Coming up with accurate data on companies’ environmental, social and governance records has always been difficult for investors. Demand for so-called ESG funds may be high, but understanding where the green capital should flow is not always obvious. The problem is most often a lack of meaningful, reliable data.

“At the moment, the risk is that it is ‘garbage in, garbage out’,” says Bernard de Longevialle, global head of sustainable finance at S&P Global Ratings.

Others agree. According to a 2020 BlackRock survey of 425 investors across the world — together representing $25tn in assets under management — poor quality or unavailable ESG data and analytics represent the biggest obstacle to sustainable investing.

The EU has now set out to rectify matters. Through a mushrooming array of rules and directives, the bloc is seeking to pin down what can be called a sustainable investment in its member states, as well as providing clearer reporting standards — although experts warn that initial results may be patchy.

The centrepiece of Brussels’ sustainability legislation is a taxonomy that defines what is green. While it has been in force since last summer, its disclosure requirements will only kick in next year. In the meantime, the debate continues over certain technical elements, as well as the various shades of green and what can be termed sustainable.

Chart of challenges to adopting sustainable reporting that shows poor data quality is one of the biggest hurdles in the path of ESG investing

A case in point is the EU’s ongoing assessment of nuclear energy’s place in the taxonomy. As Thomas Buberl, chief executive of insurer Axa, put it at the FT’s Global Boardroom event earlier this month: “When you look at nuclear today, [it] is clearly a technology that would fall more into the olive bucket than into the brown or black buckets”.

There are also issues about how classifications apply to different industries. Utility and power-generation companies, for example, appear to be more comfortable with the EU definitions because their activities are more clearly defined by the taxonomy, says one investment professional.

But, for others, “like chemical companies, the message we get is that they still find it hard to match the taxonomy [definitions]”, he says. “The differences between companies are striking.”

The taxonomy sets four overarching conditions that an economic activity must meet to qualify as sustainable.

It must, for example, contribute to at least one of six environmental objectives: climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy; pollution prevention and control; and protection and restoration of biodiversity and ecosystems.

Another of the conditions is that an activity must “do no significant harm” to any of the other environmental objectives. But this is where scrutiny becomes particularly tricky, say investors, as companies’ internal systems are not built to collect this kind of data.

Backing business activities that fall outside the taxonomy will have implications for investment products, as they cannot be labelled sustainable if they fail to meet the EU definitions. Companies will therefore have to use the same definitions in their sustainability disclosures.

All of this comes as asset managers and advisers are already dealing with the EU Sustainable Finance Disclosure Regulation (SFDR), which came into effect in March. It adds to existing investment regulations such as the Undertakings for Collective Investment in Transferable Securities Directive, or Ucits.

Under SFDR, financial companies are required to manage the sustainability risks of their activities and the impact those activities have on the environment and on people.

This “double materiality” approach is also taken by the Corporate Sustainability Reporting Directive, which covers all large companies and listed smaller businesses in the EU. It is currently going through the European legislative process.

There is hope that the double materiality principle will force companies to rethink governance structures so that sustainability is not treated just as a compliance matter.

Åse Bergstedt, a specialist adviser who until last year was chief sustainability officer at private equity firm International — Capital Improved, takes issue with how companies often hand the sustainability task to someone who is not in a position to influence business strategy. She says treating sustainability as an integral part of companies’ future is essential because “what is green now is not going to be green in five years”.

Corporate sustainability rules will also be accompanied by a new, specific reporting framework. This may represent a turning point. On the one hand, the EU mandatory framework would fix the data mismatch caused by a proliferation of existing voluntary reporting standards. On the other, it risks adding to the already thick alphabet soup of sustainability disclosures — TCFD, SASB, GRI and CDSB being among the main ingredients.

The EU says its framework, which would not come into force before 2024, will incorporate the main elements of the others. It will also need to consider the work of the International Financial Reporting Standards Foundation, which is studying how to embed sustainability factors into its widely-adopted accounting rules.

Besides industry bodies, other jurisdictions, such as the UK, are considering green taxonomies and disclosure requirements on financial services firms. Timothée Jaulin, head of ESG development and advocacy at asset manager Amundi, thinks the EU’s sustainable regulation package will become the international “benchmark” for those efforts.

And the fact that so many are trying to tackle the sustainability data issue proves how much is at stake, reckons S&P’s de Longevialle. “What’s happening at the moment, in terms of the need to develop more comprehensive and standardised disclosures, [is] the mother of all battles,” he says.