Regulators Defend ESG Data Requirements

Regulators defended requirements that financial firms source detailed data on the environmental and social impact of investment decisions for mandatory disclosures, during a public hearing held on July 2.

“The European Supervisory Authorities (ESA) are aware that the data constraint is one of the biggest challenges when it comes to sustainability-related information to end investors, especially in the case of principal adverse impact on investment decisions,” said Grainne McEvoy, director of consumer protection at the Central Bank of Ireland, and chair of the ESA’s subcommittee on consumer protection and financial innovation.

“There are already market participants providing environmental, social, and governance (ESG)-related data, even when those approaches have limitations. Nevertheless, we believe these proposals will play a part in generating more data from financial market participants and financial advisors,” said MvEvoy during the hearing.

The hearing was held via Skype, so that market participants could ask questions about the regulatory technical standards (RTS) in the ESA’s draft consultation on disclosures, which they published in April. The ESA comprises the European Securities and Markets Authority (Esma), the European Insurance and Occupational Pensions Authority, and the European Banking Authority.  

These RTS interpret the EU’s 2019 regulation on sustainability-related disclosures in the financial services sector, a regulation that is intended to prevent greenwashing and protect investors in what are marketed as environmental, social and governance (ESG) products. The draft RTS are for seven different requirements under the disclosure regulation, and, along with the associated EU Taxonomy regulation, are informed by the “do no significant harm” principle. This is the idea that economic activities must be assessed to ensure they do not cause harm to environmental and climate change objectives.

In these draft RTS, this assessment consists of measuring the principal adverse impact (PAI) of investment decisions on sustainability. To make these assessments, firms must collect detailed data and calculate the impact of their investment decisions using indicators provided under the Taxonomy Regulation. Asset management firms, pension funds, and others will have to disclose adverse sustainability impacts, not only on the level of their investment product documentation, but also make entity-level disclosures, displaying adverse impacts on their company website.

The draft RTS say that where information relating to the indicators is not readily available, firms must disclose the best efforts they have made to obtain that information directly from the companies they are investing in, or failing that, the best efforts they have made to obtain it via other means, including turning to third parties.

“We have recognized that data on these indicators may not always be available, particularly the ones that are opt-in or not as much reported on. There is a hierarchy of behavior we have tried to require publication of information on,” said Patrik Karlsson, a policy officer at Esma, who conducted the morning session of the hearing.  

“So our proposal—and I will stress again this is a consultation paper and we are looking for feedback from you—is that ideally the data should be obtained directly from investee companies, and where that is not possible, despite best efforts, then other methods should be used, be it data providers, research, external parties, and so forth. What is key is that this is disclosed in the relevant section,” Karlsson said.

Buy-side market participants are concerned that if these draft RTS are finalized, they will have to disclose data that is difficult to source. Large institutional investment firms say they will probably have to buy some of the data from data providers, adding to their existing ESG data costs. If they have to reach out to the corporates on their portfolios for qualitative assessments, that will require more human resources, driving up costs even more. And all this for disclosures that in some cases may not even be relevant, or material, to the investment product.

“The ESG data required to prepare the indicators is currently not available in a standardized format and electronically in a way that facilitates access for financial market participants and minimizes the costs of obtaining this information,” said Myrto Pargana, an advisor at the European Savings Banks Group, in a comment that was submitted during the hearing.

“Apart from that, the scope of the indicator set should be significantly reduced. Currently, ESG-related data on the proposed indicators is not consistently available at the level of the associated companies, or it is not sufficiently reliable. The information provided by affiliates is not always of good quality and the information provided by ESG data providers can be inconsistent,” Pargana said.

Pargana said that while the ESAs acknowledge these issues with the sourcing of ESG data, they still require it to be collected. “The mere hint that the data situation will improve does not solve the problem for financial market participants, who should collect this data by June 30, 2021. Alternatively, the ESAs could, from a proportionality point of view, suggest options for introducing individual sustainability indicators instead of requiring the filling of extensive lists of mandatory indicators that are not relevant in individual cases,” she said.

Other questions submitted during the hearing said that while some indicators in the taxonomy might be considered to always have an adverse impact on the environment or society, not all the indicators are relevant to all financial market participants or products. Mandatory reporting on non-material indicators could present a company’s activities as having an adverse impact on the environment just because, for example, that company did not have a deforestation policy. What if a deforestation policy was completely irrelevant to that business?

Karlsson responded that the ESAs’ approach was “relatively black and white. We believe that these indicators do lead to adverse impacts, and therefore should be disclosed.”

However, he said, the template for disclosures provided in the RTS does leave space for entities to explain why a factor might not be relevant. The template can be found in Annex 1 of the consultation paper.

“There is the possibility to explain the particular circumstances under which these PAIs happen, and also you should remember that there is the possibility to provide a summary in the first part of the template. This summary allows some freedom for you, market participants reporting on principle averse impacts, to summarize what you consider to be the adverse impacts within the report that you have done. And then all the details, whether they be high or low results for each of the indicators, would then follow in the template,” Karlsson said.

Comments on the draft RTS can be submitted until September 1.