Investors face major challenges in plugging data gaps as they bring their portfolios into line with new EU sustainable finance regulations by 2022, and data is set to remain patchy for the coming years as investors and companies apply the new rules to their strategies.
By Jan. 1, 2022, investors managing environmental, social and governance-related funds will have to explain how they use an EU classification system, or taxonomy, to determine the sustainability of their investments. They will also have to disclose what percentage of their investments are in line with the taxonomy. The new regulation is expected to radically change how investors and companies report on their environmental performance.
"The No. 1 challenge that investors report is that they are not sure if they are going to have sufficient data on their underlying holding," Nathan Fabian, chief responsible investment officer at the UN-backed Principles for Responsible Investment and chairperson at the European Platform on Sustainable Finance, said in an interview.
Companies do not have to disclose their own taxonomy alignment until the end of 2022, according to Fabian, who also served as rapporteur for the Taxonomy Group at the EU's Technical Expert Group.
"So, at the start there will be gaps in the data," he said. "The European Commission knows that, the European supervisory authorities know that and so it is just a case of getting started with what you have got and building the data over time."
Under its sustainable finance action plan announced in 2018, the EU created the taxonomy to define environmentally friendly investments and set performance thresholds for companies and industries that seek to reduce greenhouse gas emissions or adapt to a changing climate.
The taxonomy assesses 67 economic activities, spanning manufacturing to transport, and is designed to steer companies as they adapt their business strategies to climate change, as well as help investment funds judge sectors based on their environmental performance.
The PRI ran case studies with more than 40 asset managers and owners, including AXA Investment Managers and Credit Suisse Group AG, to test the taxonomy. One of the main challenges cited was the lack of clearly defined, publicly available, or reliable data. An absence of standardized ESG data has been highlighted as a potential brake on the growth of sustainable investing.
As a first step, investors will likely use ESG rating companies and service providers to screen portfolios, Fabian said. For example, ESG data provider Vigeo Eiris launched a taxonomy alignment screening tool in October.
Isobel Edwards, green bond analyst at NN Investment Partners, the investment management arm of Dutch insurance group NN Group, said the biggest challenge in bringing NNIP's green bond portfolio into line with the taxonomy was finding the relevant information. Green bonds — debt that finances environmentally friendly projects such as wind farms or solar power — have attracted growing investor interest, particularly in Europe.
"Often, it's us doing all of the searching, all of the research, all of the analysis. That is a just a big time commitment and often the information in the end is not out there yet," she said. NNIP has created its own methodology for verifying green bonds' compliance, and will spend much of 2021 verifying whether a green bond meets taxonomy requirements for reducing greenhouse gas emissions and not harming the environment.
NNIP aims to share its methodology with other asset managers and work with green bond issuers to help with data collection, Edwards said. Data collection will be easier when issuers submit their taxonomy alignment at the end of 2022, she said.
"We have an advantage in that we have acquired a large green bond franchise," Bram Bos, lead portfolio manager of green bonds at NNIP, said. "In terms of EU taxonomy and aligning projects to assessments, we have quite a lot of knowledge in-house to do this exercise, but I can imagine for asset managers who are a little bit smaller or don't have specific green bond knowledge, it is going to be really, really challenging."
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Sean Kidney, member of the EU's sustainable finance platform and CEO of the non-profit Climate Bonds Initiative, which promotes green investment, said there was "a lot of extra data work to be done" on the taxonomy.
The CBI is part of the Future of Sustainable Data Alliance, a scheme launched by data provider Refinitiv in early 2020, and the group is working with the EU Commission on "ensuring there is a synchronization of the taxonomy and the data sets," Kidney said.
"That part of it is underway," he said. "The timeline for adoption is reasonable in the context of the progress we are making in data availability."
No investment fund will be fully aligned to the taxonomy in the beginning, industry participants said. A typical European equities fund will probably have 5% to 15% alignment at the start, but it is a step in the right direction, Fabian said.
"Investors don't expect every company to be 100% green today. We all know they are not. What we want to know is 'Do they know how green they are?' and 'What are their plans to improve over time?'"