As companies increasingly add disclosures on sustainability to their reporting, it is clear that the wide array of standards used is a problem for ESG investors. In order to continue the integration of ESG factors into investment decision making, it is imperative that the standards converge or that regulators introduce mandatory sustainability reporting requirements.
In July 2020, two of the most prominent organisations that issue sustainability reporting standards announced that they would be collaborating. The frameworks that SASB and the GRI have developed are the most widely used by companies globally. Their decision to work together is significant and will bring optimism to participants in the ESG investing community who have been crying out for a more streamlined approach to disclosure requirements in order to help the industry grow further.
The rapid growth of ESG investing and its adoption into the financial markets in recent years has been impressive. For too long, social and environmental issues were dismissed by investment professionals as personal, ethical beliefs which should not be factored into investment decisions. There have been many reasons why this change in consensus within the investment community has happened: increased climate change awareness is leading to policy and regulator changes; consumers and NGO’s are pushing companies to adhere to social standards; corporate failure has shown the need for good governance; and influential asset managers such as Larry Fink (Blackrock CEO) have made the case for why a focus on sustainability is perfectly aligned with creating long term value for their clients.
However, for all the success and growth, one thing that is holding back the full integration of ESG into investment decision making is the data. There are many factors contributing to the data problem in the industry. For the last hundred years, the only information that investors cared about was financial in nature. Consequently, a robust and consistent set of standards were created and made mandatory by regulators globally – this provided users of company statements with accurate and reliable financial data. But reporting on non-financial information is new, because it is only recently that investors have started to take an interest. In this vacuum, with no single recognised standard in sustainability reporting, there has been a proliferation of frameworks and standards that can confuse even the most dedicated professional in the ESG space – and this is a significant barrier to ensuring that capital is steered towards investments that will finance the transition to a more sustainable economy.
Why is the convergence of sustainability reporting standards important for the success of ESG investing?
Currently, the requirements for each standard vary widely. This allows many companies to choose to use a framework which will present them more favourably to the public. It also means that each company will disclose different information and different metrics. Even if a similar metric is reported, the standards may allow for different methods of calculating or measuring the data. All of this can make it nigh on impossible for an investor to fairly compare the environmental and social impacts of two companies using different standards. The standardisation of ESG data would enable investment professionals to properly judge which companies are genuinely outperforming their peers on ESG issues and for computer algorithms to more easily pick up data from company reports.
If ESG investment analysts had comparable, timely, complete, and accurate ESG information it would allow them to make better investment decisions. Better investment decision-making would result in better performance for their sustainability-focused funds and strategies which would in turn lead to more capital being allocated to their funds and therefore to the projects, companies and industries that are driving positive societal change.
The current system makes reporting difficult, costly and time consuming for companies. Investors and other stakeholders often complain of the alphabet soup of the current reporting landscape. For a company looking to start making sustainability related disclosures, it is challenging to choose one of the many different reporting frameworks and moreover, they will often be asked by different stakeholders to report to different standards. This can create a huge burden for the company that disincentivises making sustainability disclosures at all.
So, are we close to achieving “clarity and compatibility in the sustainability landscape”? Standardisation in sustainable reporting has been spoken about for many years. The challenges surrounding non-financial information have been apparent for a long time and are a substantial obstacle for the industry’s development. The announcement by SASB and GRI is a step in the right direction, but not a big step.
The most likely means by which we arrive at a single, gold standard for sustainability reporting is through changes in regulation. The introduction of mandatory sustainability disclosures would lead to the quality and consistency of information that investors have been calling for. Preferably, this would be an international collaboration so that reporting is consistent not just within but between countries as well.
Efficient allocation of capital relies on good data; so if we want capital to flow towards sustainable investments then we need to provide investors with consistent, relevant, and accurate information they require to make those decisions effectively. High-quality sustainability disclosures by companies and asset managers will make ESG a major focus in the capital markets, but to achieve that we need a convergence of the standards and metrics that are reported. Reducing the complexity of the current reporting landscape will enable asset owners to hold their asset managers to account, and asset managers to invest in companies that are properly evaluating ESG risks and opportunities.