Financial institutions must invest in understanding ESG data better, not just having more of it

• ESG and sustainability data are moving in the direction of more mandatory disclosures
• Regulators want more consistent ESG data, but that won’t guarantee it is more useful
• Investing in capacity to understand the nuances behind different ESG data and the context in which they are reported and used is critical to making more ESG data translate into better outcomes

The future of sustainability reporting and disclosure is evolving rapidly, but regulators see it transitioning from voluntary to mandatory and expanding in scope, beginning with climate-related topics. The International Organization of Securities Commissions (IOSCO) has released a summary of two roundtables held by a Sustainable Finance Task Force with a few key conclusions that reflect the perspectives of regulators and multilateral organizations around “the practical implementation of a global system architecture for these disclosures”.

The frame of reference for the discussions held by IOSCO is for an International Sustainability Standards Board to be set up before COP 26 in November 2021 by the IFRS Foundation. This would be charged with setting out a reasonable time frame for development of sustainability reporting standards using a ‘building blocks’ approach based on current market references, which are largely voluntary, as a way to “give a running start” (IOSCO’s emphasis) to new reporting requirements.

For those that are or would be reporting ESG information, the degree of thought and experience that regulators can draw on should make clearer what is coming. There will be more disclosures required, and the quality and assurance underpinning the data will be much more rigorous. For those incorporating ESG information already, this process could be a significant boon if they can take more structured disclosure and extract useful information from it.

That doesn’t just mean finding more ways to technically input a more standardized formatting of the data into a financial institution’s decision-making process. It means also recognizing and adapting to what types of data are useful in which contexts. IOSCO is focused significantly on more standardized quantitative metrics with a “climate first” approach, recognizing the immediacy of that topic.

Climate is a critical cross-cutting issue, but it is not the only one that will have wide-ranging and systemic impacts. Natural capital is similarly important but much more difficult to quantify. It is easy to assume that more quantification automatically means more useful data. For example, as we highlighted last week, financed emissions are a critical risk embedded in investors and financial institutions have been reporting Scope 3 emissions but excluding financed emissions.

Scope 3 emissions relating to business travel, employee commuting and other operational sources give very little insight into what the embedded climate risk is for a financial institution. This type of qualitative judgment in interpreting what data are presented quantitatively cannot be integrated by only making more data available. It also won’t always work just by requiring certain data points to be reported where there can be confusion about the completeness of reported data, like we see with Scope 3 emissions for financial institutions.

On a broader level, IOSCO lays out some key sources of data that can be improved with a reporting framework that they outline, including:

• Quantitative metrics and standardization;
• Clarity on forward-looking metrics (e.g., scenario analysis);
• Linkages between sustainability and financial reporting (e.g., integrated reporting); and
• Disclosure of key assumptions and industry-specific standards and metrics incorporating different dependencies on natural, social and human capital

For both reporters and users of this type of data, the priorities outlined by IOSCO should provide a call to action to invest in the capacity to produce this reporting. It also requires investing in the capacity to technically integrate it into decision-making and to understand the nuances more. ESG data aren’t fully standardizable, which is acknowledged by the discussion of creating building blocks as a starting point while allowing regional and national variation.

Each regulator will lay out its own requirement in relation to the local context. Not everything that is prescribed by a regulator will be useful to every user of the data or relevant to companies reporting the data. This summary from IOSCO provides insight into the regulators’ surveying of the landscape of sustainability and sustainable & responsible finance, but it also highlights how just taking a compliance view of ESG data reporting or interpretation can undervalue all of what ESG data can and should include.

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