02 July 2019
Investors are demanding an increasing amount of data from companies. How good is it and how does it need to improve, asks Peter Cripps
The dramatic rise in the number of investors considering environmental, social and governance (ESG) metrics has led to an explosion in the amount of ESG data being demanded and disclosed.
In 2011 the ESG disclosure rate for companies in the S&P500 was about 20%, explains Mamadou-Abou Sarr, director of product development and sustainable investing at Northern Trust Asset Management. It has now gone to 81%, he adds.
He attributes this to "more transparency by companies due to market pressure – investors, and ultimately regulators, pushing hard for improved data".
"We moved from data scarcity to having [almost] too much data .... making it difficult to decipher," he says.
This deluge of ESG data is nonetheless to be welcomed, but how good is it and how does it need to improve?
ESG data can be reported in numerous ways, including corporate and social responsibility (CSR) reports, information integrated into financial accounts, or via questionnaires or reporting frameworks.
Although more companies are reporting ESG data, the quality of that data is often criticised.
The catalogue of complaints includes a lack of historical data, the fact that not all companies report, a lack of standardisation of data, the fact that some parts of the world and some sectors see more reporting than others, and some ESG considerations see better reporting than others.
An army of ESG ratings providers has emerged to address these problems, but users of the data point to a lack of consistency within these ratings. (This will be explored in a separate feature on ESG ratings providers.)
ESG data is, by its very nature, messy, points out Christopher Greenwald, head of sustainable investment research and impact investing at UBS.
"It's important to recognise that this is a new information set," he says. "If you look at 20 years ago, there were 100 companies that issued sustainability reports and there's now over 5,000. It's revolutionary, the amount of information and metrics that we now have.
"It's new information, it's still relatively immature and not fully standardised, and it's primarily voluntary. Within that context, it has evolved quite quickly and we have a tonne more information than we did 10 years ago."
He says that this lack of standardisation can lead to companies reporting different metrics or key performance indicators (KPIs) for the same issue.
Carbon dioxide (CO₂) emissions have been one of the metrics to have been reported for longest, helped by regulation such as the UK's Mandatory Carbon Reporting requirement, and the introduction of the EU's Emissions Trading Scheme in 2005.
Disclosures have also benefited from guidelines issued by the Greenhouse Gas (GHG) Protocol, an initiative set up by the World Resources Institute and the World Business Council for Sustainable Development. It defines:
- Scope 1 emissions as: all direct GHG emissions from sources that are owned or controlled by the reporting entity.
- Scope 2 emissions as: indirect GHG emissions, from consumption of purchased electricity, heat or steam.
- Scope 3 emissions as: other indirect emissions, such as the extraction and production of purchased materials and fuels, transport-related activities in vehicles not owned or controlled by the reporting entity, electricity-related activities (e.g. losses as a result of transmission and distribution) not covered in Scope 2, outsourced activities, waste disposal, etc.
"Even a data item like carbon emissions is imperfect, and investors will need to use some estimates for companies that don't report," adds UBS's Greenwald.
One of the main bones of contention is that calculating Scope 3 data, which requires companies to look at their supply chains and how their products are used by consumers, can be fiendishly complicated.
As a result, many companies do not attempt to report Scope 3 emissions, and instead stick to the simpler task of reporting their Scope 1 and Scope 2 emissions.
Researchers from the University of Hamburg found very low levels of consistency in Scope 3 data between "the main providers" – Bloomberg, CDP, ISS, MSCI, Sustainalytics, Refinitiv (formerly Thomson Reuters) and Trucost.
They also found that, when looking at all three scopes, estimated data was more inconsistent than reported data.
Self-reported Scope 1 data was fairly consistent between all the main data providers, the research found.
However, separate research has shown that even when it comes to Scope 1, there are major problems. The 100% Climate Disclosure Initiative, which is run by academics and industry, says that while thousands of companies report a figure for their Scope 1 carbon emissions, just 20 globally reported the entirety of their Scope 1 emissions, according to the initiative's criteria, to Bloomberg in 2016.
