Sustainable Finance Is All About Data

In the wake of the Paris Agreement of 2016, the EU Sustainable Finance Action Plan of 2018 and the EU Green Deal of 2019, the EU has made tremendous efforts to transform the real economy by redirecting financial flows towards investment in sustainable development.

We argue in our recent paper that the generation, aggregation, and disclosure of sustainability data are central to the EU Sustainable Finance Framework. We argue that datafication is central to sustainable finance strategies, both in the EU and across the world.

Towards Datafication

We argue that datafication—the application of analytical tools to digital data—is a necessity to measure and integrate sustainable risks and impacts in the financial sector. Datafication not only includes generating sustainability data but also structuring and disclosing the staggering amount of data required, including making the digital data accessible for analysis, including models, algorithms, machine learning and other forms of artificial intelligence (AI). Datafication functions as an essential translative mechanism for the financial sector to process and handle sustainable information, essential to financial efficiency, risk analysis and capital allocation processes.

We argue that the ambition, scope, detail, and pace of the EU Sustainable Finance Framework has never before been seen in European financial law, or any system of financial law for that matter, making the identification of the lessons learned to date particularly important.

Based on the principle of ‘double materiality,’ the Taxonomy Regulation, the Sustainable Finance Disclosure Regulation, and the Corporate Sustainability Reporting Directive stipulate a comprehensive reporting regime for financial and larger non-financial entities: reporting entities along the entire financial value chain must report, on the one hand, on sustainability risks impacting the reporting entity and, on the other hand and as a novelty, on how the reporting entity impacts on sustainability factors.

It has been estimated that the value of global sustainability data reached 1.3 billion USD in 2022, and that European institutions alone accounted for 60% of this market. Europe’s dominance of this market is an outgrowth of the EU’s Sustainable Finance Strategy.

Looking forward, we argue that the datafication of the sustainable finance sector, both in the EU and globally, will demand substantial efforts around the standardization, quantification and validation of data.

To address these issues, we outline four policy considerations that are the missing building blocks of a Sustainable Finance Data Ecosystem: the use of green FinTech, RegTech and SupTech; the pursuit of best practices coordinated through public-private co-development; the achievement of proportionality through an expanded use of estimates; and the transition from a market-based to a mandatory regime.

Green FinTech, RegTech and SupTech

The amount, granularity and complexity of the data to be reported paired with the risks of significant penalties for incorrect reporting and reputational risks necessitate the use of Green RegTech by market participants.

Similarly, understaffed regulators and supervisors can and must use SupTech to keep up with the rapidly increasing amounts of data. The amount of data allows deep insights into structures at micro and macro levels, thereby enabling better recognition of sectoral and systemic risks, and supporting precise adjustments to existing regulations. Looking forward, the next major impetus towards datafication of sustainable finance and the evolution of FinTech, RegTech and SupTech will come with the implementation of the European Single Access Point, a major pillar in the EU’s wider Capital Markets Union, digital finance and sustainable finance strategies. This approach of combining mandatory reporting (driving RegTech) with reporting infrastructure (enabling SupTech) is one of the major emerging strategies globally to drive sustainable finance.

Best Practice

The EU Sustainable Finance Framework raises questions around how one can achieve standardized and effective measurement. The path taken by the EU, which has been to publish extremely detailed standards in a short timeframe with little practical testing, is far from optimal.  We argue that a more market-oriented approach could achieve the same ends faster and more cost-effectively. We recommend the implementation of digital reporting standards co-developed by industry and regulators working together.

Proportionality and Official Estimates

The expenses related to data measurement, data storage, and updated data systems disproportionately burden smaller enterprises, and the need to adjust to future regulatory measures will further increase these costs. Therefore, the principle of proportionality must be applied. For small and medium-sized enterprises, regulators should allow, in most sustainability dimensions, the further use of official estimates rather than admittedly accurate, but overly costly, actual measurements.

From Market-Based to Mandatory

As the EU Sustainable Finance Framework relies on the invisible hand of the capital markets, mandating sustainability preferences (including duties to prevent, avoid, and/ or mitigate negative environmental and human rights impacts) is somewhat inconsistent with this market-based approach.  Yet, we note there is a trend to move from voluntary to mandatory sustainability preferences in supply chain regulation. This move from market-based to mandatory consideration of sustainability concerns will further propel datafication.

To conclude, to fully realize the benefits of sustainable finance, it is necessary to pursue strategies based on datafication, as is being done both in the EU and more generally through the development of standards internationally coordinated by the International Sustainability Standard Board and implemented domestically and regionally across a growing number of jurisdictions around the world. To succeed, these strategies must take into account these policy considerations to mitigate the existing gaps in the standardization, quantification, and validation of data. Ultimately, the process of datafication will shift the perspective to the transaction costs that truly matter for financial markets: datafied solutions will allow for cost-efficient compliance with sustainable reporting and risk management requirements and thereby enable sustainable financial products to be offered competitively in comparison to other financial products.

The paper can be accessed here.

Dirk A Zetzsche is Professor of Law and ADA Chair in Financial Law (Inclusive Finance) at the Faculty of Law, Economics and Finance, University of Luxembourg.

Marian Unterstell is a Doctoral Researcher at the ADA Chair in Financial Law (Inclusive Finance) at the Faculty of Law, Economics and Finance, University of Luxembourg.

Ross P Buckley is an ARC Laureate Fellow and a Scientia Professor in the Faculty of Law & Justice, UNSW Sydney.

Douglas W Arner is the Kerry Holdings Professor in Law and RGC Senior Research Fellow in Digital Finance and Sustainable Development at the University of Hong Kong.