It took decades for the law requiring companies to report their financial data to take its current form, but investors cannot wait for all the teething problems to disappear from SFDR and will have to work with data themselves. So say data experts from UBS Assest management Rajdip Ghosh and Katerina Papamihail in the paper 'Bridging the ESG data gap'.
Sustainable Finance Disclosure Regulation (SFDR) is the first SI data regulation that has the heft of – and is potentially as consequential as – the Securities Exchange Act of 1934. In comparison, the sustainable investing (SI) data and regulatory ecosystem is still in its infancy – or gestation, depending on where in the world you look – and waiting for another 87 years for it to mature to a point of ubiquity is not an option.
Sustainability issues can have a major influence on the risk and return potential of an investment, investors simply can’t afford to shy away from addressing this complex data challenge, the UBS AM experts say.
“ESG data combined with inconsistent global reporting standards create a ‘missing’ data problem when you look across the asset class universe. This becomes especially pronounced when you move outside of developed markets. For example, many Chinese companies lag their regional peers in terms of disclosure on company policies to tackle emissions. But amid growing market pressure, we are already seeing sustainability disclosure requirements improve reporting standards and ESG practices across Chinese companies.”
In developed markets, however, the lack of ESG data some investment grade corporate bonds, as well as across both private and public companies is under extreme scrutiny and is driving pressure from all corners to report accurate ESG data, the experts say.
“So, given the gaps in data, how can we build an ESG data model for so-called ‘poor reporters’ from other best-practice companies? This challenge is not unusual as investment decisions are actually typically made using imperfect data that requires making both inferences and assessing probabilities of certain outcomes.”
According to the experts, using ‘base rates’ as a mental model which relies on specific information rather than exact calculations when making a future probability judgement can help to ground financial forecasts and, potentially prevent some of the biases that might exist. “These base rates can be used alongside a market hierarchy. For example, by taking different data points being reported across companies in the same sector, hierarchical mental models can then be used as a starting point to fill the data gaps for a more effective forecast.”
To make more progress in the sustainability journey of investors, companies will need to take steps to increase the robustness of their ESG data. “However, until better metrics are available, finding innovative solutions that use the power of statistics to infer how to fill in those gaps will be of vital importance for portfolio managers to make sustainable choices and, by doing so, seek to maximize the positive impact of investors’ portfolios”, the experts conclude.
Here you'll find the complete Panorama, a broad investment outlook, including the article on ESG data reporting: https://www.ubs.com/global/en/assetmanagement/insights/investment-outlook/panorama.html