James [00:00:02] Hello and welcome to this State Street State of the Street podcast, discussing ESG data and Solutions. I'm James Redgrave, Vice President of Thought, Leadership and Editorial at State Street. The significant growth of ESG investment products and strategies in recent years has highlighted the importance of accurate, consistent and extensive data, for institutions investing in this area. Governments and regulators are beginning to try and address this issue, for example, with the European Commission's Sustainable Financial Disclosure Regulation, but there are still significant gaps in the information and capabilities investors need to make decisions on ESG investments. According to a State Street survey of more than 600 investment institutions worldwide, taken at the end of last year, nearly half of respondents did not rate themselves as strong at accessing ESG data or applying it in their investment processes. And more than 40% of respondents also cited a lack of consistency and transparency in the methodology behind ESG data sources, as well as poor coverage across all asset classes. I'm joined now by Philip Kim, global head of ESG product and Mark Parker, Director of Risk and Analytics Services at State Street, to discuss the various ESG challenges investment organisations face in not only getting access to reliable data, but also making use of it when they do. Phil and Mark, thank you for joining me.

Mark [00:01:13] Thank you, James.

Philip [00:01:14] Thanks, James. Happy to be here.

James [00:01:16] So, first of all, I'd like to talk about ESG being a huge topic lately. From client enquiries and seeing more and more frequent media articles every day about greenwashing and regulators getting involved with things like fines, what are you seeing in the market today and what challenges are your clients facing?

Mark [00:01:31] ESG is a, it's a growing topic in the investment management industry as we speak with our clients, we're finding really an increasing number of stakeholders that consume and are looking to learn more about how ESG is impacting their investments. It's much more than attempting to link performance to an ESG score, board members, regulators, risk and compliance managers, portfolio managers and as well as investors each with a need for more information and that brings a certain amount of challenges. First, data management and operations, the ability to scale those operations, hire staff within a short period of time, relatively smaller budget is not really an easy task [00:02:18]to take. [0.1s] The data sets tracking ESG factors are diverse; maintain inconsistent scoring methodologies that are sometimes difficult for many of those stakeholders to fully understand. There continues to be a lack of universally adopted disclosures or reporting frameworks, as regulators and industry groups have different perspectives. And then data starts to get thin with the emerging markets, with alternative asset classes such as fixed income, private equity and real estate. Another challenge we're seeing is client risk assessment. Ultimately, there are medium and long-term risks to climate change as clients make carbon net zero pledges. Investors really need to understand their baseline of exposure. Once they understand that baseline of exposure, from there, they need to plan how to execute on investing as organisations manage that transition to a low carbon economy. Investors need to understand how they're trending, so understand how they're aligning versus their peers, how they are holding up versus certain industry benchmarks. What we're also seeing is a more immediate area of spending is really within that risk management and regulatory reporting office. Firms must comply with multiple regions and their corresponding regulatory obligations. Just to name a couple SFDR are TCDF. These are acronyms of how to create more transparency into certain reporting structures. Now, with the FCC proposing certain language out there to help track what is within your funds, ultimately clients need more checks in place to prevent potential greenwashing. Uncover as much transparency into those short, medium and long-term investment risks that they might have. And this is beyond just environmental and carbo, clients need to track investment in companies and understand how they stack up with their social profile as well as their governance best practises.

James [00:04:29] Thank you very much. We talked a little bit about sort of where institutions are investing in this area and where they're looking to improve. So Phil, what is sort of coming down the line in terms of solutions for investment institutions and helping them to meet these challenges? And how are they planning to address them in future?

Philip [00:04:45] Yes, so, you know, there's a lot for clients to unpack here among, you know, those various challenges that Mark just mentioned here in data management, climate risk and regulatory compliance. You know, to get the right systems in place, it's time and resource intensive and can be quite costly, especially if not built the right way. So there are various solutions out there today, some home-grown, some provided by third party ESG data providers or service providers. And just to give you kind of a little bit provide a little bit more colour on the state of things here, you know, firms typically get their ESG data from third party ESG data providers, right, from the likes of MSCI, Sustainanalytics, S&P Trucost, etc. and then they integrate this data into their internal systems. To address data coverage issues, firms typically are now leveraging about 3 to 5 different ESG data sets on average in many of these firms, then combine them into their own bespoke ESG score based on their own proprietary methodology. So many firms have developed their own definition of ESG, if you will, or views on materiality. And so producing their own house view is their way of differentiating their products. And so what they end up doing is they develop their own systems for mapping these data sets, normalising if needed and [00:06:20]weighting [0.0s] factors according to this house view. Firms also, in addition, also grapple with incorporating all this data with their own holdings. So, you know, they typically leverage third party services to aggregate all their funds from multiple custodians and administrators and then marry their portfolio and holdings with ESG data. And as part of this process, firms will develop ways to handle short positions or derivatives and potentially address data gaps with industry or sector level estimations, or by filling in data with parent entity level ESG data. So now with all the data management piece sorted, you know, firms need to understand their various ESG exposures within their portfolios. And for many that the key focus there is on climate risk. So this entails setting up the various dashboards or reports that will help them understand their current carbon footprint, their baseline, for example, and any potential transition or fiscal risks. They'll also set up views to track their carbon trajectory, especially if they pledge to net zero and to track their portfolios implied temperature score to assess their Paris alignment. So all this requires having, you know, the resources to wade through all the various ESG data dictionaries of the different vendors out there to ensure they're visualising these analytics in the right way. And then finally, regulatory compliance, right, the need for ESG Risk Compliance Officers has really ramped up this year as incorporating this kind of independent risk oversight or integration of sustainability into risk and compliance tools and processes really becoming critical in the current landscape. So firms are starting to figure out how to sufficiently incorporate ESG into their risk functions and corresponding platforms. On top of that, you typically have the ESG team, compliance and operation folks spending many cycles to understand all of the regulatory requirements, especially in the EU with SFDR regulations, and then how to find, you know, spending time finding scalable solutions or methodologies to produce the required disclosures. This then goes right back to, you know, the data management piece and developing the right data management stack to then be able to adequately produce these reports, leveraging the right data points from the different data sets to meet the wide array of different requirements from the SFDR and within SFDR, there are many requirements from the principal adverse impacts. There is the EET template, the European ESG template. There's pre-contractual and periodic reporting annexes that needs to be adhered to and also TCFD climate reporting. So again, no easy feat here for firms to do this alone and so we're really starting to see firms looking for, you know, scalable solutions and not just, you know, working with the data providers, but really ESG service providers to help them with a more integrated, streamlined, end-to-end solution to really help them with all of these particular challenges. In this new, you know, regulatory regime, you know, firms really need to start looking at ESG from front to back and back to front. So we think those solutions that can cater to a more end-to-end offering here to help clients across the entire investment lifecycle, from portfolio construction to compliance, risk management, regulatory reporting is where clients will ultimately gravitate towards.

