Putting Companies in the Driver’s Seat to Enhance ESG Reporting

Rakhi Kumar is Senior Managing Director and Head of ESG Investments and Asset Stewardship at State Street Global Advisors. This post is based on a publication prepared by State Street Global Advisors. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here) and Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

ESG. It’s one of the fastest growing areas of investment today. Representing 1-in-4 of every dollar that is professionally managed, sustainable investing is being integrated into portfolios at 17% each year. [1] And yet, for all the investor interest and excitement around ESG, companies struggle to understand what information to report, how to report it, and the relevance of ESG information to investors.

For State Street Global Advisors, we believe financially material ESG factors can impact a company’s long-term performance. Our goal is not just to build ESG portfolios but also to encourage companies to focus on issues that matter while providing them with the transparency to meet those expectations. This is the only way to create sustainable markets and long-term value for investors.

To drive progress in this area, we have been engaging with hundreds of companies to understand how they disclose and incorporate ESG into their long-term strategy. And now, we’ve built a tool we believe will incentivize companies to make a big leap forward.

Here’s how it works.

Addressing the ESG Data Challenge [2]

Over the course of our conversations with companies in our portfolio, a few things have become clear. Investors need access to ESG data that is material, consistent, comparable and as easily available and accessible as more traditional financial data. However, many companies aren’t disclosing a lot of ESG information—and when they are, it isn’t always material to their industry or particularly helpful to investors.

Part of the challenge is that there is no commonly accepted framework to help companies or their investors navigate ESG materiality. For instance, while it might be nice to know what a footwear company does to strengthen community relations, understanding their supply chain management practices and how they source their materials is far more relevant for investors.

Recognizing these challenges, in 2016 the Principles for Responsible Investing (PRI) laid out in its Blueprint the need to “drive meaningful data throughout markets” as one of its core areas of impact for signatories, who together represent more than half of the world’s professionally managed assets. PRI sees this as critical to building sustainable markets.

But making progress on ESG reporting also requires this work to be done cost effectively so that every company can be part of this new investment paradigm. Indeed, the less speculation required by a company when it comes to figuring out what to report doesn’t only mean more resources available to collect and report the information itself. More importantly, it also allows companies to manage financially material ESG factors as part of their day-to-day activities and incorporate them into their long-term strategy.

Our Solution: R-Factor™

To focus companies on the financially material ESG factors considered relevant by investors, we have developed a scoring system that leverages multiple data sources and aligns them to widely accepted, transparent materiality frameworks to generate a unique ESG score.

As one of the largest asset managers in the world, we see this not as simply a product or service—but as our responsibility to investors. And so, we call this score “R-FactorTM.”

The R-FactorTM score leverages the materiality framework of the Sustainability Accounting Standards Board (SASB), as well as market-specific corporate governance codes. [3] The advantage of utilizing the SASB framework, which is supported by investors representing more than $32T in assets, is that it focuses only on ESG factors that are likely to impact company financial performance. These factors have been shown by academic research to contribute to long-term returns. [4] Detailed standards published by SASB guide companies to disclose material ESG information which, in turn, will improve disclosure and management practices.

Taking the Guesswork Out of ESG Reporting

R-FactorTM is the first ESG scoring system that puts companies in the driver’s seat and allows them to take the action needed to enhance their scores. It is built to address the current challenges with ESG data by removing opaqueness around ESG materiality in the scoring process.

Put simply, it takes the guesswork out of ESG reporting.

R-FactorTM not only powers our investment and client reporting capabilities—it is also fully integrated into our stewardship program. Our stewardship team is already sharing companies’ R-FactorTM scores with portfolio companies.

As companies develop infrastructure to manage ESG factors and improve their disclosure, we expect to see more meaningful ESG data driven throughout markets.

With R-FactorTM, we have made it easier for smaller companies to focus their ESG efforts and report on what investors want to know. It’s particularly the small, mid-cap, and emerging market companies who stand to be the biggest beneficiaries of our ESG reporting playbook.

The world of ESG disclosure may seem complex—but with R-FactorTM, companies and investors no longer have to go it alone. Together, we can forge a new standard in ESG investing and responsibly create long-term sustainable value for investors.

Endnotes

1McKinsey, ”From ‘why’ to ‘why not’: Sustainable investing as the new normal”, October 2017(go back)

2ESG Data Challenge.pdf(go back)

3Link to our R-Factor paper(go back)

4Khan, Mozaffar, George Serafeim, and Aaron Yoon. “Corporate Sustainability: First Evidence on Materiality.” Accounting Review 91, no. 6 (November 2016)(go back)

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3 Comments

  1. Arthur Rosenbloom
    Posted Wednesday, May 8, 2019 at 10:33 am | Permalink

    It would help if you defined ESG in the first sentence of your piece for folks like me unfamiliar with it.

  2. Angeline Chua
    Posted Wednesday, May 8, 2019 at 10:56 pm | Permalink

    Can R-Factor be applied to other jurisdictions? How robust is this so-called R-Factor?

  3. Nicolaas Koster
    Posted Monday, May 13, 2019 at 9:52 am | Permalink

    In ESG investing, we are not just facing a problem of data consistency, materiality, and data availability.

    An equally important question is “Can we trust the data?” The problem in ESG is a lack of audited data, heightening the risk of “garbage-in-garbage-out”.

    I think we need to explore going a step further by striving for auditability of the ESG data trail.

    I wrote about it here: https://medium.com/@nicolaas.koster/rethinking-esg-creating-a-shared-open-platform-for-esg-data-and-rankings-2733a444a275

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