René van Merrienboer, Director of Sustainable Markets, PRI, and Pepijn Rijvers, Executive Vice-President, Redefining Value, World Business Council for Sustainable Development
Standard-setters, policy makers and regulators have made significant strides this year towards standardised sustainability disclosures by companies, launching several major consultations. The value of corporate sustainability information is clearly becoming more widely understood.
Sustainability issues can affect the financial performance of a business and hence its value over the short, medium and long term. Aware of this, a growing number of investors use sustainability information to assess the likely effect of sustainability risks and opportunities on the cash flows of existing or potential investee companies.
The way investors value companies using sustainability information in addition to the company’s broader equity story varies – even between teams within the same investment firm – due to different strategies, objectives, mandates and resource levels. For instance, some investors may use proprietary sustainability datasets and rating systems and explore the implications of different sustainability-related scenarios. Others may adjust their forecasts for a company’s financial performance, their model assumptions, valuation ratios and the weights of certain securities based on the companies’ exposure to sustainability risks and opportunities.
All approaches have the same objective: to predict how sustainability factors may affect the expected cash flows of a given company and its risk premium. To do this, investors require quantitative and qualitative information on a broad range of sustainability issues. For instance, for investors to assess whether a given company is delivering on its quantitative climate-related commitments, they need to know the details of its net-zero transition plan.
The practice of integrating sustainability information into valuation continues to develop. Exactly how different investors approach this process may soon become more apparent as they are increasingly required to report on the ESG characteristics of their investments and on the way they take into account ESG issues in investment decision-making.
The promise and the challenges
However, the new age of transparency is something of a double-edged sword.
On the one hand, greater clarity on how investors use corporate sustainability information can incentivise companies to take action on the sustainability risks and opportunities they face. As for investors, they will welcome standardised, easily accessible sustainability information on companies – especially on smaller firms, which are less likely to be covered by third-party data providers such as Bloomberg. Closing existing data gaps will enable investors to factor sustainability issues into valuation and portfolio weighting more effectively by, for example, identifying “best in class” companies.
On the other hand, even the best-resourced companies may find it challenging to comply with the emerging multitude of standards and rules on corporate sustainability reporting.
Therefore, there needs to be alignment between relevant global standards and jurisdictional rules. Most notable are proposals released this year by the International Sustainability Standards Board, EFRAG, which advises the European Commission, and the US Securities and Exchange Commission.
In addition to lowering the reporting burden on companies, such alignment would improve the consistency of sustainability disclosures across jurisdictions. The PRI, World Business Council for Sustainable Development (WBCSD) and the International Federation of Accountants have recently called for alignment between the three reporting initiatives, issuing a joint statement signed by 65 investors, companies and professional accounting firms.
If designed effectively, sustainability disclosure standards and requirements can improve the accessibility, comparability and verifiability of corporate sustainability information, and advance the use of sustainability information in valuation decisions.
At the same time, as we outline above, transparency on how investors use sustainability information in the investment process is also needed.
The road ahead
Aiming to foster this two-way transparency, the PRI and WBCSD have convened a diverse group of chief investment officers from investment firms and chief financial officers from listed companies. The executives have participated in a series of roundtables exploring what constitutes decision-useful sustainability information, how investors use it and how company-investor communication on sustainability can be improved. We intend to reflect their input in our respective work programmes.
The PRI will focus on:
- developing a framework to deepen the PRI’s understanding of signatories’ sustainability data needs and to inform the PRI’s engagement with standard-setters, policy makers and regulators;
- engaging with global and jurisdictional standard-setting and rule-making processes/initiatives on behalf of PRI signatories, to ensure that investors’ data needs are understood and considered, and raising awareness among signatories on these developments.
WBCSD, in turn, continues to work on:
- understanding and advancing valuation, as well as financing, in a way that ensures that action by businesses on sustainability risks and opportunities is recognised and rewarded;
- contributing and responding to the development of global standards for corporate sustainability reporting together with and on behalf of leading sustainable businesses, to ensure that such standards result in regular and consistent disclosures of decision-useful information.
In parallel, the PRI and WBCSD are considering areas for future collaboration and will provide an update on this in due course.
The PRI blog aims to contribute to the debate around topical responsible investment issues. It is written by PRI staff members and occasionally guest contributors. Blog authors write in their individual capacity – posts do not necessarily represent a PRI view.