Environmental, social and governance (ESG) criteria are being accepted as standards in making investment decisions about companies and their business practices by socially conscious investors. ESG data aims to present how a company performs as a steward of nature and society. This information helps increase transparency and accountability when looking at how companies manage projects or when considering possible long-term partnerships and/or costly investments.
Environmental data includes information regarding air quality, water and wastewater discharge, and greenhouse gas emissions, for example. Social data considers factors like gender, ethnicity, age and health, and allows for the consideration of social impacts, both positive and negative. Governance focuses on how an entity might be set up, including processes, policies, compliance, structure, culture and management.
Making stewardship determinations when advising on business transactions includes a review of corporate self-reported ESG data. While anyone can share anecdotes and create ESG tables, it is crucial to consider what the data actually means. How did it originate? How was it gathered? How was it monitored and measured? Has it been independently verified and what reporting procedures were used?
The challenge in making stewardship determinations is that ESG data isn’t standardised and can be gathered and reported differently, varying by region, market, business and even by departments within the same organisation. For companies, it is critical to make every effort to provide clear, accurate, and consistent data for interested parties internationally. It’s also important to adhere to international best practices for data collection and reporting, as well as to understand ongoing changes in the ESG data reporting space.
Regulators, ratings agencies, consultants, lenders and investors are all regularly seeking consistent and comparable ESG information. If/when the international reporting community demands standardised data, the requirement will reduce greenwashing, improve data clarity, allow for easier understanding and comparisons, and enhance monitoring of data over time.
Because ESG data is often not consistent, comparable or accurate across industries or countries, it is particularly difficult to determine which entities are truly good environmental and social stewards and makes it hard to assess what risks might be involved in an investment. Part of the problem to begin with is that there are many mixed reporting messages about what net zero actually is. Some corporations are aligning with Paris Agreement guidelines, while others are aligning with The UN Climate Change Conference’s 1.8 degrees Celsius target or other standards.
Getting on the same page regarding ESG and climate change standards is a challenge that many are trying to tackle. As an example, the CDP database is widely used globally to capture and document companies’ environmental transparency, performance and action. CDP endorses the Science Based Targets initiative (SBTi) net zero standard, and works to motivate companies, as well as cities, states and regions, to disclose their impacts on environmental and natural resources — and to take action, where needed, to reduce negative impacts. CDP uses a scoring methodology to incentivise entities to measure and manage environmental impacts through participation in climate change, water, forests and supply chain programs. Once an entity’s information is entered on the CDP site, grades are assigned. The challenge is not all international companies are in the database, so an apples-to-apples ESG comparison is rarely possible.
Another concerted movement globally to standardise ESG data is being spearheaded by international organisations such as the IFRS Foundation, which is a not-for-profit public interest group committed to developing a single set of high-quality, understandable, enforceable and globally accepted accounting and sustainability disclosure standards.
The IFRS Foundation Trustees established an International Sustainability Standards Board in November 2021. Since international investors with global investment portfolios are increasingly calling for high-quality, transparent, reliable and comparable reporting by companies on climate and ESG matters, this standard-setting board will help meet a pressing demand. Add to this, standardisation efforts by task forces on climate- and nature-related financial disclosures, and it’s easy to see where the future is headed.
Specifically in the United Kingdom, the government is committed to drafting a bill on corporate government reform. The government has also announced plans to refine the country’s audit and corporate governance framework by establishing a strong, independent regulator, the Audit, Reporting and Governance Authority (ARGA), which will provide better ESG oversight and call for more comprehensive corporate reporting.
While standardisation of data is being called for globally, it will take time and will not solve all ESG reporting difficulties. If standardisation is ever set in place, it will provide increased assurance to lenders and investors seeking to make large-scale investments, allowing them to more confidently incorporate environmental risks and opportunities into strategic planning, risk management and asset allocation decisions.
When considering transactions, wading through greenwash statements and trying to understand ESG data is a challenge, but experienced consultants can guide lenders and investors through this minefield. A knowledgeable transaction advisory consultant should be highly experienced at obtaining ESG data. It helps if the consultant has an internationally experienced team that can review ESG information and provide an independent opinion on the suitability and accuracy of the data. Beyond that, the consultant should be highly qualified in making informed opinions on ESG challenges and potential risk mitigation for given investments and/or capital expenditures.
Properly managing environmental, social and governance data and risks can help companies stay competitive during an age when environmental and social stewardship matter more than ever.