Why so many ESG reporting standards miss the point

A current study of ESG reporting by 4,500 US and European companies finds between 50 percent and 75 percent of 2022 ESG data reported was unnecessary to comply with regulations and satisfy the guidelines of relevant investment funds. 

Yet companies are outdoing each other in producing sustainability reports of 200-300-pages, which makes it difficult for investors to wade through the data noise.

The average listed company spends $675,000 annually on ESG data and ratings, with asset managers shelling out $1.4 mn, according to a survey by the SustainAbility Institute by ERM. This stands to increase as 92 percent of companies planned to spend 10 percent more in 2023 and 18 percent expected to increase their expenses by 50 percent, according to Bloomberg and Adox Research.

But many companies are finding it difficult to keep up with the onslaught of the roughly 2,400 ESG regimes in 80 jurisdictions. Why is the volume of ESG data being reported skyrocketing?

These are the key drivers:

• Governance regulation – Governance gained momentum with the Sarbanes-Oxley Act of 2002 in the US, reacting to accounting meltdowns such as Enron and WorldCom. The aim of governance was to help safeguard against non-transparent and fraudulent management practices that had incurred billions in losses for investors
• Environmental regulation – Popular and resulting political pressures to control pollution and climate change are the underlying drivers
• Social regulation – Inequality, poor work conditions and child labor, among others, are still cited as key reasons and categories in social regulation
• Regulation momentum and competition – While the above drivers are plausible, ESG standards organizations and governments such as the European Commission appear to be outdoing themselves in ESG regulation, generating an ever-increasing cascade of overlapping compulsory and voluntary directives
• Avoiding greenwashing – The multitude of ESG standards has seemingly encouraged greenwashing, which means misusing certain standards to paint a misleadingly positive picture of a company’s ESG performance
• Company competition – At least 10,000 large companies worldwide are outdoing each other in reporting more and more ESG data in sustainability reports in attempts to market themselves to investors, regulators and the public · ESG rating agencies – ESG ratings are a multi-billion-dollar market. Even so, a recent study by MIT with a subtitle reading ‘ESG data are noisy and unreliable’ reveals that the ESG ratings of the largest agencies have an average correlation of just 0.54, compared with credit ratings’ correlation of 0.92. This lack of uniformity in ESG ratings should make companies question their utility.

Last year, PwC’s survey of investors revealed that 81 percent are not willing to give up many financial returns for ESG. As such, companies should avoid the noise produced by endless and financially irrelevant ESG data. Investors focus on key performance data and find too much non-actionable ESG data detracting.

They would likely reward a shorter, more focused approach to ESG reporting along the following lines:

1) Comply with mandatory – and thus unavoidable – reporting regulations in your markets. Chances are that if you comply with EU guidelines, you will be covered for most other markets

2) Check which ESG standards are needed to be included in specific funds likely to invest in your company’s equity and debt

3) Avoid reporting endless data according to countless voluntary frameworks (‘noise’). If you are already collecting data according to such frameworks as GRI, use the data as inputs for point 4 below

4) Calculate and report the financial impacts of your company’s ESG efforts. Investors need to know key items such as ESG impact on cost of equity, company fair value, revenues and margins.

Dr William Cox is CEO of Yieldrive, a Fintech in Switzerland specializing in calculating ESG in dollars and cents