Despite immense growth in popularity this year, ESG remains a notoriously difficult area for many investors to navigate. The lack of universal standard for reporting on ESG themes creates space for issues such as greenwashing. Hannah Wright explores the challenges for firms reporting on ESG, and in establishing an international standard

2020 will long be recognised as the year which changed everything. The global health and economic crises have represented pivotal moments for governments, organisations and society. As articulated by the Green Climate Fund, the steps taken by leaders, from this point forwards, will either cement our dependence on fossil fuels or help us to forge a path towards achieving the goals outlined in the Paris Agreement and the Sustainable Development Goals (SDGs).

Within the financial sector, the importance of going green in 2020 has manifested itself in the rise, nay explosion, of ESG integration. According to the Investment Association published in November, responsible investment funds recorded net flows of £7.1bn ($9.5bn) in the first three quarters of 2020. This represents a 275% increase when compared to 2019. In fact, institutional investors are interested in ESG issues for all potential entities they invest it, be it equities or bonds, listed or unlisted.

Over the last decade, ESG considerations have transitioned from a peripheral concern to a core component of investment analysis across all asset classes. According to the London Stock Exchange Group, the numbers are promising; the Principles for Responsible Investment (PRI) manage around $89.7trn AUM, an increase of $67trn since 2010. Further research from the Global Sustainable Investment Alliance indicates that sustainable investment strategies now represent more than 60% of professionally managed assets for EU investors.

The analysis and reporting of ESG issues offer insight into the advantages and disadvantages for organisational performance. Prioritisation of such themes also helps position firms at the cutting-edge of the green transition. Outlined by the PRI, ESG integration does not necessarily require investing in a specific strategy or product, but the incorporation of such information in investment decision-making and stewardship practices. The ways in which investors practice ESG investing bears many faces, which subsequently influences industry-wide ability to measure ESG impact. Report and rating methodology vary tremendously from provider to provider.

Essential characteristics of ESG data

When reporting on ESG, it is often “hard to know where to start” says Hugh Stacey, executive director of investment solutions at IQ-EQ. “As a fund manager it is no use sitting on your hands, worrying about which metrics to track as selecting the right framework is not an easy process, especially without the right in-house ESG expertise. It’s better to choose a number of metrics and go for it. Until you do that, it’s going to be paralysis by analysis.”

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Highlighting the role of data in ESG reporting, Stacey continues: “The hard part is the collation of data as you must make sure it is clean and consistent.”

IQ-EQ provides bespoke ESG reporting for clients, predominantly fund managers, via an online platform – Cosmos. 

Stacey also revealed the firm are soon to launch Compass, which is the firms latest holistic ESG offering. “Outsourcing this function works well for many firms. ESG reporting is constantly evolving, and you don’t want to spend time hiring people, choosing a software, and getting to grips with everything because doing that from scratch is a massive undertaking.”

Firms utilising ESG data to inform capital allocation or investment decision-making must ensure their information is consistent, comparable and clear. Earth Capital is a firm specialising in advising on investments that deliver a commercial risk adjusted return and address the challenges of sustainable development. The firm’s sustainability impact is measured through the input of data into the Earth Dividend tool, which provides a consistent measure of the contribution to sustainable development.

Richard Burrett, chief sustainability officer at Earth Capital, explained the importance of this tool: “The Earth Dividend™ looks holistically at everything we do and provides a consistent measure of the contribution of our investments to sustainable development. We repeat the Earth Dividend™ process on an annual basis to identify areas where we can improve what our portfolio companies are doing. We only invest in businesses that have a positive impact overall. We want to understand both positive and negative impacts and be prepared to report on them. Unless you’re transparent on everything you do, it can easily lead to greenwashing. It’s a big allegation against so many investment companies – many only tell us the good stuff, not the bad.”

When asked whether he believes greenwashing is a major problem Burrett responds: “Globally, it is pretty clear that the investment world is not making investments focused on sustainability. We are heading in the wrong direction. An initiative like the PRI manages well over 50% of global AUM. But the reality is that not all these assets are entirely responsible. The PRI are aware of this and they’re trying to recalibrate their assessment of their members, because everyone seems to be performing well. Unless we can see demonstrable evidence that the investment is leading to positive outputs and decisions, the accusation of greenwashing will remain.”

