LSFI Working Group Issues Recommendations to Financial Professionals to Address ESG Data Challenges

The Luxembourg Sustainable Finance Initiative (LSFI) has released the outcome report of the analysis conducted by the LSFI ESG Data Working Group.

The working group, composed of thirteen experts from financial institutions, consulting firms, data providers and financial associations, sought to clarify the current challenges associated with ESG data and provide recommendations for overcoming these difficulties, while ensuring a broad understanding of their complexity and interlinkages.

The Outcome Report includes: objectives, timeline and methodology of the LSFI ESG Data working group; challenges identified, including key issues such as data reliability, lack of global standards, transparency, cost and regulatory complexity; recommendations for financial professionals to overcome the identified challenges by asset class: private assets, listed, debt and indirect investment; questionnaire to support financial professionals when dealing with data providers; recommendations for policymakers; recommendations for the LSFI.

Over the last six months, the working group focused on examining the challenges associated to the raw ESG data used by financial institutions in the context of investment/lending or commercial decisions, risk assessment, ESG performance assessment and investors and regulators' reporting. In particular, the members analysed and ranked the existing challenges and issued a set of recommendations for financial practitioners, for policymakers and for the LSFI.

"When engaging with the financial industry, data consistently emerged as a top priority and challenge. However, the issue of data is very broad, and it is often unclear what the specific issues are. Identifying the root causes of these problems is the first step to addressing them. Additionally, financial institutions often rely on data providers, but due to the complexity of the topic and fast-changing regulatory requirements, they sometimes face difficulties in understanding their exact needs and tackling issues like data reliability. These challenges led to the creation of this working group, aimed at clarifying discussions and laying the groundwork for progress on this critical topic," explained LSFI CEO Nicoletta Centofanti.

Nathalie Dogniez, Chair of the LSFI ESG Data Working Group and Chair of Eurosif, added: "Financial institutions must implement data quality processes for the ESG data they use. Since data quality and data sources vary, financial market participants must understand the data scope, acquisition processes and estimation methodologies underpinning the data they use. This is crucial for selecting data sources and data providers and maintaining data quality controls. That’s why, beyond analysing the current challenges and providing recommendations, we have also developed a questionnaire to help financial professionals improve ESG data reliability when acquiring data."

Challenges

In general, the working group identified that all asset classes currently face challenges related to: reliability of the data; absence of global standards and thus difficulties in ensuring comparability and consistency; lack of transparency, especially associated with methodology opaqueness; cost issues related to acquiring the data, but also the technology required and companies' reporting; complexity and rapid regulatory changes.

Recommendations

After assessing these general challenges, as well as those associated with each asset class, the working group identified a series of best practices and recommendations to address these difficulties for each asset class.

These can be summarised as follows:

• Private: Collaborate with portfolio companies, create a clear and transparent internal evaluation framework and continuously assess key information to maintain consistency in metric calculations across portfolio companies. Develop strong internal frameworks to adhere to strict criteria. Integrate ESG reporting and data acquisition costs into fund expenses through negotiations in the Limited Partnership Agreement.
• Listed: Perform comprehensive initial due diligence on data providers. Use multiple data providers for comparison, if feasible within budget. Ensure transparency on whether the data is raw and how it has been aggregated and manipulated. Report transparent and reliable KPIs. Develop a precise data architecture by centralising data, and establishing a clear audit trail, track record and golden source.
• Debt: Engage with companies using dedicated or shared questionnaires to gather ESG data. Assess various reporting frameworks and ESG data providers to find solutions and sources that ensure neutrality, trustworthiness and transparency. Train relevant staff to prepare for third-party audits, certifications or assurance of ESG data reported by borrowers. Utilise public data sources to supplement your ESG data set with publicly available information by geography or sector. Evaluate potential partnerships and collaborations with fintech companies, scientific experts or academics.
• Indirect: Align your portfolio's objectives with an established framework (e.g. SFDR). Tailor the ESG objectives of your product to mitigate the risk of divergence over time with the underlying instruments. Ensure consistency in your data and methodology across the organisation. Look for synergies in acquiring and maintaining ESG data from aggregators (such as EET aggregators) while being cautious of not encouraging data monopolies.

The working group has also elaborated a questionnaire to be used by financial professionals when dealing with data providers. It includes questions to help them assess the data quality, the data scope and coverage, the data sources and methodologies used, the data management and delivery structure, and the data interoperability, among others. 

Together with the recommendations issued for financial professionals, the working group also suggested that policymakers prioritise digital access to structured data, pursue efforts in developing global reporting standards and alignment of underlying measurement methodologies, provide free resources and training and require transparency over ESG raw data. Additionally, the working group recommended that the LSFI to reinforce its Take Action - Instruments toolkit as well as to offer masterclasses that would help financial practitioners face their current challenges.

The Outcome Report can be downloaded here.