Truth, fiction, and trust in ESG reporting

Why businesses can no longer afford to stay silent on their environmental, social, and governance performance

Mounting pressure from institutional and retail investors, customers, and employees is upping the ante for environmental, social, and corporate governance (ESG) disclosures. Ignoring ESG factors is increasingly fraught with business risk — from fines and lost contracts, to difficulty securing financing, paying higher interest rates, and losing valued employees.

One point of sharp concern for both ESG-focused stakeholders and business leaders is greenwashing: when companies claim their products and policies are more environmentally friendly than they actually are.

The greenwashing effect

Four in five institutional investors found sustainable investing challenging in last year, according to the 2021 Institutional Investor Study from Schroders, which manages almost US$1 trillion in assets. Almost 60 percent identified greenwashing as the biggest challenge to investing sustainably.

Greenwashing doesn’t just undermine trust in the company making unsupported sustainability claims, but the broader market as well. After all, without a clear idea of who is being honest, it’s much simpler to just assume nobody is.

Another important gauge of squandering confidence is the Trust Barometer Special Report: Institutional Investors, an annual report from U.S. public relations and marketing consultancy Edelman. Edelman’s latest work surveyed 700 institutional investors in seven markets, including Canada, this past summer. It found even though 88 percent of investors globally say they subject ESG to the same scrutiny as operational and financial considerations, 82 percent — and 77 percent in Canada — believe companies frequently exaggerate their ESG progress when disclosing results.

Furthermore, 72 percent of investors globally don’t believe companies will achieve their ESG commitments and 84 percent specifically look for instances of companies failing to do so. Investors in the U.S. were most skeptical of company disclosures surrounding diversity and inclusion goals / pledges (53%), effective management of climate risk (52%), and greenhouse gas emissions (46%).

Of course, not all the concerns are directly related to climate-change issues: Forty-one percent of investors said they are worried about how companies will respond to accusations of unethical conduct and 42 percent indicated company accountability in communicating risks was a concern. Other issues they are uneasy about include executive-worker wage gaps (40%) and employee health and safety (38%), both of which have the potential to become controversial media items and make it harder to attract talent in a tight labour market.

The cost of inaction

Many companies are still waiting for government intervention before they act on ESG, believing it’s minimizing ESG costs and maximizing profitability is in their shareholders’ near-term interests. Complaints about the lack of consistent standards to measure their baseline performance is another common justification for failing to set and progress toward ESG goals.

But mandatory reporting will soon be a reality for large and mid-sized organizations. The International Sustainability Standards Board (ISSB) has already released two draft prototypes showing some of the data that companies will have to disclose in the near future. Formalized standards are expected in Canada by mid-2022. In many ways, the United Nations COP26 conference crystallized the environmental focus of the private sector and provided a substantial boost to the broader movement toward ESG issues.

Public companies will have to get on board or pay a price in the eyes of stakeholders who care about such issues. Big money is at stake: global sustainable investment assets under management reached US$35.3 trillion at the start of 2020^[1], according to the Global Sustainable Investment Review released in July 2021. That represents a 15 percent increase from 2018.

Edelman's barometer suggests the trend will continue. The report found 92 percent of institutional investors believe that “a company with strong ESG performance deserves a premium valuation to its share price.” And 90 percent believe companies that “prioritize ESG integration represent better opportunities for long-term returns than those who do not.” 

But regulators may also punish companies if they don’t come up with and stick to climate-change plans. For example, Canada’s banking regulator, the Office of the Superintendent of Financial Institutions, is considering forcing banks to maintain higher capital requirements if they can’t prove they’re adequately adjusting for the financial risks posed by climate change. Maintaining more capital in reserve leaves less money to expand and/or give back to shareholders. 

Furthermore, 87 percent of investors anticipate companies that do not deliver on their ESG promises will face an increased risk of litigation. Such lawsuits are already happening, particularly around the issue of greenwashing.

