A wide variety of ESG Reporting Standards
Facing the difficulties in reporting sustainability metrics, various stakeholders have urged the necessity of more standardized reporting policies. Organizations that are considering adopting an ESG reporting framework should take note of the wide variety of disclosure standards developed by ESG reporting standard providers around the world. Different providers cover distinctive cross-sections of ESG topics and vary in their approaches. Typically, the frameworks differ concerning their sector focus and how they prioritize climate versus social issues.
For example, the TCFD framework includes both general and sector-specific guidance, but only on climate-related topics such as the physical risks of the effects of climate change. On the other hand, the GRI includes topics such as labor, human rights, and biodiversity impacts. In addition, the GRI provides a materiality assessment based on the impact that emitters have on the economy, environment, and society, whereas other frameworks focus solely on information they consider to be financially material. The multitude and complexity of the various standards have led experts to call for the "standardization of standards".
Problems with unstandardized ESG Data
Although ESG rating providers primarily retrieve ESG information from the issuer disclosures and reports and set up their ratings based on the same data, ESG ratings can vary significantly depending on the provider. ESG ratings have been criticized for applying different methodologies and information processing systems, resulting in discrepancies in ESG ratings for the same company. This discrepancy between ratings implies that ESG investing decisions could depend on the rating provider on which the investor relies. In other words, two companies could potentially obtain different rating results even though they have the same commitment to business sustainability.
The metrics used by data providers in the ESG ratings are impacted by the lack of consistency and varying levels of transparency in the information generation process. Methodologies are rather different among major market data providers such as Bloomberg, Thomson Reuters, FTSE, MSCI, and Sustainalytics. Although varying analytical methods and assessments may give investors additional insights, the correlation between the ratings assigned to the same company is low.
Major differences in ratings may arise for a number of reasons. They can origin from differences in frameworks, metrics, key indicators and metrics, data use, and qualitative judgments. Moreover, differences in subcategory weighting and reweighting of scores affect the ratings. Too big deviations in ESG ratings across providers can diminish the importance of a high-ranked ESG due to a lack of trust and transparency.
Complicated risk evaluation
In recent years, as more publicly-traded companies release sustainability reports, investors are increasingly raising concerns that the absence of a standardized regulatory framework for ESG disclosure hinders investors' ability to assess and benchmark companies' ESG practices and risks effectively.
Thus, a lack of standardized ESG data may impede risk management. On the other hand, a structured ESG management system could be a valuable tool for accessing reliable data-driven information to measure, evaluate, and analyze risk. Although relying on secondary data sources like ESG rating providers or sustainability reports might seem alluring, complete control over what and how it is measured can only be achieved with an in-house ESG management system.
More possibilities for fraud
In summary, the absence of a standardized ESG information framework can lead to different ESG ratings depending on the data provider. Given the obscurity regarding the information processing methodology of each provider, ESG rating scores can be manipulated more easily than under the guidance of a transparent, unambiguous procedure. Therefore, standardized data can also prevent investors from mistrusting ESG ratings because of confusion over different and non-transparent rating scores.