Sustainability disclosures are turning into tick-box exercises
An excessive focus on ESG reporting risks derailing efforts to deliver positive environmental and social outcomes, and companies and investors should focus on internal management practices instead.
With global assets under management invested in ESG strategies estimated to exceed $50tn by 2025, the spotlight is on disclosures to support those investments. But the way markets currently look at sustainability reporting raises two important questions.
First, are we focusing on reporting the information that matters most, and that provides the necessary context and clarity to guide users to make more informed decisions? And, second, is the somewhat evangelistic focus on transparency drawing attention away from other gaps that need to be filled? While reporting is important and necessary, it is insufficient on its own to drive change at the scale and rate needed for the move to a green and more inclusive economy.
Across the board, there is a lack of clarity on definitions and a lack of standardisation, which is creating confusion and conflation between different objectives and approaches.
One challenge is drawing a clear distinction between investment approaches and products that seek to maximise financial returns by considering ESG risks (requesting higher returns to compensate for higher ESG risks) and those focused on delivering positive environmental and social outcomes (including by reducing or avoiding negative outcomes).
Products and approaches also tend to be somewhat atomistic by design – drawing attention towards certain aspects, at the risk of losing sight of others that may be equally or more important, in effect, creating bias in investment decisions. There is also a lack of ex-post reporting to hold investment managers and product manufacturers to account in terms of their performance against their stated ex-ante objectives and intentions.
These shortcomings undermine market trust and confidence, and are fuelling increasing cynicism and claims of ‘greenwashing’ or ‘impact washing’. Whether intentional or unintentional, the effects on market trust and credibility are the same.
Another challenge is the adequacy of the information reported by companies and used by investors to make decisions.
Even focusing on investors’ risk/reward needs, ESG reporting has a number of challenges, as investors have long been lamenting. These include quality and completeness of data reported by companies, its usefulness to make investment decisions, and a lack of transparency on the methodologies of the ESG ratings third parties assign to those companies.
Reporting, more broadly, has its limitations. It is largely a backward-looking exercise; it is also often treated by companies as a compliance exercise, which can result in an approach that favours form over substance.
To drive a focus on forward-looking decision-making, sustainability and managing for impact needs to be integrated into internal management and investment decision-making practices – including in governance practices. This would likely also: improve the quality of external reporting; make external reporting more efficient; and reduce reporting risk, as organisations would develop more robust internal management systems and a single source of truth to generate multiple external reporting requirements from.
This is why we are calling for companies and investors to focus on their internal management practices using the SDG Impact Standards, which have been designed to support the UN Sustainable Development Goals. In this way, sustainability – and its links with long-term business performance – will be better understood and incorporated into companies’ everyday activities.
Sustainability is complex and cannot be solved by a handful of metrics and a box-ticking approach. We need to recognise these inherent complexities, and invest in strengthening the skills needed to collect, manage, interrogate, interpret and use the data to make better decisions that create better outcomes for all.
Fabienne Michaux is the director of SDG Impact, part of UN Development Programme's Sustainable Finance Hub