James [00:10:22] That's very interesting, thank you and it's particularly interesting, I think, that you talk about the sort of the input of regulators here and new legislation and regulation and also the more holistic end-to-end services that solutions providers are offering in the area. I'd like to get a bit more of a sense of the extent to which change here is being driven from that sort of top down regulatory direction or whether it's more coming from reform within the industry and demand from institutions. I mentioned some research we conducted earlier and respondents to that were split more or less 50-50, 48 felt it should be a predominantly regulator driven issue, 52 said that the market should lead on reform. What sense do you get of the direction that?

Philip [00:11:00] It's you know, it's interesting to see this stat because, you know, I think regulations has been the biggest driver of change at least recently. And I do wish the reality was more in line with this survey result, as we should be tackling these ESG data challenges from all angles. The ISSB, the International Sustainability Standards Board is developing, you know, a new ESG standard using SASB and its corresponding materiality map as the foundation to this new standard. And to gain traction, I think the market will need to ultimately drive this. And I think investors are the catalysts for such adoption to, you know, really push corporations to disclose along these standards. Will that happen, you know, organically? I don't know and we may find that, you know, the standard needs to be more tightly integrated with all the regulations in order to really be adopted ubiquitously. So for many clients, again, especially in the EU and we're starting to see more in APAC, especially in Australia, Hong Kong and Singapore, you know, they're really reacting to these regulations that are here and now. So the need for better data and overall end-to-end ESG solutions and systems is really critical here. And I want to emphasise that it's not just the data but also how you incorporate data again in your entire investment lifecycle. So although implementing the regulation has not been the easiest task, I believe it's been a good development for the industry as it will hopefully lead to creating more transparency for investors and boards and really help the industry get more comfortable with the data and the outputs. So at the end of the day, ESG can be viewed as a form of risk management and quality risk management is key to long-term success.

James [00:13:04] Thank you again and talking a little bit more now about this data input question, where institutions get their data from, how they source external sources, as it were, how they find vendors and providers for this data, Mark, how will the industry evolve from here?

Mark [00:13:19] Sure, you know, at first it has been and will continue to be a learning curve for our clients. Each stakeholder has a very unique point of view. They have a unique background. So when it comes to understanding these many data sets and that those different perspectives are okay as ESG investing evolves, these news articles that we are seeing that you referenced, the increased transparency introduced into each one of these investment processes [00:13:50]are [0.0s] first starting as we're talking about with regulation. Our clients can then begin to have useful conversations with their clients, and that will continue to, I guess, roll down across the industry. The conversations will ultimately be beyond the drive that never ending balance that you hear of, of risk versus performance, but will evolve to the value of having a robust process in place. Data sources will also evolve. Vendors will eventually consolidate. They will increase their exposures to more asset types. So challenges such as private equity, real estate, getting more information from emerging market regions, the methodologies of data collection will improve. Regulators will have better ways to track data from which pressures to standardised reporting will, I think become much more natural. We do maintain that working across multiple partners, servicing many different types of clients and being on the ground floor of this journey is a, it's a good thing. It's a good thing for our clients and it's a good thing for the industry as a whole. I can certainly say ESG investing is not going away. I am optimistic that the industry will grasp these challenges that are in place today and ultimately streamline their operational concern and the ability to manage their investment risk.

James [00:15:21] Phil, Mark, thank you very much for your time.

Philip [00:15:23] Thanks, James. Thanks for having me.

Mark [00:15:25] Appreciate it, James. Thank you for having us.

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James: The significant growth of ESG investment products and strategies in recent years has highlighted the importance of accurate, consistent and extensive data, for institutions investing in this area. Governments and regulators are beginning to try and address this issue, for example, with the European Commission's Sustainable Financial Disclosure Regulation, but there are still significant gaps in the information and capabilities investors need to make decisions on ESG investments. Hello and welcome to this State Street State of the Street podcast, discussing ESG data and Solutions. I'm James Redgrave, Vice President of Thought, Leadership and Editorial at State Street. I'm joined by Philip Kim, global head of ESG product and Mark Parker, Director of Risk and Analytics Services at State Street, to discuss the various ESG challenges investment organisations face in not only getting access to reliable data, but also making use of it when they do.