Alberto Lopez Valenzuela, Founder and CEO, alva, says investors and corporates will benefit from a wider range of inputs into sustainability reporting.
Barely a month passes without another step forward in the widespread adoption of ESG principles. In April, the European Union took things further by proposing a standardised model to ESG self-reporting that attempts to create a unified framework to solve the patchy and inconsistent metrics that come with sustainable investing.
These measures are being hailed as key to cutting down on the greenwashing issues that blight ESG-focused investment. And while this will allow the EU to firmly plant a flag on ESG’s still nebulous terrain, it is my view that the rules fail to respond to many of the immediate pitfalls of ESG reporting. Neither do they offer help to companies themselves to understand why sustainable approaches are important.
Central to the shortcomings is the inconsistency that comes with self-reported data, a concern recently shared by Bank of America’s Vice Chairwoman Anne Finucane, who opined: “Data is an issue. There is no consistency, it’s challenging.”
No neat package
Many areas of ESG activity aren’t represented in easily reportable figures, don’t have generally accepted measurement criteria, and defy clear definition. They don’t generate a pithy soundbite to include in annual reports, or statistics to present to the board. There is no neat package for complete ESG reporting.
Such shortcomings are exemplified in the way that companies have widely differing opinions about what it means to treat employees fairly. Take Amazon’s recent battle against unionisation in the US – the company made a point of showing that relative high pay was one of their metrics for social impact, while many workers, and likely many corporations, would instead argue that the provision of union rights is more effective.
Companies also differ in the weighting of importance of ESG factors, the most obvious of which is the disparity between environmental aspects and other categories. It is far easier to quantify your carbon footprint than it is to calculate positive community impact, leading to the likelihood that the latter may be misrepresented.
Furthermore, the importance and prevalence of different areas of ESG activity varies from sector to sector and indeed from company to company. There is a huge risk that many companies will be oversimplifying their ESG reporting to just what can easily and consistently be measured, rather than what actually matters.
Additional tracking measures
Overcoming the challenges of self-reporting will happen over time. As ESG becomes a more central component of investing, regulators will likely react with a more rigorous regime around how sustainability should be measured. For now, it is the business community’s responsibility to develop a proactive mindset about ESG in its totality, by improving reporting so that there is less subjectivity, opacity and cherry-picking.
One way to achieve this shift is for businesses to spread the focus into additional tracking measures, and in particular the analysis of publicly available content. These measures need to take into account the reality of ever-shifting perspectives through real-time analysis of publicly available print, online, broadcast, and social media content.
Reporting needs to incorporate:
- Comprehensive data, beyond company disclosures, be they voluntary or mandatory
- Sector-specific ESG topics, classifying and weighting using industry best practice (e.g. Sustainability Accounting Standards Board (SASB) standard taxonomy)
- Sector benchmarking, to understand how a company’s ESG profile compares to other businesses operating in the same environment
- Stakeholder specific factors, to reflect the competing demands and perspectives on ESG topics that different stakeholders have
- Rigorous scoring, both for overall ESG performance and also the materiality of the ESG issues faced, be they risks or opportunities
- Traceable data, to enable scores and movements to be linked back to their underlying drivers
- Real-time reporting, to reflect the speed with which ESG issues are evolving
This would of course mean a huge volume of data to process, but machine learning and natural language processing (NLP) technology can help to create an ESG scoring system to offer a reliable, objective overview of risk and potential.
The consumption of additional reporting does, of course, represent a challenge for institutional investors already bombarded with a wide range of disclosures from corporates in many different formats. Therefore, there is a growing need for platforms that can make it easier for investors to synthesise and compare thousands of companies – and focus on the outliers that matter.
Informed strategic decisions
Spreading the reporting focus won’t just enable investors to make truly informed investment decisions. It will also enable companies themselves to make more informed strategic decisions, while offering management a more complete picture of outside opinion, enabling them to mitigate risk.
By including unsolicited stakeholder sentiment as a data set alongside mandatory reporting and self-disclosures, businesses can complete the picture. Stakeholder sentiment surfaces new concerns and areas of interest, while reflecting back what people actually think about the company’s policies.
Why is this important? Let me offer an example. Take a large multinational firm with operations in different countries, each nation hosting its own approach to sustainability. There is an increased danger that ESG risks will crop up unexpectedly.
Companies in the oil production industry might benefit from a relatively stable perception domestically while simultaneously facing serious environmental challenges in other parts of the world. And if the concerning issues are directed through a subsidiary, there would be even less likelihood that they would be picked up by ESG self-reporting.
But an assessment of stakeholder perception is likely to capture the common conflation of parent company and subsidiary that could be hugely damaging to the main brand.
Similarly, a growing risk is the lack of control a company has over the actions of supply chain partners – take, for instance, the issues experienced by major tech companies with regards to the extraction of cobalt for use in their devices. ESG analysis may be used to tease out any public conflation of supply chain firms with the end organisation, allowing companies to better pre-empt risks and improve their accountability.
Looking ahead and outward
As long as the nature of big business relies on partnerships, whether that be with suppliers, contractors or other collaborators, then the potential remains for uncontrollable situations that are not immediately visible.
That is why the movement towards standardisation of reporting models made by the EU and elsewhere must be seen as an opportunity for businesses to look outward and increase their respect for public perception as a key indicator. In doing so, companies will not only prepare themselves for improved future regulation, but will also ready themselves for the new normal in public opinion.