By Peter Walsh, Director, ESG Market Strategy & Partnerships, Benchmark ESG
ESG has taken off
With the massive focus on ESG, knowing what ESG can deliver and what it cannot is essential. We must not lose sight of the fact that this is a construct designed by and for the financial community. Although it contributes significantly to sustainable development programs, it does not replace them and may sometimes work against them.
Whoever Cares – Wins
The ESG story begins with a meeting convened by the UN Global Compact program in 2004. It brought together a group of financial institutions representing assets of 6 trillion USD under management to address environmental and social risks and opportunities, along with rising public expectations for better accountability and corporate governance. The outcome of this conference was the report, Who Cares Wins, Connecting Financial Markets to a Changing World. Recommendations by the financial industry to better integrate environmental, social, and governance issues in analysis, asset management, and securities brokerage.
While some actors in the financial sector had already been addressing these issues through initiatives such as the Principles for Responsible Investment and Corporate Social Responsibility, often as a niche activity, the Who Cares Wins program recognized the complexity and diversity of issues involved and sought to provide the industry with better guidance on ways to evaluate and manage investment risk. ESG was born.
Fast forward to 2022, and the total assets under management in dedicated ESG funds have soared to $38T (Clermont Partners), and 88% of limited partners say they use ESG performance indicators in making investment decisions. ESG has become a mainstream issue, and debate is raging about how best to implement ESG mandates, their impact, and how they can be regulated. Multiple standards, protocols, and legislative instruments are slowly but surely converging towards a more streamlined and globally integrated approach.
This is encouraging, as it is essential in mobilizing the finance needed to manage climate change, implement the energy transition, and address other environmental and social issues. Debate continues whether the shift is enough and whether the publicly stated positions reflect actual business practice, but movement is in the right direction.
However, the increased focus on ESG investing has led to scrutiny of both the reliability and value of ESG mechanisms. ESG ratings are questioned, accusations of greenwashing are proliferating, and debate about the purpose and integrity of ESG investing is ongoing. Legislation is being developed to address greenwashing, along with tighter regulations around auditing and verification.
This has led to a focus on data quality and provenance, with EHS and Sustainability practitioners facing new demands to meet the requirements of the ESG community. Investment-grade data is demanded, and companies are working hard to implement the cross-functional teams, processes, and technology necessary to deliver this.
The commonly accepted characteristics of investment-grade data are:
- Relevance. (materiality)
In addition, new legislative frameworks such as the EU Taxonomy and the Corporate Sustainability Reporting Directive are raising the bar with requirements such as third-party auditing and machine-readable data.
The accounting profession has spent over 100 years developing globally accepted reporting standards (and, in fact, still operates on twin protocols, the International Financial Reporting Standards and, in the USA, the Generally Accepted Accounting Principles). Such reporting is expected to use internal controls to ensure data quality and reliability, including segregation of duties, reconciliations, policies and procedures, transaction and activity reviews, and information processing controls. This approach provides rigor far ahead of most current ESG and Sustainability reporting.
But Will Investment Grade Data Support Sustainability?
A company that successfully meets this ESG data quality objective and can affect regular disclosures with investment-grade ESG data will have met a key management objective, i.e., addressing the needs of its investment stakeholders. Nevertheless, does this also support broader management objectives, specifically sustainability programs? No, it does not. As always, publishing data does not change anything; only actions flowing from those insights do.
Do not forget that it’s the intention of ESG to be utilized as an investment risk assessment tool, not a sustainability management tool. ESG disclosures will assist investors in evaluating risk and making informed investment decisions but are not always helpful in formulating and managing sustainability strategies. Investment-grade data will facilitate risk assessment for investors, and however, if the objective is to achieve positive change, the sustainability profession needs more. Decision-centric data is required.
Decision-centric data is needed to effect real change, not just financial risk assessment.
In the MIT Sloan Management Review, Bart de Langhe and Stefano Puntoni argue that while executives have more data available than ever, an approach driven by data rather than decisions will produce sub-optimal results:
“Data-driven decision-making anchors on available data. This often leads decision-makers to focus on the wrong question. Decision-driven data analytics starts from a proper definition of the decision that needs to be made and the data that is needed to make that decision.”
Decision-centric data to support sustainability programs needs to provide the information necessary for managers to evaluate options, test scenarios, verify outcomes, and adjust and scale programs as appropriate. It enables innovative problem-solving while also improving operational efficiency. It begins by looking at the strategy and objectives to be supported and develops a data and reporting capability to enable these. The generation of decision-centric data will give sustainability managers the tools they need to succeed in their programs.
Decision-centric data should rely on investment-grade data, as described above, to provide a solid accepted foundation of facts and evidence-based information on past performance. It must go beyond this to include elements of forecasting, value judgments, extrapolations, and aspirational objectives. The defining features of decision-centric data that can support sustainability programs include:
- Context: showing change over time, trends, and direction of travel. Single snapshots need to be put in context.
- Holistic: not just a single issue. For example, biodiversity and climate change are tied together; one cannot be addressed without addressing the other.
- Outreach-driven: Any performance evaluation must be placed in the context of stakeholder priorities. KPIs should be based on and address stakeholder expectations.
- Forward-thinking: leading rather than lagging. For example, Transition Plans are leading in that they do not simply report past performance but also describe how short, medium, and future long-term targets will be met.
- Benchmarkable: using commonly accepted metrics, especially sector-specific, allows relative performance to be placed in context. Benchmarking against peers allows performance to be evaluated in context and to identify above or below-average outcomes.
- Forecasting: Sustainability practitioners are responsible for setting and meeting goals. Decision-centric data must enable users to determine the likely outcomes from current actions and test scenarios to develop strategies and programs that will meet corporate objectives.
If this decision-centric approach is taken, an organization can move beyond the static, backward-looking ESG disclosure data and generate information and insight that can be genuinely useful in driving improvements to operations. ESG data will continue to play a valuable and vital role in helping investors allocate capital appropriately and driving the energy transition we need. However, the renewed focus on data disclosure is an opportunity to advance beyond the current state of sustainability management and develop new best practices for the scale of the massive challenges we face. Moving from investment-grade to decision-centric data will give organizations a greater return on investment in data systems and provide a powerful tool for sustainability practitioners.
Benchmark ESG is building decision-centric data capability into its operational and ESG platform. This will allow users to enhance their operational intelligence and insight continually and proactively drive sustainability objectives across their organisations.