Environmental, social and governance (ESG) issues affect companies in some way, and understanding the related risks and opportunities is key to any investment case.
However, the systems for producing, distributing and consuming ESG data are less mature than those for financial data, which poses a challenge to integrating this data into investment models. Improving transparency on ESG risks and opportunities is one of the Financial Reporting Council’s (FRC) objectives as part of its role as an improvement regulator. With this in mind, the FRC Lab carried out a project on ESG data, with the first phase looking at how companies produce the data, and the second phase identifying how investors collect and use the data. Across both phases, from our interviews with participants we noted three common elements for understanding the company and investor perspectives and were the basis for the reports:
- Motivation: why is the data collected?
- Method: how is the data collected and processed?
- Meaning: what is the data used for and how does it influence decision-making?
The ultimate objective of both reports is to help companies improve their practices and the quality of their ESG data so that it can be more effectively used for their internal strategic purposes as well as by investors for their decision-making.
What can companies do to better meet investor needs?
Investors encounter difficulties in using ESG data effectively because it is not of the same quality as financial information. As a result, when it comes to producing ESG data, companies are recognising that they need to bring it to an equal footing as their financial data by applying similar rigour and controls. Increasingly, ESG data is not the sole remit of sustainability teams, but it is being integrated into the responsibilities of finance teams. Internal audit teams are also more involved to help with testing methodologies and applying controls over the data, including evidence trails, reviews and sign-offs. The Lab’s report encourages companies to more widely adopt this approach.
Similarly, companies should not treat ESG data just as part of an annual reporting cycle but instead should integrate it in regular processes and embed in the company’s culture to truly benefit from it. ESG data can help management understand their company performance and impact, risks and opportunities, progress against commitments and what action they need to take. Investors then expect to see this understanding reflected in companies’ reporting.
The Lab encourages companies to use their annual report to communicate their ESG priorities and those issues which impact their performance, business model and strategy. Companies have multiple ESG data requests from various stakeholders, but the annual report should not be the vehicle to meet all the different demands – it should focus on what is material to investors. Instead, a datasheet can be a helpful one easy-to-find repository for the many data points that companies need to complete to address questionnaires, data providers’ queries and reporting against different frameworks such as SASB and GRI. Some companies are also mapping their ESG data to the Sustainable Finance Disclosure Regulations (SFDR) and Principal Adverse Impacts (PAIs) within their ESG datasheets. Companies recognise that investors often rely on third party data providers to obtain quantitative ESG data in an aggregated manner, and therefore anything that facilitates that process, including clarity and consistency of location of data, will help with getting the right data to the end user, i.e. their investors.
How can investors help companies?
The demand on companies for providing ESG data can pose many challenges, but there are some steps which investors can take to help improve the quality of ESG data they receive from companies:
- Use your influence with data providers to help improve their processes and the quality of reported data. Companies often struggle to engage with data providers particularly where they note errors in the data. As clients of the data providers, ask for clarification of data points which seem out of line and encourage the data providers to correct any errors you detect.
- Engage with your portfolio companies on which ESG matters you consider to be priorities and expect the companies to discuss their impact within their narrative reporting. Use meetings with management to discuss progress on those issues.
- Consider the burden on companies when sending questionnaires to them. Rather than asking companies to respond to surveys from individual asset management firms, consider if it is possible to coordinate your approach through an initiative or an investor group.
- Take a proportionate and more engagement-based approach with small companies which do not have the same resources as larger companies to produce ESG data and may be unfairly penalised by data providers for missing data points.
The findings from both phases of the Lab’s ESG data project can be further explored in the data production report and the data distribution and consumption report. If you are interested in discussing these topics or any other work of the Lab, email us at FRCLab@frc.org.uk
Marie Claire Tabone is a Project Manager in the UK Financial Reporting Council (FRC) Lab. The Lab aims to improve the value of corporate reporting by facilitating discussions on reporting topics between investors and companies. Marie Claire is a qualified accountant and has specialised in corporate reporting, particularly on sustainability-related topics, and investor engagement for the last 7 years. Previously, she worked in audit in London, the Channel Islands and Malta.
Disclaimer: The views expressed in the blog are those of the author and do not necessarily represent the views of CRUF participants.