INTEGRATE & DISCLOSE – PART 4 OF 5

Corporate Sustainability Reporting: A Chance to Bridge the Data Gap

This post focuses on sustainability reporting, continuing the series on the five elements of successful ESG integration.

The lack of comparable ESG data is the single most important challenge in the sustainability space, obstructing regulators, investors, and other stakeholders in their efforts to analyse corporate ESG performance. This dearth of information stems from flawed corporate disclosure, which currently fails to satisfy the demand for in-depth data on corporate environmental and social performance, including external impact. Data from the third-party providers, which is often used to fill in the gaps, does not always offer a suitable alternative. The role of ESG ratings in the investment analysis process and the benchmark construction has been widely criticised in connection to their lack of transparency and reliability. The 2020 OECD report showed that a high ESG score does not always correlate with improved environmental performance[1]. This observation illustrates one of the central obstacles presented by the lack of reliable ESG data – if investors are to allocate funds efficiently, they need to know which companies are behaving in a sustainable way. Companies also suffer in this environment – even the most effective ESG strategy needs to be transparently communicated to reach the market and non-financial stakeholders.

ESG reporting is a rapidly evolving space that can be difficult to navigate due to the multitude of existing frameworks. The most prominent and well-known are GRI, SASB, and TCFD, but there also a number of ongoing initiatives designed to facilitate convergence, including WEF Stakeholder Capitalism Metrics and the IFRS work on establishing a Sustainability Standards Board. According to a recent KPMG report, most companies follow GRI, while our ESG White Paper, published in September 2020, indicated investor preference towards SASB. TCFD reporting is another frequent investor demand, with BlackRock and Vanguard encouraging companies to align with this framework. These demands are now being reinforced by regulatory momentum in the UK and the EU. Investors’ preference for SASB and TCFD is based on their shared focus on financial materiality, which highlights ESG issues that can impact company revenues. Many of these frameworks (along with several newer initiatives) have attracted criticism for overlooking the interests of non-financial stakeholders and omitting companies’ material external influences.

Corporate impact reporting is relevant to a wide and growing audience beyond the traditional investor community. In addition, the increasing demand for impact investment products requires data on companies’ contributions to society and the environment – information that is often difficult to obtain as most companies struggle to quantify and report on their external impact.

The UN Sustainable Development Goals offers a way to measure companies’ impact on several sustainability factors including climate action, reducing inequality, education, and others. Disclosing a proportion of revenues linked to specific SDG topics allows companies to easily communicate their impact to investors. Andrea Carzana, ESG European Equities Fund Manager at Columbia Threadneedle Investments illustrated the usefulness of SDGs in the recently published Investor Update ESG Reporting paper: “When it comes to impact, it’s simpler to use the SDGs because impact is such a wide word, and the SDGs really help you to narrow which impact we are referring to. They’re consistent and global as well as being easy to assess, easy to understand, easy to use and that makes them practical. A lot of companies tell us that they are linked to a particular SDG, but they do not say how much of their revenues are linked to that goal. Companies need to quantify how much of their revenues are linked to a specific SDG.” This approach is also at the heart of the Sustainable Development Investments initiative, which uses public financial data to determine the proportion of revenues derived from products and services that contribute to the SDGs[2].

Regulatory ESG disclosure requirements are also expanding. The UK and New Zealand have committed to making TCFD reporting mandatory, while the SEC is conducting a review of the current climate disclosure practices intending to issue updated guidance. The EU sustainability regime continues to develop, with SFDR increasing investor appetite for ESG-linked disclosure and the new requirements introduced in the Taxonomy. The ongoing NFRD review is expected to improve on the previous EU sustainability reporting regime, which failed to ensure high-quality reporting. Most companies within the NFRD scope do not provide information on their environmental and social indicators and impacts required by the current rules. The revisions will aim to correct existing deficiencies. It may also lead to the creation of EU-wide sustainability reporting standards, which are currently under consideration of the European Financial Reporting Advisory Group. There is significant room for improvement – current corporate disclosure is lacking, even on the widely explored climate indicators. Most corporates focus on their ESG policies and do not provide sufficient information on quantifiable outcomes.

Companies that do not address gaps in their ESG reporting are likely to become targets of intensifying engagement initiatives, as investors struggle to respond to increasing regulatory pressure and consumer demand with limited data. In the absence of relevant disclosure, investors will have to source data from third-party service providers, which can result in evaluations based on assumptions or out-of-date information. Taking a proactive approach to ESG reporting will allow corporates to take control of the narrative and avoid any potential misrepresentations.

[1] Boffo R., C. Marshall and R. Patalano (2020), ESG Investing: Environmental Pillar Scoring and Reporting, OECD Paris http://www.oecd.org/finance/esg-investing-environmental-pillar-scoring-and-reporting.pdf

[2] https://www.sdi-aop.org/