There’s a reason that a new effort from MIT aimed at better appraising ESG is called the Aggregate Confusion Project: the breadth of different methodologies, reporting standards, and datasets make measuring ESG, well, confusing. As the Project’s directors write, “the correlation among prominent agencies’ ESG ratings was on average 0.61; by comparison, credit ratings from Moody’s and Standard & Poor’s are correlated at 0.92.”
This lack of a uniform measurement protocol creates challenges for investors who want to compare investment opportunities. It also leaves ESG initiatives vulnerable to mounting critiques of greenwashing or, as several politicians have recently argued, politically-driven investment decisions.
Though there may be no one-size-fits-all solution, there are different ways of thinking about ESG measurement that can help address the problem. In sum, the more focused the measurement – and the more it can be based on hard, financial data – the better.
Measure less, but better
So reads the headline of a recent Economist article, which provides a compelling diagnosis of where ESG measurement has proven ineffective – and what can be done to improve it.
The thrust is that ESG is too broadly defined, imprecise, confusing and “infected with moral judgments that change with the weather.” Instead, the industry should be more targeted in its efforts, selling products for particular investor constituencies: “climate funds for people who want to reduce carbon emissions, social funds for those interested in human capital; and governance funds for those worried about mismanagement.”
Measurement would then be centered around specific and clearly defined aims – and, ideally, built around financial rather than qualitative disclosures.
“Accounting boards have shown the value of standardized, audited financial statements for the development of capital markets, economic growth and as checks on the way managers run companies,” the article reads. “Sustainability disclosures should try to follow a similar path.”
Investors would like this, too. Yet even trying to standardize the narrower frame of sustainability disclosures into a broad framework isn’t going to work. As suggested by the Economist article, ESG investors are passionate about very specific causes. For sustainability alone, one investor might be passionate about reducing carbon emissions, while the other is concerned with improving sustainable farming techniques to reduce hunger. Though both fall under the umbrella of “sustainability,” they entail entirely different reporting and metrics.
So how do you solve for both, without creating an overly burdensome reporting system?
Specialty fund administration can help
At JTC, we’ve been doing targeted, focused impact measurement for years, creating purpose-built solutions for mission-oriented Opportunity Zone (OZ) and EB-5 funds. That’s no easy feat: reporting accurately at a smaller scale and measuring specific impacts to meet complex regulatory requirements can be a significant administrative burden.
Yet as ESG funds attract more scrutiny – and become increasingly targeted in their aims as a result – it’s likely that more ESG funds will start to look like specialty funds. It follows that solutions built for specialty impact funds like OZs will be well-served to deliver the measurement and reporting their ESG counterparts need.
“The key to making ESG reporting cost effective is to approach the sector with a view to ‘Specialty Financial Administration,’” said Reid Thomas. “Traditional fund administration solutions don’t work. These funds have unique requirements that are best solved with purpose-built technology, and specialized expertise. In other words, you need to use the right tool for the job.”
There are other benefits. If a fund administrator like JTC is already handling back-office accounting and administration, they’re better positioned to measure ESG in a way that harnesses the hard financial data investors demand. And by taking a holistic approach to administration, reporting, measurement, tax, and compliance, the right fund administrator can help lower an ESG fund’s operating costs, too.
Bespoke, technology-driven ESG solutions
JTC not only offers fund administration solutions for impact funds like Opportunity Zones, but a full suite of ESG services, including our award-winning virtual Chief Sustainability Officer (vCSO). The vCSO solution, which enables clients to access the benefits of an in-house Chief Sustainability Officer on a flexible, outsourced basis, provides fund managers, corporations, and family offices with a cost-effective way to meet their complex ESG regulatory and reporting obligations.
As with all of JTC’s specialty fund administration solutions, the vCSO is grounded in a given client’s specific needs and goals, and powered by intuitive, purpose-built technology.
“Organizations of all types and sizes know that ESG is crucial to their success and a sustainable future, but navigating the alphabet soup of standards and regulations is an immense task,” added Thomas. “JTC approaches ESG through the lens of its deep expertise in fund, corporate and private client services and then overlays the latest ESG knowledge on top. We start from the position of understanding a client’s core business, and then, through the vCSO service, help them to create a bespoke ESG program that is tailored to their specific needs.”
