Changing conversations around sustainable finance
Environmental Finance: As sustainable investing has moved firmly into the mainstream, how have your client conversations changed?
Elena Philipova: The key difference is that we’re moving from the ‘why?’ – why should I care? – to the ‘how?’. The industry is grappling with how to create effective and trusted solutions to meet the raising demand for ESG products. It is looking to data providers to filter through the noise and supply non-financial and sustainability data that is actionable from an investment perspective. They expect solutions that enable them to identify signals and properly measure and manage sustainability-related risks and opportunities, and integrate them into existing workflows and investment strategies.
Sylvain Chateau: We have a broad range of discussions. Some investors are in the early stages of taking action, and are looking for simpler frameworks, such as exclusion data. It’s now very common to have first-layer screening to exclude sectors or address controversies. At the other end of the scale are very sophisticated investors who want forward-looking data to align investments with future targets. That involves different sets of data and more advanced index methodologies.
EF: What challenges are your clients facing in addressing climate change?
SC: A big challenge for our clients is that we can’t rely solely on data reported by companies because some of the risks are external – e.g., exposure to physical climate risks and macro transition trends. Take physical climate risk: there are more than 50 climate models, all with their specific focus, and using billions of data points. How should investors use the outputs from these models? How can they translate them into actionable risk assessments they can use in portfolio management? It’s very complex. We’re entering an era that requires tech enablement and artificial intelligence to better assess those risks.
EF: Recent research from FTSE Russell shows the green economy now represents more than 7% of global equity markets. What are the barriers to its continued growth?
EP: There are challenges around trust and credible solutions, partly as a result of the lack of clear global standards and definitions. That is why the creation of the International Sustainability Standards Board last year at COP26 was so important; driving towards consistency and a global mandatory disclosure framework is critical to build trust and credibility in the available ESG products and solutions. There is enough capital to finance the transition: I think the biggest challenge is connecting the capital to the products that have the desired impact.
In addition, there are still significant gaps when it comes to ESG data. However, I would stress that investors should not use data gaps and challenges as an excuse to delay action. Recent history shows that there is sufficient ESG data to inform investment strategies that can be very impactful from both a financial and sustainability perspective. This is the largest business opportunity unfolding in the global economy.
EF: Where do you see opportunity in the ESG data and index business?
SC: The market is very dynamic, especially in passive investments, where clients are asking for more diversity in their benchmarks – for sustainability or climate versions of the Russell US Indexes, for example. We see a real opportunity for investors to shift assets from standard benchmarks to these new indexes.
Other ESG dimensions are still emerging. The social pillar has been a bit overlooked in the past, but with the pandemic we are seeing a recognition of the financial risk that can be attached to these social issues. We intend to increase the resources we have to cover these metrics.
EP: Our priorities are informed by our customers and what the industry needs. But we see three main interconnected areas. The first is around climate risk and opportunity. The second is regulation, which is one of the strongest forces shaping the direction of travel for the industry. The third is around corporate reporting, because the investment solutions and products are only as good as the quality of the data used to inform them, which greatly depends on companies’ disclosures. This is an area where we are working with corporate clients; our Refinitiv Corporate ESG Reporting Solution aims to simplify, automate and streamline ESG disclosure.
EF: And what about risk?
EP: I think the sustainable finance industry risks overcomplicating things and using complexity as an excuse for inaction. Instead, we should strive for simplification. The industry has enormous capabilities at its disposal to have a very positive impact on the sustainability agenda. We should try not to solve the scientific problems of the world through capital markets, but we should let capital markets perform their primary function, which is capital allocation that serves society. The industry needs to be empowered through data to channel that capital towards a decarbonised, more sustainable and resilient economy. There is a significant distinction there, but the line between the two has been blurred over the years.
For more information, see: lseg.com/sustainable-investing