ESG Reporting has Investors Interested in Sustainability
Explained: The Growth in Sustainable Investing
The global financial crisis of 2007–2008 is considered by many economists to have been the worst financial crisis since the Great Depression of the 1930s. Many business models that were considered to be risk proof, crumbled. As a result, it became imperative for investors to look at new risk factors affecting business – especially the long term risks associated with a business. Though sustainability, corporate social responsibility, triple bottom line concepts existed even before the crisis, these are assuming increasing importance in assessing the risk bearing capacity of business models.
With increased interest in sustainability by investors, the term ESG has been thrown around a lot. To better understand why ESG and sustainability reporting are becoming more critical, it is important to break down the term and understand why it is changing how investors value companies.
What is ESG?
Environmental, Social, and Corporate Governance (ESG) refers to the cost of inventing in a company, in the context of sustainability and ethics. This term was created as a way to outline specific understanding on the impact that a company has on the world. Almost everything in a business relates to each three components of ESG and the impact these factors have on the world.
- Environmental concerns include climate change and environmental impact.
- Social concerns relate to human rights, diversity, and consumer protection.
- Corporate Governance concerns relate to pay, management structure, and employee relations.
What is Sustainability Reporting?
Businesses can collect internal data and release a sustainability report that gives information about economic, environmental, social and governance performance. Investors can then use this data to determine which companies can be invested in responsibly.
Why is ESG and Sustainability Reporting Important?
Evidence suggests that companies with better ESG sustainability ratings are a better long term investment.
The past 15 years have seen explosive growth in the ESG defined investment market. Most of the world’s big banks now have departments and divisions exclusively addressing Responsible Investment; additionally new firms specialising in advising and consulting on ESG have emerged. The world’s financial markets have moved to provide ESG relevant ratings indexes, like the Dow Jones Sustainability Index, and the London Stock Exchange’s FTSE4Good Index.
The S&P 500 is a selection of large-cap companies most widely used as gauge for investors of large-cap U.S. corporate entities. There is more than US$7 trillion investments benchmarked to the S&P 500, with index assets of almost $2 trillion represented. The index captures more than 80 percent of available market capitalization. The G&A Institute monitors US corporations included in the index and analyzed the reporting practices of the constituent companies. In 2010 20% of S&P 500 companies were releasing sustainability reports. In 2016, 82% of the index was reporting -- only 18% of the 500 was not releasing ESG reports. This marks a drastic flip in the number of large companies reporting this sustainability data.
Space for Improvement
One of the challenges of ESG is measuring a company's impact. It is easy to look at financial filings and to determine a company's worth, but it is much harder to put a value on a company’s practices, like how they treat their employees or where they source their materials.
This relates to another issue with ESG, which is disclosure. Presently, investors rely on information that is provided by the companies themselves, which has the potential to be unreliable. So far this has worked well for companies and investors, but as sustainability reports become more essential, this data needs to be accurate. Because of the inherent subjectivity of self reported ESG data, many have proposed creating universal standards and a third party verification for the measurement of ESG factors. The International Organization for Standardization already has highly researched and widely accepted standards for some of the areas covered. Separately, the GRI Standards are the first global set of standards for sustainability reporting and measuring ESG.
As the number of companies reporting ESG data increases, and standards become more widely adopted, the importance of sustainability reporting will only grow in the future.