exclusions are in compliance with their guidelines. Another is preparing for new regulatory reporting requirements. We also use ESG data to inform our engagement program – for example, ESG data can help identify companies to engage with on a topic like climate change - (for example, which have high levels of emissions relative to their peers in the sector, or which are lagging their industry on disclosure).
And finally, whilst we don’t necessarily believe that the rating methodology of third-party providers is always the right way to look at the ESG credentials of a fund, monitoring ratings can help us challenge our own thinking.
S: It seems like ESG data are going to continue to be a big topic of conversation for some time. What’s on the horizon for 2022?
A: I think the focus is going to be on disclosure, whether its regulators in the UK increasingly asking pension schemes to report against TCFD recommendations or managers placing more of an emphasis on engaging with companies to get better disclosure on topics such as climate emissions or gender equity. We’ve also seen investors increasingly voting against management on ESG topics in shareholder meetings in 2021, and I expect that to continue into 2022. In Glasgow last fall, the International Sustainability Standards Board was announced to coordinate global sustainability reporting efforts. Improving the consistency, transparency and robustness of disclosure on ESG matters is a key focus for both the industry and SEI over 2022.
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SEI considers ESG factors as part of its Portfolio Manager Research and due diligence process including an evaluation of each Portfolio Manager's approach to integrating sustainability risk in its investment process; however, no minimum threshold has been established with respect to these capabilities in order for a firm to be hired as a Portfolio Manager.
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