Firms in the "100% Club" commit to disclose all of their Scope 1 GHG emissions (or at least 95% accompanied by a Quantitative Statement of Completeness), encompassing all of their activities and subsidiaries.
"The current lack of clarity surrounding emissions disclosures makes it impossible to fully understand the impact a company is having on climate change," claims the initiative's website. "Inadequacies in GHG emissions disclosures have the potential to mislead investors and hinder progress of country, investor and business initiatives addressing climate change and looking to accelerate the transition to a low-carbon economy."
Professor Andreas Hoepner of University College Dublin, who helped to set up the initiative, says: "To provide asset owners with any chance of aligning their portfolios with 2°C scenarios and responding thoroughly to the Task Force on Climate-related Financial Disclosures (TCFD), it is paramount that the vast majority of corporations listed on equity or bond markets take complete and public accountability of their Scope 1 GHG emissions instead of reporting some number that is probably the majority [of their emissions] but [is] far from complete."
The Carbon Disclosure Project, now known as CDP, is a platform through which companies can report their carbon emissions. The NGO has been pressing companies to report, based on the old adage 'What gets measured gets managed'.
"If you start measuring something, you can start figuring out what the impact might be, which is where disclosure and data might drive change," argues Carole Ferguson, head of investor research at the NGO.
The number of companies reporting GHG information to the CDP has grown from 220 in 2003 to 6,937 in 2018. They now represent over 50% of global market capitalisation, claims CDP.
Its questionnaire is aligned with the GHG Protocol, and CDP provides guidance on how to report in an attempt to make the data comparable. It also encourages companies to independently verify their data.
CDP provides, without charge, raw data based on companies' disclosures. It scores companies from grade A to E based on the quality of their response to its questionnaire including the targets they set. Companies are graded F if they fail to disclose. It also sells cleaned and modelled datasets.
CDP data is available on platforms such as Bloomberg and S&P's Trucost, and CDP says it forms the basis for much of the environmental analysis done by other data providers who license the data, such as ISS, MSCI and FTSE Russell.
So, how good is the data companies submit to CDP?
"At the end of the day, data quality is always an issue," says CDP's Ferguson. "The leading companies have certainly got much better at providing data. The companies doing well are making the effort to answer [our questionnaire] accurately."
She concedes that Scope 3 remains a difficult area for companies to report on.
"Companies have got pretty good at measuring Scope 1 and probably Scope 2," she argues. "Scope 3 – emissions outside your organisation, upstream in supply or downstream, and the use of sold products – that's where disclosure is still weak.
"Most companies now do lifecycle analysis as part of that process. It's difficult, but a lot of good companies are starting to do it quite well."
She points out that the bulk of a company's emissions can be found in different Scopes, depending on its activities. She gives the example of a mining company producing aluminium, that will generate most of its emissions in activities that are classified as either Scope 1 or 2. On the other hand, a thermal coal producer will create the bulk of its emissions when its product is burned.
David Harris, head of sustainable business at the London Stock Exchange Group, argues that Scope 3 emissions are not good enough to be “usable from an investment standpoint”.
“The data is so modelled, you are preparing generic datasets – there are so many assumptions,” he argues. “There are some challenges in scope 1 and 2, but for scope 3 the data is so incredible that it’s questionable trying to use it.”
He argues that the Low Carbon Revenues Data collected by FTSE are a much “more robust dataset”.
Carbon remains the most commonly reported environmental metric, but increasingly investors are demanding other types of environmental data. This can be seen in the way that CDP has expanded its remit to collect data about water and deforestation.
"There's an increasing acknowledgement that there are too many reporting frameworks" - Janine Guillot, SASB
CDP's Ferguson adds: "Water and forestry see a much smaller number of disclosers and the questionnaire is shorter. But there's an increasing interest, particularly in water."
Environmental Finance's Water, Finance and Sustainability conferences have heard that investors are frustrated with the paucity of data on water, particularly in emerging markets.
Cyrus Lotfipour, water risk specialist at MSCI ESG Research, said obtaining accurate data on companies' vulnerability to water is not easy, particularly as this calculation requires knowing how much water is consumed by individual facilities and where they are located.
