Active investment commentary & analysis

Meaningful ESG reporting requires a more rigorous approach

While corporate social responsibility (CSR) reporting is becoming increasingly common place the same rigour and standardisation which is applied to financial accounts is still clearly absent. There are many organisations such as the UN’s Global Reporting Initiative and the Sustainability Accounting Standards Board which are attempting to inject more rigour into the process but without increased regulatory intervention we are still a long way from a situation where ESG research can be as complete and as thorough as more traditional financial analysis. Standardisation and completeness are particularly relevant where peer group comparisons are to be made, an essential process if investment managers are to have confidence in the merits of one stock against another.

The lack of standardisation is clearly behind what is a gaping hole in the provision of today’s CSR reports and that is a comprehensive external audit. Even where a report has been audited it is often the case that much of the environmental and social disclosure is buried somewhere deep in a company’s website rather than disclosed in one single auditable document. We do, however, find cases of good practice and can use this as an invaluable tool for our stewardship activities.

 Although often taking the form of a limited audit with the auditor stressing the same rigour is not applied as would be the case with financial reporting such scrutiny does add a sense of gravitas and urgency helping investors in their push for better standards of disclosure. A recent example we encountered in the retail sector helps highlight the approach.

Our own research had identified a material risk in the supply chain of the company involved. We then sought to assess the severity of this risk based on the practices and procedures followed by the company. Both reputational damage as well as potential fines or regulatory action have the potential to seriously dent share prices.

Qualitative commentary was in abundance, but specific quantitative reports were incomplete. For example, numbers were given for supplier audits undertaken by the company for self-selected areas of the business, but the coverage was far from universal. A supplier audit is of course welcomed but in isolation is meaningless. An interested investor needs to know both the scope and results of these audits in terms of compliance with, for example, a Code of Conduct, as well as remedial actions taken where failures are identified. Such data is evidence of the process being more than a mere tick box exercise.

And here the auditor had a role to play. Embedded in the audit report was the statement by Ernst and Young that the company “reports mostly qualitative disclosures in relation to people and society and, where quantitative metrics are used, they are primarily input or output based”. Dry words perhaps, but a call in itself for a more rigorous approach to be adopted and an endorsement of the importance of meaningful ESG reporting.

Backing from a professional auditor provides considerable weight to a company engagement process. Too often requests for ESG data can be shrugged off as irrelevant and requiring too much detail. Should more standardisation be put in place and the audit of such material becomes compulsory ESG can then become even more firmly integrated into investment processes. Engagement with company management will become ever more meaningful as the thoughts of investors and auditors combine.