Environmental, social and governance (ESG) investing is one of the fastest growing areas of investment management—experts believe it could almost double over the next five years. But the problem has always been the provision of ESG information from investee companies. Step forward State Street Global Advisors to break the deadlock.

State Street, a fund manager with a hefty $2.8bn under its control, has developed a new scoring system that it claims not only helps investors but also aids companies to boost their ESG (environmental, social and governance) scores.

In a report, State Street says that its new scheme, dubbed “R-Factor”, is “the change needed for ESG to become an integral part of the financial system”.

That is a big claim, but it has been clear for some time to many in the sector that ESG monitors are in need of a shake-up.

Research has revealed there may be as many as 250 products available that “rate, rank or index” companies based on ESG factors. However, there is little standardisation of the information they use, how the information is reported, or the materiality criteria applied.

Barriers to integration

Despite this confusion, fund managers have been allocating capital on the basis of ESG performance in ever-increasing volumes.

Earlier this week asset managers at a conference hosted by MSCI, an index provider, estimated that that the global share of assets based on ESG principles would double, from the current 25% of assets, to 50%, or more, in the next five years.

This drive is boosted by organisations such as Principles for Responsible Investment (PRI), a UN-sponsored campaign aimed at persuading investors to select their investments “responsibly”. PRI has attempted to set best-practice principles for ESG investment and its integration into investment approaches.

But after surveying 1,100 investment professionals it found the “main barrier” to ESG integration was “a limited understanding of ESG issues and a lack of comparable ESG data”.

Investment managers know there is information available “but advances in quality and comparability of data still have a long way to go”. That’s an issue if you’re trying to allocate hard-earned savings of pension fund holders.

State Street’s R-Factor scheme melds methodology used by the Sustainability Accounting Standards Board with data collected by four major index providers (Sustainalytics, ISS-Oekom, Vigeo-EIRIS and ISS-Governance).

The process also draws on national governance codes, where they apply. Using multiple data sources means information gaps are filled, says State Street, and “reduces potential bias” in data gathering.

The scores drawn from the data are then shared with boards during engagement. In case studies provided by State Street, a company may be presented with as many as 26 different metrics that it can then work on to improve its overall ESG performance. State Street says these will be metrics directly relevant to a company’s business sector.

Observers say the new process is good news for companies because the focus is on materiality and allows them to see exactly how they improve their ESG scores.

But there remains a concern that it is yet another rating systems collecting information, one of the many already contributing to “reporting fatigue” among companies.

Disclosure requirements

The demand for ESG data disclosure comes not just from investors. In the EU, listed companies are required to disclose ESG information by the Non-Financial Reporting Directive (NRFD), though this has faced criticism for failing to provide detail on what information should be disclosed and how.

A campaign group, the Alliance for Corporate Transparency, says the NFRD needs fresh legislation to introduce a “mandatory baseline of disclosure requirements and metrics”.

This chimes with research across the EU undertaken by Board Agenda, which found a reassuringly large number of companies recognised the importance of sustainability to long-term value creation. But only half of those questioned could say their sustainability aims were delivered by “effective business policies”, and only a third could say sustainability had been integrated into performance measures and compensation schemes for executives.

US regulators continue to grapple with the disclosure of ESG information (ironic, given asset managers like BlackRock, the world’s largest, have publicly voiced the importance of ESG data). The stumbling block to more enthusiastic use of ESG information remains how to access it in a reliable form.

In October last year academics filed a petition with the Securities and Exchange Commission (SEC), the US financial watchdog, demanding that it begin work on defining “mandatory” disclosure requirements. Congress is also considering proposed disclosure legislation.

Commenting on the developments, Jessie Gabriel and Lauren Attard of BakerHostetler, a US corporate law firm, wrote: “Between the monthly reports of impending and dramatic climate change, the #MeToo movement, and more and more data confirming the importance of board governance to a company’s bottom line, the SEC may finally bow to the pressures of public opinion.”

The climate crisis is a dominant global issue and will remain so for the foreseeable future. Reports from organisations such at the Intergovernmental Panel on Climate Change have warned of the need to tackle global warming urgently. ESG issues will therefore continue to be an ever more important part of the investment chain.

That being so, companies will need to improve their strategies. Investors, in their turn, will have to hold them to account. Better metrics are therefore at a premium.