Investors are increasingly recognizing the multi-dimensional nature of the modern bottom line. Beyond quarterly earnings and annual revenue, there is mounting evidence that long-term returns may best be calculated using a company’s environmental, social and corporate governance (ESG) metrics.
“Savvy investors tell me that the corporate governance metrics are the best long-term indicators of healthy corporate performance,” Evan Harvey, Director of Corporate Responsibility for Nasdaq, says. “The more proactive a company can be in measuring and publicizing performance in that area, it seems to pay dividends.”
A reluctance remains in the investor sphere to implement investment strategy based on ESG factors despite the long-term pay-off; fulfilling short-term returns based on the bottom line remain a dominant hesitancy.
However, the globally successful 21st century company balances the many aspects of governance to create a sustainable corporate strategy that considers not only monetary returns, but ESG practices in relation to long-term company value. As $30 trillion in assets moves from the current to younger, more sustainably oriented investors, an increase in SRI has incentivized companies to implement more comprehensive ESG reporting measures.
“Leading companies internalize their material externalities by quantifying environmental and social impacts in financial terms and examine these alongside financial reporting,” Robert Dornau, Director of Sustainability Services at RobecoSAM says. “As a result, the company’s true value appears quite different, and other issues besides financial emerge as value drivers.
THE NEW STANDARD
Nelson Switzer, Chief Sustainability Officer of Nestle Waters North America, has recognized a familiar pattern in annual reporting over the last 10 years: 3 to 10 pages of ESG data and risk management prefaced by a commitment from the company’s CEO in the opening letter. Lately, however, we’ve seen the emergence of integrated reporting to bring context and confluence to these ESG metrics.
“It has now become the standard, but the distinction with the integrated report is really where you have now woven in all of those factors that actually influence your performance into each section,” he explains. For example, he offers, the integrated report shows how a reduction in greenhouse gas impacts profitability, logistics, the supply chain, the value chain, etc. He believe this integration is “one of the most potent and powerful things a public entity can do.”
Identifying key stakeholders and their demands may be the first step, but synthesizing corporate ESG data in an efficient, easily digested fashion satisfies the growing demand for more proficient environmental, social and governance reporting.
“Attention around the way a company identifies, evaluates and invests in ESG areas is growing from multiple directions: investors, policy makers, regulators, customers, business partners, employees, among others,” Kristen Sullivan, a Partner and Sustainability Risk Advisory and Assurance Services Leader of Deloitte & Touche LLP says. “Companies increasingly need to expand the lens through which they define their key stakeholders and capitals on which they depend, beyond financial capital, to drive long-term value.”
As ESG metrics become standard aspects of corporate reporting, stock market exchanges are developing designated ESG indexes specifically designed to assess listed companies in terms of environmental, social and governance performance.
“As market operators, and stewards of public trust when it comes to a level investment playing field, exchanges use a variety of means to create ESG transparency—and, ultimately, better ESG performance,” Harvey says. “Some stock exchanges have a listing rule related to ESG disclosure; many others, like Nasdaq, emphasize a program of voluntary participation.”
The S&P 500 ESG Index saw 14.52% total returns in the 2016 calendar year, 2.56% higher than the S&P 500 as a whole.
A number of ESG reporting frameworks around are being generated by stock exchanges around the world, including the Qatar Stock Exchange, the London Stock Exchange, and the Singapore Exchange. Nasdaq Nordic published the ESG Reporting Guide earlier this month, which provides a framework of ESG reporting standards for listed companies.
These frameworks provide a set of standards for companies to adhere to in the reporting process. Switzer says that there have been a few emerging trends in corporate reporting, including a “gross consolidation” approach to ESG reporting and companies have been able to report in a way that is “engineerable, or even re-engineerable.”
“Not too long ago, people would technically just put out a number—a series of numbers—and it was difficult to do analysis on those numbers because you couldn’t reverse engineer them,” he explains. “You’re seeing more and more organizations recognize the ability now to take that information, pull it apart and put it back together. They’re being more transparent.”
THE MATERIALITY DEBATE–OVERCOMING REPORTING OBSTACLES
Traditionally, the issue for management and investors alike lies in the materiality debate when it comes to corporate ESG practices.
According to a survey conducted by the Chartered Alternative Investment Analyst (CAIA) Association and Adveq, the biggest hurdle to ESG incorporation is a lack of standardized, comparable data on material sustainability issues (cited by 69% of respondents).
By effectively identifying the aspects that have the greatest impact on a company’s drivers of value and reporting them in a compelling, comprehensive way to stakeholders, the required level of transparency to maintain effective engagement is achievable.