In order to identify greenwashing, Burrett advises investors to look for robust evidence that ESG is genuinely being integrated across the whole portfolio. He concluded: “It is vital that we have a clear narrative about how they are going to protect value at risk in your portfolio, and what the future areas of investment growth are. This is where you would start to have a conversation about impact analysis.”

Towards a global reporting standard framework for ESG

The absence of a generally accepted international framework for the reporting of material aspects of ESG preserves the issue of greenwashing. The vast array of standards, frameworks and data requirements is daunting, and issuers may struggle to identify the indicators and standards which are most relevant, writes the LSE group. According to a report from the group, those most widely cited by investors are: the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), the Sustainability Accounting Standards Board (SASB), the UN Global Compact, the CDP, the Climate Disclosure Standards Board, and the FSB Task Force on Climate-Related Financial Disclosures.

As articulated by Barclays Investment Bank: “companies disclosing ESG credentials have multiple reporting frameworks to choose from. There is now strong demand for reporting standardisation from companies and investors. To this end, we believe the ESG framework launched by the World Economic Forum’s International Business Council (IBC) has a strong chance of rapid global uptake”. The WEF framework is aligned with UN SDGs and other global standards. It is not purely limited to factors deemed to be financially material and two thirds of WEF members at Davos 2020 said they were ready to embrace the initiative. The aforementioned Compass, operated by IQEQ, is built around the WEF standard. Stacey explains: “The WEF standard concentrates on 4 main areas: Governance, Planet, People and Prosperity. We follow their core metrics, which have 21 main data points across the 4 areas. We find that manageable for most of our client base. We think it’s better for people to capture a smaller number of data points well rather than a huge amount inconsistently.”

Bridging the ESG reporting standard gap

In attempts to fill the standardisation void, BNP Paribas Wealth Management (WM) established the clover system over ten years ago. The clover rating measures the sustainability level of all recommended financial instruments whether responsible or not. A consistent approach, with criteria adapted to all asset classes, to position the sustainability level on a single rating scale from 0 – 10 clovers. “Sustainable” begins at five clovers, which is the minimum for sustainable mandates and advisory.

Eleanore Bedel, head of sustainability at BNP Paribas WM, explained the benefits of the internal regulatory system: “The clover rating has enabled us to navigate an industry without standards for years. There are more standards now, but they’re not homogenous. In Belgium, France and Germany – they’re all completely different. If you’re a European investor, then you’re completely lost because you don’t understand the difference. That’s why we have a system that enables you to see all asset managers under the same lens, whatever country you’re from. They are all judged on the same criteria.”

Bedel highlighted her concerns surrounding an international ESG standard. “I would love for there to be one single standard for all asset classes, that could provide the same level of clarity that we have with our current clover mechanism. We built the mechanism because there was a void in the market, but it is also incredibly useful internally. It fits our needs; it fits every asset class and it allows us to have a portfolio view from our clients. If an international standard is issued in the future, it would have to be as granular as what we have in place now. It would need to cover all the asset classes. Even with this standard, we would likely continue with the clover system because of the granularity it provides.”

Sustainable intuition

According to Bedel, the only way to avoid greenwashing is to have informed investors that know how to ask the right questions. “Training is the issue with every asset manager and in every firm today. That is the most important part. This topic is huge. For a private banker to do their job properly, they must be trained to understand sustainability and what that means for their bank and the products they are selling. For an asset manager, it is their responsibility to know what it means to integrate sustainability into a fund, how they can assess ESG and how they can determine risk. This training must be adapted to the variety of roles, and it is not something that can be mastered in one or two sessions. That is why we need sustainability in universities. We need students to be trained on this topic so that it becomes second nature in the workplace.”

In order to bridge the knowledge gap, BNP Paribas have partnered with the Cambridge Institute for Sustainability Leadership. Bedel said: “We send a cohort of fifty individuals to Cambridge to learn about sustainability from the experts. It is one of the best trainings I have ever had. We have now sent four cohorts, and there has also been an upskilling of top management. We are trying to make sure that this knowledge and understanding is available to everyone.”

Whatever the future of ESG reporting, Burrett concluded: “we must work harder to prove that what we are investing in really is green. The fact that it’s green today does not mean it will be green in five or ten years. Firms must keep their fingers on the pulse. Otherwise you might find your investments that were doing well last year have suddenly been down valued. It really is a dynamic process.”