For example, separate class action lawsuits were filed in December against Cover Girl Cosmetics, its parent company, Coty Inc., and Shiseido Americas Corp. The suits allege these companies inappropriately promote their products as safe and environmentally friendly, even though some of those products allegedly contain manufactured chemicals known as perfluoroalkyl and polyfluoroalkyl substances (PFAS). The U.S. Environmental Protection Agency says PFAS has been found to have harmful health effects in humans and animals.

It’s getting harder to come up with reasons not to act

There is clarity on the path the ISSB is taking regarding disclosure standards. They are consolidating expertise, content, and resources — including guidance — through merging with the Climate Disclosure Standards Board (CDSB) and the Value Reporting Foundation (VRF). Their technical standards and frameworks will take guidance from the Task Force on Climate-related Financial Disclosures (TCFD) and Stakeholder Capitalism Metrics developed by the International Business Council of the World Economic Forum (WEF). Knowing these influences on ultimate disclosure requirements gives the necessary insight to begin planning strategies to address these issues today.

If corporate leaders believe investor trust is important, it makes good sense to get ahead of the inexorable trend. It will cost a lot in terms of up-front time and investment, but this is the price of being the master of one’s own brand and reputation. It’s also better than being overtaken by competitors.

What will it take to regain trust?

Stakeholders are looking for baseline reporting, benchmarks against industry best practices, and ongoing impact assessments — as well as independent, third-party verification of such disclosures. In other words, they are looking for meaningful goals, action plans, and tangible measures of progress.

One way or another, investors want corporate information about ESG factors. According to the Edelman Barometer, 81 percent feel companies are currently not disclosing enough information about their ESG risks and policies, and 85 percent of them are in favour of mandatory disclosures. Furthermore, 84 percent say that governments should apply more pressure to enforce corporate ESG compliance.

Taking a proactive approach can certainly act as a rather long olive branch.

It’s not just about the environment

While the attention of the media and capital markets is heavily focused on environmental factors, companies should also be considering the social and governance aspects of ESG, such as diversity, labour, and oversight. Failing to consider these factors could derail the best-laid intentions in the environmental realm.

The recent Edelman survey indicated workplace culture and practices are equally important considerations for 85 percent of institutional investors — most of who, overwhelmingly believe a workplace culture that fosters employee empowerment is important for building trust in a company.

Why? Because an engaged workforce is more innovative, generates more profitability, and is less vulnerable to stress, which can lead to burnout and other health issues that drive increased turnover. Furthermore, 74 percent of respondents said employee activism within a company is indicative of a healthy workplace culture, good leadership and/or a highly engaged workforce. That’s a complete reversal from the 2019 survey, in which 74 percent of global investors agreed that companies with activist employees were less attractive investments.

Edelman’s barometer found respondents currently use a range of frameworks — including the Sustainability Accounting Standards Board (part of the VRF), the Global Reporting Initiative, the United Nations Sustainable Development Goals, the CDP (formerly the Climate Disclosure Project), WEF, and the TCFD — and found them to be at least somewhat. The creation of the ISSB by the International Financial Reporting Standards Foundation, which establishes accounting rules for jurisdictions around the world, will go a long way toward addressing skepticism over whether companies are achieving what they say they do.

But investors also rely on a variety of other sources, with 71 percent indicating that report summaries / fact sheets and social media outlets (LinkedIn, Twitter, blog posts) were very useful. Investor days and/or conference presentations were near the bottom, with only 63 percent saying they were very useful. Perhaps that’s indicative of the nature of such presentations as propaganda, not necessarily a trusted source of unvarnished truth.

The obstacle is the way

We’re currently at a major inflection point in the history of ESG, with a lot of uncertainty and the actions of an unscrupulous few making things harder for those organizations that want to embrace real change.

Government and international bodies have a fundamental role to play in defining ESG standards and the rules the market needs to abide by. In many ways, the playing field will be a lot easier to navigate when those do eventually land — but it will also mean a lot of panic, costs, and chaos for those companies that need to start playing catch up.

Companies that start disclosing their progress in all areas of sustainability will be better off in the meantime and in the long term. After all, investors, customers and employees aren’t looking for such information at some distant point in the future. They want it right now.

Footnote:

[1] Based on assets reported by the United States, the European Union, Australia, New Zealand, Canada and Japan.