Statistics show that still too few companies report on their sustainability practices, and those that do are still not meeting the information needs of investors.
At the same time, as investors mature in their ESG integration practices, they increasingly want issue-specific information and quantitative performance metrics and targets, which only companies can provide. In the end, investors may hold the key to resolving this challenge, through continued engagement with reporting issuers on ESG disclosures.
2018 may very well turn out to be the year that ESG integration goes mainstream in capital markets. So much is happening all at once: increased focus on climate change and the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD); release of the Canadian Securities Administrators’ long-awaited Report on Climate change-related Disclosure Project (which, in our view, opens the door to better disclosure on material ESG issues in general); early signs of evolution towards impact measurement through the implementation of the UN Sustainable Development Goals (SDGs); growing competitiveness of ESG integration among asset managers in the wake of the exponential increase in UN PRI signatories; and more recently, the launch of the Canadian Expert Panel on Sustainable Finance.
These initiatives and market forces are pushing the envelope, no doubt, but we should not lose sight of – what is in our view – a key principle of responsible investment, which is to “seek appropriate disclosure on ESG issues by the entities in which we invest” (UN PRI Principle 3), and without which many of these initiatives will not succeed.
Working at the intersection of investors and public companies, we regularly hear from Investor Relations Officers that they are not getting ESG-related questions. While the roll-out earlier this year of ISS’s Environmental & Social QualityScore did succeed in drawing the attention of many management teams, are market participants any further ahead in having reliable, comparable, future-oriented decision-useful information? Have we perhaps narrowed our focus on climate change and carbon data a little too much, to the detriment of pushing for better disclosure of all ESG issues that are material to a company?
At Millani, each year we comb through the websites and reports of companies in the S&P/TSX Composite Index to collect statistics on their corporate sustainability reporting or ESG reporting practices. While we are seeing a slight increase in the number of companies reporting on ESG issues, there is still a lot of room for improvement in Canada, with only 39% of companies in the index doing so in 2018 (up from 36% last year). In comparison, 93% of the largest companies around the world report on their sustainability practices. For the mainstream investors to integrate ESG, there remains a need for more companies to provide ESG information.
Moreover, investors don’t just need more information, they need better information. Indeed, much has been said about the information disconnect between investors and companies, and how investors remain dissatisfied with the information they are getting from companies. In fact, we believe the information disconnect may be getting worse.
We are finding that as investors’ ESG integration practices mature, their focus is sharpened, they seek more company-specific explanations of how material issues are managed, more granularity. They also seek more raw data, such as key performance indicators on individual material ESG issues, rather than an aggregated overall or partial rating from third-party service providers. To be clear, these third-party providers serve a purpose in bringing information to the market, but they have come under scrutiny of late, and their sheer numbers and disparateness may also contribute to increasing the information disconnect. If we want to see a broad-based uptake of ESG issues by capital markets, there remains a need for reporting issuers to provide company-specific information and quantitative performance metrics and targets on their financially material ESG issues.
From working with companies, we know firsthand that they are aware of their material ESG issues – even though they may not call them by that name – and that they are managing them rather well. However, only if they communicate it to capital markets can they realize the inherent value of managing these issues well and generate the alpha that investors are seeking.
We believe investors already hold the solution to their need for ESG information, in the very expression of active responsible investment practice: engagement. By asking questions to the management teams about their material ESG issues, by requesting they publish information on these issues, and by clearly describing what information they need to have, investors can drive the change they want to see in corporate ESG disclosures.
Recognizing the appeal – and the pressure – in the responsible investment arena to embrace leading-edge practices that move the market forward and enhance competitiveness, we would simply advocate not to lose sight of the basics. As long as there is a need for more, appropriate, and quantitative data from companies, there will be a need for continued focus of engagement activities on ESG disclosures.