The End of ESG Denial

06/28/2016 04:12 pm ET Updated Jun 29, 2016

Co-authored by Allen White

Big data does not automatically translate into big insights. This reality is becoming increasingly evident in the world of corporate sustainability reporting. With more than 13,000 companies around the world reporting on their environmental, social and governance (ESG) performance in standalone sustainability reports investors and reporting companies alike continue to ask: does all this reporting provide value?

Both parties agree that financial reporting is increasingly deficient in providing the intelligence needed to make to sound, long-term investment and management decisions. As intangible assets—e.g. human, intellectual, social capital—surpass 75% of market capitalization of large corporations, the tangible-asset based financial reporting has become increasingly detached from the real drivers of long-term performance. In order to calculate, communicate and rate value creation in all its complexity and nuance, market players need to understand the risks and opportunities present in a fast-changing global economy.

Financial markets are not oblivious to these structural shifts. Worldwide, ESG-based assets under management (AUM) total an estimated $21 trillion. But capital allocation is but one indicator of the movement of sustainability-based investing. The U.S. Securities and Exchange Commission (SEC) is seeking comments on new sustainability content in the business and financial Disclosures required under regulation S-K. In May, the UN-affiliated PRI released a Statement on ESG in Credit Ratings to which 100 investors representing US$16 trillion assets under management (AUM) and six credit rating agencies (including Moody’s and S&P) commit to enhanced, systematic and transparent consideration of ESG factors in the credit analysis of debt securities. A 2014 EU Directive mandates disclosures pertaining to environmental, social and employee matters, human rights, anti-corruption and bribery.

This rising tide of sustainability-based actions on both the supply-side (company disclosures) and the demand side (investor needs) heralds the end of what may be termed “ESG-denial.” Collectively, these and similar developments have effectively debunked the lingering skepticism surrounding the view that strong sustainability is a correlate of strong, long-term financial performance. Sustainability, in short, is steadily moving from the margins to mainstream in contemporary investment strategy.

With this landscape taking shape, the need to build a trusted infrastructure to guide disclosure, analysis and application of material ESG information across all industries becomes increasingly evident. Like any high performing market, the supply and demand for ESG information interact efficiently and synergistically. Trusted, relevant disclosures fuel user uptake, and user uptake, in turn, drives richer, more comprehensive disclosure. For the former, sustainability accounting standards help ensure that companies disclose the sustainability risks and opportunities that are material to their industry. Between the supply and demand sides are the intermediaries, entities that transform raw data into information, and information into insights. In the ESG world, those intermediaries operate in the form of 120 ESG research/raters/ranking/index providers worldwide that offer over 500 products to the global markets. To achieve improved risk-adjusted returns, however, ESG ratings, rankings, and indexes need to evolve to rate companies on performance on material sustainability factors, as opposed to volume of sustainability disclosure.

Building a trusted infrastructure amidst the surging interest in sustainability performance is the job of independent standard setters and government regulators. Investors and companies alike need assurance that their commitment to ESG integration is matched by rigorous, dynamic and widely accepted—if not outright mandatory—frameworks widely embraced by all market players. Fortunately, exactly this kind of infrastructure is rapidly taking shape, spurred by a shared urgency in the face a plethora of ESG challenges—e.g. climate change, corruption, inequality—that threaten the well-being financial markets and the broader global economy.

In the last decade, and especially the last five years, sustainability reporting and ratings initiatives are emerging to transform a chaotic landscape into an orderly ecosystem of disclosure, analysis and application. In the history of major financial and business innovation in the post-WWII era, the rapid emergence of this ecosystem is a leading example of collaboration among corporate, investor, government and civil society. ESG denial has shifted to demand, confusion to clarity. The lessons of this experience warrant the attention of all those seeking workable solutions to a wide range of pressing sustainability imperatives in the coming years.

Dr. Jean Rogers is Founder and CEO of the Sustainability Accounting Standards Board Dr. Allen White is Founder and Acting Chair of the Global Initiative for Sustainability Ratings and Co-Founder of the Global Reporting Initiative.

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