When it Comes to Sustainable Finance, Market Governance is now Data Governance

Greg Medcraft, Director, OECD Directorate for Financial and Enterprise Affairs

Originally published in the GDF Annual Report 2020

The pandemic has provided a unique moment for reflection. Governments around the world have articulated a vision to “build back better” and pursue a “green recovery”, while investors increasingly recognise that non-financial sustainability issues, notably environmental, social and governance factors, can and do impact long-term value propositions. These tail risks; low probability, high impact events like pandemics, popular social movements, or the more severe, less predictable weather events we can expect as the physical effects of climate change manifest in the years to come.

As such, practices and products to better incorporate material ESG considerations into financial decision-making have grown steadily. Today numerous providers offer ESG ratings for companies, designed to assess material sustainability performance and risks, while metrics, disclosure frameworks, investment approaches and ESG-based financial products have similarly proliferated. ESG assessment has become a significant feature of global capital markets, with ESG-rated companies now making up 78% of total global market capitalisation.

However, new analysis in the OECD’s 2020 Business and Finance Outlook has shown that in practice market participants often lack the tools they need, such as consistent data, comparable metrics, and transparent methodologies, to properly inform decision-making through a sustainability risk lens. In this context, current ESG practices may not support well-functioning markets, and may actually distort markets if such information is used to incorrectly price risks, allocate capital inefficiently, or misrepresent sustainable financial products to financial consumers.

Though there are several gaps to be filled, information asymmetries are at the core of this market failure, and data must be at the foundation of addressing it. Individual investors and financial markets need ESG data that appropriately reflects material risks, is consistent, verifiable, and allows for accurate comparison between assets – and this is not something the private sector will deliver on its own. For policymakers and regulators, market governance increasingly means focussing on data governance.

To truly harvest the potential benefits of ESG practices, regulators and international standard setting bodies will need to work together towards a globally mandated data reporting framework – and the more grounded in digital practices, the better we can leverage current and emerging technologies to meet the needs of investors today and tomorrow.

This means formulating a common data taxonomy as a foundation for data collection and reporting. It means considering issues of interoperability between the systems that collect ESG data and those that analyze and disclose it. It means building transparency and accessibility into those systems, for example by incorporating application programming interfaces at the network level, and establishing an independent data repository to ensure the integrity and availability of data at the global level.

Looking further into the future, as ESG reporting grows in importance companies will need to consider how best to collect, analyze and report a host of non-traditional, non-financial data in the service of financial decision-making. Here, emerging technologies hold great promise.

Smart sensors already measure common ESG metrics, like carbon dioxide emissions in power generation or industrial water usage, and the application of internet-enabled devices will likely expand to automate the collection and reporting of a much wider range of performance data. Artificial intelligence will be critical in interpreting this wealth of data, in particular using pattern matching and predictive algorithms to help determine which ESG risks are financially material in which industries and companies — but careful attention is needed to ensure algorithms are fit-for-purpose and data is of sufficient quality. Blockchain technology is ideally suited to secure and authenticate such data, ensuring quality and veracity, through decentralized consensus mechanisms — and is already in use to assure employment conditions and pay in risky industries like cobalt mining.

This journey has already started. International standard setters, from the OECD to IOSCO and the Financial Stability Board, already have a solid foundation of existing policy tools and guidance on which to build a common data framework. The International Financial Reporting Standards Foundation’s proposal to establish a Sustainability Standards Board presents a platform to convene and coordinate these efforts and drive them forward at the global level.

Of course, none of this will be successful without close engagement and collaboration with business every step of the way – and clearly the global blockchain, crypto, and digital assets sector has a role to play here which should not be underestimated. As we advance, we look forward to working with all players in the financial sector to ensure the market has the sustainability data it needs, and to support the innovation required to get there.

Read more from regulators, policy makers, and industry leaders in our Annual Report 2020 here.

GDF is an industry body promoting the development of best practices and conduct standards for the cryptoasset industry and advocacy with policy makers.