As more asset managers look to incorporate environmental, social and corporate governance (ESG) criteria into their investment decisions, the need to put those factors into quantifiable and comparable metrics has gained momentum.
However, putting solid numbers behind things like a corporation’s environmental impact or its policies around ethical supply chain management can be tricky. Several financial data providers collect corporate data around the factors, but their categories, definitions and methods of collecting the data vary. In many cases, the information needed is too scant to make a truly objective rating.
The Sustainability Accounting Standards Board, a non-profit consortium of academics and financial firms, is taking the most ambitious approach, creating a standardized set of criteria—specific to a particular industry—that they hope corporations will report to investors. They are pushing for these non-financial metrics of a company’s performance to be considered as useful to investors as traditional accounting ones, and to be considered as important by regulators.
SASB takes the stance that ESG disclosures fall under the Supreme Court’s definition of materiality for corporate reporting, and therefore are actually already required from companies, much in the same way that financial disclosures are considered material. Yet, to date, there is no SEC-recognized set of standards for how and what should be reported—unlike financial statements which must be disclosed according to the Generally Accepted Accounting Principles (GAAP).
“The law is appropriate,” said Janine Guillot, director of capital markets policy and outreach for the SASB. “What’s needed are standards for companies to comply with.”
Almost 70 percent of U.S. companies have disclosed—in some way, shape or form—on three-quarters or more of pertinent SASB sustainability topics, mostly due to investor pressure. But, the disclosures vary in quality and depth, often omitting useful metrics, which leaves investors with incomplete, incomparable information, according to a SASB report.
Third-party data providers, like Sustainalytics and MSCI, work to aggregate pertinent ESG data on companies and create ratings so investors can, ideally, make informed decisions with a wider breadth of information.
The methods of collecting the data vary. Some, like the Dow Jones Sustainability Index, are based on detailed questionnaires filled out by the companies themselves. Others, like MSCI’s ESG ratings, are based on existing reports, datasets from governments, non-governmental organizations and the media.
A ratings provider might look at corporate policies related to a pertinent ESG issue—such as how a mining company handles environmental management—to see how the policy is structured and if it’s enforced. Then they compare that company to others in the same industry, ultimately assigning relative grades.
But trying to quantify some issues that are inherently more subjective can make the process messy. “There is a wide spectrum of disclosure levels among companies in different markets, of different sizes, etc.,” said Simon MacMahon, head of research for Sustainalytics, which sets their own metrics around sustainability factors. “In addition, in ESG areas that are less mature, such as carbon, data accuracy can be a concern.”
Not only is the lack of third-party verification worrisome, but companies interpreting and reporting on their own actions can result in embellishment. For instance, is the carbon usage of an outside shipping firm that delivers resources to a company’s production plant factored into its carbon-emission score? Does the carbon use of a corporation’s subsidiaries get factored in, or out?
“The further you go down, the more ambiguous metrics become,” said Olga Emelianova, head of ESG research at MSCI, adding that the big question is really how the existing ESG data will affect economic output, which is something investors must determine for themselves.
“The good news is that the landscape is changing,” said MacMahon. “ESG issues are much more at the forefront for both investors and companies, and we are seeing a related improvement in both the quality and the quantity of information being disclosed.” Sustainalytics is used by Morningstar for its mutual fund sustainability ratings.
Many financial professionals with an ESG mandate subscribe to multiple research firms to get a high-definition picture of ESG opportunities and risks. Pax World Management, which offers numerous ESG and sustainable investing funds, subscribes to MSCI as well as Sustainalytics, for the sole purpose of taking in as much data as possible.
“We’re not slaves to their research. We look at the stuff and compare,” said Julie Gorte, senior vice president for sustainable investing at Pax. For her, the variable accuracy of ESG data is not unlike any other information incorporated into the investing.
“Sure, we have really good financial information, but that doesn’t mean it’s accurate,” Gorte said. “There’s a lot of wiggle room.”
There is also the question of the utility of the use of the ratings for investment managers who have their own sustainability thesis that differs from the data scorers.
“There's no shortcut,” said Garvin Jabusch, CIO at Green Alpha Advisors. “If you're interested in ESG investing, figure out what matters most to you, then do your homework.”
Jabusch says that ESG factors and factor weightings are useful for constructing indexes and determining ESG hierarchies of firms within an industry, but for active asset managers, they don’t do much to inform about what a business does or how it might be contributing to a sustainable economy.
For instance, Toyota Motor Corp. typically fairs well in terms of ESG scores, but its fleet fuel efficiency dropped from 2015 to 2016 and it doesn’t sell a plug-in hybrid or electric car in the U.S., which, for Jabusch’s investment thesis, disqualifies the car company as a sustainable investment option.
“There's not a snowball's chance I could learn that [information] pushing the S&P 500 through an ESG factor screen,” he said.
Jabusch sees the value of including “readily quantified” metrics, such as carbon emitted per dollar of economic value produced, but maintains that active asset managers will still find their own relevant criteria, which might not be included in the standard-setting initiatives.
Still, many ESG stakeholders believe that the pressure to release relevant ESG data in a standardized way across an industry may make it easier for firms to agree. “Those engagements will likely ameliorate friction or tension between investors and companies over ESG issues,” said Matt Orsagh, director, capital markets policy at the CFA Institute.
SASB wants all stakeholders to get involved in that type of prodding. The end goal for the organization, after all, Guillot said, is to improve the amount of publicly available information.
“The biggest thing is to make clear to the investment managers they use and the companies they may directly engage with is that they care about sustainability issues,” Guillot said. “[Let them know] that this is a value driver.”
