(Jan 31): The growing focus among asset owners, governments and regulators on ESG (environmental, social and governance) is amongst the largest factors driving change in the way capital is allocated today. The overwhelming majority of pension funds, sovereign wealth funds and insurers have ESG at the top of their agendas.
However, for something which is fast becoming a fundamental aspect of how and where institutional investors place their money, the data quality surrounding ESG remains surprisingly poor. This problem is sizeable and will not be fixed in the next 12 months — but I believe 2020 will be the year of “ESG definition and discovery”, in which major advances are made.
Specifically, I think we will begin to see more success in defining the alpha-generating capabilities of ESG. Unless ESG impact — both on society and on the risk/return profile of portfolios — can be measured, the shift will remain a movement rather than a revolution. Until ESG can be measured in a consistent and transparent way, investors will struggle to measure the necessary metrics of progress. Improving consistency of measurement will eventually lead to high standards of ESG becoming a matter of existential importance for every company in the world that is seeking capital.
The key to making this happen is the data that companies are expected to provide. It is in this area that I believe we will see major breakthroughs next year. In April 2019, the Network for Greening the Financial System (NGFS), a partnership of 34 central banks and financial supervisors, advocated for a global standard of environment-related disclosure and for climate-related risk to become a core part of financial stability monitoring. In the UK, the government and Bank of England have been vocal about the requirement for all listed companies and large asset owners to make climate-related financial disclosures in a consistent format by 2022. These moves by regulators will be an important catalyst for change.
It is not enough, however, to have recommendations or rules in place. Companies need to buy into the data that regulators ask them to provide and go beyond minimum requirements. Considering how sectors vary considerably from one another — financial services, industrials, retailers and pharmaceuticals for instance — a one-size-fits-all approach to data provision pertaining to inclusive growth, climate impact or governance will not enable investors to analyse companies’ ESG standards effectively. Data disclosures need to be appropriate to, and benchmarked against, factors such as a company’s size, its operations, its supply chain, and the nature of its workforce. This is no mean feat.
We expect to be in constant dialogue on this topic over the year ahead and to see sizeable growth in our direct ESG work with clients. Driving forward conversation on ESG disclosures so that they produce better data, on fewer things, that matter more, is one of the most important roles we can play as trusted advisors to our clients and as investors ourselves.
I can see a new role emerging for investment firms — that of mediator between corporates and regulators, helping to fine-tune the ESG data that companies need to provide, how this is presented and the range of considerations that should be factored in to avoid inadvertent false positives and negatives. We are at the early stages of a long journey, but 2020 promises to be a year when the global investment industry will take meaningful steps forward.
Sheila Patel is chairman, Goldman Sachs Asset Management
