August 2nd 2022
Republished from article in The Hedge, October 2021
Number, Number, Weight, Division. Investors often feel they need the prophetic powers of Daniel to interpret the mass of ESG signals that now confronts them.
A new arms race is underway between data providers keen to proffer a competitive edge, while companies invariably put their best foot forward selectively presenting their sustainability credentials through impact reports littered with virtue-based metrics. This before data scraping the internet and social media channels or taking account of the multiple competing certification schemes which may (or not) denote good practice.
Making sense of these inputs to distinguish good and bad operators on a relative scale is a full-time job for many but one made more difficult by the raft of competing assessment standards.
Much of the problem lies in the very breadth of the ESG landscape; it is an immense task for companies to act on policy and report against a vast range of factors such as greenhouse gas emissions, electronic waste, modern slavery, diversity, customer relations, privacy and data security, to name just a few. Unsurprising therefore that data providers aggregate these various observations in simplistic headline ESG scores – single scores – for ease of comparison. Useful in theory but the trouble is these rankings are very subjective due to the weighted calculations behind the scores and which can both hide some ugly behaviours as well as huge gaps of reporting in certain areas. But these single scores present a huge marketing opportunity for marketeers of ESG oriented strategies in aligning with positive sounding trends without requiring much evidence around compliance on specific factors. Accusations of green-washing are often well founded.
Unsurprising also that reporting against a multitude of diverse metrics is too great for many smaller organisations, or for those in private ownership who are better equipped to shun public scrutiny. A common response has been for larger asset managers to develop their own proprietary assessment frameworks which will inevitably differ from others. A divergence of opinion is defensible, but less so when it is not clear why the judgement has been reached.
And so it is problematic for investors to benchmark sustainability outcomes either between providers or across different asset types.
In the absence of mandatory disclosure regulations building around a common global framework so ESG reporting will always remain patchy at best. In fairness, there are attempts by regulators to advance carbon emission disclosures under the banner of the UN sponsored TCFD initiative reflecting the climate emergency we all face. But even here participation remains largely a voluntary undertaking.
An obvious answer is to widen the remit of accounting standards to incorporate certain ESG metrics within the audit process. This has the advantage or establishing consistency, a baseline of performance while also ensuring independent verification. Yet there seems little enthusiasm for this path, whether due to inherent cost or as many accounting practices generate substantial consulting revenues from the ensuring confusion. Industries may suggest their own reporting protocols or “pathways” but inevitably these are self-serving to the priorities of the larger players. Political imperative is key.
Europe arguably carries the baton with their EU taxonomy, a statutory reporting framework that should also extend beyond ‘E’ concerns to some ‘S’ and ‘G’ issues in due course. Whether other countries or the UK as chair of Glasgow COP26 offers such leadership remains to be seen.