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Foreword

Andrew Edgecliffe-Johnson, US Business Editor, Financial Times

If there is any truth to the adage that “you can’t manage what you don’t measure”, then the biggest revolution in business for 50 years will not fulfil its potential without new metrics. When economist Milton Friedman was in his pomp and shareholder returns were all that mattered, establishing how a company was doing was pretty simple — at least once the hard work of thrashing out international accounting standards had been done.

Now that stakeholder capitalism has elbowed aside the singleminded focus on investors, however, things have become more complicated. How should we assess a company’s impact on the environment, its employees or its supply chain? And with most investors having accepted that environmental, social and governance factors affect their returns, what data should they be demanding? As Sarah Murray explains in our second Moral Money Forum report, finding answers to those questions is no less challenging — or vital — than it was when the task was agreeing on international financial reporting standards.

The proliferation of ESG metrics and reporting frameworks in recent years has left executives and investors complaining about the difficulty of keeping up with so many apparently clashing standards — or even remembering what the different acronyms stand for. But this year is shaping up to be a pivotal one for efforts to simplify the “alphabet soup” of ESG reporting.

When we asked FT Moral Money readers for their input to this report, there was scepticism about whether current frameworks were truly measuring companies’ impact on people or the planet. “Our internal standards are all PR,” one told us.

One theme, though, came through strongly: the need to focus on “materiality”, or what it is that adds value to a company and signals risk and opportunity to investors. Or, to strip away the jargon, it is about what matters.

In a 2018 speech about the future of corporate reporting, Erkki Liikanen, a former Bank of Finland governor, recalled Europe’s debates over adopting the International Financial Reporting Standards almost two decades earlier. “It was becoming increasingly clear that different accounting requirements of differing quality were adding cost, complexity and risk to companies and investors,” he told delegates at a European Commission conference.

Liikanen, who chairs the trustees of the IFRS Foundation overseeing international accounting standards, could just as easily have been describing what has become known as the “alphabet soup” of acronym-heavy measurement and reporting standards surrounding ESG (environmental, social and governance) approaches to business and investment.

Yet, after years of complaining about the proliferation of competing metrics, companies and investors are beginning to hope that more consistency in measurement and disclosure is in sight. “This is emerging as we speak,” says Kirsty Jenkinson, head of sustainable investment and stewardship strategies at Calstrs, the Californian teachers’ pension fund. “It feels like there’s a better direction of travel, but it will be interesting to see how this next phase is going to play out.”

That phase is unfolding rapidly. Last September, five leading independent standard setters announced that they would work together towards a comprehensive corporate ESG reporting system. Earlier this year, rules came into effect in Europe to make financial firms and investors disclose “double materiality”, which covers the risk that their operations pose to society and the environment as well as to their profitability.

And while it will add another acronym to the mix, all eyes are on the IFRS Foundation, which is on track to launch a global Sustainability Standards Board at the UN’s COP26 climate summit in November with the backing of the International Organization of Securities Commissions (Iosco), the umbrella group for global markets watchdogs.

“What you have is a massive acceleration in a very short period of time — pretty much 12 months of a real willingness and ambition to sort all these problems out,” says Ashley Alder, the chair of Iosco and chief executive of the Hong Kong Securities and Futures Commission.

Even so, the idea of standardised ESG reporting remains highly contested. Companies argue that the unique nature of their operations will make comparisons difficult — just as they did at the launch of the IFRS and the generally accepted accounting principles, or GAAP. “Nobody is ever happy with a standard. It’s a giant compromise,” says Bob Eccles, a professor at Oxford university’s Saïd Business School and an expert on sustainability. “What you have with accounting is a social construct and an agreed-upon definition of reality that we all start from — that’s where we’re at with ESG.”

Some crucial questions still have to be settled. Can sustainability measurement and reporting standards serve not only companies and investors but also people and the planet? Can a framework for reporting on climate change — the SSB’s first priority — be applied to complex social issues while enabling comparisons across different sectors and jurisdictions? Can a global standard operate alongside the many existing ratings systems? And how many national governments will adopt it?

