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Global Divergence on ESG Metrics Poses Challenges to Financial Institutions

by M&Co. Staff

The 26th annual UN Climate Change Conference of the Parties (COP26 summit) is the latest event to spotlight climate risk and drive greater corporate commitment to ESG initiatives. A broad array of stakeholders—especially institutional investors seeking to make more sustainable investments—is demanding that corporations lower their carbon footprint. Complicating these interactions is the lack of standardization in global ESG reporting methodologies, a problem that is amplified across different global jurisdictions, including China.

All of this rolls up into a key communications imperative: As the various parties, private and public, involved in achieving common standards work towards a solution, companies will need to make sure they communicate their overall progress on ESG initiatives in a clear, consistent, and compelling way.

ESG Is a Priority

ESG remains top-of-mind for global investors. The PwC 2021 Global Investor ESG Survey found that 80% of those surveyed considered ESG an important factor. In fact, nearly half of respondents (49%) said they were willing to divest in companies that were not taking sufficient action on ESG issues, while an equal number also said they would not accept a lower return in exchange for ESG benefits.

At the same time, investors want to see more detailed reporting by companies on their progress of achieving their ESG goals. Only one-third of investors surveyed think the quality of ESG reporting is good, and 75% consider it important that reported ESG-related metrics are independently assured.

Standards, Standards Everywhere

Notwithstanding the work of standards organizations—such as GRI, IIRC and SASB—and the reporting frameworks that include GRESB and others, there is still frustration about the lack of uniform global standards. The result is an evolving patchwork of best practices and regulations that creates challenges for both corporations reporting on ESG metrics and investors trying to evaluate ESG criteria across a global portfolio of investments.

Key overseas markets are dedicated to transitioning to a green, low-emission, and climate-resilient economy; and the global carbon market is expected to grow significantly in the near term. China is one country that is expected to step up its efforts around ESG disclosures following a September announcement from President Xi that China aims to achieve carbon neutrality by 2060. One of the drivers behind that goal is recognition of the surge in global demand for sustainable investments. According to Traders’ Insight, the total AUM of ESG-related mutual funds in the domestic Chinese market reached a record high of US$31.6 billion at the end of 2020.

In order to achieve carbon neutrality and continue to capture inflows into ESG investments, China will need to enforce more rigorous ESG standards. In fact, a research report prepared by Principles for Responsible Investing (PRI) and SynTao Green Finance is recommending that Chinese financial regulators introduce a mandatory ESG disclosure framework, requiring all major companies to report on a series of standard ESG indicators and to supplement these quantitative metrics with related information on governance, strategy, and risk management of ESG issues.

As an international financial center, Hong Kong is in a unique position to play a strategic role as mainland China’s gateway and mobiliser of capital to facilitate the national carbon neutrality goal. For example, HKEX recently published a new ESG Reporting Guide that outlines minimum parameters for reporting as a means to assist issuers’ disclosures and communications with investors and other stakeholders. The Guide does not set out calculation/measurement methods for KPIs. However, the new requirements cover the description of targets for emissions, waste, energy use, and water efficiency, and the steps taken to achieve them. Companies also need to report KPIs and ESG information in a consistent way to track performance, establish a standardized ESG data management system, and set appropriate targets.

Although there is currently no formal, centralized ESG regulatory framework in the United States, there has been greater focus on ESG under the Biden Administration. One of the more significant actions taken by the federal government is the Executive Order on Climate-Related Financial Risk signed by President Biden in May.

The SEC is expected to play a central role in setting a regulatory stage for public companies’ disclosures. The SEC has introduced a myriad of actions over the past year to advance the ESG agenda, such as highlighting a greater focus on climate and ESG risk in its 2021 examination priorities and establishing a climate and ESG task force within its Division of Enforcement.

Avoid Communications Missteps

The differences between emerging ESG disclosure practices and the ESG frameworks embraced by Europe, North America, and Asia-Pacific need to be acknowledged. Eddie Yue, Co-Chair of the Steering Group and Chief Executive of the Hong Kong Monetary Authority, phrased it succinctly when he said, “The lack of globally aligned standards, as well as capacity and data constraints, are hindering the growth of green and sustainable finance, not just in Hong Kong but also globally,” in a statement issued by the MPFA’s Green and Sustainable Finance Cross-Agency Steering Group.

That point was reinforced in a recent report from S&P Global Market Intelligence that said confusion around ESG reporting standards could impede growth in what has become a rapidly growing global market for sustainable investing. According to the Organization for Economic Cooperation and Development, sustainable investing accounted for $30 trillion in assets under management in Australia and New Zealand, Canada, Europe, Japan, and the U.S. at the end of 2019. Report authors noted that investors are unable to properly assess a company’s ESG performance and pinpoint material risks because of a lack of standardized data.

This lack of standardization around ESG disclosures also poses significant challenges to institutional investors that are trying to clearly communicate to regulators and clients their approach to ESG investing. Local and regional asset managers in APAC are grappling with this perpetual evolution on standards, reporting and how to communicate these to a client, existing and potentially new.

For example, Hang Seng Bank, a leading local bank in Hong Kong, aspires to become known for its ESG offering in the banking industry. To achieve this, the bank is stepping up consideration and inclusion of ESG issues with respect to its products, services, operations and disclosures. In particular, it focuses on sustainable finance that addresses one out of many major and urgent challenges of climate change. Hang Seng Bank’s contribution to tackling issues that require a global response has made it the only bank in Hong Kong that is a constituent of the Dow Jones Sustainability Asia/Pacific Index and FTSE4Good Developed Index.

Communications strategies also have to be careful to avoid “greenwashing” ESG performance. Major financial entities, such as BlackRock, have come under fire for in recent years for greenwashing when its communications in support of sustainability have not matched up to its actions. Barron’s reported that BlackRock supported only 13 percent of shareholder proposals on green-oriented resolutions in 2020, down from 20 percent in 2019. Though BlackRock signed on to Climate Action 100+, a global investor engagement initiative, the company supported just two of 12 resolutions presented by the coalition.

A major risk with the whole sustainability issue is that “it’s kind of been kidnapped” by a strong interest to just earn money and not actually deliver sustainability, said Erik Thedéen, Chair of the task force on sustainable finance within the International Organization of Securities Commissions (IOSCO) and current Director General of the Swedish Financial Supervisory Authority. “There’s a clear risk that you get a labeling of things that are not in line with the actual content of the financial product.”

Thedéen recently shared his insights on the role regulators can play in bringing more clarity around ESG within financial markets during the first virtual event for the Bloomberg Sustainable Investing Summit, “Driving Global Standards on Sustainable Finance.” IOSCO’s task force is currently engaging in roundtable discussions and distributing questionnaires to better understand the risks of greenwashing and what information within disclosures from mutual funds and other financial products might mislead investors.

Lack of standardization creates communications risks for all companies when reporting on ESG goals and progress to stakeholders, and those risks multiply for global institutional investors reporting across a varied regulatory landscape. The cornerstone of a strong ESG communications strategy is to understand the regional nuances around a thorny topic like ESG that also ties into a broader global perspective. Otherwise, there is the risk of contradiction in your communications that will bring greater scrutiny from the regulators, media, and clients as skepticism around ESG reporting standards grows. Communicating effectively, and transparently, about your progress with ESG is the only viable approach to take as standardization progresses. Real leadership is showing a commitment to achieving real outcomes with ESG, regardless of how long it takes to have the world as a whole moving in lockstep on creating a single system for measuring success.

Contact us for help in communicating your ESG story to stakeholders.