It’s turning into an all too familiar refrain – ‘Investors need better information on organizations’ environmental, social and governance (ESG) performance’. And the refrain is trailed by the issues that exist with the current sources of ESG data. While this is an absolute necessity, “good” ESG data is nonexistent in the market.
Tim Mohin, the chief sustainability officer for Persefoni AI and former chief executive of the Global Reporting Initiative, mentions the barriers to ‘Better ESG Data’ and says that, “The ESG data crisis has been building for decades and will come to a head in 2021. In a market that had developed normally, there would be several competing solutions before we had reached this point, but there are several intrinsic barriers that have prevented the assimilation of better ESG data, and which are important to recognize now so we don’t compound the problem going forward.”
1. Sustainability is not just an investment – Sustainability is a global movement aimed towards keeping up and improving life on this planet. Only recently have a portion of these issues crossed the ambit of mainstream investors. Voluntary reporting of ESG data has become an apparatus of large organizations, with around 90% of the S&P 500 now issuing Sustainability reports. Nonetheless, this reporting custom is undeniably more inclined towards the marketing division than for investors or creating a positive impact.
2. Immaturity of accounting – In contrast to financial disclosures, the accounting rules for some ESG topics are immature. This is as yet the situation for many, ESG concerns, with one notable exemption: carbon. The Greenhouse Gas Protocol gives grounded and globally acknowledged strategies for estimating GHG emissions. Yet, on the off chance, the GHG Protocol runs more than 750 pages, and there is still a ton of confusion with indirect (Scope 3) emissions.
3. Inconsistent standards and lack of assurance – There have been numerous calls for the convergence of reporting principles as a threshold step toward better ESG information. Progress is being made toward consolidating the current principles while the International Financial Reporting Standards Foundation (IFRS) is building up its ESG guidelines, beginning with climate. On the off chance, this was not confusing enough, there is a strong norm from the American Institute of CPAs as well and an emerging international standard from the International Auditing and Assurance Standards Board.
4. Lack of regulation – for now – While most ESG disclosures are still voluntary, guidelines are on the rise. The Europeans are driving the path with the Nonfinancial Reporting Directive (NFRD), which initially came into power in 2014. The EU is currently revising the NFRD due to concerns with respect to the consistency and quality of the reporting. There will likely be new legislative and regulatory moves in the U.S. also.
5. Lack of comparability – In contrast to financial reporting ESG is a broad collection of categories that are often difficult to compare. The WEF, through its International Business Council, has proposed a bunch of 22 metrics drawn from existing standards that it suggests all organizations, regardless of sector, should report. If all organizations report on the same ESG metrics, investors could all the more effectively compare the outcomes.
6. Lack of technology – Another barrier is the development of robust technology for gathering, managing, forecasting, evaluating, and reporting sustainability data. However, with mounting pressure from investors, mandates from regulators, and converging standards, better solutions are quickly arising in the market.
The primary concern: A tipping point is near on ESG data “What gets measured gets managed ” is the old adage ascribed to the management guru Peter Drucker — and it’s never been more apt than with ESG data. The barriers illustrated above have thwarted organizations from managing ESG issues and investors in making portfolio choices lined up with ESG performance.
Yet, 2021 signs a tipping point where the boundaries to better ESG data will be overcome. With regulators driving reporting mandates, level of cash streaming into ESG assets, and pressing factors from mainstream investors, this market will rapidly mature. Also, in the nick of time.