LTIMindtree : Fintech can accelerate ESG integration for financial advisors

10 January 2023

Of:Mukund Raoand Neil W Dsouza

The recently concluded United Nations Climate Change Conference (COP26) held in November 2021 in Glasgow not only demonstrated the progress made with the landmark Paris Agreement of 2015, but also showed the challenges in the long road ahead towards realizing net-zero emissions targets by 2050. It an enormous commitment is required from all countries, and especially the larger ones.

Finance is a key aspect and it is estimated that $123 trillion will be needed to help achieve the goals. Financial institutions such as investment banks and investment managers are at the forefront and have committed to the cause by being signatories to or collaborating with organizations such as UN PRI, Ceres, TCFD, UN SDG and the Net Zero Asset Managers Initiative. It also provides an opportunity to be the channel for green money and to be catalysts for positive change.

However, investment advisors have yet to get over the macro shift in investments. A recent SEI survey of nearly 800 registered investment advisors found that while 80% cited client demand as the primary driver for incorporating sustainable investment strategies into a portfolio, only 34% of RIAs have implemented sustainable investment strategies for their clients.

Possible reasons are sheer inertia and lack of understanding, as well as the extra effort and due diligence required to analyze ESG investments. In addition, there is concern that the higher expense ratios of these investments may take up a larger portion of the fee budget, although a number of studies have indicated that the correlations between ESG scores and market value are positive and significant in all regions.

Given the increasing awareness and demand from clients and potential clients, it is important that financial advisors are fully trained in ESG and stay abreast of fast-moving changes.

Although it is the starting point, integrating ESG or managing exclusions into the investment advisory and portfolio management processes requires commitment and appropriate tools to achieve the mission. Fortunately, digital transformation and artificial intelligence have democratized financial advice and now with ESG integration it can even be offered to the wealthy masses and retail investor segments.

When it comes to fintech tools, small to mid-sized advisors should look to ESG capabilities with their investment management platform providers or from independent third-party providers.

Larger advisers, asset managers and investment managers who operate their own investment, risk management and research technology platforms have more options. They can either implement an ESG-focused platform that helps with ESG integration or build on top of existing research and portfolio management capabilities. In the case of the former, data integration into vendor platforms is the primary effort, while in the case of the latter, a greater effort is involved.

For those looking to establish their own platform, the following framework – which includes structures and processes to ensure the reliability and consistency of data analysis and decision-making – may be helpful. This framework is based on five pillars:

• Assess the current state of ESG data. Identify what data is currently available, along with potential gaps in available data relevant to ESG standards. Determine a solution to obtain the remaining data needed to obtain a complete picture of each company in a firm’s portfolio.

• Establish an accessible data hub. A data hub collects data from multiple sources so that everyone across the company can access, edit and gain insights from the data. For securities firms, a data hub is where the data portfolio, analysis and repository will be located. Cloud-based data hubs enable more flexibility and ease of use.

• Develop an intelligence team. The use of artificial intelligence and data analysis tools will help investment companies better manage and derive insights from their ESG data. Specific industries can develop individual data models to enable more customized decisions.

• Establish an ESG reporting capability. Customers want complete transparency to be confident that ESG standards are being met. Developing reporting, disclosure and governance processes is key to providing this level of trust, compliance and transparency.

• Using front-end data visualization tools. Data visualization tools – charts, maps, graphs – allow us to ingest large amounts of data quickly and understand trends, patterns and connections. This is important for managers who need to quickly assess the ESG status of companies in their portfolio.

Regardless of whether financial advisors and investment firms want to rely on supplier services or develop and expand existing capacities, it is important to integrate ESG in investment management, and delaying implementation is fraught with great risks.

There is an incredible opportunity for firms to differentiate themselves with smarter, more informed, data-driven decision-making in research, by advising and monitoring the ESG performance of client portfolios.

Those firms that establish the right business architecture and use appropriate fintech tools to integrate ESG into the administration of financial advice are more likely to earn the trust of their clients and translate that trust into long-term partnerships.