Recently, the head of ESG at a blue-chip asset manager that is paying more than $200,000 annually for ESG data told me: ‘Once we get this ton of data from a major data provider, our work just begins. We have to make some financial sense of it.’
His remark points to a fundamental problem with ESG data and the $50 tn ESG investment market: there are too many indicators and too much non-actionable data. For an investor, knowing how many tons of greenhouse gases a company emits annually says little, if anything, about its performance, for example.
In a recent survey of 420 asset managers, 71 percent say they find ‘inconsistent and incomplete’ ESG data to be a barrier to ESG investing. In the EU alone, there are 1,144 recognized ESG data indicators.
Environmental reporting by companies is increasingly governed by an onslaught of regulations and guidelines. Indeed, environmental regulations have increased 38-fold since 1972, according to the UN.
In a way, this makes things easier for companies reporting data. But it does not help investors much in translating this data into financial performance numbers. Investors typically seek only data that helps them link ESG to company financial performance. Recent ESG regulation is pointing in this direction.
Commenting on the International Sustainably Standards Board’s issuance of new ESG accounting standards, partners from law Morrison & Foerster said: ‘Notably, IFRS S1 and S2 are focused on financially material ESG risks and opportunities that affect the overall bottom line.’
Investors care about environmental data for at least two reasons. First, compliant companies are less likely to incur scandals and the high costs associated with them.
In 2015, Volkswagen was hit by accusations of misreporting emissions on certain automobile models. This affected 11 mn vehicles and the firm’s stock price tanked by more than 20 percent overnight. As a result, Volkswagen incurred its first quarterly loss – €3.5 bn ($3.8 bn) – in 15 years. The company set aside €6.7 bn to cover the resulting expenses and losses.
Second, investors focus on indicators that can be directly linked to financial impacts. For IR, this represents an opportunity to communicate clearly around these topics. For example:
- Digitalization – Existing production equipment can reduce costs by operating more efficiently, for example, when equipped with 5G-driven micro sensor networks thus optimizing the use of raw materials, reducing energy consumption and improving product quality
- Environmental risk management – Risk management controls and quantifies risks that could lead to environmental violations and expensive scandals
- Reporting environmental data according to the Sustainable Finance Disclosure Regulation – Major asset managers structure their portfolios to include companies compliant with regulations and accepted guidelines, thus driving and stabilizing the stock prices of those companies
- Reducing defective products – Defective products mean wasted resources and costs. A quality and efficiency program to reduce defective product rates saves costs
- Carbon credits strategy – Carbon credits can reward cleaner operations and be traded, yielding income
- Waste management – A concerted waste management program can reduce waste removal and processing costs
- Environmental crisis plan – Having a ready-to-go crisis plan can reduce negative impacts on costs and stock price if and when a crisis occurs.
Knowing the metrics investors really care about will mean IROs are best placed to communicate clearly in the long run.