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Environmental, social and governance (ESG) goals have moved to center stage to dominate corporate conversations around the world. Organizational leaders are taking action to support ESG programs and processes, helping all stakeholders (investors, employees and customers) understand the big picture with clear ESG strategies. Beyond that, today’s institutional investors are tasked with backing up their net-zero pledges and green energy commitments with hard facts and reports.
Across the pond, major regulators, including the EU and the UK, have set guidance for what companies should disclose going forward. Later this year, the SEC will finally debut its general disclosure rules, and among them will be requiring companies to disclose detailed data about their sustainability strategy, starting with the environment and the financing of greenhouse gas emissions through investments. This information will cover not only the outcomes of transitioning to sustainable aligned businesses, but also the impact of their supply chain on their ESG ratings.
However, investors understandably struggle to understand the processes, procedures and strategies they need to be compliant from day one. Leaders who challenge the status quo and implement compliance measures will avoid steep financial consequences and unwanted regulatory scrutiny. The lack of standardized criteria makes it difficult to know what makes an investment viable. Despite all this, stakeholders agree that their focus needs to be on sustainability and data.
To facilitate compliance with data disclosures and achieve ESG goals, here are several tactics that can help institutional investors kick-start their US financial ESG compliance operations.
Use Europe as a model
Europe leads the ESG regulatory landscape, making it a key asset for the US as it prepares for more formalized ESG regulation. While there are nuances among European regulations – and standardization will no doubt be an issue given the historical evidence surrounding global regulation – much of Europe continues to issue more precise guidelines that are likely to influence SEC disclosure requirements.
The UK’s Financial Conduct Authority (FCA), for example, has set increasingly detailed guidelines that are prescriptive for many classes of investors, such as public companies AND asset managers. THE European Insurance and occupational pension authority (EIOPA) has developed a comprehensive framework for key investors such as pension funds and insurers. As supervision expands into more ‘niche’ categories as well, the European Commission (EC) last year approved clear guidance on investment in bridging fuels such as gas and nuclear.
In light of these recent changes to European frameworks, investors would do well to revisit this guidance as similar oversight descends in the U.S.
Develop an integrated ESG strategy
To make ESG a key part of the business, investors need to step back and think about their ESG reporting the same way they think about any other organizational function: with clearly defined priorities, goals and outcomes. This begins by asking key questions such as:
- What ESG criteria do we want — and likely need — to report for our investments?
- How do we change organizational structures to integrate sustainability into investment analysis and decision-making?
- What are the short, medium and long term benchmarks that we are looking to achieve and how do they integrate with our operational goals?
- What are the financial benefits of our ESG focused investments? Does the return on ESG-friendly investments outperform non-ESG-friendly investments?
- Is the data we need available to us to make this a reality, and how do we get it?
Companies that communicate their ESG objectives to investors and explain how their efforts can meet their benchmarks have the opportunity to generate significant shared value and competitive advantage. In this way, they increase their chances of successfully implementing environmental and sustainable initiatives.
Data management strategy for ESG reporting
We currently see inconsistencies and a greater variety of self-reported ESG data from security issuers, along with different methodologies for determining metrics. This serious lack of standardization points to many different factors, including the pool of vendors providing this data in the market.
Investors are increasingly relying on more than one data provider to get a comprehensive view of ESG factors within investments. For this reason, organizations require scalable technology that can support data aggregation and normalization between third-party data. A consistent data management strategy can help organizational leaders easily report on sustainability metrics to corporate stakeholders and regulators.
Anticipate a crackdown on greenwashing
While ESG factors have become a more important decision driver and more intertwined with stock prices, ESG inflation discussions have exposed weaknesses, particularly around ESG misrepresentations and misconduct. To address ESG misconduct, the SEC established a climate and ESG task force and issued a handful executive actions throughout 2022. With the volume of ESG-related assets under management rapidly increasing, it is currently expected to hit nearly $34 trillion by 2026, according to PwC, we expect regulatory enforcement to follow suit.
For investors, this size of the market means the potential risk of exposure is immense. To mitigate ESG risk, robust technology-based capabilities can provide data transparency, helping organizations detect greenwashing risks early and often. Technologies like blockchain can help credit carbon credits and increase transparency about ESG factors in the supply chain. While this will likely be a challenge for many investors in traditionally slow-moving industries like insurance and government, now is the time for investors to upskill in blockchain and tech automation and fill their ranks with the talent they have needed to enable better corporate governance.
While ESG enforcement may only start to take shape in the US, laggards who don’t follow best practices could soon face huge repercussions. By observing European regulations to prepare for upcoming US ESG disclosure requirements, organizations can build an integrated ESG and data strategy across all business lines and functions, as well as invest in detecting greenwashing risks so investors can maintain a good reputation with regulators. Beyond the tangle of regulations, investors will gain visibility and peace of mind that their ESG investments are actually being used as intended.
Sandeep Sahai is CEO of Clearwater Analytics.
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