Environmental Finance: What limitations do you see from the market’s current reliance on company-reported ESG data?
Eli Reisman: The most glaring limitation of company-reported ESG data is that the disclosures are made voluntarily by companies, allowing them to pick and choose which metrics to disclose. This leads to both a bias in the data and obstacles to truly comparing companies. Although this will improve as mandatory disclosure regulations like the EU’s Corporate Sustainability Reporting Directive start to come into effect, these regulations are unlikely to solve all the ESG data gaps that currently exist.
The second limitation with such ESG data is that it is backward-looking by nature. Most companies don’t disclose their ESG data more than once a year. When they do disclose, it is usually after their financial year, meaning the data is already stale.
EF: How is evolving regulation addressing these issues?
Eli Reisman: New ESG regulations are popping up all over the world which will establish a solid baseline of standardised ESG disclosure for certain metrics. This will allow firms to perform a cross-comparison of companies against similar metrics, particularly around carbon emissions.
However, the current set of proposed regulations will not bring us to a state where investors are satisfied with corporate ESG disclosure. As evidenced by International Financial Reporting Standards Foundation’s plan to consolidate key frameworks into one overarching corporate disclosure framework via the International Sustainable Standards Board [ISSB], investors are going to continue putting pressure on companies to disclose additional material information. In the future, it is likely that companies will comply with their local regulation and disclose to the ISSB as a voluntary next level of disclosure.
With the emergence of new regulations and a single consolidated corporate disclosure framework, we are likely to see a movement towards ESG data standardisation over the next five years. Although this is a positive trend for the ESG industry, investors are likely to need even more alternative ESG datasets that can give them an analytical edge.
EF: How is innovation enabling the acquisition of alternative ESG data?
Eli Reisman: The core of most ESG datasets continues to be company self-reported metrics, but there are several new technologies that are helping investors better assess a company’s ESG behaviour. For example, FactSet’s Truvalue Labs dataset uses natural language processing, machine-learning algorithms, and sentiment analysis to review hundreds of thousands of news articles and documents daily. Consumers are then able to identify when companies are being discussed in relation to sustainability issues and how positively or negatively they are behaving. FactSet’s Truvalue content set gives investors a real-time view of how companies are handling ESG issues; it also provides a differentiated perspective from a company’s self-disclosed information.
Over time, we are likely to see more ESG datasets that use alternative technologies (e.g., satellite data, artificial intelligence, or sensor data). These will to offer a different perspective on company ESG performance, which will go beyond what companies are saying about themselves.
EF: Most ESG disclosure to date has been by publicly listed companies. To what extent are you seeing demand from private companies? What are the challenges in accessing this information?
Private company ESG data is certainly gaining significant interest. This is mainly being driven by private equity and venture capitalists wanting a better insight into their investments and fixed-income investors wanting better coverage for their investment universe. ESG disclosure by private companies is much sparser than for public companies, due to their smaller size and the fact that there is less pressure on them to provide data.
Truvalue’s technology allows consumers to score and track companies regardless of if they are disclosing ESG information. We've therefore decided to expand our coverage to more than 220,000 companies by August 2022, which will include 150,000+ private companies.
EF: To what extent is materiality of ESG indicators objective, and to what extent does it depend upon the perspectives of the stakeholders concerned?
Eli Reisman: Materiality is very much subjective and it is the source of a lot of current debate in the ESG world. The debate over single vs. double materiality will certainly shape the face of corporate reporting over the next few years. Although this debate is valid, it often misses the nuance that the line between single and double materiality can be fluid—an impact that a company is having on the environment or community can ultimately have financial repercussions.
Since Truvalue data tracks article flow for the 26 Sustainability Accounting Standards Board categories and 16 of the 17 Sustainable Development Goals, FactSet can create a company-level score referred to as “Dynamic Materiality”. The score identifies what percentage of articles over a trailing twelve-month period is tagged to each category. Users can see which categories are the most talked about (i.e., relevant) at any point in time, to better identify which issues are important as well as which rise to their definition of what is ‘material’.
For more information, see: www.factset.com/esg.