Even though Morningstar reported recently that investment flows into sustainable funds nearly doubled each month this year compared to 2017, financial advisors and other stakeholders continue to express lukewarm sentiments about the transparency and trustworthiness of ESG-related investment data.
“Overall, we were disappointed by the lack of transparency and rigor of ESG ratings,” Shiva Rajgopal, the vice dean of research at Columbia Business School, writes in a recent Reuters opinion article. Rajgopal and his co-author cited problems with ESG’s data methodologies and greenwashing — or the false promotion of a company’s environmental policies.
In addition, BlackRock found in a February-issued study that companies reporting they follow ESG practices are more likely to be targets of lawsuits and regulators’ enforcement actions.
But solutions to problems plaguing ESG investors potentially could be developed based on blockchain and smart-contracts technology. Both technologies are expected to dramatically change multiple industry business models; could they also disrupt ESG data creation? Might those technologies provide tools to bolster ESG data’s credibility, thereby further pushing advisors and clients to those asset classes?
“I think it’s a great idea,” says Robert Fernandez, a vice president of ESG research for Breckinridge Capital Advisors in Boston, Mass., which has $33 billion in assets under management.
Although Fernandez echoes the sentiments of others, many hurdles exist before blockchain and smart contract-verified ESG data become reality, according to Fernandez and others focused on ESG, blockchain technologies, or both.
“As always it’s a matter of alignment of incentives,” says Alexander Lipton, the chief technical officer of the fintech payment system provider SilaMoney, a Connection Fellow at M.I.T. and a former senior manager at Bank of America Merrill Lynch, where he received the first Quant of the Year award in 2000.
Is such an alignment taking place now? “It’s not happening at the moment,” Lipton says.
Blockchain, or distributed ledgers, are structured so that once information is entered into a system, each and any change is traceable. Smart contracts are self-executing software programs that bar transactions from taking place before previously set conditions occur. So accountability is automatic for participants on any blockchain or those who enter into any smart contract. Bottom line: both technologies narrow trust gaps.
Lipton expects blockchain technology to disrupt payment systems in the near future, but he ranks as “challenging” any proposals to “harness blockchain on real-world situations” – to verify ESG data. “It would be very hard to abstract the business logic from the actual processes,” Lipton says.
Moreover, the existing blockchain platforms are too “flimsy” for widespread application to ESG data verification, he says.
In addition, the “tremendous carbon footprint” of public blockchain platforms also represents a hurdle for ESG advocates, he says.
To that point, the Environmental Law Institute, a nonprofit advocating for sustainability solutions, announced this month that it is funding both research into assessing blockchain’s direct energy use, and, at the same time, blockchain’s potential for sustainable supply chain management.
Under development now, however, are multiple additional blockchain platforms, some of which would not create such carbon footprint issues if used for ESG verification. Trying to pick the winners among those platforms is Eterna Capital, a London-based €20 million venture capital private equity fund founded by ex-BlackRock analysts. Nassim Olive, Eterna Capital’s chief economist & COO, says his fund is not yet seeing investable ventures developing blockchain and smart contract technology for ESG data verification. But he draws a connection between concerns about the faulty qualitative measures for ESG data and the potential blockchain has to “increase transparency and immutability.”
About blockchain technology, Olive says: “It could give you full transparency of what is really behind the data.”
Already, the trends in big data and artificial intelligence have given ESG a boost. This summer, Cerulli Associates issued a study about the growing influence on big data and artificial intelligence in helping ESG investing “to gain a firm foothold in quantitative investments.”
Big data and AI allow vast amounts of data from object sources in real time to be added to themed investing.
“The use of big data and AI is radically transforming data gathering. These changes have opened up ESG investments to quant funds, which are busy developing new algorithms to systematically evaluate companies,” Justina Deveikyte, an associate director of European institutional research at Cerulli, reports.
Jeff Bohn shares some of the optimism for ESG data and blockchain marriages but tempers it with a question. Bohn, a credit risk and data-science specialist, is the director of Swiss Re Institute, a Zurich-based research unit of a re-insurance company.
“The technology has created the opportunity to realize this vision. But where are the natural group of stakeholders who are going to drive and put the technology in place?” Bohn asks.