In this overview on the state of ESG data, the Global Head of Research for MSCI’s ESG Research group Linda-Eling Lee, provides a helpful sense of where we are now, and where we might be going with disclosure, accuracy and analytics. Tim Nixon, Managing Editor, Thomson Reuters Sustainability.
Tim Nixon: How would you assess the usefulness of ESG data obtained by voluntary disclosure?
Linda-Eling Lee: As noted in our 2018 Trends paper, we find voluntarily disclosed data to be quite helpful and in fact necessary to the rating process. There are some items – mainly about companies’ own practices and quantitative performance (e.g. emissions, diversity, etc.) – the specifics of which can be difficult or impossible to find out about by other means. So it’s very useful as far as it goes. It’s just that there are increasingly other sources of information out there that are also useful, whether about individual companies specifically or about what can typically be expected for certain types of operations in certain types of locations.
Tim: Does coverage vary by jurisdiction?
Linda-Eling: Both voluntary and mandatory disclosure does vary by jurisdiction. We are seeing, for example, that voluntary disclosures are starting to rise considerably in Japan and some emerging markets where it hasn’t been as common in the past. And as stock exchanges and some regulators start to require certain disclosures, we do see variation in what type of information is available where. For example, Japanese companies have recently had to begin reporting on an array of workforce diversity statistics. They don’t all report all of them, but they have to meet the minimum requirement and quite a few do go beyond that – so that’s an area where we see mandatory disclosure spurring additional voluntary disclosure on the same topic.
Tim: How important is regulation to obtaining a minimum amount of usefulness?
Linda-Eling: Regulation can help ensure that what is reported is comparable across different companies, in addition to ensuring that it gets reported at all. But usefulness really varies across companies. There are some companies out there doing really excellent voluntary reporting, and there are companies providing glossy greenwash with little substance. Neither necessarily reflects what is required by regulation.
And even with regulatory disclosure requirements, as we pointed out in the paper, even the financial disclosure requirements that have long been in place – and, indeed, some of the voluntary financial disclosures that have become common – can be deceptive or fail to highlight underlying problems. So that’s a limitation that I think is going to apply to pretty much all types of company reporting.
Tim: Is it important to push back on company disclosures which do not appear accurate?
Linda-Eling: I would say we don’t see a lot of disclosures that seem “inaccurate”. What is much more common is for companies just not to mention certain things, or to downplay things. Sometimes we know that there are things out there not being mentioned and sometimes we don’t.
Tim: Do current disclosure methods allow for investors to see a trend in performance on a given issue?
Linda-Eling: If a company is consistent in what it discloses and how it does so – i.e. using the same methodology to measure something – then yes, it is definitely possible to see a trend and we do in fact commonly get a view into trends based on company reporting. I think companies that are genuinely interested in making this information available to investors and other stakeholders understand the importance of this.
But of course plenty of companies either do not make the type of disclosures that would be needed or are inconsistent or don’t provide sufficient detail to be able to tell exactly what is being reported (e.g. scope of operations included). This is where it is so useful for us to be able to develop estimation methodologies and to rely on large data sets from other sources that tell us what certain types of operations are likely to be doing even if we don’t have the information from the company.
Tim: Will the next generation of ESG analytics tell us more about the “direction of travel” of a business model or strategy?
Linda-Eling: The field of ESG Research and ESG investing is evolving very rapidly so it’s hard to say what the “next generation” might do. That being said, we definitely hear interest from our clients about getting a better understanding of where a company is headed, i.e. its trajectory. To some extent we have already built this into our model, where we look at trends over time in things like carbon intensity or health & safety metrics.
At a higher level, many of our clients find the “ESG Momentum” signal useful – this indicates whether the rating has gotten better or worse recently. In fact, in a study a couple years ago, we found that the best portfolio results were obtained by tilting toward companies that were improving their ESG performance even if it still wasn’t great. Weighting in favor of strong performers did well, but not as well as the momentum strategy.
Tim: Is “direction of travel” important when considering divestment?
Linda-Eling: The answer to this question will really vary by investor. Some people feel strongly that it is absolutely important.
We have research findings that suggest that investments in companies that are improving their ESG performance outperformed both non-ESG approaches and approaches that selected stocks that had high ESG ratings.
And some investors feel it makes more sense to engage with a company or reward it for being on the right trajectory even if it has a long way to go. But on the other hand, there are investors who are just not comfortable holding stocks that have serious negative impacts on the world, even if they are starting to improve.
Tim: Will technological plug-ins to supplement data really be enough to provide a more complete understanding of a company which is not transparent?
Linda-Eling: There is probably no way to have a 100 percent complete understanding of a company, even if it is pretty transparent. There are probably certain pieces of information that could only be obtained by a company choosing to share them. But there is a lot that can be done to fill in the rest of the picture without their help, and we expect that will only become more true with time.
Tim: Is the state of ESG disclosure sufficient to allow investors to pick equities and thereby meaningfully help achieve the SDGs?
Linda-Eling: This is really the question of the moment. Many of the investors we work with and talk to are trying to figure out how to do exactly this.
At this point, I would say that yes, there are ways to do this – but I would also say that there is not much consensus in the marketplace about what the best way is to think about and to approach it.
Many investors we talk to are focused mainly on companies’ products and services and whether they are the right kinds of things needed to achieve the SDGs, but others are also looking at companies’ own operations: are they reducing water usage, carbon emissions, etc.; are they promoting women; do the provide good working conditions; and so on.