As ESG disclosure and reporting requirements and ESG-aligned products expand, high quality ESG data is in great demand. Technology and data can play a vital role in the ESG ecosystem, and the regulatory environment is adapting accordingly.
The challenges of ESG data and role of standardisation
ESG disclosure and reporting requirements and ESG-linked product offerings have grown significantly. At the same time, concerns of 'greenwashing' have never been higher. As a result, investors, companies and regulators have a growing need for high quality data on ESG metrics.
Open and rich datasets are not, however, always available or sufficiently granular to support reporting. In other cases, there may be an abundance of available data, but not in the format that companies and investors need. Gathering and managing ESG data presents various challenges: ESG encompasses a broad range of issues from climate change and habitat loss, employee diversity and executive compensation; how do we agree what metrics to measure, and how? Once data is collected, how should it be managed, accessed, processed and verified?
Another challenge has been the proliferation of different ESG reporting frameworks and the lack of global consistency and harmonisation of reporting standards, although change is underway. The International Sustainability Standards Board (ISSB) was formed out of COP26 in Glasgow in 2021, to improve and consolidate consistency of ESG reporting. The ISSB's first two reporting standards are expected to be published in Q2 2023 and will introduce a 'common language' for sustainability disclosures: IFRS S1 provides a framework for general sustainability-related disclosures and IFRS S2 specifically addresses climate-related disclosures. These standards will operate as a global baseline for consistent and comparable sustainability and climate-related reporting, that regulators and companies can build upon.
How can Big Data help companies measure, report and increase the value of ESG metrics?
The successful integration of ESG considerations into companies' activities and products relies on high quality, granular and globally comparable data. The range of potential use cases for technology are vast, including:
- Enabling transparency in disclosure and reporting on sustainability, including characteristics of corporate assets and their supply chains and incorporation into carbon accounting software. For example, data analytics and artificial intelligence can help leverage insights from supply chain data, increasing transparency, agility and efficiency.
- Automating assurance and verification of ESG data, including for listed issuers and ESG-labelled corporate bonds. For example, the new generation of privately operated satellites can detect lower emission rates, enabling specialist data analytics services to verify emissions. Ground-based IoT devices can also help verify data in areas like water and air quality. These tools and data sets can help cater to the needs of emitting firms, as well as investors, analysts and regulators.
- Verify companies' carbon offsetting programs. The sharp rise in net zero commitments has seen a renewed interest in carbon offsetting. Offsetting should not replace efforts to reduce primary emissions, although can provide flexibility and play a role in transition plans – so long as offsets actually represent genuine carbon reductions. It's not without controversy or criticism, in particular if emission reduction claims are unverified. Technology can play a role in helping increase trust in genuine offsetting projects, for example using IoT to monitor tree-planting or using blockchain as an immutable record of certificates to avoid theft or double-counting of allowances.
- Understanding ESG risks and inform decision making. If applied effectively, technology can monitor and improve the ESG characteristics of existing enterprises. For example, companies with physical operations can deploy smart water metering and efficient waste management systems, and report improvements to investors.
- Improving consumer understanding of ESG characteristics of products. Consumers are increasingly making decisions with sustainability in mind. Businesses that use rich data to support and evidence their ESG claims can protect themselves from claims of greenwashing. New models of e-commerce are also emerging; for example, using data from open banking to link consumers' spending patterns to carbon footprint analysis, and integration with rewards-based e-commerce models to empower positive change.
Trust and transparency in ESG data and ratings: is regulation on its way?
With companies, investors and consumers making investment and purchasing decisions based on ESG ratings, there's an increasing reliance on ESG data and rating services. However, ESG ratings and data providers are not currently subject to specific regulatory requirements (unlike credit rating agencies, for example). This has led to calls for regulatory oversight of certain ESG data and ratings providers, to support greater trust and transparency.
In capital markets in particular, the FCA sees a clear rationale for regulatory oversight of certain ESG data and ratings providers and is working with the UK government to potentially bring certain providers within the FCA's regulatory perimeter. If this happens, in-scope data providers would need to be authorised by the FCA and subject to a "proportionate and effective" regulatory regime.
