Lily Dai on data challenges and the future of sustainable and climate regulations and taxonomies

Lily Dai from FTSE Russell talks to Climate Action on the data challenges and the future of sustainable and climate regulations and taxonomies.

"Green" investing has been challenging to quantify. For years, green was loosely defined, based on concepts rather than a specific industrial system. With considerable thought, FTSE Russell has developed a structure, measurement methodology and process to meet client demand for quality data to help truthfully size and monitor aggregate and individual contribution to the growing green economy. Lily Dai, Sustainable Investment Research at FTSE Russell, shares her thoughts on the data challenges, and the future of sustainable and climate regulations and taxonomies.

Do your data tools define ESG scores and performance in line with transparency in reporting material ESG data?

Corporate disclosure is fundamental for ESG data, and more broadly, sustainable investment data, and it is the starting point for assessing the sustainability performance of companies and providing scores. At FTSE Russell, when we collect ESG data from company disclosure, we also engage with companies to ask for additional information or feedback.

When there is limited corporate disclosure, we may use proxies or estimations, of which the methodologies are kept transparent. Take Green Revenues data, for example. For the lion’s share of companies with green revenues, public disclosures are insufficient to determine exact revenues from individual green business activities. If we are not able to obtain supplementary information on revenue breakdown through company engagement, we use the proxy information, such as production volume or product market share, to form a reasonable basis for estimating revenues from each green product or service.

Proxy data are also used for assessing the EU Taxonomy (EUT) alignment. Currently, most EUT technical screening criteria (TSC) are not covered by the existing ESG data landscape or corporate disclosure as they are very forward-looking or specific to EU legislations. For example, after mapping the Do No Significant Harm (DNSH) TSC against c.300 ESG indicators related to environmental issues, we found that only 43 ESG indicators can be used to approximate DNSH TSC for assessing the EUT alignment. Given the incomplete coverage by ESG data, we propose to use controversies screening, which checks companies’ involvement in controversial conduct, as another layer of examination to flag violations against DNSH-related issues.

With ongoing regulatory changes both in Europe and globally how difficult is it to provide consistent and accurate data?

It is challenging to keep track of and navigate all the taxonomies around the world – more than 20 taxonomies are developed or being developed now. Although most green activities covered by taxonomies should be similar as we pursue similar environmental objectives (such as climate change mitigation/Paris agreement and pollution control), different countries and regions may have additional requirements and thresholds. As a data provider, we must capture these differences, even minimal, so the data solutions can be applied across jurisdictions.

We keep monitoring the taxonomy development worldwide and provide support for regulators. As a member of the Future of Sustainable Data Alliance, we are working with experts to track the taxonomy development globally and map the underlying data sets that will fulfil the taxonomy requirements. We are also a member of the UK Green Technical Advisory Group and Singapore Green Finance Industry Taskforce, providing recommendations on taxonomy development. We are encouraging taxonomy regulations to have standardised and common metrics on measuring environmental impacts and push for detailed corporate disclosure so that we can measure and compare the sustainability performance of assets/businesses in different jurisdictions.

How difficult is it for your clients to overcome the challenges around the lack of standards in measurement and reporting and do you expect improvement with SFDR?

We expect to see better disclosure along with the implementation of disclosure regimes related to the EU Taxonomy regulation such as Corporate Sustainability Reporting Directive (CSRD) and Sustainable Finance Disclosure Regulation (SFDR), which will over time generate much greater volumes of data—and higher quality data—about sustainable economic activity. This data will facilitate more sophisticated analytics that will help investors anticipate and respond to emerging trends in the green economy. In turn, these will help inform policymakers as they seek to encourage investment that facilitates the transition to a sustainable global economy.

However, until companies globally, not only those in the EU, provide full transparency on the taxonomy-aligned activities, it will prove challenging to precisely measure the green exposure of global investment portfolios and calculate the size of the green economy. The requirement for related disclosure by companies covered by the EU’s CSRD will, over time, address this issue (at least for companies covered by the CSRD). Still, it is likely to take time for standardised disclosures to emerge. Investors must, therefore, choose datasets that provide the best proxy to measure the environmental performance and the taxonomy alignment of their investment.

How important is it for asset managers/ investors to leverage advanced data and analytics tools to develop forward-looking scenarios?

Climate change creates both challenges such as physical and transition risks, and opportunities – for example, new technologies and industries like EVs. Investors are increasingly looking at how their assets are exposed to climate risks, whether they align with the Paris Agreement climate objectives, and how to capture investment opportunities during the transition towards a green economy. This requires forward-looking scenarios planning with support from data and analytics, including using both backward-looking indicators such as carbon emissions and forward-looking metrics like carbon target and implied temperature rise.

For example, the Transition Pathway Initiative assesses companies’ preparedness for the low carbon transition against benchmark scenarios (Paris Pledges, 2 Degrees and Below 2 Degrees) on two dimensions - Management Quality and Carbon Performance, using data points such as carbon intensity, financial cost of climate risks, climate change policy and carbon emissions reduction target.

In terms of regulations, the European Commission established the EU Climate Benchmark Regulation, setting out minimum technical requirements for the methodology of the EU Climate Transition Benchmark (EU CTB) and the EU Paris-Aligned Benchmark (EU PAB). These benchmarks involve forward-looking aspects by requiring the underlying portfolio to be on the decarbonisation trajectory or be aligned with the Paris Agreement climate targets. Metrics for the requirements include carbon emissions reduction per annum and carbon emissions reduction compared to the reference benchmark. Investors can use these climate benchmarks, which have clear objectives and transparency on carbon performance and impact, to support their decarbonisation or net-zero strategies.

What potential development or new features of taxonomies are you expecting to see in the near future?

There have been discussions on the ‘traffic light system’ for taxonomies, which aims to provide more granularity on the environmental performance of activities. The EU Platform on Sustainable Finance published a consultation in 2021, proposing to differentiate activities with substantial contribution performance (green), intermediate performance (amber) and significant harm performance (red). Similarly, the consultation paper from Singapore Green Finance Industry Taskforce also suggests a traffic light system to set out green, yellow (transition) or red activities based on their level of alignment with environmental objectives.

I expect or hope to see further harmonisation of taxonomies around the world. The EU and China have already been working on the Common Ground Taxonomy, recognising the differences between the two, such as approaches on technical screening criteria and DNSH. It is important that taxonomies are comparable and interoperable – for example, environmental objectives and metrics on measuring environmental performance, so that there will be more consistent disclosure and data to assess activities and companies in different countries or regions.

To learn more read the paper: Do No Significant Harm’ and ‘Minimum Safeguards’ in Practice Navigating the EU Taxonomy Regulation

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