Most companies fail to report the impact of ESG issues on their financial performance.
The notion of CSR has been around for years, and its history goes back to environmental reporting. These reports were voluntary and boards paid little attention to them beyond a good-for-you attitude. As a result, none of this information was a meaningful part of regulatory documents filed with the SEC, such as the S1 and 10K forms.
Despite sustainable investment having been around as a concept for decades, it has only started growing in significance, popularity, and scale in the last couple of years. So, why has such an evolution taken place? What can companies do to communicate their ESG practices, which increasingly contribute to market capitalisation, more clearly?
Move from ‘nice-to-have’ to ‘need-to-have’
Things are changing rapidly. CSR has evolved into ESG reporting and is now almost mandatory; it’s only a matter of time before it actually becomes completely required. The attention around ESG-conscious companies is increasing, both within the private and the public investment community. Global sustainable investment comes in at over $30tn, which is a staggering increase of 1,000% since 2004 and 68% since 2015.
There is no correct way to deliver ESG reporting to a target audience. Still, there is much room for improvement to items that are lost in translation, such as which information is communicated by issuers, and which, as well as how, information is sought by investors, and why. Out of the ESG reports we have reviewed, we found that most of them looked like CSR reports, even the ones from large-cap companies with amazing graphics and tons of useful information.
There is a lot going on in these reports, enough for a reader to say ‘wow, great job!’. Still, that’s not enough to make a pension fund manager write a cheque. That’s because most reporters, having gone to the painstaking trouble of collecting and aggregating all the useful data, stop short of explaining the bottom-line impact on their financial performance.
What are investors looking for today?
Over recent decades, several studies have shown that besides the simple do-good notions of sustainability, companies that care about ESG do better operationally. They also tend to more effectively monitor and mitigate risks that scare the hell out of investors in SEC filings.
Knowing management and the board of directors must have mitigation strategies, and are proactively monitoring key risk factors, warrants a valuation premium for added investor peace-of-mind. A recent McKinsey article outlined results of more than 2,000 studies on the ESG-impact on equity returns, showing a 63% positive correlation.
As a result, investors that pursue ESG-centric strategies can enhance their returns on the same financial fundamentals by selecting companies that keep their affairs in order, with all other financial metrics being equal among their peers at any given moment in time.
Most investors, even if not specifically focused on sustainability, assign some weight to ESG and, while examining reporting components in sustainability reports, often ask… ‘so what?’.
Ensure investor-radar visibility
Portfolio managers know how to find companies with good investment metrics through experience and, often, software. However, scanning for companies with the magic ESG touch is not as easy. Rating agencies aren’t the answer for many portfolio managers because most companies, even publicly traded ones, have yet to start reporting it.
According to the latest OECD data from October 2019, out of the 41,000 listed companies in the world, only around 120 firms delivered ESG reporting according to the standards of the Sustainability Accounting Standards Board (SASB). Meanwhile, 5,000 companies have used the Global Reporting Initiative (GRI) for their reporting at least once, and a total of 785 organizations support the reporting guidelines of the Task Force on Climate-related Financial Disclosures (TCFD).
So, we can conclude that this reporting is still a very much uncharted, informal, and unstructured practice for most public and private companies. While many issuers are still coming to terms with the basics around ESG, investors are grading them at an advanced level. To compete for investor affections, companies need to meet a high bar of ESG compliance.
We recommend three steps to those organisations who are just starting their ESG journey. With these steps, they should generate more impactful results after reporting even minimal amounts to the capital markets audience.
Moving to quantifiable metrics
These steps are attainable in a relatively short amount of time, whilst at the same time delivering a learning curve for any issuer to secure its place on investor radars, and even while its internal team is still getting up to speed in its ESG practices.
- Understand reporting standards. There are more than half a dozen reporting standards, ranging from TCFD, GRI, Climate Disclosure Standards Board, CDP, SASB, UN Sustainable Development Goals, EU guidelines, and so on. Learning the difference between them and selecting one or two frameworks to follow should always be the first step.
- Understand material concepts. Determine which subjects are most material and most likely to have an impact on core business and the industry in general. SASB has an easy-to-follow materiality map that each corporate can rely on whilst answering detailed questions that SASB put together. In fact, there is a great deal of help from prominent institutions. As issuers develop their ESG practices, they should add items of lower materiality to their reporting, as well as other standards into their framework.
- Answer the ‘so what?’ question. Where possible, the quickest and most important remedy is, regardless of reporting subject, to relate each topic to a financial statement item or risk factor, and then quantify its impact. This simple step generates more lightbulb moments from investors, who currently have to spend time extracting meaning from lengthy ESG reports, before converting them into quantitative elements for their financial models.
Move away from inconsequential CSR; move towards an impactful ESG mindset. Regardless of the reporting maturity of corporate ESG practices, all capital market participants, both public and private, will appreciate a corporation’s ability to effectively connect the dots and demonstrate the additional value their business model brings through the power of internal ESG practices.