What’s keeping ESG rankings so convoluted?

With its recent acquisition of environmental, social and governance data analytics provider Sustainalytics, Morningstar Inc. is taking aim at the disparate ESG disclosure requirements still hampering the investment industry.

In a recent report, Morningstar sussed out some of the issues hindering ESG measurement tools. “Simply put, ESG disclosures from issuers are all too often inconsistent and non-comparable and material information is not always available.”

One key problem, it noted, is that ESG disclosures often cover different time periods than are released by other, more traditional financial disclosure companies. This makes it more difficult for institutional investors to clearly link ESG data with financial performance over a given timeframe and act on those connections.

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“For their part, public companies produce voluminous sustainability reports, but they often pick and choose indicators from a variety of standard-setting organizations,” said the report. “These reports may not contain information that is material given the firm’s business context and do not help investors meaningfully understand a company’s ESG risks while impeding comparisons between companies.

“Many of these reports read more like marketing documents than clear discussions of material ESG risk or areas of investment in green technologies, leading to some cynicism on the part of asset managers and financial advisors about sustainable investing in general. Environmental, social and governance disclosures need to focus on critical, material issues that are relevant to a company’s business strategy and products.”

As well, the report highlighted that ESG disclosures need to keep up with financial disclosures as they trend toward machine-readability. Further, looking globally, fewer than 30 per cent of stock issuers use a comprehensive and consistent method of ESG disclosure.

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Even so, in private markets, disclosure is even worse. More capital raising is becoming focused on private markets, said the report, noting that, since private issuances have minimal ESG disclosure, the role of examining ESG data for private companies will become increasingly important.

Inconsistencies are also problematic when analyzing fixed income ESG disclosures, it said. A bond’s ESG rating can be based on completely different concepts, such as the issuer’s ESG risk or the purpose of the capital generated from issuing the bond.

“Policy-makers need to be cautious about stifling innovation, but they also need to help investors by standardizing ESG disclosures to make them more comparable, material and useful. Regulators need to embrace third-party standard-setting organizations’ metrics for reporting ESG indicators, with an emphasis on material and forward-looking disclosures.”

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