Climate Data in the Investment Process: Challenges, Resources, and Considerations

Estimating the long-term economic impact of climate change is extraordinarily complex, but it is generally expected to be enormous. An analysis by Deloitte (2022) projects that an increase in global warming of 3 degrees Celsius — as implied by the country policies currently in place — could lead to USD178 trillion in global economic losses over the next five decades. In contrast, the Deloitte analysis estimates that transitioning to net-zero emissions by mid century could yield USD43 trillion in economic gains.

Key to addressing the immense climate change investment risks and opportunities is having reliable climate-related data to measure and analyze them. In “Climate Data in the Investment Process: Challenges, Resources, and Considerations,” we discuss the issues surrounding climate-related data and how to overcome them.

Data Quality Challenges

Climate-related data are used in the investment process not only to assess climate change risks and opportunities but also to value assets, set shareholder engagement goals, and meet investor preferences for low-carbon or more sustainable investments. Climate-related data is also used in products and services provided to investment managers, such as indexes, credit ratings, environmental, social and governance (ESG) ratings, and research.

Obtaining comprehensive, reliable, and comparable climate-related company data is challenging because many jurisdictions lack climate-related disclosure obligations. Although many companies choose to voluntarily disclose climate-related data, a high degree of inconsistency often exists in the climate-related information disclosed. Companies struggle with obtaining the resources needed to collect, calculate, and report the information for which investors and regulators are looking. An OECD (2022) report found that large-cap companies are far more likely to disclose climate data than small or mid-size companies. Emerging market companies and privately held companies also tend to lag on greenhouse gas (GHG) emission disclosures.

Companies may disclose data in their filings with regulators, in their corporate sustainability reports, or to industry organizations, nonprofits, and multilateral agencies. Because investors often find it difficult, time consuming, and costly to collect, estimate, and process data for the hundreds or thousands of companies that make up their investment or product universes, they often opt to obtain climate-related data from third-party data vendors. Using third-party data solves some but not all climate-related data availability and comparability problems.

Many data providers lack coverage of smaller companies and emerging market companies. In addition, numerous assumptions and estimations underlie the calculations of various climate-related data and metrics, and methodologies are often opaque. Sizable errors may occur, leading to unintended consequences such as higher-than-expected portfolio climate risk exposure or a violation of fund label criteria or climate-related characteristics.

Investors may also turn to ESG ratings as a way to access or assess climate-related information. Like the climate-related data they contain, however, ESG ratings are unique to each provider and not directly comparable. Substantial differences exist in the ESG ratings for individual companies among providers (see, for example, Berg, Kölbel, and Rigobon 2022). Moreover, the aforementioned OECD (2022) report found that high “E” pillar scores are not directly aligned with decarbonization, low GHG emissions, or low carbon intensity and do not serve as a useful measure for assessing a company’s management of its climate-related risks and opportunities.

The widespread use of ESG ratings in many investment products and the issues of ratings transparency and comparability have not been overlooked by regulators. Several regulators have issued or are in the process of issuing regulations or voluntary codes of conduct for ESG rating agencies and data providers.

Milestones in Regulations and Standards

Various regulations, standards, and industry initiatives have recently been enacted or issued to improve the availability, consistency, and quality of climate-related information. In June 2023, the International Sustainability Standards Board (ISSB) issued two inaugural standards with the intent to establish a global baseline for financially material corporate sustainability and climate-related disclosures. The standards—IFRS S1, General Requirements for Disclosure of Sustainability- related Financial Information, and IFRS S2, Climate-related Disclosures—are the first global reporting standards for disclosing financially material sustainability and climate-related data.

The European Financial Reporting Advisory Group has created its own set of sustainability standards, the European Sustainability Reporting Standards (ESRS), issued under the EU Corporate Sustainability Reporting Directive. The ESRS require sustainability and climate-related information reporting on a double-materiality basis; that is, the ESRS encompass both financial materiality and impact materiality. Application of the regulation extends to non-European companies doing business in Europe and will take place in stages through 2028 according to type of entity.

In March 2024, the United States Securities and Exchange Commission announced standardized climate-related disclosure requirements under Regulation S-K and Regulation S-X for US-based companies and companies doing business in the United States.

Although these and other long-awaited regulatory and standards solutions are either entering force or on the horizon, investors still have their work cut out for them. According to Sandra J. Peters, senior head, Financial Reporting Policy Group, CFA Institute, it appears unlikely that interoperability efforts among organizations and jurisdictions will result in a global disclosure baseline (CFA Institute, 2023). A detailed comparison of these regulations and standards is a substantial undertaking, but in broad strokes each includes some type of provision for

• disclosures related to GHG gas emissions and
• disclosures related to governance, metrics, sensitivity analysis, and transition plans related to climate risks.

Each disclosure standard or regulation is sufficiently different to make consistency and comparability of climate-related data a continuing challenge for investors. Differences exist in types of materiality, the audience for the information (i.e., investors or other stakeholders), the location of the information (i.e., annual reports filed with regulators, separate sustainability reports, and filings with other governmental agencies and bodies), the timeline for the adoption of the standards, and the degree to which the information will be verified by external parties, such as auditors. Peters believes that if the history of financial reporting is a model for climate reporting, we are at the beginning of an information journey that could take decades.

Data Strategies: What Can Investors Do?

Until regulations and standards can provide meaningful solutions, investors should not be deterred from using climate-related data. Instead, investors must (1) use their judgment to make effective use of the data available to them and (2) be conscious of the limitations of those data, just as they would with any imperfect data set.

Investors can take steps to identify data errors and verify third-party climate-related data by cross-checking with original source documents, industry organization databases, or other data providers. When using estimated data, understanding and comparing provider methodologies is also helpful, though not all providers disclose their estimation methodologies. Subscribing to a number of third-party data vendors can help fill gaps in region, industry, asset class, or cap size. Data subscriptions, however, can be expensive, and the cost of multiple subscriptions may be beyond the reach of some investors.

Investors can help improve the current state of climate-related data by participating in standards-setting processes, encouraging issuers to voluntarily adopt disclosure standards, and advocating for high-quality, globally consistent disclosure regulations.

References

Berg, Florian, Julian F. Kölbel, and Roberto Rigobon. 2022. “Aggregate Confusion: The Divergence of ESG Ratings.” Review of Finance 26 (6): 1315–44. https://doi.org/10.1093/rof/rfac033.

CFA Institute. 2023. “RE: Request for Information: Consultation on Agenda Priorities” (1 September). https://rpc.cfainstitute.org/-/media/documents/comment-letter/ 2020-2024/ISSB-Agenda-Consultation-Comment-Letter_10-18-23.pdf.

Deloitte. 2022. “The Turning Point: A Global Summary” (20 June). www.deloitte. com/global/en/issues/climate/global-turning-point.html.

OECD. 2022. “ESG Ratings and Climate Transition: An Assessment of the Alignment of E Pillar Scores and Metrics.” OECD Business and Finance Policy Paper No. 06 (8 June). www.oecd.org/publications/esg-ratings-and-climate- transition-2fa21143-en.htm.