The great ESG language divide

THERE is today a huge disconnect between the way investors consume sustainability content, and the way companies produce it. They have to meet in the middle.

Companies’ sustainability communications have to be less self-serving. And investors have to bite the bullet and pick up some technical jargon to tune in to the conversation and keep companies accountable around new environmental, social and governance (ESG) focuses. 

I see why there is a divide. Having watched the ESG space for a year now, I can now fully appreciate the running joke that if we haven’t drowned from rising sea levels by 2050, we would drown instead in the sea of acronyms, jargon, and words.

ESG is a lot of words. Sustainability reports of the 20 largest primary-listed companies by market capitalisation on the Singapore Exchange covering their most recently-concluded financial year are in by now, and they average 45,939 words. That’s three times the word count of their financial statements for the corresponding FY.

And the 45,939 words, laid out on 108 pages on average, hardly make for an inspiring read. The words start to look the same after a while – on a surface read, you mostly get the hunky-dory type of communications painting a wonderful image of how the company is resilient, adaptable, making an impact, and turning risks into opportunities. 

Greater objectivity in the way the information is presented would be appreciated here. 

Just as bottom-line indicators are usually the highlight of a financial statement, no matter how unflattering they might be to the company, investors shouldn’t have to dig through a sustainability report to get a weighted view of the company’s progress on things such as emissions reductions or sustainable revenue. 

Can companies be far more forthcoming about where they are at? Better still, are there ways to compel companies to be objective and honest?

From press releases that come out of every earnings season, even within the allowable bounds of accounting standards, most companies are already seen to be picking at indicators that paint the friendliest narrative of where they are headed. They might adjust their inventory value or slow down depreciation to avoid a loss, for example.

Already, some judgement calls are being made in sustainability accounting. Companies can choose between market- and location-based methods in calculating the emissions tied to energy consumption.

The International Sustainability Standards Board’s (ISSB) recently published sustainability disclosure standards might not have dealt with these directly, but it covers a few connected concepts.

One that could shorten the disclosures a fair bit is its point that sustainability-related financial information must be “relevant” and “faithfully represent” what it purports to represent. It defines “core content” as disclosures around governance, strategy, risk management, and metrics and targets.

There is also materiality, which calls entities to disclose information that could “reasonably be expected to affect the entity’s prospects”. Its litmus test of materiality is if omitting, misstating or obscuring that information could reasonably be expected to influence the decisions that primary users of general-purpose financial reports make on the basis of those reports.

This is where I sense myself losing some investor-readers, but here’s my pitch: If you only have the capacity for two technical terms now, know materiality and Scope 3.

It’s only a matter of time before Singapore mandates ISSB reporting for both listed and non-listed entities, and these two terms will be what companies will be sweating about.

Materiality, simply put, is “why should I care”. It is helpful as a filter to assess if a company is talking enough about the things that matter to the company’s ability to continue running undisrupted. If, for instance, there is a telecommunication company selling up its tree-planting efforts, then maybe it is time to ask what it is doing to green its data centres.

Scope 3 refers to the greenhouse gas emissions that a company is indirectly responsible for up and down its value chain. Loosely put, it shows the calibre of suppliers the company supports to walk the talk on sustainability. For financial institutions, it encompasses the emissions of those they finance and invest in as well.

Previously, companies could get away with focusing their disclosures on Scope 1 – direct emissions – and Scope 2 – emissions from the purchase of electricity – and conveniently leave out what it outsources. ISSB was the first major global standard-setting institution to require accountability around Scope 3. 

It’s important to know the impetus behind such disclosures. When giving his final speech as chairman of the Monetary Authority of Singapore last month, Tharman Shanmugaratnam referenced “tragedy of the horizon” when premising a need to introduce sticks nudging companies towards decarbonising.

The phrase, coined by former Bank of England president Mark Carney, refers to a situation where climate change creates tremendous risk for financial markets, but these mounting risks are ignored by investors due to the market’s tendency towards myopia.

Tharman said: “We now have to think of financial regulation and supervision as part of the arsenal of public policy required to bring forward actions to avoid catastrophe, not merely as tools to deal with the risks on today’s balance sheets, in today’s financial institutions.”

My personal consolation is that if financial jargon such as “operating cash flow”, “working capital”, and “earnings before interest, taxes, depreciation, and amortisation” (still a mouthful) are terms now easily understood, there is hope for more ESG terms to become common parlance.