ESG ratings, ESG reporting and EU Mandatory Disclosure Regulations – Companies are facing the 3 Rs
The ESG landscape companies are operating in is changing. This article looks at the impact emerging from third-party ESG-ratings, ESG reporting, regulatory changes made by the European Union, and the options corporations have to respond to the 3 Rs.
ESG ratings influence how potential investors perceive the ESG performance of companies. However, these ratings come with the challenge of different rating methodologies that may lead to different results. At the same time, an ever-growing number of companies is disclosing non-financial reports to make their voices heard and share their view on ESG related topics.
Companies can choose from a wide range of evolving reporting frameworks. Some are industry-specific, while others follow a universal approach. As a result, some ESG related aspects will receive more attention than others. At a different angle, the European Union has released a regulatory regime related to ESG – and companies have to meet those requirements, too.
How does this all work together? What are the challenges emerging for companies from the 3 Rs (Rating, Reporting and Regulations)?
ESG Ratings promise easily understandable insights into the ESG performance of companies. Information is condensed to fit on a single page, so it is easy to digest. The main challenge with third-party ESG ratings is that they all use different metrics and rating methodologies.
According to a paper by Florian Berg, Julian Koelbel and Roberto Rigobon titled Aggregate Confusion: The Divergence of ESG Ratings, the main drivers are:
- Scope divergence
- Weight divergence
- Measurement divergence
Therefore ratings for the same company may look very different depending on the rating provider. Some investors have taken a different approach and decided to rely on in-house ratings or a combination of third-party and in-house ratings instead.
ESG Reporting Frameworks
ESG reporting frameworks evolve. With no such thing as the definitive ESG reporting framework emerged yet, interoperability and comparability of reported results is a difficult task. Some reporting frameworks follow a universal approach (e.g. GRI), while others are industry-specific (e.g. SASB) or focus solely on one industry (e.g. GRESB).
One challenge for corporations when it comes to ESG reporting is to find a reporting framework that gives added value to reporting. Having a closer look at the inner workings of different reporting frameworks, what kind of information these frameworks require for reporting and how the reporting can lead to meaningful actions is a good starting point.
Another aspect is the data and data quality required by the reporting framework. You can only manage what you can measure. In general, a reporting framework that follows a data-driven approach along with high-resolution data can be an option for companies looking for a goals and objectives driven concept.
The EU Regulatory Disclosure Regime
The EU Regulatory Disclosure Regime is another challenge for companies. The EU Regulatory Disclosure Regime consists of three parts:
- The Taxonomy – An environmental classification system
- NFRD – The disclosure regime relevant for corporations
- SFDR – The disclosure regime towards investments (financial market participants and financial advisors)
To comply with the NFRD or Non-Financial Reporting Directive, large public corporates in the EU need to disclose their non-financial ESG performance under this directive. On the other side of the spectrum is the SFDR. The SFDR requires financial market participants and financial advisors to disclose ESG relevant information related to investments. The taxonomy describes the environmental data to be disclosed under NFDR and later used with SFDR. Social and governance-related data are not in the scope of the EU taxonomy yet.
How Companies Can Take Action on the Three Rs
Facing the 3 Rs – ratings, reporting and regulation – companies have to take action.
It is essential to know how ESG ratings are composed and what information influences your ESG score. Depending on the methodology used by a rating company, corporate filings, data from NGOs, media sources, and other data is used to calculate the ratings. Corporate filings include sustainability reports and ESG related disclosures. Therefore high-quality reporting and communications are becoming key instruments here.
After the stakeholder engagement, materiality assessment, data collection, strategy development, goal setting and tracking, it is time to disclose the ESG report. This entire process needs clarity on motivation, strategy and goals. Is it all about compliance and meet legal requirements? Or is it about improving transparency and visibility while developing a framework for ESG related action?
It is also about deciding on reporting frameworks to use. Some corporations decide to report on several frameworks to meet the demands of their investors. There is also a dependency related to mandatory disclosures by national or European regulations. So the reporting should also align with these demands.
After the reporting, the real work starts. Companies doing this process for the first time have the chance to harvest all the low hanging fruits. It is also about considering the frequency of reporting. Mandatory reporting is due once a year. Yearly reporting comes with the price tag of being reactive. For tracking goals and objectives, quarterly or even monthly reporting can be a better option. Starting in Q4 with the reporting may be a good decision since many other tasks are due in Q1.
Companies should keep in mind what their foremost driver for ESG reporting is and act accordingly. Start smart with a clear vision and learn along the way.
Aggregate Confusion: The Divergence of ESG Ratings https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533
European Union on Corporate Sustainability Reporting
Convergence in ESG Standards
Unifying ESG Standards
NordESG is an independent consulting firm that advises on sustainability and ESG. We support companies in navigating their sustainability landscape and develop strategies and concepts individually tailored to their requirements. This also includes managing the transition to CSRD. We look forward to hearing from you via email. You can also make an appointment with us directly for a free introductory meeting.