ESG Disclosure Is Essential to Bolstering Trust in Markets – Barron’s

esg-disclosure-is-essential-to-bolstering-trust-in-markets-–-barron’s

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After years of market-led efforts, U.S. regulators and policy makers are signaling interest in advancing corporate disclosure on critical sustainability issues, including climate change. Now is the time to enact an effective regulatory framework for environmental, social, and corporate governance disclosure in the U.S. The question is not only about what should be done, but also how to do it.

Investment decisions are fueled by data. As the CEO of an investment management firm working across global capital markets, I can tell you that the lack of comparable, consistent, and reliable ESG data is a burden my firm faces daily—and it is putting trust in the capital markets at risk.

For example, our clients want investment solutions that mitigate physical risk due to climate change. When the operations of, say, a healthcare facility located in a coastal region or floodplain are disrupted, there are likely to be negative impacts on its financial statements and ability to provide essential social services. To get that information, we need to look at the facility level, and we need a model for assessing the physical risk to that facility because of climate change. Both pose challenges.

The first problem is that company-reported data are not readily available for many ESG risks, so investors purchase them from data providers. While our firm can spend millions per year on data and research, many retail investors cannot, nor should they have to. Fair and efficient markets need to ensure equitable access to reliable ESG information.

The second problem is that the data we purchase vary widely because there is no standard for calculating the physical risk exposure of facilities, or other ESG factors. Without a regulatory framework, companies disclose ESG information in myriad ways. When they don’t disclose, data providers often “fill in the blanks,” compounding data-reliability and comparability problems.

This data challenge exists for all ESG issues, not just climate. Thus, it’s encouraging that under the Biden administration, the Securities and Exchange Commission has signaled an appetite for addressing climate disclosure (and recently, invited public comment on how to do so). More broadly, what does an effective ESG regulatory framework in the U.S. look like?

Sustainability issues transcend borders—as do capital markets—so a disclosure system that meets the needs of the U.S. capital markets must also align with international efforts. As different jurisdictions have unique needs and regulatory mandates, a system of separate but interlocking “building blocks”—in which some building blocks are global, and some are regional—would help ensure international comparability while also facilitating jurisdictional specificity. The U.S. should engage in ongoing efforts to establish a global building block, which key players, including the International Financial Reporting Standards Foundation and the International Organization of Securities Commissions, are leading.

Investors need a global system built on a core that is industry-specific and focused on enterprise value. For example, standards from the Sustainability Accounting Standards Board, or SASB, identify the subset of ESG issues most relevant to financial performance in each of 77 industries. International investors with upward of $72 trillion in assets under management support those standards. Prominent investor associations in the U.S. and abroad endorse them along with recommendations from the Task Force on Climate-Related Financial Disclosures. SASB uses a rigorous and transparent due process to help the standards evolve alongside the markets, which is critical given the dynamic nature of ESG factors.

The U.S. also needs a regulatory framework that covers all financially relevant ESG factors, not just climate change. Yes, climate change is an urgent systemic risk, and investors need improved disclosure on how companies are managing it.

But the events of 2020—including the pandemic and protests for social justice—showed the need for improved data on a variety of ESG issues, such as worker health and safety, and diversity, equity, and inclusion. The U.S. needs a regulatory framework for the full range of ESG issues relevant to enterprise value creation.

Finally, the U.S. needs an ESG regulatory framework that is thoughtful and logical and addresses components in the right sequence. We first need issuer disclosure, and then we need investment product disclosure. Information about an investment product can only be as useful as the information about its underlying assets. Enhanced company-level disclosure enables enhanced product-level disclosure, providing retail investors with a clearer understanding of whether an investment product’s strategy and investment priorities—including ESG objectives—meet their needs.

Investors evaluate the attractiveness of one company versus another, or one security versus another, based on available information. The current quality of ESG data isn’t fit for investment decision-making. Now is the time for the U.S. to seize this opportunity to enhance ESG disclosure. If we don’t, we hamper the ability of the market to do what it’s supposed to do: provide a critical feedback loop from investors to corporations, for the purpose of improving competition and improving outcomes.

John Streur is president and CEO of Calvert Research & Management.

Email: [email protected]

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