Written by Nadiya Nair, Strategy and Development Team Lead - Renewable Energy and Carbon Markets, and Teresa Teo, Sustainability Team Lead, ACT Commodities
Furthermore, according to McKinsey & Company, an effective ESG framework correlates to a higher equity return, which is ultimately favourable to both companies and potential investors. As a result, disclosure of ESG policies, performance, and climate action has become increasingly commonplace, whether on a voluntary basis or mandated by investors.
What are ESG data and disclosures?
Although they may vary based on the specific disclosure framework or requirements, ESG disclosures typically require companies to report specific information such as environmental management policies, energy consumption, waste generation, greenhouse gas emissions, targets to reduce environmental impact, and initiatives implemented to achieve those targets. This information serves as a strong indicator of a company’s willingness to reduce its overall environmental impact — especially its carbon footprint.
Existing challenges with ESG data and recommendations for improvement
Given the importance of ESG disclosures, the accuracy, consistency, transparency and credibility of the reported ESG data is crucial. However, this is not always the case, which can lead to lack of trust in the information reported. Throughout this article, we will draw on industry insights and expertise to outline key existing challenges with ESG data and disclosures, as well as explore key strategies to build trust.
1. Standardisation of reporting frameworksDepending on the market, regulators have adopted varied approaches towards the usage and reporting of ESG data. The European Union’s Corporate Sustainability Reporting Directive (CSRD) focuses on a broader scope of ESG issues. Comparatively, in the U.S., the Securities and Exchange Commission (SEC)’s proposed climate disclosure rules are ringfenced to climate change issues.
This variation can pose challenges, especially in the environmental aspect of ESG reporting. Different companies today often deploy varying carbon measurement approaches based on different guidelines, which can result in inconsistencies and makes it relatively difficult to compare emissions data reported by companies.
In recent years, new developments have been introduced to address this issue of disclosure fragmentation. First, in the context of sustainable finance, a common language for defining sustainable activities has been introduced, to promote investment into them and in so doing, advance environmental action. Examples of these include the European Union’s Sustainable Taxonomy and ASEAN’s Taxonomy for Sustainable Finance. In addition to guiding investments, these taxonomies could also be useful for defining sustainable activities for the broader economy. Second, international sustainability disclosure standards, IFRS S1 and IFRS S2, were published in 2023 to harmonize sustainability disclosures globally. The International Sustainability Standards Board (ISSB) developed the standards to outline the disclosure requirements for sustainability-related financial information and climate-related disclosures. To ensure compatibility with existing reporting frameworks, ISSB is working with existing organizations such as the Global Reporting Initiative (GRI) and the Task Force on Climate-Related Financial Disclosures (TCFD).
Third, the increasing uptake of disclosure platforms – such as CDP – for companies to report their ESG data in an organized and transparent manner, have also mitigated this fragmentation by standardising templates for companies reporting their emissions data. This allows companies to align against a singular system with defined metrics, enhancing comparability between companies.
While these are promising developments towards greater harmonisation of ESG disclosures, many of these frameworks and standards are new and it remains to be seen whether they will be effective. Adoption of these standards will be key. Furthermore, while disclosure platforms are driving more standardisation, there are still multiple platforms that exist today, leaving further room for greater harmonisation.
2. Increasing accuracy of data collection and transparency of reportingGiven the importance of ESG disclosures, the accuracy and transparency of the reported ESG data is crucial and offers various benefits for companies and their investors. Accurate and credible allows companies to keep track of their sustainability performance over time, which enables them to identify areas of progress and further improvement. It also allows for comparability with other companies. For investors, accurate and credible information allows them to evaluate companies more comprehensively for potential investments. Without such information, according to Ernst & Young, access to capital could be stifled and ultimately hinder progress on decarbonisation.
