If 2021 was the year that environmental, social and governance (ESG) investing went decidedly mainstream, then we can expect 2022 to be the year in which capital markets participants get in on the action.
Nobody likes missing out. Capital flows into global ESG-focused funds continued to outpace the wider market over the course of last year as more investors sought to take advantage of the demonstrated outperformance of sustainable investment strategies. And expectations are that these trends will accelerate in 2022, with Bloomberg Intelligence recently revising upwards its estimates for near-term growth in ESG assets.
While these are encouraging trends, companies that want to partake will need to show investors how they’re achieving positive ESG outcomes without compromising financial performance. Though straightforward in principle, success hinges on navigating the kinks in the ESG information pipeline. Key among these obstacles is the investor community’s use of inconsistent, opaque, and otherwise unreliable assessments of company ESG performance made available by third-party ESG ratings providers (ERPs).
To that end, companies should address the two predominant reasons today’s ESG investors defer to third-party ratings when evaluating a company’s ESG performance: a dearth of investment-grade ESG data from issuers and a shortage of in-house ESG expertise.
It’s up to business executives to take control of both the substance and delivery of their firm’s sustainability narrative. They have to ensure their ESG data is accurate, timely, complete, financially relevant, and verifiable. Doing as much requires a robust materiality assessment to determine which ESG issues are relevant to both the firm’s bottom line and the objectives of their investors. As for delivery, a comprehensive accounting framework teamed with data analytics and reporting capabilities can enable seamless communication of investment-grade ESG data.
To cultivate the substantive ESG data investors want, start with a thorough materiality assessment. Company leadership should take care to focus their ESG performance measurement and management efforts on issues where there’s agreement across stakeholder groups. Striking this balance, however, requires a commitment to continuous engagement. To that end, periodic fact-finding missions, from employee surveys to regular consultations with customer advisory boards and major shareholders, will help business executives gauge the divergence in their stakeholders’ priorities and help them monitor any convergence.
For instance, should an industrial manufacturing firm’s EHS compliance officer learn that mitigating COVID-19 transmission risk is the priority concern for both the firm’s employees and investors, they may elect to implement advanced HVAC systems to improve indoor air quality across their facilities. If the HVAC installations achieve the desired outcome, then the search for a common ESG priority continues. But there’s no guarantee they’ll find one. Assuming the upgraded HVAC systems require additional power supplies, investors may turn their attention to the firm’s operational emissions while employees on the assembly line may be more concerned with their risk of injury on the job.
Juggling divergent and changing stakeholder expectations without error or delay, however, can be difficult without an appropriate system of record that facilitates streamlined data collection, traceability, analysis, and reporting. Armed with the right insights, our EHS compliance officer can quantify the outcomes of one intervention—e.g., the installation of advanced HVAC systems—across all three ESG pillars and, importantly, be able to communicate those outcomes to their stakeholders.
By way of example, say the new HVAC units increase the risk of facility power outages and, in turn, heighten the risk of injury for employees using heavy equipment on the assembly line. If a review of the building performance data concludes as much and subsequent consultations with their employees and investors find their original priorities intact, then our EHS compliance officer will need to change course. Whatever alternative our protagonist elects—be it the installation of a failsafe like a building energy management system or the implementation of more rudimentary COVID-19 transmission risk mitigation measures—they should turn back to their ESG data to substantiate their rationale.
Performing a robust materiality assessment and implementing an effective ESG performance management solution are just some components of a holistic ESG program. And it will take time before the investment-grade data produced through these processes supersedes the ERP’s ratings in the eyes of investors.
This is not to say, however, that these are not worthwhile endeavors. A recent survey commissioned by my company found that, despite the evident imperfection of the ratings ERPs confer, 63% of investment decision-makers defer to these ratings when informing their ESG investment approaches. With spending on these data poised for precipitous growth, keep in mind the risk that companies’ self-reported data could be overshadowed by ERPs’ inaccurate assessments.
Accordingly, in my experience, while it may take time for self-generated and reported ESG data to eclipse the inferences made by third-party ERPs in the marketplace, these meticulous processes will be appreciated by increasingly judicious investors. Perhaps unsurprisingly, reliance on third-party ratings is proportional to the availability and quality of companies’ self-reported data. Companies that produce their own investment-grade ESG data may also drive the improvement in their ESG scores, many of which are extrapolated from a combination of open-access resources and publicly disclosed ESG performance data.
For business leaders looking to nurture a trusting, bidirectional relationship with stakeholders, substantive, verifiable, and clearly communicated data can make all the difference. When investors and other stakeholders know their say carries water, they’ll know with whom their concerns should be raised as well as which data to consult.
R. Mukund is the CEO of Benchmark Digital Partners