Investors have an important role to play in confronting climate change risks, but to exercise the power of sustainable capital allocation, they need easy access to more data and better insights.
- As the global shift among companies towards decarbonisation continues, the importance of disclosing emissions data has never been greater.
- ESG focused investors argue that sustainable investment approaches are financially attractive.
- High-quality data helps investors develop sustainable investment strategies and to assist them in focusing on particular environmental goals and themes.
This content was paid for and produced by LSEG in partnership with the Commercial Department of the Financial Times.
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Companies worldwide face more pressure than ever to be transparent about their decarbonisation plans and emissions data, including indirect impacts via their supply chains and product life cycles.
New disclosure regimes are coming into force in multiple territories. In part, this pressure reflects the need for accountability: stakeholder groups including owners, customers and employers are demanding more robust information about corporate real economic impacts.
Better corporate reporting also helps investors to direct capital and finance the journey towards net zero.
Reporting on environmental impact
Corporate reporting on environmental impact should go hand in hand with financial reporting, argues Eric Hespenheide, interim CEO of the Global Reporting Initiative — the international organisation that promotes common standards for such disclosures.
“We advocate for a comprehensive corporate reporting system, with a two-pillar structure in which robust sustainability and financial reporting are on an equal footing,” Hespenheide explains.
Progress is being made.
At a supra-national level, for example, the influential IFRS Foundation has just announced the launch of the International Sustainability Standards Board (ISSB), which will develop a global baseline of sustainability disclosure standards to ensure that investors have access to better and more timely ESG information.
“To properly assess related opportunities and risks, investors require high-quality, transparent and globally comparable sustainability disclosures that are compatible with the financial statements,” says Erkki Liikanen, chair of the IFRS Foundation.
It has committed to finalising its baseline standards by the end of 2022, raising hopes that a single sustainability reporting framework will soon be available.
Why do investors need better quality data?
Better quality data will help investors to develop more sustainable investment strategies and focus on specific environmental goals and themes. However, while a minority of investors may have the confidence and resources to interpret the data for themselves, most are likely to tap into metrics or scoring services generated by third-party providers.
One such provider is Refinitiv, an LSEG business, which provides comprehensive ESG data and solutions across asset classes, including a scoring process that derives relative scores from the underlying, reported data for individual companies.
The environmental data is grouped across three themes: emissions and waste; resource use; and environmental innovation.
The importance of different environmental metrics varies across industries, so such scores need to reflect the materiality of every metric to the industry concerned.
The role of sustainable capital allocation
“ESG metrics give managers another view into their investment strategy,” explains Elena Philipova, of Refinitiv. “Capital allocation will play an important role in helping economies reach net zero, but allocators of capital need materially relevant metrics to optimise their investment and financing decisions.”
For example, recent analysis of how emissions scores have changed over the past four years sought to identify which industries are performing most strongly on this issue and how performance is changing over time.
It found that while the financial sector has the highest number of companies with an emissions score, real estate businesses have improved their score most markedly and that utility companies have the highest average score.
Different investors will use such data in different ways, Refinitiv’s Philipova adds. “The data points that are most pertinent to investment decisions may differ based on whether you are using them to support risk management, to drive the search for an alpha generation or to focus on social or environmental impact,” Philipova says.
These are not necessarily mutually exclusive objectives. Indeed, data suggests companies that score highly on environmental metrics frequently deliver superior returns, particularly on a risk-adjusted basis. For example, in the case of emissions scores, companies with higher scores not only delivered higher absolute returns in Refinitiv’s analysis but also did so with less volatility.
Supporting the UN SDGs
In a broader exercise, based on analysis of environmental, social and governance (ESG) factors, Refinitiv looked at how portfolios of businesses constructed with the aim of supporting the 17 United Nations Sustainable Development Goals (SDG) would have performed compared with the rest of the market.
Again, the data suggested no compromise on investment performance was necessary – and in some cases, the SDG-aligned portfolios outperformed on a risk-adjusted basis.
Such findings support ESG-focused investors who argue that ESG investment approaches are not only ethical but also financially attractive. But they also underline the connection between the financial performance of a business and its ESG credentials, reinforcing the importance of reporting and disclosure regimes that focus on both.
However, that means more than simply reporting on sustainability matters that affect the company financially, warns the GRI’s Eric Hespenheide. “Disclosure on a company’s financially material sustainability topics is not sufficient to deliver full transparency,” he argues.
As investors seek to build a full picture of the businesses to which they might allocate capital, they will continue to demand more varied and granular information.