In the meantime, the FCA is working to support and encourage industry participants to develop and follow a voluntary Code of Conduct. International agencies (including the International Capital Markets Association and International Regulatory Strategy Group) are leading work in this area to help ensure consistent global standards.
This question is also being looked at in the EU, including by the European Commission with support from the European Securities and Markets Authority (ESMA).
To help get ahead of policy pressure and avoid pitfalls in this area, we'd encourage firms to consider aspects such as governance and managing conflicts of interest upfront. This is particularly important where different business lines (eg consultancy services and ESG ratings) have the potential to create conflicts of interest.
Supporting innovation: from data access to Sandboxes and TechSprints
To increase available data on ESG and digital use, the European Commission has proposed the creation of the "European Single Access point" (ESAP), an EU-wide platform to provide investors with seamless access to public financial and sustainability-related information about EU companies and EU investment products. This would not impose additional reporting requirements on companies, but would provide access to information already made public under the relevant European reporting requirements. The intention is for data to be disclosed in standardised and machine-readable formats and easily accessible via APIs, to enable innovative services based on analytics, Big Data or artificial intelligence/machine learning. This ambitious project could present further opportunities to maximise the value of ESG data.
Regulators are also keen to create a regulatory environment that supports innovation in ESG and data disclosure. The FCA has its own commitments on ESG and promoting positive change, including the transition to net zero. Supporting innovative technology solutions is a key part of this, and the FCA is looking closely at how technology innovation and a data-led approach can support ESG integration.
The FCA's 'Digital Sandbox' is one tool designed to support innovation . Aimed at firms at the proof of concept stage, it allows innovative firms to test and develop use cases in a digital testing environment. Between November 2021 and March 2022, the FCA ran a pilot Digital Sandbox focused specifically on ESG data and disclosure. This included experimenting with making synthetic data available to firms to train machine learning models and test ESG data products (the FCA has separately recognised the role that synthetic data can play in innovation in financial services). Following the success of this pilot, the FCA is exploring establishing a permanent operating model to support innovation.
'TechSprints' are another tool at the FCA's disposal, bringing together participants to develop tech-based ideas or concepts to address specific challenges. In October 2021, the FCA held its first sustainability focused TechSprint, looking at specific use cases including how technology can help regulators verify ESG disclosures and generate insights.
For start-ups, RegTechs and FinTechs, these market-facing programmes can provide valuable insights, help foster positive relations with regulators, and provide market kudos in today's competitive fundraising environment.
ESG impact of technology itself
As with other areas of ESG, use of technology for sustainability has attracted debate and controversy.
For example, distributed ledger technology (DLT) can play an important role helping companies monitor ESG characteristics of supply chains, including by providing an auditable trail of diamond supply chain provenance to provide assurance on conflict minerals. Proof of Work (PoW) consensus mechanisms used in some applications of DLT such as Bitcoin have, however, come under fire for high energy usage and environmental impacts. But alternatives are available. Proof of Stake (PoS) consensus protocols have a much lower energy footprint, with the switch of the Ethereum blockchain from PoW to PoS (known as "the Merge") estimated by developers to have slashed Ethereum's energy consumption by 99.95%. Helping consumers cut through the noise and headlines to make informed decisions on ESG is important.
There is currently no agreed set of indicators or metrics for measuring the environmental impact of cryptoassets or DLT. The government's recent consultation on the future financial services regulatory regime for cryptoassets seeks views on what information about environmental impact would be useful for consumers making decisions about investing in cryptoassets, and how these might be interoperable with recognised sustainability standards such as those of the ISSB.
Cryptoassets are just one example of the bigger picture. As disclosure requirements on companies and investors increase, users of technology (whether data analytics, DLT, cloud computing or AI/ML) will request data on the ESG implications of that technology itself.
The challenge for industry, regulators and standard-setters is to ensure that data that is collected or disclosed is actually useful and can have a tangible impact on ESG goals, without imposing too high a burden or cost, and while simultaneously enabling innovation.
Find out more
In addition to our other articles in this month's Interface, see our ESG collection, Part One.
