Still think environmental, sustainability, and governance investing is a niche market? Perhaps not.
In the last few years, a growing number of analysts, rating companies, and reporting services have been pressing companies to disclose their ESG initiatives, believing that such data offers a more complete performance picture than traditional, purely financial measures. For many, the proliferation of these requests has created a confusing and potentially risky landscape, making it all the more important that companies understand how to navigate the ESG investing community.
Even companies that don't issue such reports (still a large number of the total) are being tracked, rated, and ranked by investors, customers, and government agencies alike. “They're looking at you, analyzing your performance, whether you know it or not,” said Mike Wallace, director of the Sustainability Reporting Framework, GRI, during a recent Webcast on ESG investing trends.
ESG investing is now big business (trillions in total investment capital) and growing every day. Consider the following groups:
Principles for Responsible Investment. Established in 2006, PRI currently represents over $22 trillion in investment capital with more than 800 international signatories.
Carbon Disclosure Project. Established in 2002, CDP currently represents more than $71 trillion in investment capital, acting on behalf of 551 institutional investors.
Interfaith Center on Corporate Responsibility. Established in 1972, ICCR currently represents more than $100 billion with 300 members.
Investor Network on Climate Risk. Established in 2003, INCR currently represents $9 trillion in investment capital with more than 90 members.
Institutional Investors Group on Climate Change. Established in 2001, the organization currently represents $6 trillion in investment capital with 70 members.
Out of the growing requests for data, a number of research organizations have emerged that provide information to investors and rating firms about companies' ESG performance. Research done by Bloomberg, for example, looked at 20,000 of the most capitalized firms around the globe, and found that 4,500 firms in 52 countries disclose some level of ESG data.
“These are big companies making big decisions, and they want to communicate those efforts to the investor community,” says Curtis Ravenel, global head of the sustainability group at Bloomberg.
Ravenel said it is “surprising” that the United States, according to Bloomberg's data, has the most companies reporting, given that Europe, which ranked second, places such great emphasis on ESG reporting initiatives.
Ratings are, in part, dependent on public information, “so frankly, the single most important thing you can do if you want to do well on ratings across the board is become a better reporter.”
—Michael Sadowski,
Director,
SustainAbility
The Bloomberg ESG customer base indicates that the buy-side is the largest data consumer, with the plurality (32 percent) made up of investment advisers and broker dealers (12 percent). Other top users include universities (11 percent), corporations (9 percent), and hedge funds (9 percent). As might be expected, Equity Portfolio Managers and Analysts are the principal users of ESG data.
Bloomberg released its own ESG report for the first time in 2011 using the Global Reporting Initiative framework as its standard. Ravenel advised other companies to use the framework because it's so well known. “It does provide a very solid framework to address multiple stakeholders,” he said.
Rating Raters
Efforts also are underway to improve the performance of the raters themselves. For example, SustainAbility, a think-tank and ESG strategy consultancy, has set out a four-phase research project, “Rate the Raters,” designed to assess and improve the quality and transparency of such ratings.
SustainAbility Director Michael Sadowski said the research is being conducted due to the “great confusion over the many raters and ratings that are out there.” In addition, the community is only growing; just in last year, about another dozen rating programs have popped up, he said.
Sadowski explained that the first phase of the project involved taking a look back at evolution of ratings in the last 10 years; those findings were published in a report in May 2010.
In the second phase, SustainAbility released the research report “Taking Inventory of the Ratings Universe” in October 2010. The report inventoried 108 global rating programs, and more than 1,000 sustainability experts were drilled on a variety of questions to gain their perspectives on these ratings. For example, “Which ratings do you believe are most credible? What is it about those ratings that you find most credible?”
ESG DISCLOSURES SURGE
According to this chart from Bloomberg, there has been significant growth in the number of firms disclosing ESG data from 2005 to 2010:
Source: The Conference Board Webcast.
Among the key findings: rating programs use a large variety of methodologies, most of which are not disclosed to the general public. The study also concluded that “universal rating” (covering multiple issues, industries, and regions) prevails as the norm for establishing these rankings.
Furthermore, the more a company discloses, the better it is likely to score on ratings. Additionally, most ESG ratings are based on information that has been publicly disclosed by the company.
“We strongly recommend that companies prioritize those ratings,” Sadowski added. With 108 ratings agencies and growing, you can't just respond to every rating coming though the door, he said.
In the last phase of its ESG research, expect to launch this month, SustainAbility hope to “articulate what ratings need to look like in the future in order to be credible to have higher quality,” Sadowski explained.
In this phase, SustainAbility has been collaborating with companies and raters to discuss what useful, high-quality ratings would look like. The group is also exploring “big sticky questions,” Sadowski said, such as whether raters can also be consultants (a possible conflict of interest), and how raters can be more transparent without giving away commercially important information.
Managing ESG Demands
So how can companies ensure they get a good rating? Sustainability experts recommended a few things.
Ratings are, in part, dependent on public information, “so frankly, the single most important thing you can do if you want to do well on ratings across the board is become a better reporter,” Sadowski said.
ESG DISCLOSURE BY INDUSTRY
The following chart from Bloomberg Industry Classification (used during the Webcast) shows average ESG disclosure by industry:
Source: The Conference Board Webcast.
During the Webcast, sustainability experts also stressed the role of governance. In the realm of ESG, “it's hard to get the ‘E' and the ‘S' right if you don't have good governance,” Ravenel said.
ESG is ultimately about communication, transparency, separation of powers, and diversity, Ravenel said: “Governance shows how forward-thinking and how well a firm is managed.” That is the kind of critical information the investment community wants to know.
“Without sound governance, you won't have a company long-term,” Sadowski agreed. “I would also say you also can't have strong sustainability performance without proper oversight.”
Quite a few raters are asking questions around: Does the board have a committee that looks after these issues? What are the reporting lines? What are controls around these issues?
“The best thing you can do is report. Disclose and be transparent,” said Ravenel. “If you don't disclose, you're going to suffer more consequences. Sometimes if your transparent about your shortcomings, that can provide some cushion as opposed to if you don't, which can result in a bigger penalty from investors,” he said.
One final plea: “Please don't add to the ratings universe,” said Sadowski. Some companies are developing supplier ratings, for example. “Please look around and see what's been done before you decide to devise your own ratings.”
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