It is time to accurately measure ESG performance

Can we close the current reporting gap? alva CEO Alberto Lopez Valenzuela has some suggestions


Alberto Lopez Valenzuela, founder and CEO of alva, and author of The Connecting Leader

Vitaly Nesis, chief executive of London-listed gold producer Polymetal, recently called for common reporting standards on ESG performance, pointing out that the current methods of scoring are often inconsistent, inaccurate and an exercise to “tick the boxes”.

In making this statement, he brought attention to the concern around performance measurement, something which grows among the investment community as ESG criteria increase in value.

Globally, the percentage of retail and institutional investors that apply ESG principles to a quarter or more of their portfolios leapt from 48% in 2017 to 75% in 2019. In 2018, sustainable investing assets totalled £10.9trn in Europe and £9.3trn in the United States. By 2025 Deloitte predicts ESG assets in the US are expected to hit £27.1trn.

With so much value being placed on sustainable investing, investors are seeking more accurate ways to measure ESG performance, and identify ESG risks to inform the investment process. This will help them to better identify companies likely to see good financial performance in the long-term due to their ESG-focused business models.

Finding a way for investors to accurately identify the best performers when constructing their investment strategy is important: a report by BofA Merrill Lynch revealed that a portfolio based on buying stocks in companies ranking well against various ESG metrics would have beaten the broader market by 3% every year for the last five.

The voluntary GRI Sustainability Reporting Standards represents one method of measurement, which was established in 2016 by the Global Reporting Initiative to support best practice in impact disclosure. Covering topics from tax to emissions, anticorruption, biodiversity and occupational health and safety, this aims to offer a flexible framework for creating integrated ESG reports.

More recently, in September 2020, the World Economic Forum (WEF) released a set of ‘stakeholder capitalism metrics’, designed to assist in the benchmarking of sustainable business performance. These metrics are centred on four pillars, encompassing a number of ESG factors: People, relating to diversity reporting, wage gaps, and health and safety; Planet, relating to greenhouse gas emissions, land protection, and water use; Prosperity, relating to employment and wealth generation, taxes paid, and research and development expenses; and finally Principles of governance, such as purpose, strategy, and accountability informing risk and ethical behaviour.

The WEF is encouraging businesses to include a full set of metrics in their corporate and financial reporting. But I agree with Vitaly Nesis that self-disclosure – something which continues to be encouraged by the WEF – is a recipe for inconsistency, subjectivity, and opacity.

There are many areas of ESG activity that aren’t represented in easily reportable figures, don’t have generally accepted measurement criteria, or which defy clear definition. They don’t generate a pithy soundbite to include in annual reports, or statistics to present to the board. There is no neat package for complete ESG reporting.

Furthermore, the importance and prevalence of different areas of ESG activity varies from sector to sector and indeed from company to company. There is a huge risk that many companies will be oversimplifying their ESG reporting to just what can easily and consistently be measured, rather than what actually matters.

So how can we close the current reporting gap? I argue that there is a need for other tracking measures, not only to help investors but also so that companies themselves can gain a realistic understanding of their own position on ESG. These measures need to take into account the reality of ever-shifting perspectives through real-time analysis of publicly available print, online, broadcast, and social media content. Reporting needs to incorporate:

  1. Comprehensive data, beyond company disclosures, be they voluntary or mandatory
  2. Sector-specific ESG topics, classifying and weighting using industry best practice (e.g. Sustainability Accounting Standards Board (SASB) standard taxonomy)
  3. Sector benchmarking, to understand how a company’s ESG profile compares to other businesses operating in the same environment
  4. Stakeholder specific factors, to reflect the competing demands and perspectives on ESG topics that different stakeholders have
  5. Rigorous scoring, both for overall ESG performance and also the materiality of the ESG issues faced, be they risks or opportunities
  6. Traceable data, to enable scores and movements to be linked back to their underlying drivers
  7. Real-time reporting, to reflect the speed with which ESG issues are evolving

This would of course mean a huge volume of data to process, but machine learning and natural language processing (NLP) technology can help to create an ESG scoring system to offer a reliable, objective overview of risk and potential.

Such scoring could be delivered to shareholders to help them to make truly informed investment decisions – while also allowing companies to make better strategic decisions.

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