ESG Investing Will Not Grow Successfully Without Global Data Standards And Regulations, Says OECD

The interest and growth in sustainable investing is an area that appears to have gained greater momentum since the COVID-19 crisis. The buzz in political and business circles is all about making our society more resilient and better equipped to deal with global crises.

It is as much about your personal health, as it is about the health of your wealth, and the health of your community, the company you work for, the government, and our planet. As important, it is about making our global village more resilient to crises that affect us all.

Last week, the OECD released its 2020 business and finance outlook report, Sustainable and Resilient Finance. The reports delivers a consequential and timely conclusion: ESG scoring and reporting has the potential to unlock a significant amount of information on the management and resilience of companies, but will require agreed global data standards and regulations.

The report cites that over $30 trillion in recent years has poured into sustainable investments in some form of Environment, Social and Governance (ESG) investing. More than twenty-five percent of publicly listed companies around the world are now ESG measured and rated, with the larger share of these companies in the U.S.

Share of market coverage by ESG scoring companies by region, 2012-2019

The growth of ESG investment can be attributed to a number of factors but ultimately it is investors of all shapes and sizes demanding that investment managers put their money to work, not only to deliver a risk adjusted financial return, but also to ‘do good’. Investors are now choosing to invest in companies that reflect their values and goals. Three-quarters of individual investors worldwide and 71 percent in the U.S. say it is important to align their investments with their values and ethics.

A company that delivers stellar stock performance but pollutes the environment, treats its staff poorly, and does not employ a diversified workforce that reflects its market demography is a stock that increasingly investors are choosing to shun.

And it is not just investors focused on the explosive growth of ESG. In his recent letter to CEOs, Larry Fink, the chief executive officer of Blackrock
, references a recent study asking corporate leaders to identify the primary purpose of public corporations. 63 percent of respondents said ‘improving society’ is the primary purpose over ‘generating profit’.

The top five ESG investment areas to date are:

1.   Climate change/carbon

2.   Fossil fuel divestment

3.   Sustainable natural resources/agriculture

4.   Gender equality

5.   Clean water/water scarcity.

These top areas tell us that the ‘E’ in ESG is often more of a focus that the “S and G”. Statutory carbon targets will be implemented in Europe by 2030 as the planet moves from fossil fuels to cleaner and renewable energy sources leaving these old carbon-based assets ‘stranded’. Plastic in the ocean has recently attracted a lot of global attention due to the alarming rate at which we appear to be dumping plastic in the ocean.

Regardless of where you sit on ‘the climate issue’, dumping tons of carbon into the atmosphere and polluting the oceans is inexcusable, especially if the offenders are companies with whom your pension is invested.

Gender Equality, and Diversity are important measures to both ‘S and G’ and are focused on ensuring our governments, companies and community agencies reflect the diversity of the populations they serve and or profit from. The Black Lives Matter campaign has shone a new and very bright light on a range of issues in this area. Numerous surveys show that in general three-quarters of women investors are interested in engaging in ESG investing which will help drive some of these factors.

In the paper, ESG Investing, Myths Versus Reality, Dr. Margaret Towle, an ESG investing specialist, draws attention to the growth of intangible assets on company balance sheets which play an important role here.

“In 1975, tangible assets such as real estate and equipment represented 83 percent of the value of the S&P 500, and intangible assets represented only 17 percent of the value of the S&P 500. Today, the situation is reversed, with intangible assets representing 84 percent of the value of the S&P 500 and tangible assets representing only 16 percent of the value of the S&P 500. In fact, the value of intangible assets is five times greater than tangible assets for most industries,” cites Towle in the paper.

The growth in importance of non-financial data and how the data is harvested, processed, measured, and reported to investors is one of the biggest issues with ESG investing that is concerning policy makers and regulators alike. What is clear is that something very important is going on here, and with greater numbers of investors now looking at ESG investments, the OECD report findings shine a light on why policy makers and regulators should be concerned about ESG data measurement.

Selected ESG ratings and credit issuer ratings by sector in the U.S. in 2019

The report analysis points to the vast distribution of performance in ESG ratings by different Providers for the same companies, across all sectors. This begs many questions for investors and regulators alike, especially when compared to the bellwether of company financial ratings, the credit rating.

“The use of ESG analysis is fast becoming one of the main tools for investors to manage all kinds of non-financial risks, from carbon exposures to human rights violations. The current ESG practices are falling short in giving the market the information it needs to properly price such risks – essentially, we have a market failure,” says Greg Medcraft, Director, Directorate of Enterprise and Financial Affairs, OECD.  

With over 1,000 ESG indexes in the market, and the veritable flood of new ESG indexes on the drawing boards of firms, regulators and policy makers are rightly concerned that companies will embark on ‘rating shopping’ tours to pick the ESG index provider for an index that best suits their ESG narrative, and this may be (significantly) misaligned if not in contrast to the truer picture of their (non-financial) performance and associated risks.

“We need a global, mandated, auditable ESG data reporting framework – a minimum set of data points to track and compare ESG performance. Voluntary industry standards will not address these issues,” says Medcraft.

The OECD is putting out a call to action for policy makers and regulators to come together with industry to develop a minimum viable standard for ESG measures, and where necessary, to enshrine these in jurisdictional law. Following the outbreak of COVID-19 and the accelerating popularity of ESG investing, this is starting to look like a burning platform for policy makers and regulators, as if they needed another one.

If there is an urgency in public markets for ESG transparency and standards, private markets are not far behind. This is the big growth area for investors and there is a need to make these markets more transparent to investors full stop. With the great ESG asset rotation upon us, from stranded assets like coal to liberated assets like solar, many of the new companies making a difference and contributing to significant ESG factors are in the private markets and are not easily accessible or measurable for investors.

Medcraft concludes, “This latest report presents a compelling call to action. The OECD will use its convening powers and considerable analytical capabilities to lead in this priority area – we will bring governments and industry together to accelerate the development of a data framework for ESG.”

This report is a must-read for policy makers and investment professionals alike who cannot sit idly by watching this space and must engage now.