ESG Reporting A Quagmire But Regulation, Technology And Client-Centric Solutions Offers Hope For More Consistent Future

Partner Content provided by WM Nexus

ESG and impact reporting is a relatively new discipline facing increasing and sometimes confusing regulation but with growing innovation as well.

Delegates at the WM Nexus Impact Investing forum heard Gregory Chouette, COO at Landytech, Danielle Woolf, principal ESG consultant at Danesmead Partners and Frank Tobé, investor, board member at SuperNova discuss how to build investors’ trust in data and reporting.

The debate was chaired by governance and management consultant Niall Husbands, who asked how do investors find data they can rely upon amid an alphabet soup of acronyms and in what forms can data be provided to facilitate investors’ trust.

Chouette said that areas subject to regulation are growing dramatically.

He said the EU’s Sustainable Finance Disclosure Regulation is a big contributor to this. “From January 2022, you need to start tracking investments. You need to demonstrate they are in a framework by June 2022, and in January 2023, essentially you need to start reporting. That's the requirement. If you don't do that, this will have a major impact on your business. You can't operate in the EU market.”

Two worlds

He said that there are two worlds in terms of ESG and reporting – the big companies – Schroders, Blackrock – they have people doing ESG “all day”.

For now, the smaller operations, unless they have a specific interest, don’t care but they will have to.

He said family offices approach this from an investor’s viewpoint looking for something that fits with their values and avoids greenwashing but in terms of ESG frameworks, the task is really only beginning.

Tobé was cynical about the whole approach.

He said: “There are 350 standards. In practice, that’s a contradiction in terms, you can't have 350 standards. Then somebody else comes to say we're going to do the standard of standards. Now that’s 351 standards.”

He framed the two worlds a little differently. The financial industry has interpreted ESG as a risk management tool, which takes money and returns as a leading principle.

In contrast, amongst clients, there's a growing need and demand for value aligned investing where, “not returns, but the values represented in a portfolio are the leading principle”.

He warned that these drivers are constantly being confused with each other with a great deal of misunderstanding especially around ESG scores. That is exacerbated further because you get different scores for companies from different managers. “You ask why they are different, and you are told it is proprietary.”

Woolf conceded there are issues but suggested some of it was driven by financial services’ need for and even love of standards. “We love to be able to quantify things and measure things and predict things. But what we're trying to do is applying that approach to something that is really subjective. It's difficult to fit this ESG concept into our approach. What we really want is someone to say this is right and this is wrong. But that isn’t available. We have to start somewhere.”

She agreed that there are far too many standards. “Part of our work is trying to help our clients understand the difference between standards versus say organisations that are facilitating collaborative engagement.”

The panellists also noted the differences between a very far-reaching regulation such as SFDR and other regulators whose regulations focused on much simpler disclosure.

Chouette said he agreed that the user experience could be horrible in terms of understanding what factors and weightings were being used. However he said disclosure requirements are useful as you have “to put what you are doing on the table, you have to report, you have to be transparent and you have to give a granular methodology”.

He suggested one approach was to provide the factors but not necessarily doing the aggregation and letting investors create their own weightings.

Tobé agreed: “I would start with the client and asking him or her what the most important items are he or she wants to look at. That's different for everyone. Then base your report or the insights on outcome-based metrics. Try and do as little judging on this side as possible. No waiting, no scoring, no anticipating, no extrapolating - these kind of things are where it gets blurry.

“There are very concrete and good metrics that a company can be judged by.  Carbon footprint is pretty much set in stone. These are validated by external companies, you get your scope ones, twos and threes. It’s not perfect, but it's a pretty reliable outcome.”

He said another is percentage of women on the board. “You can call them and ask them are you on the board?”

He says there are list of what he called B-rate metrics say around biodiversity strategy. “Well you can hire someone to a role, but do they report well.”

For certain asset classes, the challenges are even more complex. For example, Woolf discussed the challenges of hedge funds in terms of the short and long side of trades particular around CO2 which some were simply netting off the short side from the long side.

She noted discussions by academics suggesting that if the hedge fund sector didn’t come up with a smart solution one was likely to be imposed.

Woolf added: “There's been a huge amount of focus on trying to prove this calculation, but it's really getting away from what actually needs to be happening, which is engagement with the companies to reduce the impact and not just sort of calculate your way out of it.”

Data with confidence

Husbands asked: “What can be done to make investors trust data with confidence when they allocate their capital to a ‘cause’?”

Chouette said: “It’s such a nascent industry. A lot of that data is being compiled right now and sometimes the quality is poor. But overall, I wouldn't be that dismissive. There are some companies out there that are doing great reports. It's very expensive. That is one barrier to entry. But some of the firms are doing a decent job.”

He added that there are more open-source providers and indeed firms looking at the blockchain to help provide validation and verification.

The panel then discussed the downside risks of greenwashing to share prices especially when they faced regulatory actions and even, in some jurisdictions, potential criminal action.

Tobe added: “It also requires the regulator to take a stance on what is a good company, and what's a bad company.” He notes that this is politically tricky, yet he believes investors will be patient while industry practice catches up. “What you're trying to capture is reality, stuff coming out of a chimney. Things that are infinite in motion, right? It's maybe a bit philosophical.

“Yet I think the blockchain can work. There are triangulation methods, satellite imagery to validate certain data points. You could even apply Wikipedia techniques edited in committee. That could be the same for ESG as well, unleashing the power of the masses.”

For now, the challenge remains, but with innovations, regulations and the power of investor pressure, solutions may well be on the horizon.

John Lappin is Contributing Editor at WM Nexus