Asset managers are in an impossible "Kafkaesque" situation as a messy schedule of ESG disclosure regulation means they have to show their funds’ alignment to the incomplete EU Taxonomy standards using corporate reporting data that do not yet exist, according to a report by Jefferies.
From January 1, the EU's Sustainable Finance Disclosure Regulation requires asset managers to show the alignment of their funds to the EU Taxonomy, which classifies which investments can be labelled as sustainable.
However, data on funds' underlying investments are not yet available as companies will not start reporting their taxonomy alignment until early 2023 – a situation that Jefferies analysts describe as a "debacle" and "back to front".
“SFDR’s required disclosure of Taxonomy alignment from asset managers is the problem because it's way in advance of the Taxonomy regulations and there are all sorts of data problems,” said Luke Sussams, an ESG and sustainable finance research analyst at Jefferies, and one of the authors of the report.
The Taxonomy needs to be finalised so that companies have a clear idea what is required of them. Only a handful of European firms currently disclose their Taxonomy alignment.
“That corporate reporting element is missing. I think that's partly because the Taxonomy has not been finalised so corporates don’t know what they are being assessed against," said Philip Spyropoulos, a partner at law firm Eversheds Sutherland.
The EU is hoping to adopt a final text of the Taxonomy by the end of January after publishing its draft Delegated Act on December 31, but the controversial inclusion of some gas and nuclear projects has delayed deadlines and the Taxonomy is now not likely to be finalised until the end of the summer.
Missing data mean funds reporting under SFDR will lack robustness and remain self-governed for the foreseeable future, Jefferies said.
“The inevitable outcome of this debacle is that fund-level taxonomy-alignment disclosures made in 2022 will be very rough estimates. Data quality will remain poor until corporates begin to disclose taxonomy-alignment, either voluntarily or on a mandatory basis,” the report said.
SFDR was designed to provide a common set of rules on sustainability risks and prevent greenwashing. Funds have to report if their products are Article 8, which promotes environmental or sustainable characteristics; Article 9, which has sustainable investment as its objective; or Article 6, which has no sustainability objective.
“The data that we’ve seen suggest that the labelling of Article 8 are not robust and is essentially a catch-all,” Sussams said.
Scramble for data
Although the publication of technical details on how asset managers should report on the sustainability of their products under the SFDR has been delayed until early 2023, asset managers are having to push on regardless with data gathering while awaiting stronger guidance.
"I think firms are still scrambling to get as much data as they can,” Spyropoulos said.
ESG data providers are working to provide estimates for the missing data, but there has been some pushback around using proxy data to plug the gaps, due to concerns about potential accusations of greenwashing and possible reputational risk.
"There really isn't any corporate data. ESG data providers like MSCI and Sustainalytics are obviously sprinting to fill that data gap because there's money to be made from it. But even then, estimates are really rough and finger in the air," Sussams said.
Many think the market will have to wait for the underlying corporate disclosure to catch up and it will take time for the necessary data sets to build.
"There's a general recognition that the SFDR data don't exist. And that's really the function of the regulation over the next two or three years – to build up the marketplace for data,” said Trisha Taneja, Deutsche Bank’s global head of ESG origination and advisory. “The question is then, will that data drive capital allocation?"