ESG: made to measure

ESG is becoming a must-have for investors, and fund managers are under growing pressure to demonstrate their ESG credentials through accurate reporting based on high-quality, real-time data. So what reporting tools are available to them? And how are firms responding to client calls for consistent measurement?

Demand for environmental, social and corporate governance (ESG)-linked products has been gathering momentum for a decade now, but the pandemic, along with growing social unrest and a series of natural disasters, has pushed it to the top of the investor agenda.

Yet while investors are in agreement about its importance, reporting and regulation in the ESG space remain a complex challenge.

One of the issues, according to Victoria Gillespie, Head of ESG Services at JTC, is the absence of common standards.

“There is a real lack of universally adopted ESG reporting standards upon which companies and funds can measure and report their sustainability or their ESG metrics,” she says. 

“From a company perspective, this lack of standards adds to the confusion about what to actually report. Many don’t know where to start, which leads to lots of companies adopting a hybrid solution, where they look at combining tools such as the [ESG reporting tool] MSCI along with other frameworks.”

Time pressure

The challenge of ESG reporting is, according to Gillespie, further exacerbated by a lack of timely information.

“There’s no blame here, but what we’re seeing is that a lot of information is reported so far after the event that we’re always backward-looking rather than forecasting,” she says. “Once a company has identified what it wants to report on, often it can’t find the information to feed the metrics. 

“There’s also a lack of information available in the public domain, which can’t easily be identified by either data-rating agencies or directly by potential investors themselves.

"We don’t see many private equity houses communicating directly with the data-rating agencies. In an ideal world, that would happen a lot more to ensure a store of information that everyone could use.” 

She adds: “There’s also the lack of data-provider consistency. All these data providers are going out and sourcing data and using their own methodologies, but there is no overarching guidance and therefore a lack of comparability.”

When it comes to ESG-linked products, the information required by investors from a reporting and regulatory perspective is wide-ranging. 

Gillespie says SASB (Sustainability Accounting Standards Board) reporting and Principles for Responsible Investment (PRI) are becoming more widely used in the space.

“We’re also seeing investors ask more questions along the lines of: ‘Is the company carbon-neutral?’,’’ she adds. 

“If you’re dealing with a private equity house, you want to know that they’re doing what their portfolio is looking to achieve. Are they aligned from a cultural perspective to the service offerings they bring to market? 

“From an investor perspective, the story you sell needs to be believable and embedded within the products you sell. The two need to be aligned. This means companies need to provide substance behind any form of reporting. They need to be able to prove that they’re doing what they say they do. 

“The best way to do that is through party assurance engagements. These allow for credible sources and reviews, which ultimately feed back to the management company and also the investors. Companies can then tweak what they’re doing.”

Raising standards

For Mark Cleary, Interim MD Guernsey Funds and Director in Jersey at Zedra, today ESG is raised and prioritised by clients in a way that it wasn’t just five years ago. 

“I do have some clients who are completely ESG-focused, so each of their portfolio companies will have an ESG plan and will be expected to live up to certain standards,” he explains. 

“Depending on the type of company, it could be to reduce carbon emissions or it could be to make sure that there’s a 50/50 split between men and women on the board. 

“Every single company will also be given a target to achieve net zero by a certain date – so they’re really incentivised to make a positive impact on the planet while earning a return for their shareholders.”

Cleary believes the governance of ESG-linked funds is becoming even more essential as ESG issues further drive investment decisions.

“From the investors’ perspective, they don’t really see or hear anything about fund governance unless – and until – something goes very wrong in the fund, at which point fingers immediately point towards the boards of directors,” he says. 

“They then might ask what the directors were doing or weren’t doing, or what aspect didn’t get covered. It’s not only investors but also regulators who will start asking questions when things go wrong.

“The other angle is that directors have got a really important role in terms of the counterparties that their funds appoint. Whether it’s an administrator or a custodian or a bank – wherever there’s a touchpoint – ultimately, it’s the board of directors of the fund that are responsible for those decisions. 

“If they don’t pay due regard to those decisions, investors do have a right to question the appointment if and when something goes wrong.”

The challenges around reporting, particularly with regards to ESG, are multi-faceted. In fact, Victoria Gillespie believes the lack of common standards means some companies may be questioning the value of the data sourced by third-party providers compared with the cost. 

“The regulators and the market need to keep pace with the requirements of investors, and make sure that what’s been asked is relevant,” she says. “We’ve seen with some regulatory requirements that they’re just not practical in their application. 

“So, while the theory is great, the practical application doesn’t bring any value – and actually delivers a cost. 
 
“Whatever reporting guidance and frameworks we bring to market, they need to give ultimate value – financial value and ESG-aligned value as well.”

Tailor-made reporting

With all these challenges in mind, what tools are companies using to report on their ESG-linked products? And how are they negotiating the minefield of inconsistent and often delayed data?

“At the end of last year, we aligned our financial statements to the SASB framework and in the near future we’ll have to align our reporting to the TCFD [Task Force on Climate-Related Financial Disclosures],” says Gillespie. 

“For our clients, we do deliver some ESG-transparency reporting tools, tailored for various focal points and factors. 

“We listen to what the client is looking to achieve, who the audience is and the required timeframe, and then we offer solutions that support that strategy and meet the purpose. As part of this, we look at what data provider coverage is available.”

Gillespie continues: “If we’re working with a private equity house, for example, and they’ve got a number of private equity investments, we look at the coverage available and then we consider how to address any data gaps. 

“It could be talking with the underlying investor or investment company, or it could be applying ESG-specific scenario analysis, which would give us an output score. That might also be led by carbon reporting, for example.”

While she believes there are valuable reporting tools out there, she feels that often they either need to be tweaked or companies have to pull out what’s applicable to them, which can be difficult to assess.

She is confident, however, that the new frameworks being developed will in the near future fill the investor requirement and market need.

“The IFRS [International Financial Reporting Standards] Foundation is working on a new International Sustainability Standards Board, which we’ll be following closely,” she says. 

“We think that will give the markets a line in the sand in terms of where to start and what reporting to adhere to.”