Let’s talk: sustainability, Issue 5

Tomorrow’s investment rules: How global institutional investors are using ESG to inform decision-making in 2015

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For the second year, EY sought the assistance of the Institutional Investor Research custom research group analyse the ‘future of non-financial performance and investment decision making’. The findings showed that more investors than ever were functioning ESG into their decisions and that there exists a great opportunity for early report issuers to set the standard and tone for future non-financial reporting.

The survey included the involvement of a number of high-level decision-makers from an array of global third-party investment management firms, over half of whom had portfolios of more than US$50 billion.

Four clear messages emerged from the analysis of non-financial performance reporting and investment decision making:

  1. Investors are concerned with the risk of stranded assets, which is closely linked to ESG (environment, social and governance) factors.
  2. Investors are adopting more structured, measurement-oriented approaches to non-financial/ESG information.
  3. Investors face an information deficit – they do not receive enough accurate, standardised information relevant to risk and performance assessment.
  4. Investors want non-financial/ESG information that allows the comparison of sector peers.
  • Investor concern over risk of stranded assets

    This year’s research found that in the last year, more than a third of respondents cut their holdings due to the risk of stranded assets, with another 27% planning to monitor this risk closely in the future. While 30% of respondents hadn’t cut their holdings, 8% were unsure if this risk motivated cuts in their fund.

    Moreover, the research identified that, unlike last year, investors are factoring ESG risk into all industry sectors, not just energy and extractives.

  • Adoption of more structured and measurement-oriented approaches

    When asked how they evaluate non-financial disclosures relating to the environmental and social aspects of their company’s performance, 37% of respondents claim to conduct a structured, methodical evaluation of environmental and social impact statements and disclosures. About 16% stated that they rely on guidelines or information from third parties, such as the UN Principles for Responsible Investments, with a further 27% informally evaluating environmental and social impact statements. The proportion of respondents claiming to conduct little or no review of environmental and social aspects of their company’s performance was down to just 21%.

    Somewhat surprisingly then, despite an increasingly structured approach to analysis, ESG factors had not driven more investment decisions in the last year, with 48% of respondents stating that such factors seldom or never played a pivotal role, an increase from 42% in 2013. Of these individuals, 46% informed us that disclosures were insufficient to know ESG issues’ material impact’ with and 29% finding company disclosures inconsistent, unavailable or unverified.

    While some progress has been made, these findings indicate that more education is required on the material impacts of non-financial information, and that there is further work to be done in ensuring that this information is consistent and easily available to investors.

    From a variety of non-financial issues, respondents identified the impacts of regulation and the necessity to minimise risk as the most important issues as an investor, followed by their use as evidence of improved future valuation with business forecasts.

    A common theme among investor decisions is the ability to measure risks to performance. 76% of respondents would reconsider their investment in an entity which presented risks of poor environmental performance, 73% would reconsider due to unaddressed risks in the supply chain, and 69% would reconsider based on the risk of resource scarcity. These figures have remained consistent from the previous period.

  • Investors facing an information deficit

    When gathering non-financial information, respondents overwhelmingly preferred information directly from the issuers, naming annual and integrated reports, corporate websites and press coverage most useful.

    However, nearly two thirds of those surveyed believe that companies do not adequately disclose ESG risks in this information. When adequate ESG information is gathered, 80% find mandatory board oversight of the information essential or important, followed by 78% who would expect audit committee oversight and independent verification.

    In terms of motivations, 64% of investors believe that companies report their impact on non-financial issues to build their corporate reputation with customers, while 59% believe they are motivated by the necessity to comply with regulatory requirements.

  • Desire for comparison of sector peers

    It is clear from this year’s survey results that investors are eager for non-financial/ESG information that allows the comparison of sector peers. When questioned, 74% of investors said that industry-specific reporting criteria and KPIs would be very or somewhat beneficial, while 65% saw the benefits of separate sustainability and financial reporting.

  • Meeting investor demand

    For companies to keep ahead of global investor demand for non-financial disclosures that help them value long-term resilience, EY suggests:

    • Undertaking meaningful materiality assessments to determine the most important aspects of performance to disclose
    • Engaging investors and other stakeholders to determine what risks and opportunities they feel should be considered in corporate strategy
    • Applying the same rigour to financial and non-financial disclosures, for example by seeing independent assurance over non-financial disclosures

    Considering developing frameworks such as, GRI G4, SASB and the IIRC’s Reporting Framework to help guide future reporting.

EY’s 2nd survey on the future of non-financial performance and investment decisions will be launched in the coming months, and will be available on our website.