Building Trust in ESG: Focus on Key Areas

In the rapidly evolving world of environmental, social, and governance (ESG) investments, there is a pressing need for more trustworthy and useful data to inform capital allocation decisions. However, the sustainability information ecosystem faces significant challenges in achieving this goal.

Currently, there is little agreement within the ecosystem on what ESG includes, how to apply agreed metrics, and how best to use available data. This lack of consensus creates a fragmented landscape, making it difficult to compare and understand ESG performance across different companies and industries.

To address this issue, about half of the world's largest companies currently have assurance over their sustainability disclosures, with most obtaining "limited" rather than "reasonable" assurance. This step towards verified reporting is a positive move, but more rigorous standards are necessary to build trust in the industry.

One promising initiative comes from the European Union (EU), which is working with China on a Common Ground Taxonomy. This collaboration aims to find commonalities within taxonomies while reflecting different energy transition pathways and political realities. The EU taxonomy is intended to help the EU scale up sustainable investment and implement the European Green Deal.

Independent assurance can play a crucial role in building trust in sustainability information and the actors within the ecosystem. The US Securities and Exchange Commission draft climate disclosure rule, for example, starts with mandatory limited assurance before moving to reasonable assurance, and EU rules are expected to follow a similar path.

Enhanced standards for sustainability information, coupled with independent assurance, are essential for real comparability and transparency in sustainability reporting, including among emerging countries. The absence of comprehensive sustainability data in these economies suggests a need to lower barriers for market participants in these economies to disclose sustainability information.

The sustainability information ecosystem includes a wide range of actors, including investors, board directors, management, employees, ratings providers, auditors, regulators, and policymakers. A global standard on sustainability reporting is supported by the majority of investors, and there is a desire for the reporting of ESG performance to become a mandatory requirement.

Differing legal systems and varying social and political contexts influence the principles that determine standards and regulations governing sustainability information. Jurisdictions need taxonomies founded on complementary principles to achieve real transparency and comparability in sustainability information.

The international standard-setting work being done by the International Sustainability Standards Board may benefit emerging countries if they adopt its standards into their own legal frameworks. The organization responsible for developing future governance systems for sustainable investments in developing countries is the Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH.

However, challenges remain. Composite indicators, which score companies on a wide range of ESG issues with different weights, can present challenges due to a lack of consensus on definitions and calculation methodologies.

Despite these challenges, the ESG movement is experiencing a significant surge in interest, particularly among millennials and Generation Z investors. The "three lines of defense" – corporate governance, independent external assurance, and regulatory supervision – are critical for building trust and maintaining a rigorous reporting system.

In conclusion, building trust and transparency in ESG data is a complex but crucial task. Collaboration between governments, businesses, and investors, along with the development and adoption of global standards, will be key to creating a sustainable and resilient future. Emerging economies, which will account for a large majority of the world's greenhouse gas emissions by 2050, have less resilience to adapt to the impacts of climate change and are likely to be more exposed to severe climate-related events. It is essential that we address these challenges now to ensure a sustainable and equitable future for all.