- 98% of institutional investor respondents evaluate nonfinancial performance based on corporate disclosures
- 91% say that nonfinancial performance has played a pivotal role in their investment decision-making over the past 12 months
- 75% would find value in assurance of the robustness of an organization’s planning for climate risks
Institutional investors are ramping up their efforts when it comes to assessing the performance of companies using environmental, social and governance (ESG) factors, according to the fifth EY Climate Change and Sustainability Services (CCaSS) survey of 298 institutional investors globally.
The vast majority of investors (98%) evaluate nonfinancial performance based on corporate disclosures, with 72% saying they conduct a structured, methodical evaluation, according to the survey. This is a leap forward from the 32% who said they used a structured approach in the survey’s fourth edition in 2018.
At the same time, investors are increasingly holding companies accountable, with ESG factors playing a central role in their decisions. Investors (91%) say that nonfinancial performance has played a pivotal role in their investment decision-making over the past 12 months, either frequently or occasionally, with the proportion of investors that say this happens frequently jumping to 43% from 34% in 2018.
Climate change, in particular, plays a significant part in investors’ decision-making process, with 73% responding that they will devote considerable time and attention to evaluating the physical risk implications of climate change when they make asset allocation and selection decisions.
Mathew Nelson, EY Global CCaSS Leader, says:
“The rules for capital markets are being rewritten, in turn, impacting the drivers that influence investors as they direct capital to support economic recovery. What we see is that instead of retreating to short-term performance models, institutional investors are focusing on long-term value creation and raising the stakes when it comes to assessing company performance using ESG factors.”
In Malaysia, the demand for sustainable finance, focusing on ESG considerations, has been gaining momentum since the launch of the Sustainable Responsible Investment (SRI) framework in 2014. As of June 2020, a total of nine (9) investment managers and asset owners in Malaysia – which include the Employees Provident Fund (“EPF”), Khazanah Nasional Berhad (“Khazanah”) and Kumpulan Wang Persaraan (“KWAP”), among others – have signed the United Nations-backed Principles for Responsible Investment (UNPRI), under which they have pledged their commitment towards ESG best practices and sustainable investing principles. This includes embedding ESG considerations into investment analysis and decision-making processes, as well as seeking appropriate ESG disclosures from investee companies.
Arina Kok, Director, CCaSS, Ernst & Young Advisory Services Sdn Bhd says:
“The COVID-19 pandemic has exposed the vulnerability of businesses in managing emerging risks. It has also further reinforced the importance of having strong ESG disclosures, underpinned by appropriate structures, reviews and controls to regain and rebuild investors’ confidence. Business leaders are finding themselves at a historic crossroads, with prospects to integrate climate change action into their recovery plans. To move forward, they must consider broader stakeholders’ interest and redefine business objectives in view of changing expectations and uncertainties.”
The growing ESG disconnect
The survey also identifies a growing disconnect between the increased focus on evaluating ESG performance from investors and the availability and robustness of standardized and rigorous nonfinancial data from corporates.
The number of investors that are dissatisfied with environmental risk disclosures has jumped to 34% from 20% in 2018. At the same time, the percentage of respondents who say that companies do not adequately disclose the social and governance risks that could affect their business models increased to 41% (from 21% in 2018) and 42% (from 16%) respectively.
Asked about challenges to the usefulness and effectiveness of current ESG reporting, 46% of investors identified the disconnect between ESG reporting and mainstream financial information as the top challenge. The lack of real-time information (41%), or information about how the company creates long-term value (41%), as well as the lack of forward-looking disclosures (37%) and the lack of focus on the material issues that really matter (37%) completed the list.
Arina says: “While public listed companies in Malaysia have progressively enhanced their ESG disclosures in line with regulators’ guidelines for better reporting practices through sustainability reporting and integrated reporting, the quality of corporate reporting can be further improved in certain aspects such as demonstrating the integration of ESG factors in the risk management process, setting ESG targets and linking them to business strategy.”
Collaborative efforts in building climate change resilience within the Malaysian financial sector is increasing, with Bank Negara Malaysia (BNM) and Securities Commission Malaysia (SC) both taking action to support the management of climate-related risks in the financial sector. In September 2019, the Joint Committee on Climate Change (JC3) was established by BNM and SC with representation from 20 industry players to advance risk management, governance and disclosure, product and innovation, engagement and capacity-building on climate change. BNM also encouraged Islamic banking institutions to adopt the Value-based Intermediation Financing and Investment Impact Assessment Framework (VBIAF) to incorporate ESG risk considerations in their risk management systems.
Investors call for independent lens on ESG performance
While ESG disclosures are gaining significance, it is important for organizations to instill discipline into their nonfinancial reporting processes, tapping on the extensive experience of the finance and risk teams. The EY research found significant appetite among investors for an independent lens on ESG performance with three-quarters (75%) saying they would find value in assurance of the robustness of an organization’s planning for climate risks. Investors also see a strong need to build confidence and trust in green investment disclosures, with 82% saying it would be useful to have independent assurance of the impact of green investments.
Nelson says: “ESG performance reporting generally lacks the rigorous systems and controls that characterize financial reporting. As a result, investors and corporates cannot guarantee the accuracy and reliability of nonfinancial reporting. Establishing effective governance practices and assurance of nonfinancial processes will help build trust and transparency.
Overall, these findings show that addressing urgent environmental and climate change threats is more important than ever in the eyes of investors. Although many organizations are in crisis-response mode as a result of the COVID-19 pandemic, those with strong sustainability functions that focus on what is most material to their long-term success will be more likely to rebound once the crisis is over and deliver long-term value.”
For further leading edge thinking and insights around climate change, sustainability and nonfinancial reporting, please visit the new EY Sustainable Impact Hub.
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About EY’s Climate Change and Sustainability Services (CCaSS)
Governments and organizations around the world are increasingly focusing on the environmental, social and economic impacts of climate change and the drive for sustainability.
Your business may face new regulatory requirements and rising stakeholder concerns. There may be opportunities for cost reduction and revenue generation. Embedding a sustainable approach into core business activities could be a complex transformation to create long-term shareholder value.
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About the survey
How will ESG performance shape your future? is the fifth consecutive survey of more than 290 institutional investors globally, including managing directors, CIOs, COOs, equity analysts and portfolio managers on their views about the availability and quality of corporate nonfinancial information and on how, if at all, they use this information when making investment decisions. The survey and in-depth interviews with respondents were carried out in February 2020 by Longitude. Survey respondents represent high-level investment decision-makers and 32% of respondents work for institutions with US$10 billion or more in asset under management.