Mitigating the risks of greenwashing
From Best Execution:
The challenges of data in environment, social and governance (ESG) reporting and integration are well documented but a new report from EY and Oxford Analytica outlines five areas to mitigate the risks of greenwashing and build a trusted sustainability information environment.
The report- The emerging sustainability information ecosystem, noted that ESG investing – is “facing existential questions” about standardisation, regulation and purpose. These challenges are being “compounded” due to rising inflation and the war in Ukraine.
It also highlighted that while there are “increasing connections” between financial and ESG reporting, there remain significant challenges with the latter.
Katie Kummer, EY global deputy vice chair – public policy, explained these obstacles “are a product of its infancy”.
She added, “The sustainability ecosystem is just more than 20 years old, and so still in its maturing stage compared to the financial reporting ecosystem,” she said. “It is essential that we work together to build a system that is globally consistent, trusted, responsive and where everyone has a voice.”
The first recommendation is to increase the transparency of composite indicators. Currently, companies are scored on a wide range of ESG issues, with different weights given to each issue to calculate an overall ESG rating. These issues include everything from climate change to pollution and waste, from product liability to tax transparency.
The report echoed the International Organisation of Securities Commissions (IOSCO) which wants more detail regarding the methodologies that ESG ratings and data product providers use.
Kifaya Belkaaloul, head of regulatory, NeoXam, echoes these sentiments. She says, “This report correctly identifies that there is a real need to increase transparency and understanding of composite ESG ratings. Right now, the onus is on financial institutions to take control of the evaluations process.
Ultimately, firms have to be able to harness the data that underpins these ESG ratings, and present it in a simple, clear way to investors and regulators alike. That is the key right now to demonstrating a data-driven understanding of the credentials behind ESG claims – but it all rests on the data management systems being utilised up to scratch.”
Gayatri Raman, president Europe and Asia, Clearwater Analytics also believes that “central to pursuing ESG investing strategies is being able to rely on clear and transparent ESG ratings. In this way, it all comes back to the information that sits beneath the ratings.
Before anyone can incorporate ESG factors into their investing strategies, data needs to be highly available, high quality, and easy to track. Only then will investors be able to fully integrate these initiatives into their investment process.”
The EY and Oxford report also called for increasing the understanding of the varying uses of sustainability information which are mainly leveraged for financial risk and social impact. These are not mutually exclusive but are easily confused and there needs to be greater distinction.
Third on the list was implementing conditions that enabled independent assurance to sit alongside enhanced reporting standards and rigor, similar to financial reporting. “Market forces will increase demand for robust, independent external assurance over sustainability information in the coming years. Already, the US and the European Union are considering mandatory assurance requirements for sustainability disclosure rules,” according to the report.
It also advised developing comparable and interoperable taxonomies which are systems that determine which economic activities should be considered sustainable. EY and Oxford Analytica believe this can help resolve confusion by giving a clear, data-driven reason as to why a particular activity fall within or outside that taxonomy’s definition of sustainability.
Last but definitely not least, is the lowering barriers of entry for those from emerging economies which account for a large majority of the world’s greenhouse gas emissions by 2050. “Yet they have less resilience to be able to adapt to the impacts of climate change compared with some other markets. Due to their location, they are also likely to be more exposed to severe climate-related events< “the report says.