Sustainable finance has an ‘information governance’ problem

The building blocks behind the ‘information governance’ of sustainable finance appear to be an extension of a similar process undertaken to organize financial information to support more efficient capital allocation. But sustainable finance brings a wider range of complex challenges and trade-offs that are harder to balance, which makes them even more important to address without expecting a clean and neat solution to fit every objective.

  • A BIS working paper examines how past experience relating to financial information governance, involving regulators, auditors and information intermediaries such as credit rating agencies, can inform development of ‘information governance for sustainable finance’
  • Information governance refers to the regulatory systems to mitigate situations where information flow between businesses and investors breaks down, and has been important to help improve the efficiency of capital allocation decisions
  • The information governance challenge around sustainable finance is more complex than for financial-only information because more stakeholders have more conflict about objectives and trade-offs, which are harder to reconcile with a single ‘solution’

A working paper released by the Bank for International Settlements (BIS) considers the lessons learned from past experience with ‘information governance’ related to financial metrics and how it could improve sustainable finance. Information governance refers to the process by which information relevant to decision-making is disseminated to improve the effectiveness especially of capital allocation decisions.

When talking about financial information, this references the relationship and regulatory policies to influence the circumstances through which information is flowing to investors from businesses to support capital flowing in the opposite direction. Regulation, auditors and data intermediaries have become more sophisticated over time, improving intermediation in the information governance process.

This has been occurring in relation to credit ratings and predates the widespread public dissemination of financial information by companies issuing debt. As a result, it provides experience that can inform the development of information governance for sustainable finance. The BIS working paper outlines some of the considerations for policymakers and others to improve the effectiveness of sustainable finance broadly.

Beyond the technical considerations of how to improve information governance, there are important issues of trade-offs between those who gain from different approaches and those who bear most of the costs. This is one point at which the experience of financial disclosure will diverge from the decisions about information governance around sustainable finance, because it is more far-reaching, relying on a wider range of stakeholders and more subject to legitimate differences in how data is used and towards what objectives sustainable finance should be advancing.

The working paper outlines some of the barriers that sustainable finance faces that may be more severe than the process of developing information governance in the purely financial sphere. Unlike credit ratings, which are assessments of the likelihood of repayment for an entity, sustainability ratings and verification cover a much broader range of objectives, including but going far beyond directly financial outcomes.

This has led to a much more divergent range of information being gathered in between investors and businesses. Prior to widespread publicly available financial statements, credit ratings “pierce[d] the fog of asymmetric information”. The subsequent reporting and auditing requirements from regulators and conflict mitigation regulations for credit rating agencies helped further lift the opacity around financial metrics of strength by equity and debt issuers.

Reaching a similar situation in regards to sustainable finance data will take a similarly complex process for improving the ‘information governance’ around sustainability. The BIS working paper dives into some of the relevant issues. For example, the benefit of sustainable finance data supports better capital allocation, but only if the financially material issues are able to be considered based on the information available.

More specifically, there is a concern about how effectively the sustainable finance information translates into the decision-making process. Does single materiality provide all the relevant information for decision-making by covering the issues that are financially material? Or is double-materiality — providing the information for all stakeholders that relates to a material impact even if it’s not immediately financially material — necessary to close the loop between material impacts and future financial materiality through a form of ‘market discipline’?

The information governance framework also considers how the effectiveness of making the information disclosed translate into more efficient capital allocation against the costs of the data required. There is a distinct trade-off in the amount of data required to be disclosed within an information governance framework, and the burden of collecting the data, and that trade-off is already underway.

There will not be a single decision that finds or settles the balancing of this trade-off in practice. It will continue to impact financial institutions, investors, businesses and many other stakeholders in the meantime and underpin decisions and debates about how sustainable finance information is collected and used.

It has been particularly noteworthy, to take one example, how EU regulations for disclosures have such a far-reaching impact. They impact companies (including non-EU companies), financial institutions, and the long supply chains underpinning and sometimes undermining the global economy. However, the cascading effect of this information governance architecture from developed countries into emerging markets and developing economies doesn’t always share benefits and burdens equally.

There’s a justifiable reticence from emerging market companies and financial institutions to follow disclosure regulations to maintain the status quo. This is at a time when many are facing far more severe consequences of climate change and the biodiversity crisis than they contributed. They have found it a successful but difficult struggle to get issues of loss & damage on the agenda in global climate negotiations while developed countries have fallen short on meeting previous climate finance commitments.

All of this impacts the information governance surrounding sustainable finance in a way that was much narrower and with fewer impacted stakeholders on issues of financial transparency. None of the objectives of sustainable finance are easy or quick to achieve. But the degree of success that it has generated whether linked to financial materiality, the SDGs, climate change or biodiversity loss shows that there’s a concern about the end result of what financial intermediation is doing to the real economy and the real world.

There will be no perfect catalogue or disclosure regulation to act as a panacea to guide sustainable finance towards its objectives. There will be continual messy iterations of efforts, including some focused on single materiality while others focus on double materiality. It will include difficult balancing of the trade-offs including data quality, efficient use of scarce resources by companies subject to one or many reporting requirements, and efforts to improve the information governance to limit the ‘false signals’ such as greenwashing that reduce the feedback from sustainable finance information back to capital allocation decisions. It’s not going to be easy, but that doesn’t mean it’s not worth the effort.

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Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.

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Blake Goud

Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.