The value of third-party environmental, social, and governance (ESG)-focused data, products and services is limited for fixed income investors and needs to improve.
ESG information providers have sought to make their offerings more relevant to debt instruments in recent years – having been historically tailored to meet the needs of equity investors – but significant gaps remain, which they acknowledge.
Their offerings do not reflect the complexity of fixed income instruments, which differ in credit quality, duration, and characteristics, or their issuers (corporate, sovereign, and sub-sovereign).
Furthermore, the underlying methodologies behind their scores lack transparency – for example, which ESG factors are assessed, and the weightings assigned to them.
This has significant implications for portfolio construction and asset allocation and is reflective of wider challenges the responsible investment industry faces in having consistent, reliable, and comparable ESG data – a crucial component of developing a sustainable financial system.
Between July 2020 and March 2021, alongside the advisory committee for the ESG in credit risk and ratings initiative, we engaged with 20 ESG information providers of varying sizes and specialisms (see Appendix) to:
- better understand how useful third-party data and product offerings are for fixed income investors and where they need to improve; and
- clarify how their methodologies differ from those of credit rating agencies (CRAs) and how transparent they are.
Below we present some of the main findings from these discussions, covering the following areas:
- Fixed income coverage
- Data quality
- Methodological transparency
- Product offering
1. Fixed income coverage
| Observations | |
|---|---|
|
Investors |
ESG information providers |
|
The data coverage by ESG information providers does not sufficiently consider:
|
Coverage is being improved for sovereign and private company issuers (although their reporting remains unsatisfactory – see Data quality, below). Coverage of sub-sovereign issuers (particularly the US municipal bond market) and structured products is still lagging. Different methodologies are required for different issuer types. More comprehensive loan coverage – which still requires further work – would provide a better overview of companies’ ESG exposure. Data on emerging markets is increasing, but coverage is hindered by lower levels of local market disclosure. Data expansion is driven by commercial opportunities: the choice of which market segments to prioritise depends on where demand is growing the fastest. Resources are also a consideration, as data gathering is still very labour intensive. |
2. Data quality
| Observations | |
|---|---|
|
Investors |
ESG information providers |
|
Data sources should be better signposted, distinguishing between whether an issuer’s information is public (either voluntary or mandatory) or generated by internal models and assumptions. More information is needed on how data is updated e.g. when data sources are discontinued, or historical data is revised. Quality is biased towards more-readily available information in the investment-grade market; data coverage gaps and biases need to be reduced by increasing:
|
Data sources include publicly available information (including news flow) and issuer questionnaires. Some providers also seek feedback from companies before publishing scores and reports to enhance the accuracy of the information. Issuers do not always disclose sufficient data or do not do so effectively, posing measurement challenges. Scores are not impacted by the quantity of data disclosed: in most instances if issuers do not disclose any information, they are not rated, which can be a red flag for investors. Investment-grade companies may receive better ESG scores than high-yield companies, as they are typically larger, tend to be listed, provide more ESG information, and generally have better governance. Many high-yield companies are not included in equity indices and therefore are not yet covered. Investment managers and asset owners should put more pressure on issuers to disclose ESG information. |
3. Methodological transparency
| Observations | |
|---|---|
|
Investors |
ESG information providers |
|
The differences in methodologies employed for fixed income vs. equity markets need to be better explained. Client communications in the event of data or methodological changes need to be improved (e.g., consultations; ad-hoc updates). Improved transparency would make ESG information providers more accountable for how they verify and validate their data sources and metrics. |
Data, rating, and methodological changes vary in frequency, depending on the provider, and can sometimes be driven by client demand. Client notification methods also vary – from email to webinars, for example. Making methodological updates too frequently could have negative implications for clients’ internal models and targets. Artificial intelligence and machine learning are improving data verification processes and making them more transparent, although human oversight remains an important component. |
4. Product offering
| Observations | |
|---|---|
|
Investors |
ESG information providers |
|
ESG data materiality maps should be based on fixed income issuers and instruments (listed by ISIN number) rather than relying on equity issuers’ information. Although historical data coverage is generally improving, investors would welcome more products that can generate portfolio-level insights and forward-looking analysis. More information and products on biodiversity and human rights are needed, as these areas are increasing in importance on the investor agenda and are less readily quantifiable.
|
ESG data materiality maps do not distinguish between equity and fixed income investor needs. They remain focused on issuers, not individual securities, although some providers cover subsidiaries, while others look only at parent companies. On climate change, the data research and modelling that can support the analysis of issuer-level climate adaptation and resilience is increasing. Specific ESG data[1] is included in offerings when financial market participants determine that it is materially relevant – but this is not always easy to respond to as investor preferences can vary. Offerings and services are being expanded in response to demand for issuer data that can facilitate reporting against various frameworks and regulations, including:
The existing data offering is growing to support the analysis of thematic bonds. |
Looking ahead
Responsible investment practices are evolving across asset classes[2] and fixed income investors are becoming more demanding as they build internal ESG assessment frameworks.
