Harnessing technology to drive ESG compliance in advance of new SFDR regulation

High-profile scandals, such as the regulatory investigation into whether the DWS Group misled clients about sustainable investing, and Fundsmith being stripped of its ethical rating due to mis-selling, has raised concerns that some ESG funds are misleading.

However, despite these headlines, a key challenge many investment firms face is sourcing real-time quality data to support green claims in their ESG-labelled investment funds. This is even more challenging with private companies where the availability of data is far more restricted.

At the same time, the European Commission is tightening up regulations with the launch of Level 2 of the Sustainable Financial Disclosure Regulation (SFDR), coming into effect on 1 January 2023. This update aims to create a more transparent playing field by stamping out greenwashing and ensuring greater standardisation through the introduction of taxonomies.

So, with ESG compliance under greater scrutiny and tougher regulations ahead, the pressure is now on for investment firms to establish the right auditing mechanism to ensure compliance across their portfolio. 

Launch of SFDR Level 2 

SFDR Level 1, which went live in March last year, requires investment firms to organise their EU-domiciled funds into green categories: Article 6, 8 or 9. 

• Article 6: Funds that consider ESG risks as part of the investment process or have no sustainable objectives at all.

• Article 8: Applied to funds that promote environmental or social characteristics as part of a broad investment strategy.

• Article 9: Funds designated to having a sustainable investing objective.

Level 2 introduces regulatory technical standards (RTSs), through which investment firms have to justify their fund categorisations through a series of environmental and social principal adverse impact (PAI) disclosures for Article 8 and 9 funds. This is the most challenging element of the SFDR and requires investment firms to provide extensive disclosures on sustainability factors including greenhouse gas emissions and carbon footprint. 

To comply with Level 2, investment firms must collect the right data from various sources, then map it into a singular and robust data model. The process also requires intensive data quality checks to ensure accuracy and transparency, making it a costly and time consuming exercise. But if you have hundreds of companies in your portfolio, the resource required soon adds up. Investment firms therefore need to find the right assessment mechanism that balances time, cost, accuracy and transparency.

Streamlining ESG audits

The best solution is to work with an ESG data provider to perform a thorough, accurate and cost effective ESG audit. This not only identifies a company’s ESG risks, but also ensures they take the required remediation actions to reduce risk and comply with Level 2 of the SFDR. Here’s how:

1. First step is an ESG assessment to be completed by your portfolio company. This collects information about a company’s management of, and exposure to, various environmental, social and governance metrics, for example, climate change and energy. The data is subsequently analysed to identify key areas of risk. In addition, open-source intelligence (OSINT) is collected from publicly available data sources including news feeds, social feeds, websites and NGO reports and used to provide an additional layer of assurance about a company’s ESG performance based on consumer and market sentiments, and any areas of controversy.

2. Information from the initial assessment, supplemented by intelligence from the OSINT feed, will be displayed as actionable, meaningful data on a dashboard which allows the user to drill down into key risk areas, monitor trends and conduct reassessments to ensure continued compliance.

Scaling your ESG due diligence 

As concerns about sustainability accelerates, so does the consumer's appetite for investing in green financial products. While the SFDR Level 2 update aims to stamp out greenwashing, it’s clear investment firms are still struggling with sourcing real-time quality data to support green claims in their ESG funds.

However, digital technologies offer a cost and time efficient solution to manage ESG auditing by sourcing the right data, identifying risk factors and overseeing remediation actions to ensure companies reduce risk and meet new regulatory requirements. They also allow you to quickly scale your ESG due diligence right across your portfolio. 

But with just under a year to go until the SFDR Level 2 launches, firms need to start planning now.