Gaining Trust in Your ESG Data Is a Material Issue
Shareholders are hungry for data beyond financial statements, as public companies are scrambling to feed them as much as they can while keeping their business strategies tucked away. However, the information they disclose is largely based on materiality, which has different meanings and applications among companies, market participants, and third-party standard-setters. To complicate matters, although the overarching ESG mission has been slowly sharpened over the past decade, the scope of materiality for each E, S, and G factor lacks clear boundaries.
Despite this environment, companies still have to prepare a raft of data for many stripes of market participants. To earn shareholder trust, firms need to manage their data more closely than ever to stay agile with shifting ESG expectations.
Living in a material world
What’s material depends on whom you talk to. Public issuers are currently required to disclose certain material factors, such as climate- and human-capital-related information, to the SEC.
But whether or how the agency broadens the scope of ESG materiality will determine more precisely what and how much information companies will need to disclose.
Materiality for investors continues to deepen as they seek more transparency into non-traditional metrics. Although investors are seeking quantitative data, qualitative data for them is also materially relevant. Likewise, institutional investors evaluate non-financial ESG information in different contexts for their investment decision-making.
Some public companies, however, lean toward an abbreviated scope of materiality, preferring to share financial-related information only to protect their privacy—in a sense, a curse of data for public organizations. Companies that grant more data transparency are more competitive than those that closely guard their information. Essentially, leaders have to choose between controlling their narrative and protecting their strategic interests versus possibly sacrificing them to stay competitive.
As companies try to balance these two agendas, ESG shareholders are also seeking auditor assurance with released data. However, assessing this data is not currently under the regulatory scope of auditors, and even if it was, challenges exist in verifying non-financial information because non-financial data is unstructured and unstandardized. Even though shareholders are valuing public companies using unassured non-financial data, significant risk exists for sharing inaccurate information. Gathering it requires more organizational data wrangling and, thus, increased levels of internal controls. To prepare glossy, investment-grade data, organizations need to have integrated ESG data management policies rooted into their operations.
Standards aren’t standardized enough
Other private standard-setters have stepped in to try to standardize ESG metrics with certain frameworks, namely the Sustainability Accounting Standards Board (SASB), Task Force on Climate Related Disclosures (TCFD), or Global Reporting Initiative (GRI). However, materiality also varies according to each template—each has different standards, methodologies, and data metrics suited for certain stakeholders and companies.
But investors and public companies are frustrated by the variety of these frameworks and their differing standards, which has led to inconsistent non-financial disclosures. And the information released using these templates sometimes isn’t what investors want to see. This context makes it difficult for organizations relying on these frameworks to generate on-demand data investors can trust.
But even the SEC needs a baseline. The agency may delegate disclosure rules to other existing standard-setters, create its own requirements based on these models, or establish a hybrid approach in which they would develop core standards and then use third-party frameworks for specific industry guidance. These templates may change according to the SEC’s new requirements and also may evolve in parallel with shifting ESG standards.
Tying ESG data together demands a rethink
As organizations try to keep up with shareholders’ appetite for data using these frameworks, they’re also at different stages in assimilating ESG standards into their data and broader business strategies.
In the process, the volume and velocity of unstructured data they have to organize and prepare is unprecedented. Data needs to be pulled from ERP, HR, and other corporate systems, across financial, accounting, audit, and legal operations and from suppliers, partners, and third parties. Companies that still use costly, labor-intensive manual process flows may lack effective internal controls, increasing the risk of material weaknesses that may lead to declining share prices.
According to an Audit Analytics data, companies that reported material weaknesses in 2019 experienced the following average drops in stock value:
- 90-day average drop of 6% in stock value
- 6-month average drop of 11% in stock value
- 12-month average drop of 19% in stock value
Conversely, shareholders reward companies they trust. A positive correlation exists between high ESG ratings and financial performance. In fact, companies with higher ESG metrics outperformed their competitors with lower ratings by 40%—and experienced increased three-year returns.
Although ESG agendas vary firm to firm and industry to industry, harnessing cloud-based technologies to input, process, and deliver ESG data investors trust is a necessary strategy leadership should prioritize. Financial leaders need to compare the costs of playing catch up versus transforming their financial operations to adapt.
The release of the SEC’s ESG mandates is still hanging in the air. But companies that are prepared to disclose on-demand and carefully curated data using infallible processes ahead of time will race ahead of those that can’t.
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