Investors Critique to ESG Reporting
Current State of ESG Reporting
The first reports were published in the 1980s by chemical companies who were facing public backlash. It’s safe to say that ESG reporting has come a long way. In 2017, the World Research Institute found 85% of S&P 500 Index® companies published sustainability reports.
With this push, not all these companies utilized standard frameworks, but of the ones that were, 74% of the world’s 200 largest companies use The GRI Standards for sustainability reporting. While GRI is the common reporting, investors prefer the SABS reporting framework. The McKinsey Consulting firm presents that SABS is better,
because it provides greater transparency and better risk management, and it is better suited to help identify, manage, and report on sustainability topics.
The increased interest at the board level has been guided by “Bloomberg, BlackRock, the Sustainability Accounting Standards Board (SABS), and other investors and analysts".
But, what is driven all this demand? PwC found that 79% of the investors surveyed agree ESG risks are an important factor in investment decision making. In addition, more than half surveyed, 59%, also say “lack of action on ESG issues makes it likely they would vote against an executive pay agreement”.
In the RIA report, “Survey respondents reported the top four reasons for considering ESG factors are:
Minimizing risk over time
Improving returns over time
Fulfilling fiduciary duty
Fulfilling mission, purpose or values
PwC states that only one third of the investors surveyed think the quality of the reporting they’re seeing is good enough. Amit the rising popularity in ESG reporting, there are factors at play that are limiting ESG from mainstreaming and scaling. These factors are covered below.
What can companies do?
Financial Materiality
The question for investors has become, “how can sustainability add value to our investments?” According to a senior sustainable-investing officer at one top 20 asset manager, “corporations do not provide systematic data on one-third of the sustainability factors [that we consider] material.” This poses a large problem for these companies, one that requires more in-depth financial materiality.
Most disclosures come through as check-box yes-or-no responses, generic boilerplate language or tailored narrative, rather than robust quantitative performance indicators, such as metrics on energy intensity or water consumption. These types of disclosures are weak indicators for how the ESG issue impacts business performance.
Consistent and Standardized Reporting
It may come to no surprise that investors are wanting consistent and standardized reporting. In McKinseys survey, investors and executives say that reducing the number of sustainability-reporting standard would be beneficial in helping the firm allocate capital more effectively.
But, how many reporting standards are out there? In retrospect, there is the GRI, World Business Council for Sustainable Development and the World Resources Institute, the Carbon Disclosure Project (CDP), the Sustainability Accounting Standards Board (SABS), and the Embankment Project for Inclusive Capitalism. The list goes on and on.
Given all of these frameworks, this provides a challenging experience for the investor. Different companies are reporting this information in different ways and with different levels of vigor. How are they supposed to compare and contrast portfolios when each framework has a different approach?
One reviewer said
There is not quality data that’s consistent about how firms are doing on sustainability.
In the midst of investors working to compare and contrast, to ensure better decision-making in their investment, they are left with confusion. How are they supposed to rank these different companies when the information can be vague or lacks assurance?
By ensuring universal framework and approach across industries, this would provide investors, and potentially even stakeholders, the answers they need to properly invest.
Reliability
Investors doubt sustainability reports for multiple reasons. The first being that many companies lack the infrastructure to collect quality data for sustainability reporting. They are left up to themselves to collect, measure, and analyze this data based on their own judgement.
The second issue for investors lies in the lack of third-party audits. Nearly all the investors surveyed, 97%, said that “sustainability disclosures should be audited in some way, while 67% said that sustainability audits should be as rigorous as financial audits”.
One firm, for example, ranks Tesla at the top of its industry while another ranks it as the worst, as each considers different factors in the scoring process. In many cases, the firms use sustainability metrics that have little correlation to financial materiality, meaning they do not impact a company financially. As another sustainable asset manager explains, “Rating agencies often assess companies on the quality of disclosures, or whether they have policies in place, rather than on actual performance.” It is hard to know which, if any, scores indicate material performance.
Accessible
Since sustainability reporting is voluntary, self-regulated, and used for a variety of stakeholders and purposes, this causes investors a lot of time searching for the useful quantitative data they need. Many do not even report, which sends investors in a deprecating cycle.
One sustainable asset manager states,
The data from rating agencies only covers 20 percent of our portfolio holdings. We end up having to talk directly to company management or regulators to get the information we need.”
These conversations suggest that the gaps are biggest for fixed income assets, small cap companies, and emerging market companies.
Assurance
Investors want information about corporate sustainability and performance on these issues with confidence that the companies report are precise and have consistency in calculations from year to year.
Investors want clarity and confidence about how specific ESG statements are vetted and whether external assessments of those metrics, through a process called assurance, can be trusted.
The Bloomberg Journal states, only half of big public companies hire a third party to review their sustainability disclosures, and almost none choose an accounting firm to provide that scrutiny. Just over half of S&P 500 companies, 52%, paid for a third party to check their 2020 ESG reports. Those providers included engineers and boutique consulting firms. Just 31 companies—6% of the S&P 500—hired accounting firms, best known for vetting financial reports, to provide those reviews. That handful included Verizon Communications Inc. and Coca-Cola Co., among others, according to a review by the Center for Audit Quality.
C-Suite Integration
In a survey that PwC conducted, 82% stated companies should embed ESG directly into their corporate strategy. This demonstrates the importance that the C-Suite has in the success of sustainability initiatives implemented within a company.
In addition, it is integral to think holistically about the ESG story. Investors use annual reports, sustainability reports, and investor presentations the most frequently to ensure proper decision-making on ESG issues. The ESG story incorporates multi-departments within a company, from the risk team, sustainability, financial reporting, and investor relations team. Successful reporting takes a holistic perspective and top-down approach to integration.
Forward-Looking
In the long run, investors desire to know how companies they’re invested in plan to stay competitive and resilient in the face of emerging mega trends. By demonstrating a forward-looking ESG performance goals and objectives, this helps investors better understand if the company actually considers ESG risks and opportunities.
