Many of the challenges facing ESG reporting are a product of its infancy. By learning from the more mature financial reporting ecosystem, ESG reporting can become as important in determining capital allocations.
Five shifts in the ESG information ecosystem
Despite the challenges, we anticipate five shifts that companies in Asia-Pacific should prepare to accommodate as the world tries to collaborate around more trusted ESG information.
1. Better transparency of composite indicators
With composite indicators, a company is scored on a wide range of ESG issues, with different weights given to each issue — from climate risk to tax transparency — to calculate an overall ESG rating. Currently, ESG ratings tend to be weighted toward financial materiality. Whereas climate change-related considerations are usually less than 15% of an overall ESG score, providing relatively little useful information about company-specific climate risk. In the short term, we expect investors to become more aware of composite distinctions, measurement limitations and variations.
2. Better understanding of how sustainability information is used
Sustainability information can serve two purposes: to assess financial risk and to assess social impact. These uses are not mutually exclusive but are easily confused. In the future, we expect more clarity on the distinct use cases of sustainability information. We also anticipate standard setters and ESG rating agencies to move to address the needs of all users of sustainability information.
3. The rise of assurance
Market forces will increase demand for robust, independent external assurance over sustainability information in the coming years. Already, the US and the EU are considering mandatory assurance requirements for some aspects of sustainability disclosures. And about half of the world’s largest companies already have assurance over their sustainability disclosures on a voluntary basis. Currently, some assurance in the market is limited, but we expect this to change quickly to “reasonable assurance,” as investors and regulators seek more robust levels of assurance.
4. Comparable and interoperable taxonomies
Some regions and countries are already making considerable progress with developing taxonomies. For example, the EU is working with China on a Common Ground Taxonomy to find commonalities within taxonomies while reflecting different energy transition pathways and political realities.
5. Better support for companies in emerging markets
The international standard-setting work being done by the International Sustainability Standards Board (ISSB) will benefit emerging countries, if they take the opportunity to adopt its standards into their own legal frameworks.
Supporting the sustainability agenda with strategy, skills, systems and standards
While anticipating these five shifts, companies in Asia-Pacific should prepare to support the sustainability agenda with the following:
Strategy
ESG reporting is but the outcome of business actions. First and foremost, ESG initiatives must be an integral part of corporate strategy, focusing on where the organization can truly make an impact, both for society and their competitive position. This entails finding out what ESG elements matter most to stakeholders: reducing the carbon footprint, designing products with less waste, creating a more inclusive workplace or having greater impact in the communities in which the company operates. Then companies can pick areas most material to their industry and best aligned with their purpose. Finally, leaders must develop the blueprint for driving the right behavior, choosing the right KPIs to measure impact and aligning incentives to ESG goals — and offering external stakeholders trusted and integrated financial and nonfinancial information.
Skills
Some organizations are being prevented from moving forward in sustainability information gathering due to a lack of ESG expertise and the difficulties of retaining this talent in a tight skills market. One area of untapped potential is within the finance function, which can help inject rigor into sustainability reporting and align financial and nonfinancial reporting. Companies also need better data modeling and analytics capabilities that underpin the type of sustainability information that stakeholders are increasingly seeking, such as Scope 3 and Scope 4 emissions, or modern slavery risk. Finally, the audit community will need to be extended to cover ESG assurance, requiring sustainability training.
Systems
Data and analytics are essential to enhance visibility, benchmark results and share an ESG narrative. The CFO and finance team can help to embed data controls and processes. But organizations must also standup technology to manage the underlying data and develop processes to monitor progress. To support reporting obligations, performance improvement and risk mitigation, quality ESG data and insights must be available at decision-makers’ fingertips. That means companies will eventually need an ESG solution with a variety of input options, configurable workflows, robust emissions calculation engines, embedded analytics, automated reporting tools, task completion engines, APIs and performance dashboards. The goal is for the ESG solution to eventually be able to influence behavior and decision-making. This will require better linkage between sustainability metrics and financial information, with reporting data pushed continually into the business, so ESG risks and impacts are considered in all decisions at all organizational levels.
Standards
The overwhelming majority of investors (89%) surveyed for the most recent EY Global Institutional Investor Survey said they would like the reporting of ESG performance, measured against a set of globally consistent standards, to become a mandatory requirement. In the months ahead, the ISSB will finalize its initial sustainability disclosure standards. At the same time, the region’s policymakers and regulators are likely to start mandating sustainability disclosures. Companies must therefore be prepared to embrace the likely international standard that will bring about globally consistent and trusted sustainability information.
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Summary
The sustainability agenda is driving a stronger connection between the financials and ESG. For this reason, Asia-Pacific organizations should get ready to produce trusted and decision-useful integrated financial and ESG reporting. Organizations also need to recognize the broadening of interested stakeholders and engage with environmental activists and younger generations of consumers and employees. And the future battle for capital allocation is likely to be won by organizations that can embrace and embed ESG considerations into day-to-day business and reporting.