This is not widely disclosed by companies, despite various reporting initiatives, and MSCI sometimes uses 'proxies' for water, such as reported carbon emissions, to estimate the amount of water consumed by specific facilities.
Julie Moret, head of ESG at Franklin Templeton, is also keen to see more disclosure of water data, which she believes is becoming increasingly important.
She gives the example of internet data centres, which can use water rather than energy for cooling. Water is therefore becoming an increasing component of operating costs and shortage of water could disrupt a data centre's operations.
"It becomes increasingly important to disclose where they are located, and whether they are in water stressed areas," she explains.
Franklin Templeton uses water data from the World Resources Institute to help it assess water risk, she adds.
Supply chains are another problematic area for ESG data. Kathryn McDonald, head of sustainable investing at AXA IM Rosenberg, notes that "there is still significant work to be done at the intersection of ESG and supply chain analysis".
"Understanding how a company interacts with its own ecosystem (and within society as a whole) is immensely important if we are to capture the full view of its threats and opportunities," she argues.
Northern Trust's Sarr has noticed an improvement in the levels of reporting on environmental data in the wake of the Paris climate agreement, and as "more regulators are asking for reporting on climate risk and carbon".
There's also more data around corporate governance to be found in public filings. However, he believes there is less reporting of social information "because it's not part of public filings".
Like environmental data, social data, which can include information about issues including health and safety, labour, and product liability, can be varied in its availability and quality.
London Stock Exchange Group's Harris says reporting of social data is patchy. He points to the example of data relating to workplace fatalities, which he says are only reported by a third of large and mid-cap companies.
Matt Moscardi, head of financial sector research at ESG data provider MSCI, says improving the availability and quality of human capital data, which includes fatalities, is "the most surprising low-hanging fruit".
Often companies disclose little data other than the number of people they employ, he explains.
"Productivity is a matter of people or machines," he argues. "We have a big focus on understanding all the human capital data and what it means."
Human capital data can be particularly relevant in mergers and acquisitions, he adds.
The picture can be complicated because sometimes a reduction in staff numbers could indicate investment in a technology that makes employees redundant, but is not necessarily an indication of a shrinking business.
Victoria Barron, a responsible investment analyst at Newton Investment Management, with £47.3 billion ($60 billion) of assets under management, sees a need for more data on staff equality.
"Investors want to see data on workforce and the supply chain – they want more transparency on global operations and factories," she argues. "Social [issues] can affect financial performance."
Newton is among the 120 investors to have signed up to the Workforce Disclosure Initiative (WDI), which calls for transparency on how companies manage workers in their direct operations and supply chains. It aims to "improve the quality of jobs".
A mere 90 companies disclosed to the 2018 WDI survey.
"We have been very frustrated because we couldn't find sufficient data from our data providers, or the data is out of date," says Barron. "We would like to see that data improved and better analysed."
Gender data is important for Newton – it will vote against the chairman of a company's nomination committee if it there is a lack of gender diversity on boards or the lack of a robust policy to achieve this.
Asymmetries in data disclosure are not just to be found in the fact that some metrics are more widely reported than others. Some parts of the world see more reporting than others.
For example, reporting in China tends to be poor, whereas reporting in Europe is much better.
Research by asset manager DWS reveals that European stocks tend to have higher ESG ratings than companies based in other parts of the world.
"This may partially be due to mandatory ESG disclosures in some European countries," it says. "But an implication of this finding is that investors who aim to increase the overall ESG rating of a global portfolio will find their holdings naturally tilt towards European countries."
The report also says that tilting towards companies with higher ESG ratings can also lead to a bias towards large-cap stocks.
The second instalment of this feature on ESG Reported Data is available here.
This article is part of a series of features exploring ESG data.
- To read 'The ESG data files – introduction, click here
- To read 'The ESG data files – part one: reported data', click here
- To read 'The ESG data files – part two: non-reported data', click here
- To read 'The ESG data files – part three: ESG rating agencies', click here
- To read 'The ESG data files – part four: fixed income data’, click here
- To read 'The ESG data files – part five: the impact of the EU’s taxonomy’, please click here
- To read 'The ESG data files – part six: TCFD and the challenge of looking forward’, click here