There are many challenges for companies in preparing environmental, social, and governance (ESG) information on a timely basis given the significant increase in demand for sustainability reporting and lack of standard reporting frameworks and centralized repositories for ESG data. ESG metrics and disclosures are becoming essential information for capital markets, but the demands of investors and their proxies frequently differ and can be difficult and confusing for company executives.
At Financial Executives International’s (FEI) Corporate Financial Reporting Insights Conference, an investor-focused panel shared views on investors’ perspectives about current and future use of ESG metrics and disclosures and where common ground can be found between the providers and users of the information.
Most requested ESG information
Gabrielle Rabinovitch, senior vice president of corporate finance and investor relations at PayPal, noted the focus on ESG by institutional investors accelerated and was reframed during the pandemic.
“Pre-2020, there was more ‘episodic engagement’ than ongoing interest, and ESG was not an integrated component of their analysis,” she said. “Now there is more media and public attention on employee wellness, materiality mapping, and product strategies. The institutional investor focus is more on the social and governance components of ESG, including access to financial services, human capital management, diversity and inclusion, privacy, and data security.”
Tracey Travis, executive vice president and chief financial officer (CFO) of The Estée Lauder Companies, said her company’s investors want to hear more about the impacts of climate, the environment, and responsible sourcing. “For us, the focus of the ‘E’ in our ESG reporting is packaging and plastics; the ‘S’ is inclusion, diversity, equity, and human capital management; and the ‘G’ is board structure, diversity, and compensation,” she said.
There are a number of ways analysts and investors use ESG data. “We look to companies to identify the sustainability measures and key metrics for their companies, and we encourage them to focus on key metrics and targets related to risks, opportunities, and progress,” said Michelle Edkins, managing director at BlackRock. She advocated companies disclose industry-specific information, including how risk is governed and what targets and metrics are used, along with building ESG into strategic and capital expenditure planning.
“Lengthy materials covering all aspects of sustainability are not useful to investors,” she said.
On the equity side, data is used to analyze companies’ long-term risks and opportunities. “We engage with public companies on corporate governance, including board structure and having high-quality management in place to manage sustainability risks and take advantage of opportunities for long-term financial returns,” Edkins added. She also looks at the range of products and services companies offer and how ESG is integrated into their product development.
Engagement with stakeholders and investors
The timing and frequency of ESG discussions is changing as interest and demand for reporting grows.
“An evolution has happened because the ESG conversation is continuous and ongoing,” Rabinovitch said. “Every contact touches on it in some way.”
She noted during PayPal’s earnings cycle the conversations are focused on earnings. In addition to monthly dialogues about ESG, the company hosts focused meetings and includes ESG updates in quarterly investor packages.
“Fundamental investors are using ESG as a lens to our risk profile and thinking about the company’s discount rate and cost of capital,” she said.
Travis agreed. “There is not as much ESG engagement during earnings calls but more during investor meetings,” she said. “We host dedicated ESG-specific meetings that include the CFO, sustainability group, and investor relations to discuss how ESG is integrated into our strategy and the progress we are making.”
For Edkins, fall and winter are important times for ESG discussions. “Institutional investors encourage our disclosures and support the sustainability narrative to understand how we are delivering on our objectives,” she said. “They look for our disclosures at the same time as our annual report, before annual meetings with shareholders.”
Materiality for ESG reporting
There are different materiality thresholds for ESG information and financial reporting, along with different materiality concepts within sustainability information.
“Materiality is changing, with an increased focus on human capital management,” Edkins said. “We look at what sustainability factors are business-relevant and what shareholders and investors need to know about the risks and opportunities. For example, if the water supply were turned off, would it have a significant financial impact on this business?”
“It’s important to separate the differentiators—the areas with the greatest impact,” Travis said. “Every area of our company includes in its strategy for growth or efficiency the ESG areas it will focus on, and goals are embedded in each process. This is still in evolution.”
Rabinovitch and her colleagues at PayPal performed their first materiality assessment two years ago as an in-depth exercise with 150 stakeholders and third parties. It is an ongoing process to refresh and ensure the company is still focused on the right areas, with annual internal polling and formal mapping work.
“We consider what is material to stakeholders in terms of priorities, resource allocation, company values, and where we can have the greatest level of social impact—human capital, employee wellness, data privacy, and cybersecurity,” Rabinovitch said.
Ensuring ESG data integrity
ESG data is new, evolving, and can be hard to capture and control. Which sustainability reporting standards companies choose to use and the lack of converged standards are challenging for both preparers and users.
“To make sure our data is reliable and valid, there is a close partnership between finance, human resources, sustainability, internal audit, and legal,” Travis said. The departments set up an internal database to ensure data integrity and external assurance is obtained.
As finance becomes more involved in sustainability reporting, CFOs and audit committees have different expectations about the role of the department. “In my view, it is increased integrity in disclosures, managing risk of making unsubstantiated claims, sharing ESG concepts within the organization, and having cross-functional teams to make sure information is accurate and relevant,” Travis said.
“Nonfinancial key performance indicators (KPIs) become material, as there is reporting on them on an ongoing basis,” Rabinovitch said. “You need the same rigor and hygiene for this data as for financial KPIs because investors are making decisions based on it.”
PayPal uses dedicated controller resources, internal audit, and cross-functional steering groups for data integrity. “The landscape has changed. Five years ago, you didn’t want ESG people in finance or investor relations, but now you are falling behind if you haven’t done this,” Rabinovitch said.
Edkins depends on data aggregators to standardize data and put it into BlackRock’s resource system for its quantitative analysis data team to use. She noted there has been progress in systems development for ESG data, with vendors anticipating user needs and helping ensure greater data integrity.
There is much debate about the role of third-party assurance, including auditor assurance, on ESG information and whether it is useful.
“I expect an evolution in assurance practices to make sure ESG information is reliable and used for decision-making,” Travis said.
“Without common standards, it is difficult to say whether it is useful,” Edkins said. “Assurance has to be meaningful and not vague as to what procedures were done and why.” She noted big firms are gearing up to provide assurance.
“The integrity of the process is important—how the data is captured and that a good-faith effort was made with rigor and controls,” Edkins said. She added it is also important for companies to be straightforward in their reporting if they are not sure they have captured everything.
Where ESG data is reported
Given the volume of information already included in a company’s annual and quarterly reporting, there is debate about whether rolling in ESG information, such as global impact reporting, is too much and whether it would be better to have it remain separate.
“As targets are linked to ESG, it naturally becomes part of more formal reporting in annual reports and proxies,” said Rabinovitch.
“Over time, as sustainability standards are built, the link between ESG and financial risk will be tighter and will create a more natural fit. Practice will change,” Edkins said.
Travis agreed some level of standardization of reporting will be helpful. “Reports will converge over time,” she said. “Today each report is already long, and it is difficult now to include sustainability information in with other disclosures.”
The future state
Companies will continue to make choices about which sustainability metrics are critical to their business, what standards and frameworks to apply, and when and where they will disclose their progress. Investors and analysts consider ESG information to be increasingly important to their assessment of company performance and market values, so they will continue to request more information more frequently to make investment decisions.
Strategically, companies need to meet the demands for ESG reporting from the investment community and their customers, suppliers, and employees. As a result, the dialogue will continue about the best way to report. But both preparers and investors agree to the importance of coming up with consistent, accurate, and reliable ESG information that is material to an understanding of the company.