Unfortunately, the current state is that such accuracy of ESG data collection and transparency of disclosures are not always achieved. On data collection, accuracy may be impacted by conventional manual data collection processes, which can be tedious and messy when they involve a range of data sources within a company’s operations. This is especially in the case where companies have complex operations spanning multiple geographies and business lines. There could also be added complexity if there are many parties across the value chain to collect data from, such as electricity generators and raw materials suppliers. For some companies, data collection may not be comprehensive - as the Harvard Business Review notes, data is typically gathered through an assortment of materials which may be limited to the data a company has on hand. Based on KPMG’s analysis, this means that ESG data could be patchy and out-of-date. The parameters by which data is collected, such as the units of measurement, scope of activities, time frame and access to external data sources such as from suppliers will also affect accuracy. Beyond data collection, processing the data to eliminate duplicate entries and correct inaccuracies is also important. On transparency, according to Ernst & Young, companies typically only disclose a limited set of ESG information publicly, rather than provide comprehensive information for key stakeholders to evaluate. This is due to the lack of requirements on providing supporting evidence for ESG disclosures, which makes it challenging for investors to assess the accuracy of information provided by companies.
To address issues with accuracy and transparency of ESG data and disclosures, digitalization of data collection and reporting is likely to be an effective solution. Technologies can make data collection more seamless, for example natural language processing and machine learning allow for analysis of unstructured data and extraction of relevant insights, thus simplifying the tracking and ESG reporting for companies. Once data has been collected, data analysis and visualisation is key for mining and presenting useful insights, enabling companies to assess materiality and identify trends such as risks and opportunities. As for reporting, automation has been built into ESG reporting tools to minimize time spent generating reports and to slice the datasets based on disclosure requirements (e.g. CDP, GRI, SASB, TCFD). As noted by GRI (in the image below), the incorporation of technological advancements correlates to improved performance by companies. Overall, robust data management allows for transparency and consistency which is crucial for building trust in ESG disclosures.
3. Mandating independent verification and authenticity of data
Nevertheless, no matter how seamless and efficient data collection is, independent verification – which refers to assurance of ESG data undertaken by third-party auditors or verifiers – of such data is important to vouch for its credibility.
Today, there are several gaps in independent verification of ESG data. Independent verification is largely voluntary, hence it has yet to be mainstreamed. Most companies are not seeking verification because they do not have the sufficient systems, processes and controls in place for data management - KPMG’s ESG Assurance Maturity Index 2023 reveals that only 25% of companies find that they “have the ESG policies, skills and systems in place to be ready for independent ESG data assurance. Based on the study, larger companies tend to be more ready for ESG assurance than smaller ones. Companies that do seek assurance of their disclosures may tend to focus on doing so for specific information that is critical stakeholders, such as Scope 1 and 2 emissions, rather than for their full disclosure. Lastly, even if companies do seek independent verification, a persistent issue is the robustness and consistency between assurance conducted by different auditors, as there is currently no global standard for ESG assurance.
To boost the credibility of ESG data and disclosure, mandating independent verification of ESG disclosures would help to serve as a quality control check for companies. This could also have the added benefit of encouraging companies to follow through on their sustainability targets, as they face pressure to deliver on their commitments. Some regulators are starting to mandate independent verification – the U.S. SEC’s proposed climate disclosure rules for listed companies include requirements for third-party assurance for greenhouse gas emissions. Beyond the U.S., it would be useful for regulators globally to follow suit and mandate such checks.
Another important improvement would be to introduce consistent standards for ESG assurance. At the global-level, the International Auditing and Assurance Standards Board (IAASB) has started the process of creating an overarching standard for assurance on sustainability reporting. Adoption of such standards would be important to set quality standards globally.
In addition to these efforts, it would be important for players in the ESG data ecosystem to ensure that supporting infrastructure is in place. For example, some existing digital tools such as carbon accounting platforms can produce audit trail with information such as data sources, emissions factors, calculations, thus allowing companies to maintain clear documentation and archives for verification. Increased proliferation and adoption of such tools would be instrumental in facilitating independent verification of ESG data and successful outcomes from such verification.
Conclusion
The convergence of regulations, policies, and technology is reshaping how companies view and rely on ESG data. To ensure sustainability practices are sustained in the future, companies need to recognise the central role ESG data is in promoting sustainable business practices. While building trust is not an overnight process, there needs to be consistency which requires cooperation among many stakeholders (for example, regulators, service providers, end consumers).