Thoughts on how companies and investors can navigate the ESG disclosure maze

Greater integration of environmental social governance (ESG) factors in boardroom decision making and investor risk analysis long has been seen as a crucial building block towards a sustainable, low carbon economy. After all, finance, companies and markets largely dictate how a capitalist economy grows — and how quickly it transitions to greener business models.

What's more, environmental sustainability makes good business sense. A 2015 review of over 200 studies on sustainability and corporate performance found 80 to 90 percent demonstrated that solid ESG practices and standards result in better operational performance, better stock price performance and lower capital costs.

That financial policymakers, investors and major corporates are starting to recognize the importance of environmental sustainability and long-term thinking on climate change is, therefore, positive news. Risk reporting guidelines developed by the Taskforce on Climate-related Financial Disclosures (TCFD) already have captured support from hundreds of major companies, while the EU Commission is due to imminently set out proposals to end short-termism in investment circles and unleash a new surge in green financing. And in the U.K., the government is considering making it a mandatory requirement for companies to disclose the risks they face from climate change.

Meanwhile, a survey of more than 100 IR and corporate responsibility practitioners carried out by CSR consultancy Corporate Citizenship last year found 77 percent of companies saw a need to improve their ESG disclosures.

But for sustainability executives peering beneath the bonnet of corporate climate risk and ESG reporting, trying to work out precisely how all the nuts and bolts should fit together to drive the engine of a sustainable business can be extremely complicated.

How should companies report on ESG and climate risk? What and how much data should they disclose? Precisely what are their investors looking for? And which, if any, ratings agencies and green indices should they take the time to respond to? With no single ESG and climate risk disclosure instruction manual, it is a process both companies and investors are only just beginning to grapple with.

The problem is twofold: there is both a disconnect between internal investor relations and sustainability teams within companies in terms of measuring and communicating ESG performance, as well as an external disconnect between companies and their investors on these issues.

One of those grasping the nettle on the investor side is Schroders, which manages about $550 billion worth of assets. As one of the firm's ESG analysts, Elly Irving, explained at an event hosted by Corporate Citizenship in London last week, integrating ESG across the hundreds of funds it manages can be very complex.

"We are operating now in an environment where environmental and social change is happening faster than ever, which means it is impossible to ignore these issues within our investments, while at the same time it also means there is an increasing interest to our clients," Irving said. "What we've done recently to help integrate ESG into our investment processes and communicate to clients more effectively, is develop a sustainability accreditation system so that individual funds or investment desks will have a different sustainability accreditation... All sector analysts are able to evidence which environmental social issues they've looked at when recommending a stock and how that's reflected in the valuation."

In doing so, Schroders' analysts take into account a range of data which spread far beyond just passive studying of global sustainability indices, such as the Dow Jones Sustainability Index or the FTSE4Good index, which all use different criteria. Indeed, Irving said she looks at CDP data, third party ESG ratings, NGO reports, press and media reports, policies, supply chain audits and even less-traditional data, such as the opinions of a company's consumers, stakeholders and local communities.

The approach is all aimed at gleaning more detailed data on company ESG risks and opportunities, which means, for example, that a company operating in a water-scarce area will have this factor taken into account in any valuation assumptions.

The challenge with this kind of in-depth analysis is it clearly requires a huge amount of data sources, and if investors are asking more questions of their assets, then those companies need to have the answers. That is why improving dialogue and understanding between investors and companies is so crucial to effective climate risk reporting and ESG integration.

"If we hold the debt or equity in a company we are always open to having a dialogue with those we invest in," said Irving. "Across Schroders we have 14,000 meetings a year which do touch on some of the ESG topics. Then we have 1,000 corporate meetings that are more of a deep dive on sustainability and corporate governance issues."

Irving said while she would like to work with more companies starting out on their sustainability journey. "It is never our intention to micromanage, but perhaps with our knowledge in investing we can share some insights on best practice and what we would like to see as companies are improving," she explained.

Schroders' work here is a start, certainly, but such active ESG integration is far from common practice among investors and fund managers. As such, many businesses remain unclear as to how they should be measuring their environmental value and risks, and what they should be reporting to investors and indices. Moreover, responding to numerous surveys from ratings agencies, sustainability indices and investors takes a great deal of time and resources, which may be manageable for bigger corporates, but can become a challenge for smaller listed firms.

Indeed, some attendees at the event last week, including several sustainability and financial chiefs from major corporates, pondered whether it is worth their while responding to so many sustainability indices.

Varun Sarda, sustainable banking lead at the Royal Bank of Scotland, addressed some of these concerns at the event, pointing out that while RBS fell out of the Dow Jones Sustainability Index (DJSI) leaders' group last year largely due to media and stakeholder announcement issues, the change in the rankings "didn't make us any less sustainable."

He said that sustainability ratings were an important resource for investors and a key market for companies, but that it nevertheless was important to be selective about the ratings and indices companies participate in and understand the different methodologies being used.

"We don't have unlimited resources to try and drive sustainable change within an organization," Sarda said. "So the question you really have to ask is: is time spent better driving change within an organization, having those conversations with the business to make sure you are coordinated? I'll just leave that thought there."

Yet a big part of the problem remains that sustainability and ESG data is often simply not given the same level of importance within companies as more general financial performance reporting. As a result, the quality of ESG performance data for many firms is frequently not of the same standard as financial data, according to Noel Morrin, group executive vice president for sustainability at Finnish renewable packaging firm Stora Enso.

"How could you make a decision to invest or disinvest based on sustainability data if that data wasn't given to you with the same level of assurance as financial numbers?" he argued at the event. "I don't see the debate about the legitimacy or credibility of my profession progressing very much further unless we start to provide data that is of the same quality as that coming out of the CFO's office. My job is to give my colleagues in the finance team and my boss data that is good enough to help to drive our stock price and to reward our investors on a sustainable basis. I don't understand why we aren't being asked to do this more and more."

But from the investor point of view, the challenge is not just with the quality of the data provided, but also with the amount on offer. Often companies can provide too much sustainability data that is too complex for their owners or managers to navigate. Speaking to BusinessGreen, Ben Constable-Maxwell, director of corporate finance and stewardship at M&G Investments, said the challenge was that investors want information from companies that is "both simple and relevant at the same time."

"It needs to be simple enough to cut through the noise but also contain sufficient relevant detail to help investors understand how the company is managing its risks," he said. "Companies do get asked for huge amounts of information from lots of different sources, and that can be a genuine reporting burden, especially for smaller companies. That is why simplifying information can massively help both them and investors."

Ultimately, as more companies and investors look towards incorporating ESG more deeply into their relations using guidelines such as those set out by the TCFD, these are just some issues that need to be grappled with, particularly if climate risk reporting and transparency starts to become mandatory. Unfortunately, there are no easy answers on offer.

But as Constable-Maxwell pointed out, even if this process is only at the start of its journey, at least both investors and businesses are largely now on the same page. "Corporates and their investors share the same goal: business success that is sustained over the long term for the benefit of shareholders, employees and customers alike," he explained. "The reality is that it is very much a shared responsibility."

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