Sustainability Reporting

There is still no universal standard definition of sustainability reporting. However, its purpose is to provide transparency on its contributions towards a sustainable global economy. This includes disclosure of non-financial risks and opportunities that could potentially impact the company's performance in the future. Companies issuing sustainability reporting would build trust and governance for investors, particularly those that are sceptical and afraid to fall into greenwashing traps. Based on KPMG 2020 survey on sustainability reporting, 96% of the G250 report their sustainability performances. With growing concerns over "greenwashing", assessing the reliability of ESG data providers through the transparency of methodologies has become increasingly important.

The sustainability reporting landscape is constantly evolving and a jigsaw puzzle for many companies to follow through. In overview, the landscape can be grouped into four broad categories.

1. Global goals and principles such as UN Global Compact, Sustainable Development Goals, Greenhouse Gas Protocol and Principles for Responsible Investment call action and provide goal-setting directions to establish reporting frameworks.

2. Reporting frameworks or ESG frameworks are systems used as a reference to standardize reporting and disclosure of ESG metrics. These frameworks showcase presentations of the sustainability report, such as what items to include and how to include them. Global Reporting Initiative (GRI) is a leading framework setter, with 73% of G250 adopting GRI. Other commonly used frameworks include CDP, CDSB, SASB, TCFD, IR, and others. These frameworks issue recommendations on what to include and its presentation in the report.

For instance, GRI has issued three universal standards, 34 topic-specific economic, environmental, and social standards, and 40 sector standards to be launched with their first sector standard - GRI 11: Oil and Gas sector recently released for the public. These standards are to be used in conjunction and not as a replacement for one another, frameworks used for different points of view. In all these standards, materiality is a key concept.

3. Regulations drive ESG integration, such as the 3 EU regulations on sustainability disclosure - referring to the EU Taxonomy, the Sustainable Finance Disclosure Regulation (SFDR), and the Corporate Sustainability Reporting Directive (CSRD). These three regulations are interrelated to one another.

The EU Taxonomy is a classification of economic activities and their performances concerning six environmental objectives: climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy; water prevention and recycling; pollution prevention and control; and protection of healthy ecosystems. This Taxonomy supports the European Green Deal for the EU to be the world's first climate-neutral continent by 2050 by providing explicit definitions of environmentally sustainable activities and preventing greenwashing. Other markets such as Singapore, Malaysia, Canada, Japan, and others are beginning to establish their taxonomies.

The CSRD is a renewal of NFDR which will be implemented from 2023 onwards through extending the scope of companies from small or unlisted companies to large or listed companies. Disclosure topics under CSRD will remain the same - covering Environmental protection, social responsibility and treatment of employees, Respect for human rights, Anti-corruption and bribery, and Diversity on company boards.

The scope of SFDR includes asset managers, financial advisers, and insurance providers in the EU, in which mandatory disclosures may be required. These assessments would include sustainability risks about the company's financial returns and investments impact sustainability factors and the larger society. This concept is known as double materiality of sustainability, which is applicable in all three critical regulations in the EU and forms the basis for comprehensive non-financial information disclosure.

Put simply; dual relevance can be articulated in two segments: financial materiality with investors as its audience and socio-environmental materiality with society as its audience.

4. ESG Ratings and Indices evaluate companies' ESG performance based on specific criteria and produce ESG scores for comparison purposes with their peers in similar industries. Many ESG data providers make these scores, such as Bloomberg, MSCI, ISS, Sustainalytics, S&P, and many more. While high scores might attract investors, these scores can be black and white. Due to the fragmented market, there are many players in the market. However, different ESG data providers might produce other scores, depending on different sets of criteria. Investors may also look for general ESG or more specific criteria depending on their preferences.

One of the leading ESG data providers, MSCI, calculates ESG ratings on a rules-based methodology. Companies, countries, mutual funds, and ETFs are rated from triple C to triple-A as part of their scoring system. The score will rank companies' exposure to ESG risks and mitigation in place. Analysts will measure 35 ESG critical issues across ten themes from 0 to 10 and aggregate the weighted average of crucial issue scores. The score will then be scaled to its relevant industry before arriving at an overall ESG rating. To summarize, scores will be given to individual items, weighted for the respective pillar (E, S, G), aggregated for its score, and normalized by industry before its final rating. Therefore, these weights will differ as exposure to ESG factors vary across sectors.

Source: MSCI

Another established provider, Sustainalytics, has a percentile rating system based on a company's score relative to the industry. ESG risks are grouped into five categories, ranging from negligible to severe, based on their quantitative score. Under this scoring system, one company's performance is comparable to another company in a different industry.

Source: Sustainalytics

Another approach adopted by S&P Global ESG rating is analyzing available data with responses of its company-specific assessment answered by companies. This assessment refers to the SAM Corporate Sustainability Assessment (CSA), developed over 20 years and acquired from RobecoSAM, a leading ESG assessment for quality and usefulness. These are just a few examples of ESG data providers. So, how do we evaluate the best ESG data provider? One shoe does not fit all. Companies may use more than 1 data provider, using over ten different providers to cover various ESG aspects.

Source: EY, how environmental, social and governance (ESG) data providers compare.

Understanding methodologies used by providers is essential as assumptions used as data inputs would affect analysts' final rating. For instance, overweighting or underweighting on specific ESG issues might lead to a material change in its final score. Spending’s on ESG data have been growing at over 20% annually, projected to increase from $2.2 billion in 2020 to $5 billion in 2025.

There is a strong emphasis on company disclosures, ESG integration, and rating agencies. According to MSCI research, companies in the bottom ESG quintile have been twice as likely to experience over 95% cumulative loss within three years. This is not entirely a surprise considering the downfall of companies due to their evil practices.

An infamous example is the Equifax scandal. MSCI has previously downgraded Equifax to CCC - the lowest ESG rating for its cybersecurity concerns before the announcement of the hack. The downgrade was accompanied by mentions of a previous company breach of 431,000 employee salary and tax data of one of its largest customers, Kroger grocery chain.

Source: MSCI EQUIFAX ESG Ratings Report

Thank you to Shannen Davelyn Kosasih and Marco Tarchoune, for your in-depth analysis!

14 views0 comments

Recent Posts

See All