ESG disclosures take center stage as investors raise stakes to assess company performance

Institutional investors are ramping up their efforts when it comes to assessing the performance of companies using environmental, social and governance (ESG) factors, according to the fifth EY Climate Change and Sustainability Services (CCaSS) survey of 298 institutional investors globally.

The vast majority of investors (98 percent) evaluate nonfinancial performance based on corporate disclosures, with 72 percent saying they conduct a structured, methodical evaluation, according to the survey. This is a leap forward from the 32 percent who said they used a structured approach in the survey’s fourth edition in 2018.

”In an age when investors are balancing short-term financial results and the company’s long-term goals, it is essential that organizations pay more attention to non-financial performance. ESG (environmental, social and governance) factors are becoming more important in investment management, so that information on ESG increases its relevance in reporting. That is why we are pleased to observe that the Romanian business ecosystem has started to take into account environmental, social and governance aspects, being aware that they can play a major role in the long-term success of the organization,” says Laura Ciobanu, Manager, Climate Change and Sustainability, EY Romania.

At the same time, investors are increasingly holding companies accountable, with ESG factors playing a central role in their decisions. Investors say that nonfinancial performance has played a pivotal role in their investment decision-making over the past 12 months (91 percent), either frequently or occasionally, with the proportion of investors that say this happens frequently jumping to 43 percent from 34 percent in 2018.

Climate change in particular plays a significant part in investors’ decision-making process, with 73 percent responding that they will devote considerable time and attention to evaluating the physical risk implications of climate change when they make asset allocation and selection decisions.

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“The rules for capital markets are being rewritten, in turn, impacting the drivers that influence investors as they direct capital to support economic recovery. What we see is that instead of retreating to short-term performance models, institutional investors are focusing on long-term value creation and raising the stakes when it comes to assessing company performance using ESG factors,” says Mathew Nelson, EY Global Climate Change and Sustainability Services Leader.

The growing ESG disconnect

The survey also identifies a growing disconnect between the increased focus on evaluating ESG performance from investors and the availability and robustness of standardized and rigorous nonfinancial data from corporates.

The number of investors that are dissatisfied with environmental risk disclosures has jumped to 34 percent from 20 percent in 2018. At the same time, the percentage of respondents who say that companies do not adequately disclose the social and governance risks that could affect their business models increased to 41 percent (from 21 percent in 2018) and 42 percent (from 16 percent) accordingly.

Asked about challenges to the usefulness and effectiveness of current ESG reporting, 46 percent of investors identified the disconnect between ESG reporting and mainstream financial information as the top challenge. The lack of real-time information (41 percent), or information about how the company creates long-term value (41 percent), as well as the lack of forward-looking disclosures (37 percent) and the lack of focus on the material issues that really matter (37 percent) completed the list.

Nelson says: “Continued gaps in expectations between issuers and investors are a significant concern. Given the shift we are seeing, there is a more pressing need for investors to have confidence and trust in information on nonfinancial performance. To effectively evaluate ESG disclosures, investors need standardized and rigorous nonfinancial data underpinned by appropriate structures, reviews and controls.”

Investors call for independent lens on ESG performance

The EY research found significant appetite among investors for an independent lens on ESG performance with three-quarters (75 percent) saying they would find value in assurance of the robustness of an organization’s planning for climate risks. Investors also see a strong need to build confidence and trust in green investment disclosures, with 82 percent saying it would be useful to have independent assurance of the impact of green investments.

“ESG performance reporting generally lacks the rigorous systems and controls that characterize financial reporting. As a result, investors and corporates cannot guarantee the accuracy and reliability of nonfinancial reporting. Establishing effective governance practices and assurance of nonfinancial processes will help build trust and transparency. Overall, these findings show that addressing urgent environmental and climate change threats is more important than ever in the eyes of investors. Although many organizations are in crisis-response mode as a result of the COVID-19 pandemic, those with strong sustainability functions that focus on what is most material to their long-term success will be more likely to rebound once the crisis is over and deliver long-term value,” says Nelson.