As environmental, social and governance (ESG) concerns grow in depth and breadth in the marketplace, so has the pressure and momentum for businesses to disclose their commitments and performance in these areas.

But just how useful are these disclosures? Do they serve their intended purpose of informing the market of how well companies are managing such issues? Or are they simply another form of window-dressing that belie the true state of events, being too complex to be properly understood by those who read them?

Certainly, ESG disclosures have come a long way - growing in terms of quantity and quality in recent years. Much of this has been due to the growing awareness of the impact that corporate actions have on the environment and society, and the resulting thirst for greater knowledge in this area.

A lot of the recent momentum has been driven by the development of a common set of standards for ESG disclosures, and the fact that more and more jurisdictions are looking to make, or have made, ESG disclosures mandatory for companies.

A common set of standards has a significant impact on the take-up of ESG reporting, because they give such disclosures context and make them more comparable - a must for information of this sort to be meaningful, especially across jurisdictions.

Among the first set of standards to be developed was that by the Global Reporting Initiative (GRI), whose sustainability reporting framework is now widely used around the world; while the recently launched International Sustainability Standards Board (ISSB) intends to deliver a comprehensive global baseline of sustainability-related disclosure standards. For climate reporting, the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) aims to improve and increase the reporting of climate-related financial information.

A NEWSLETTER FOR YOU

Friday, 12.30 pm

ESG Insights

An exclusive weekly report on the latest environmental, social and governance issues.

Sign Up

Various governments around the world have also started to mandate that companies include ESG disclosures in their financial reports, albeit to varying degrees. 

According to a European Corporate Governance Institution working paper, last revised in December 2021, 29 countries were identified as having introduced mandates for firms to disclose ESG information during the sample period of 2000-2017 - and these included Australia, China, South Africa and the United Kingdom.

Singapore has made it a requirement for its listed companies to issue a sustainability report, which must include - among other things - material ESG factors, its framework, targets and performance, and it also recently rolled out climate reporting for its listed companies, beginning with certain sectors.

Such developments have propelled more companies to examine and disclose their intents and actions when it comes to ESG-related matters. But, how useful and reliable are these disclosures? And who knows or cares enough to probe their veracity?

Who knows?

Unlike corporate governance disclosures - which is the other broad category of non-financial disclosures that has been in place for much longer - a number of ESG-related disclosures, especially those that relate to the climate, are science-based and not easily understood, let alone verified, by the common man. 

For example, when a company reports on the number of meetings its directors have attended in the past year - a typical corporate governance disclosure - this is a simple fact that can be confirmed by an attendance sheet; but when a company reports on the amount of its carbon emissions in the same period - in this case, a typical ESG disclosure - this is not as easily corroborated.

A sample statement from a company’s emissions report might go like this: “Group GHG emissions are a 5.1 per cent reduction from those in the baseline year (2015), to 16.0 million tCO2e, while carbon intensity has decreased to 4.3 tCO2e/$m revenue, which represents a 20 per cent reduction on 2015 levels.”

Users of the information would need to know, for a start, that GHG - or greenhouse gas - emissions are made up of various gases, including carbon dioxide (CO2), methane and nitrous oxide. All are measured separately. Carbon emissions are also categorised into 3 scopes: Scope 1 refers to direct emissions produced by the business; Scope 2 covers indirect emissions such as those produced by the building the business uses; and Scope 3 is a wider range of indirect emissions such as those along a business’s entire value chain.

Users would also need to be aware of the measurement tools, methods and assumptions - typically, complex science-based ones - used to track and calculate these; this would help them understand the basis for a company’s projections and evaluate its performance. But, it’s fair to say that such information is far from being easily comprehensible to most laymen.

A lack of understanding has several undesirable consequences: it raises the threat of greenwashing - where a company lies or tries to mislead the public about its environmental impact, in order to make it sound greener than it actually is - while leaving the user bereft of the ability to determine if it exists or not.

Take the example of when consumer giant Nestle was accused by the Corporate Climate Responsibility Monitor of having “vague” and “very low integrity” net-zero targets; the watchdog said Nestle’s declared emissions targets cannot be attained, based on its “close analysis of Nestle’s planned trajectory and targets for specific emissions sources”.

Nestle refuted such claims, explaining the baselines it used to calculate such targets. The common man, however, will struggle to figure out who to believe, because he cannot make enough sense of the information provided.

Who cares?

If this continues, we are going to be left with a similar situation that exists with the already more-easily understood corporate governance disclosures. Markets will be made up of: some financial-statement users who will not bother to look at ESG disclosures; many who will glance through them and assume they are correct, unless told otherwise; a large proportion that will not use them for their decision-making because they do not understand enough of it; and just a handful with the time, knowledge and determination to comprehend what has been reported.

That is not to say that this growth in disclosure has not been helpful - it has, to a degree. Being made to report their ESG targets and performance makes companies and their stakeholders more aware of their actions and the impacts these have; there is less obscurity and a more timely release of such information, making it more difficult for a company to hide an impactful development until it is too late. 

And, when it comes to the issues of complexity and a lack of access to source data by the common man, one could argue that these also apply to the financial numbers in a company’s financial statements. But, this is why listed companies’ financial statements are audited at the end of the financial year, so that experts who understand the way in which these numbers are collected and reported, and have access to the company’s operations and source documents, can verify if they represent a true and fair view of the company’s situation.

Independent audits of ESG information, however, while available and used in some instances, are far from being commonplace. The US-based Center for Audit Quality in August 2021 issued a report saying that, while 95 per cent of S&P 500 companies had detailed ESG information publicly available, only 6 per cent had obtained assurance from a public company auditing firm over some of their ESG information.

In Singapore, a review by Singapore Exchange Regulation (SGX RegCo), assessing the sustainability reports published by 566 listed issuers as at Dec 31, 2020, found that independent assurance remains uncommon, with only 21 per cent of issuers obtaining either internal or external assurance, or both, for their sustainability reports.

What to do

So, until our markets get to the stage where ESG information can be easily independently verified, what should we do? I would advise caution to the investors who intend to base their investment decisions on a company’s ESG data; they ought to put in the effort needed to gain a good understanding of what has been reported, and try to obtain objective reports and analyses on their target companies. 

I would exhort governments to put in a lot more effort into educating the investing public on corporate ESG disclosures and to recognise that this will be a long-term and expensive enterprise. 

Regimes must ensure they have effective and forceful market regulators in place, who would also need to be well-informed and continually educated on ESG matters; they should be transparent and timely in their enforcement, with a view to educating the investing public on relevant issues. Regimes would also do well to develop independent watchdog groups who can help scrutinise ESG disclosures.

And it is more important than ever for boards to be peopled with knowledgeable, responsible and effective directors. Companies must make the effort to pick the right candidates, while investors must hold them accountable. And regimes must ensure directors are properly and adequately trained.

In this regard, it must be said that it will not be enough for regimes to mandate that directors attend the necessary training programmes - some form of assurance must also be obtained that they have understood and are able to apply what they have learned. This does add another layer of compliance that will be unpopular with corporates, but box-ticking is already far too prevalent in director-training programmes, and cannot afford to be further tolerated.