Investors should soon see improved, and more standardized climate-related data from publicly traded companies under the terms of a new proposal from the Securities and Exchange Commission. The goal, the regulator said as it announced the proposal in March, is to get companies to start collecting and sharing data about emissions and other climate risks that could have a material impact on financial performance.
The effort is designed to get companies to provide the same set of information to investors so that it is easier to compare data across companies.
This push from the SEC for greater standardization within disclosures marked the culmination of an ongoing effort within the asset management industry to standardize at least some ESG data. Panelists at a recent CleanTechIQ event, “How Investors are Addressing the Climate Emergency,” weighed in on the SEC proposal and discussed other efforts to improve climate-related data gathering and disclosure.
ESG gets institutionalized
The relevance and impact of ESG factors on a company’s financial performance can vary greatly, even within the same industry. Consider energy companies: it would be unfair, or at least misleading, to compare the emissions of a solar energy producer with that of a fossil fuels producer. Not only do these companies emit differently, but they are also likely to report different data about those emissions. This reality can make it difficult to align investment portfolios to specific goals like net-zero emissions. But that is beginning to change.
“ESG broadly is getting professionalized,” Gregory Hershman, head of U.S. policy at Principles for Responsible Investment, said during a fireside chat on climate policy. “We’re starting to see ESG disclosures become fully integrated into what companies report, and regulators are beginning to ask questions. Those trends are making it so that companies are taking steps to report the same type of data in the same way. That makes it easier to compare.”
Hershman noted that alongside the SEC’s push for enhanced disclosure, the Institutional Investors Group on Climate Change (IIGCC) created a framework with similar goals. Many companies have used that framework as an organizing principle for reporting scope 1 and scope 2 emissions data. Investors can use these data to understand progress and alignment on net-zero goals.
The IIGCC framework also aligns somewhat with European efforts to develop a common taxonomy around emissions and other climate-related factors. In response to regulators and investor groups all asking for the same kinds of information, disclosures are becoming more uniform and therefore more meaningful.
“What the SEC and other regulators are looking for is truth in marketing,” Hershman said. “If you’re making net-zero claims or you are building an investment strategy that aligns to net-zero goals, we need data that means the same thing to everyone. We are starting to get that.”
(To watch the panel Legislative Impact on Climate Disclosure click here.)
Lydia Guett, sustainable and impact investing specialist at Cambridge Associates, agrees. “In our research process, every single person who conducts diligence on a manager needs to look at ESG issues,” she said. “If you invest in a private manager and you realize five years later that the emissions are too high on a given strategy, that’s too late. There is a recognition that these issues are really important not only to avoid greenwashing but also for long-term decision making around investments.”
Building alignment
Understanding climate data doesn’t begin and end at Scope 1 and Scope 2 emissions information. For investors and asset managers, getting this data is necessary to understand what climate risks are present at the portfolio level, so-called scope 3 emissions. As data standardization has improved and continues to evolve through regulatory action, it’s creating new opportunities to build better alignment throughout investment portfolios.
“At MSCI we have been focusing on how to maintain a consistent, repeatable process across a very large universe of coverage across both small-cap, mid-cap and large-cap companies and now private assets,” said Bruce Kahn, executive director at MSCI and a trustee of the Robert and Patricia Switzer Foundation, during a panel on aligning reporting to governance structures and climate goals. “Being able to do that is a tremendous step forward in terms of how we do a total portfolio footprint with precision.”
Mark Carlucci, sustainability equity research analyst at Morgan Stanley, echoed this point. “When we’re looking at the companies we cover, it’s one thing to consider Scope 1 and Scope 2 data on a company-by-company basis. “But when we put them together and look at the totality of Scope 3 emissions, that can change the investment strategy significantly,” he said.
Carlucci noted that investors are often surprised when they look at the Scope 3 emissions data and discover that portfolios aren’t as aligned to net-zero and other goals as they expected. When that data is available, investors can decide whether to engage with management on how to lower emissions – or divest.
“What we can do now is provide better coverage and give investors more options,” he said. “It’s not perfect, but we are seeing meaningful improvement on aligning data to governance structures and climate-related investment goals.” (A graphic that explains the difference between Scope 1, 2 and 3 emissions created by Oliver Wyman can be found here)
Cambridge’s Guett noted that, from an investment perspective, rigorous research and ratings are crucial. “When we are considering a manager, we begin with an assessment of each of the companies in a strategy,” she said. “We also want to know if there are targets for improvement and what the path forward is. Are they aware of the risks they are taking? If not, you could be looking at stranded assets.”
If there is no answer from managers, investors have to make a decision, she said. In some cases it may mean not investing with a given manager if it’s a new relationship. In other cases it may be necessary to decide if it makes more sense to divest or engage with management teams on making improvements.
“If you divest, you end the relationship. There is some recognition that it might be worthwhile to choose to engage with high emitters and affect change,” Guett said. “Looking at research and frameworks can help make those decisions.”
(To watch the panel Aligning Reporting w/ Net Zero Assessment Frameworks click here.)