Fund Solutions

The Long and the Short of ESG Reporting Becoming “Urgent”

Asset owners, asset managers and hedge funds prioritise transparency in long-short portfolio ESG reporting, says MSCI.  

There is no clear global market consensus or regulatory guidance on how short positions should be treated when aggregating the ESG attributes of long-short portfolios, said analytics and research company MSCI. In a new paper, MSCI said the issue of how to report ESG metrics for long-short portfolios is becoming “increasingly urgent” amid heightened regulatory and client scrutiny and wider adoption of ESG integration by long-short portfolio managers.  

To date, short positions – where an investor sells a stock with the intention of buying back later in anticipation of a price drop – have typically been largely excluded from ESG analysis. Reporting frameworks such as the recommendations of the Task Force on Climate-Related Financial Disclosures and Europe’s Sustainable Finance Disclosure Regulation provide little guidance on the treatment of short positions. 

ESG-related reasons for shorting a stock can include seeking upside from price falls associated with ESG risks, signalling a negative view on company practices in need of improvement and initiating an activist campaign on an ESG-related issue, such as the board’s refusal to set targets to reduce CO2 emissions.  

Consulting with more than 20 global asset owners, asset managers and hedge funds, MSCI found that transparency is the most important principle for long-short portfolio ESG reporting. Market participants said transparency enables both regulators and clients to “more accurately assess” the ESG risks and opportunities to which a fund is exposed on both the long and short sides of the portfolio. 

The main difference MSCI found in investor views on reporting short positions was whether the investor was assessing a company’s real-world impact (double materiality) or was focused solely on its ESG risk/return metrics (financial materiality). Real-world impacts were defined as tangible, measurable outcomes such as emissions released. “Their significance lies in the ability to measure these as outcomes in the physical world, and not just in accounting terms,” said the paper. 

In general, asset owners, asset managers and hedge funds agreed that reporting for ESG transparency was different from reporting for ESG risk exposure, with both being important in meeting different ESG investment reporting objectives. 

“We therefore recommend that long-short portfolios report ESG and climate metrics separately for both the long and short legs, in addition to any preferred aggregation schemes, as this allows the greatest transparency and flexibility for aggregate portfolio reporting under both a double and financial materiality assessment,” said the paper. 

As a starting point for considering ESG metrics of long-short positions in a portfolio, MSCI said investors should delineate between economic interest and ownership, and consider the implications of shorting in an ESG investment context. These implications could include possible portfolio upside from price declines associated with ESG risks, signalling a view on poor company practices that could be improved, and initiating an activist campaign against a company on a specific ESG-related issue. 

The asset owners with whom MSCI consulted predominantly expressed the view that ESG and climate reporting should focus on transparency and real-world impacts. “Moreover, they firmly delineated between ESG transparency reporting for clients and ESG risk reporting for portfolio managers, and considered that the two require separate reporting frameworks and should not be conflated,” said the paper. 

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