Yet the fact that these questions are being raised at all is a sign of progress. And as chief executives and investors set increasingly ambitious social and environmental goals, measuring what matters is something they can no longer afford to ignore.

“Sustainability disclosure is now at the top of the agenda for the world’s largest investors, the world’s largest companies and regulators in almost every major market,” says Janine Guillot, chief executive of the Sustainability Accounting Standards Board (SASB). “That’s a sea change from where this conversation was even five years ago.”

These days, some like to joke that if you want a better ESG rating all you need to do is change your rating provider. There is plenty of choice: supplying the picks and shovels of the ESG gold rush has become a lucrative business for organisations from financial advisers to sustainability consultancies and rating agencies. By 2018, more than 600 ESG ratings and rankings existed globally, according to consultancy SustainAbility.

The problem is that assessments of corporate ESG performance can vary considerably depending on the choice of ratings provider. When we asked FT Moral Money readers what their organisations struggled with most when trying to measure social and environmental impact, responses included worries that current methodologies allow companies to “cherry pick how they’re assessed” or even to “game” ESG rankings.

Researchers Feifei Li and Ari Polychronopoulos, who work for Research Affiliates, a Californian investment manager, reached a similar conclusion after looking at how two rating providers assessed Wells Fargo, the financial services group.

They found that scoring variations for social and governance ratings led to the first provider giving the bank a much better overall result than the second. In fact, the two providers gave different assessments for every single ESG dimension except the company’s environmental score

While demand for ESG ratings products is high — SustainAbility found that 65 per cent of investors survey ESG ratings at least weekly — the same cannot always be said for their quality. “We’ve been amazed at how different the data sets are on something like GHGs [greenhouse gas emissions] and the messiness and lack of consistency across those data sets,” one executive told the consultancy.

Some investors have decided to create their own evaluation and ratings systems. For example, State Street Global Advisors has its R-Factor scoring system, while TPG and the Rise Fund developed a system called the Impact Multiple of Money, which they eventually spun off as Y Analytics.

For those without the resources to develop an in-house ratings system, the current measurement and reporting landscape can be frustrating and confusing. In fact, more than three-quarters of respondents to our FT Moral Money questionnaire thought there were too many different measurement standards.

The journey towards more rigorous ESG measurement and disclosure began in the late 1990s. In 1997, the Global Reporting Initiative (GRI) launched as a non-profit organisation offering sustainability-focused reporting guidance. At the time, when a PR-heavy “corporate social responsibility” report was the principal corporate vehicle for disclosing sustainability information, few imagined how many frameworks, ratings systems and standard setting organisations would emerge from the sensible desire to find a more rigorous way of measuring companies’ social and environmental impact.

GRI has since become part of a “big five” group of global standard setters along with CDP (formerly the Carbon Disclosure Project), the Climate Disclosure Standards Board (CDSB), the International Integrated Reporting Council (IIRC) and SASB.

Rather than develop standards, the Task Force on Climate-related Financial Disclosures (TCFD) has meanwhile provided a framework on which others can build. Created by the Financial Stability Board, the rulemaking body set up after the financial crisis, its focus is climate change.

But Mary Schapiro, head of the TCFD secretariat and former chair of the US Securities and Exchange Commission, argues that its work could be applied more broadly. “When we created the TCFD framework, we based it on a foundation that would be familiar to companies that have to report on these kinds of risks,” she says. “So we have four pillars of disclosure: governance, strategy, risk management and targets and metrics. And those four pillars work for any ESG issue.”

So far, more than 2,000 organisations have expressed their support for the TCFD’s recommendations, including companies with a collective market capitalisation of almost $20tn and financial institutions responsible for $175tn worth of assets.

Nevertheless, companies and investors can be forgiven for still feeling confused. “There has been a lot of noise in the system,” says Alder of Iosco, “which is not surprising given that the demand from investors is high while the ability of issuers — asset managers and others — to provide the information is genuinely technically difficult.”