Sustainability Disclosures: Are We on the Right Path toward a Global Approach?
Environmental, social, and governance (ESG) investing and sustainability disclosures have become topics of increasing interest for investors from around the world. Regulators’ push for the development of sustainable investments, however, is challenged by the lack of reliable, consistent, and verifiable ESG data. Disclosures related to nonfinancial information also often are not consistent and do not help investors make meaningful comparisons among different products.
Some of these issues were analyzed in the first webinar of the second annual CFA Institute Financial Regulatory Symposium, which took place on 29 June 2021 and saw the participation of many regulators and stakeholders. The aim of the symposium was to discuss policy and regulatory developments around the world and their impact on the investment industry.
In his keynote speech, Erkki Liikanen, chair, International Financial Reporting Standards (IFRS) Foundation Trustees, underlined that only a truly global approach on sustainability-related disclosures can lead to greater comparability of ESG products. Regulators, including the G–7 finance ministers as well as investors, stakeholders, and private standard setters are in favor of this baseline approach.
The IFRS Foundation published a consultation paper on sustainability reporting at the end of last year to solicit stakeholder feedback concerning the Foundation’s strategy on ESG disclosures. Consultation respondents agreed that the Foundation should play a role in setting global sustainability-related standards. The Foundation cannot determine any ESG reporting rules that are required to achieve these policy objectives, but it can constantly engage with key jurisdictions to better understand how to provide a globally consistent and comparable sustainability reporting baseline, while using flexibility concerning the coordination of reporting requirements, which cover wider sustainability impacts.
Rients Abma is executive director at Eumedion, which represents the interests of Dutch institutional investors in the field of corporate governance and sustainability. Abma remarked that Eumedion members invest frequently in companies that meet minimum objectives, not only in terms of financial return and risk but also in terms of sustainability. Investors therefore need to consider ESG information that is relevant, consistent, and comparable in their investment decisions. For this reason, Eumedion urged the creation of independent authoritative international sustainability standards and encouraged the IFRS Foundation to extend its mission to sustainability reporting and take responsibility for the development of such standards.
Janine Guillot is CEO of Value Reporting Foundation, which was created earlier this year following the merger between the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards (SASB). Guillot underlined that the IFRS Foundation should not start from scratch in the development of sustainability standards as it already could count on the integrated reporting framework and the existing SASB standards, which were developed looking at both investor and firm value creation perspectives. If the new International Sustainability Standards Board works on these existing standards, an exposure draft could be ready within a short time frame.
This discussion also focused on the European Union (EU) initiatives on sustainable finance. John Berrigan, director general of the Directorate-General for Financial Stability, Financial Services, and Capital Markets Union, at the European Commission, explained that the EU policy reorients investments into economic activities aligned with the EU Green Deal by allowing investors to make decisions based on clear sustainable disclosures. Berrigan reiterated that the EU is a carrying member of the “global convergence club” and remains supportive of global convergence. A standard baseline with the possibility for jurisdictions to expand disclosure requirements should be the way forward. For instance, the EU does not want to stop with climate-related disclosures, but rather it intends to also have a framework regarding environment and other sustainability activities.
Marcelo Barbosa, chair, Securities Commission of Brazil (CVM), emphasized that, at the end of 2020, the CVM launched a consultation on the review of the existing mandatory disclosure rules to improve the quality of information on ESG aspects, as provided by listed companies in Brazil. The CVM is looking to have a balanced approach because most investors are demanding an expansion of the type of ESG information that is to be disclosed now, whereas some organizations have expressed their concern over the increasing costs of compliance of requiring more sustainability-related information. A standardized format for sustainability reporting is needed to reduce the efforts and costs borne by issuers.
John Streur, president and CEO, Calvert Research and Management, stressed that the investor perspective is fundamental in the standard-setting process and should always be taken into account by regulators. Investors, who are the primary users of these disclosures, need to have information that is useful now, and not in few years’ time. Because ESG-related issues, such as those regarding climate change, are time sensitive, regulators are urged to strengthen the current disclosures by improving the existing frameworks.
The Symposium discussion showed that policy makers are expected to continue to focus on ESG and sustainability disclosures and to pursue their policy objectives. At the same time, they need to ensure that the information required is credible, usable, and comparable for investors, while also considering the challenges that organizations would face to comply with detailed sustainability disclosure rules.
You can watch the webinar here: https://www.cfainstitute.org/research/multimedia/2021/financial-regulatory-symposium-2021?s_cid=smo_EMEASAdv_OF_LI.
Photo Credit @ Getty Images / The Good Brigade
Thank you, Roberto Silvestri, for an excellent overview of regulators’ plans for better ESG disclosure and reporting under a global framework, and for the update on their progress to date.
Ensuring consistent, accurate and timely disclosure of ESG data by issuers, while at the same time minimizing the reporting cost to those issuers is a difficult but essential task for regulators. The challenge extends from initial disclosure by issuers to ‘value-added’ information provided by ESG ratings agencies and fund certification schemes. As Silvestri notes, claims of greenwashing are difficult to refute when “non-financial information … is not consistent and do[es] not help investors make meaningful comparisons among different products.” A recent EU paper provides a good overview of the divergent approaches of the ESG ratings, data and research Study on sustainability-related ratings, data, and research. (See the paper at https://op.europa.eu/en/publication-detail/-/publication/897bee11-509d-11eb-b59f-01aa75ed71a1).
Despite the inchoate reporting framework, financially material ESG issues are nonetheless now regularly integrated into investment analysis. Integrating the information requires extra effort by analysts, but also offers potential alpha. Whether it leads to outperformance will be dependent upon the incremental cost and benefit.
Both analysts and investors will benefit as ESG disclosure standards coalesce. For retail investors there will be improved ‘truth in advertising’ for their mutual funds, and for investment professionals there will be increased confidence in source data and reporting. Standardization of reporting is a double-edged sword for analysts though, as former sources of alpha are adopted widely and become part of beta. Early adopters of responsible investment may lose some of their edge, but the ‘alpha becomes beta’ evolution has always been part of the investment process.
What is not beside the point however, is the underlying reason for seeking ESG disclosure and a global framework in the first place. Disclosure and analysis are required because too many ESG issues have for too long been ignored by too many. The information is important not just to shareholders, but also to stakeholders whose interests may be non-financial, and to regulators and legislators who must develop rules that balance corporate, societal, and environmental interests. Silvestri captures the balancing act well in describing “a globally consistent and comparable sustainability reporting baseline, while using flexibility concerning the coordination of reporting requirements, which cover wider sustainability impacts.” And if the reporting burden on issuers is reasonable, a stakeholder-focused reporting framework that relies on global standards should be in shareholders’ broad interests too.