Investors with enough resources have started developing in-house metrics to better capture ESG risk and value within their investment processes. They will prioritise having access to raw ESG data and the tools to disaggregate, customise, visualise, and analyse it over buying off-the-shelf products. As a result, ESG information providers will likely have to provide more services, such as modelling and analytics, and bespoke data feeds.
For those investors that continue relying on the ESG scores computed by external providers, improved transparency is paramount. If their underlying methodologies are well explained and communicated, investors can choose the offerings that best meet their existing investment processes. For example, some evaluations try to capture an issuer’s exposure to ESG risks and how prepared they are to manage these risks – how ESG information providers make such assessments should be better explained.
Incomparable ESG scores also remain a challenge for index construction. The number of indices designed to help investors benchmark ESG investment performance and report on ESG mandates is increasing.
These are calculated by selecting and weighting issuers, sectors, or countries relative to a traditional index, based on their ESG scores and performance.
Consequently, security selection or exclusion can vary significantly, depending on the provider that computes the underlying ESG scores, impacting asset allocation and portfolio construction.
Regardless of these challenges, the ESG information provider landscape is not static, and continues to evolve amid ongoing developments in responsible investment, including those related to corporate ESG disclosures.[3]
Alongside bringing new products to market, ESG information providers have responded to client needs by acquiring the capabilities required to improve their services. As demonstrated in Figure 1, this trend includes large firms acquiring smaller competitors and CRAs purchasing ESG information providers to expand their analytical tools and products beyond traditional credit ratings.
Figure 1: ESG information provider market consolidation 2000 – 2020. Source: See footnote [4]
The ownership of Sustainalytics was 40% in 2016 and will increase to 100% in 2022
Going forward, we intend to continue nurturing a dialogue between fixed income investors and ESG information providers, through public events, collective engagement, and case studies, to promote transparency and a better understanding of product offerings so that investment decisions are well informed.
To discuss these findings, or the initiative, please contact [email protected].
About this project
This research is part of the ESG in Credit Risk and Ratings Initiative, which seeks to facilitate a dialogue between credit ratings agencies and investors to cultivate a common language, discuss ESG risks to creditworthiness, and bridge information gaps.
It follows a survey, published in 2020, that aimed to clarify the distinction between the incorporation of ESG factors in credit ratings and the evaluations offered by ESG information providers.
The engagement was split across seven sessions – one with all participants, and six where they were divided according to their specialism or scope: some offer ESG data and services, others focus on certain topics or issuers; some are not-for-profit but most are behind a paywall (see Appendix below).
Appendix: ESG information provider participants
| ESG information provider type | Participating company |
|---|---|
|
1. Large providers |
MSCI Sustainalytics |
|
2. Acquired by CRAs |
EthiFinance (CRA: Qivalio) Four Twenty Seven (CRA: Moody’s Investors Service) SAM (CRA: S&P Global Ratings) Trucost (CRA: S&P Global Ratings) Vigeo Eiris (CRA: Moody’s Investors Service) |
|
3. Climate specialists |
Carbon Disclosure Project (CDP) Transition Pathway Initiative (TPI) Urgentem |
|
4. Controversy specialists |
OWL Analytics RavenPack RepRisk Truvalue Labs |
|
5. Data specialists |
Bloomberg Refinitiv |
|
6. Sovereign specialists |
Beyond Ratings (FTSE Russell) CountryRisk.io Eurasia Verisk Maplecroft |
The ESG in Credit Risk and Ratings Initiative is funded by the Gordon and Betty Moore Foundation through the Finance Hub, which was created to advance sustainable finance.
References
[1] As investors develop their understanding of responsible investment, the ESG factors that they consider relevant have grown to include issues that have previously been largely ignored – despite awareness of them in the market – such as structural racism and discrimination against indigenous populations in Australia and Canada.
[2] PRI (2021) The evolution of responsible investment: An analysis of advanced signatory practices
[3] Work continues across the finance industry to improve corporate sustainability reporting. For example, the International Integrated Reporting Council and the Sustainability Accounting Standards Board announced last year their intention to merge. Leading sustainability and integrated reporting organisations have also pledged to work more closely together – more details can be found here. Such efforts should positively impact the data collection and assessment methodologies of ESG information providers.
[4] Andreas Dimmelmeier (2020) Mergers and Acquisitions of ESG Firms: Towards a New Financial Infrastructure?
