If you’re reading this article, you likely don’t need to be convinced about the importance of ESG disclosures in capital markets. You’re probably already communicating ESG information to your stakeholders, and you may even be using one - or more - global reporting standards or frameworks to do so. But you may still be wondering whether what you’re providing counts as ”quality reporting”.
Are you communicating or reporting?
It goes without saying that communication is essential to organizations, which must convey all kinds of information to many different stakeholders for different purposes. Reporting is a narrower, more specific subset of communicating that must be circumscribed and regimented. IROs know that the best way to get proper information to the market is through effective reporting. When it comes to sustainability-related information, this means shifting from a communication to a reporting exercise – in other words, one that is regulated, standardized, continuous, scheduled, and verified.
Who’s asking for this?
Capital market participants, from global institutional investors to G7 finance ministers and securities regulators around the world, have denounced the inadequacy of corporate sustainability information in making effective capital allocation decisions. In a recent PwC survey, only one-third of institutional investors thought the quality of the reporting they’re seeing is good enough. The 2021 Edelman Trust Barometer points to 82% of institutional investors believing companies frequently overstate or exaggerate their ESG progress when disclosing results. And according to Danske Bank, less than one-third of reported sustainability information is financially material or otherwise useful for investment research and decision-making.
What do they want?
In a nutshell, investors want ESG-related disclosures to be decision-useful— in other words, information on issues that are material to the company, widely available and consistent over time, comparable among peers, easily understandable, timely, and reliable (because externally audited). They want sustainability reporting that is prepared with the same rigorous and well-established collection, validation, and accountability processes rooted in traditional financial reporting.
Isn’t it all about the data?
While quality reporting contains its fair share of qualitative narrative on governance, strategy, and management practices, two main ingredients for effective reporting to meet investor needs are ESG metrics and ESG data.
ESG metrics are performance measures or indicators of a company’s performance on environmental, social, and governance issues. Investors are increasingly looking for specific sustainability information, including qualitative performance narrative backed up with clear quantitative performance metrics and targets. Quantifying your ESG performance shows investors that you track and manage these issues just as you would your other enterprise data. It allows you to speak about your performance over time, against peers, and against previously set goals and targets.
Performance metrics should be related to the material issues identified and they should mean something to those tasked with managing the issues. Well-articulated ESG metrics should be useful in setting targets, assessing performance, and taking corrective action when needed. One of the challenges specific to sustainability disclosures is the need for more extensive narrative, so companies typically must use a mix of both quantitative and qualitative metrics.
Of course, quantitative performance measures require ESG data. And as companies shift from a communication to a reporting exercise on sustainability-related issues, they also need to shift to a data mindset, which is to use data to make informed business decisions. Corporate data is a foundational building block to managing and reporting on business-critical issues and to drive capital allocation decisions. Poor data leads to poor decisions and even poorer results. As the popular computer science saying goes “garbage in, garbage out” (GIGO).
Today, the relatively poor quality and reliability of ESG data remains a significant challenge to its effective use. The digitization of data collection into a system of record and the automation of data processing and reporting will go a long way to improving the quality of ESG data, making it easier for it to be used for its intended purpose, to be externally assured, and to create a virtuous circle of “quality in, quality out” (QIQO).
Where do reporting standards and frameworks fit in?
Leveraging popular and credible reporting schemes is essential to making corporate reporting comparable, especially when it comes to specific performance measures on individual sustainability-related topics. However, these reporting schemes are not all the same – in fact they’re all quite different, and often complementary.
One important distinction to remember is that a framework (e.g. TCFD) is a broader, contextual “frame” for information. It is a set of principles providing guidance and shaping understanding of a certain topic, defining the direction of information, but not the methodology of collection or reporting itself. It doesn’t specify performance measures but prescribes high-level disclosures.
On the other hand, a standard contains detailed disclosure requirements, including performance measures or metrics. Standards provide clear, consistent criteria and specifications for companies to report on their performance, including targets. The most notable and widely used sustainability reporting standards are those of the Sustainability Accounting Standards Board (SASB) (now part of the IFRS Foundation) and the Global Reporting Initiative (GRI).
Perhaps the most important distinction is that standards make disclosures auditable, frameworks do not. So while frameworks can serve as a guide to effectively structure your sustainability disclosures, narrowing in on standards is the best path toward making your ESG-related disclosures reliable.
Make the most of voluntary adoption
While adoption of - or alignment with - reporting standards is currently voluntary, this is changing fast. Trends in corporate sustainability reporting point to regulations obliging companies to disclose using specific standards and to have their disclosures externally assured based on these standards.
You don’t need to wait for that to happen to get ready. Even small steps to improve the quality of reporting on sustainability-related issues positions your company to better meet capital markets’ needs for decision-useful information, and increasingly, to meet regulatory requirements cresting the horizon.
For more ESG and sustainability-related information for Investor Relations professionals, check out the Irwin x Novisto ESG Toolkit for IROs: Part 1 - A Practical Guide to Understanding ESG and Part 2.
