Across industries, meaningful decision-making on issues relating to sustainability is being challenged by noise and rhetoric, which obscures nuance. Academics, policymakers, and media wonder whether ESG is at its end, often without defining the term beyond ‘environmental, social, and governance’. Each of those concepts is interpretable, and so measurable, in many different ways.
Just as investors have their own definitions of ESG, they have their own goals for engagement. Some view it as a moral imperative. Some have specific views about a potential transition and want to elicit corporate action accordingly. Some want to improve transparency. For any of these goals, the best common starting point is a push for more and better data.
This is made evident by CDP’s 2023 Non-Disclosure Campaign, which saw a record 288 financial institutions (FIs), representing nearly $29trn in total assets, directly engage with over 1,500 companies to request that they disclose on environmental issues salient to each company’s business operations. The number of disclosures through the campaign indicates that companies are listening and that direct engagement from investors leads to transparency. On average, companies were more than twice as likely to disclose their environmental impacts if engaged through the campaign.
Changing corporate culture is a gradual process but persistent engagement is proving to be effective. The initial investor outreach sows the seed for disclosure, and every successive engagement effort steers the company towards adopting a culture of transparency that seems to endure long beyond a CDP campaign. A staggering 90% of companies continue to report years after they are first engaged by the campaign. This demonstrates both the influence that FIs have and the importance of integrity in stewardship. Companies receive many requests for data, and they are most likely to respond when they believe the data requested is decision-useful to their shareholders.
AQR Capital Management, an active participant in recent Non-Disclosure Campaigns, undertakes direct engagement by itself and on behalf of the CDP signatory base, focused exclusively on transparency. AQR uses ESG-related data in its investment process wherever it believes that data is additive to risk or return, and in the last few years began using emissions data as an input in certain portfolios beyond the $20bn it manages in dedicated ESG solutions. As AQR consumed this data and noticed gaps, it was natural to use their shareholdings in companies to ask for improved disclosure.
With the efficacy of collective engagement increasingly well-documented, it makes sense for FIs to pair direct and collaborative modes of outreach. While there are collective engagements oriented toward specific issues or outcomes, comprehensive data is a critical prerequisite. For investors not wishing to undertake issue engagement, a push for transparency remains logical. Continually improving the quality of inputs to the investment process is both a positive fiduciary activity and favourable to the broader market. Greater transparency facilitates stronger alignment between companies and their investor base, as well as more accurate pricing of risks and opportunities, sustainability-related or not.
Many jurisdictions are introducing disclosure-focused regulation aimed at corporates and investors. From CSRD requirements to the gradual adoption of the ISSB standards and the planned California climate accountability package, data breadth is set to improve. However, it will take time for better data to come into effect, and some organizations are better-resourced than others to report on the requisite metrics. Some companies have raised concerns during engagements about undertaking too much burdensome reporting that is not required. Not only do companies want to understand what data is useful, but they want support in methodological consistency, which has not yet emerged from regulation.
In the gap before mandatory disclosure, engagement continues to matter. A focus on transparency does not solve the value judgements inherent in ESG investing, but it provides a foundation from which to weigh those judgements and a common language through which to express them. Financial institutions have the power to ask companies for support in these efforts and the responsibility to be thoughtful about the influence they seek to exert: there can be nuance even in the noise.