“Only once an organization has determined its material sustainability impacts (through extensive stakeholder consideration) and mapped those impacts to business value drivers, can it look to the multiple sustainability standards and frameworks to guide credible, reliable disclosure,” Sullivan explains.
Other issues cited by the CAIA survey include managing varied constituency requirements (44%); finding suitable investments (44%); and a lack of ESG-dedicated resources (42%).
“As a first step, every company needs to realize that they cannot simply look into the mirror,” Robert Dornau, Director of Sustainability Services at RobecoSAM explains. “They need not only to understand what the most material aspects from the company’s perspective are, but also from the perspective of their stakeholders (customers, employees, etc.).”
There has been a major increase in company report requests, according to MSCI, one of the largest providers of ESG information to the global investment community. Over the last year, there has been a significant increase in outreach and substantive feedback to their array of ESG research and analysis tools, which may suggest the beginnings of a positive feedback loop, Linda-Eling Lee, Global Head of ESG Research of MSCI, explains.
“Corporate issuers recognize that their shareholders are paying attention to ESG research and analysis on their company when making investment and engagement decisions,” she says. “They are now more motivated to understand the analysis their shareholders are using and what information and methodology underlie the analysis.”
More than 90% of the world’s largest companies report through the Global Reporting Initiative (GRI), a total of 1,614 financial services firms have signed the Principles for Responsible Investing, and 9,146 companies have signed the UN’s Global Compact—not out of obligations in law or regulation, Jon Lukomnik, Executive Director of the IRRC Institute says. “Simply put, sustainability is now rooted in business and investing strategy.”
“Companies still on the fence need to understand that ESG reporting is in fact about linking intangible issues of strategic importance with your company’s business case,” Dornau says. “It is not simply about reporting a company’s operational efficiency numbers or having nice procedures in place.”
THE PACE OF TECHNOLOGY AND THE CORPORATE TIMELINE
With a global rise in sustainability technologies, social justice reforms and modern governance strategies, a rise in corporate ESG practices are anticipated and encouraged by stakeholders across the board.
According to The Better Business, Better World report published by the Business and Sustainable Development Commission this January, incorporating goals for sustainable development into business core strategies will unlock USD $12 trillion new market opportunities across four economic systems: food and agriculture, cities, energy and materials, and health and well-being.
“Agriculture has been always in the heart of important transformations—the Agricultural Revolution, for instance, represented a new phase for our society,” Gabriela Burian, Sustainable Agriculture Lead of Monsanto Company says. “Lately also in the agriculture sector, digital technology has been adding optimization and smarter choices that are enabling smarter solutions. It’s time now to integrate smart agriculture to create new solutions that can add value to the environment ensuring its integration into our economy.”
In a webinar aired by Advanced Energy Economy (AEE) this month titled “State of Advanced Energy—Markets, Trends, Jobs,” the advanced energy market was valued at $1.436 billion in 2016, more than both the apparel and airline industries. AEE’s analysis of the Department of Energy and the Bureau of Labor Statistics also showed that there were a total of 3.3 million advanced energy jobs last year.
In 2015, renewable energy investments matched that of developed countries for the first time in history, according to the Mercatus Global Advanced Energy Insights Report.
MSCI’s 2017 ESG Trends to Watch report shows that among Asian companies, communication rates across all MSCI ESG Research products nearly tripled between 2014 and 2016. Lee believes that this trend may be attributed to the adoption of stewardship codes and an increase in attention toward ESG investment in the Asian region.
“Investors in emerging market companies have traditionally had less information about the companies they invest in compared with their peers in developed markets,” she says. “In a market like this, financially relevant ESG factors can help differentiate the leaders from the laggards.”
A global survey by State Street shows that ESG reporting obstacles are lessening, and companies are increasingly recognizing the need for ESG integration.
“The decision to become more transparent about those data points—to tell an investor just how much carbon the company uses, or how it encourages diversity and inclusion in the workplace—often involves a bit more soul searching,” Harvey says.
Still, a lack of standardized quality data continues to challenge many companies in their pursuit of transparency. According to Sullivan, the pressing need sustainability reporting has reached a critical point.
“My message to companies is this: The stakes are rising, and so is the urgency with which companies need to be focusing on the sufficiency and accuracy of sustainability reporting,” she says. “From policy and international accords to legal and heightened regulatory attention, to stock exchanges and proactive business response, indications continue to point to the importance of sustainability disclosure driving business value and financial performance.”