Does your nonfinancial reporting tell your value creation story?

An increasing reliance on ESG

After several years of growing evidence of the impact of commerce on climate change, scandals tied to poor corporate governance and a new appreciation for the social impact of business, institutional investors are increasingly likely to use nonfinancial performance information as an essential component in investment decision-making. Nearly all investors who responded to this survey (97%) say they conduct either an informal (65%) or a structured, methodical evaluation (32%) of a target company’s nonfinancial disclosures.

This represents a rise of nearly 20 percentage points since the 2017 Global Climate Change and Sustainability Services investor survey where 78% of respondents said they conducted either an informal or structured evaluation. In 2018 only 3% of respondents say they conduct little or no review of nonfinancial disclosures, compared to 22% in 2017 and 48% in 2015.

Versatile application of ESG factors

ESG information plays an increasingly important role in the investment decision-making process, and respondents believe that ESG factors can help mitigate downside risk. Nearly all respondents (96%) say that such information has occasionally (62%) or frequently (34%) played a pivotal role in decision-making.

Again this increased use of ESG information is a dramatic rise from the 2017 survey results, where 68% of investors said they used ESG information frequently or occasionally.

Investors say they are more likely to consider nonfinancial information occasionally or frequently when adjusting valuation for risk (70%), examining industry dynamics and regulation (63%) and when reviewing investment results (61%).

Investors believe that ESG factors can provide downside risk protection – 89% say that ESG information is somewhat more valuable (80%) or much more valuable (9%) in investment decision-making in a market downturn.

Increasing reliance on integrated and annual reports

Investors are relying increasingly on ESG disclosures from the target companies themselves, and their use of corporate social responsibility (CSR) or sustainability reports, equity research from broker-dealers, press coverage and other external sources is decreasing or unchanged. Nearly all responders (94%) reported that integrated reports are very useful (88%) or essential (6%) sources of nonfinancial information. The same percentage reported that annual reports are very useful (82%) or essential (12%) sources of nonfinancial information.

In the  2017 Global Climate Change and Sustainability Services investor survey, only 57% reported that integrated reports where very useful or essential, and 63% reported the same about corporate annual reports.

More than half of respondents (56%) say that a company’s nonfinancial disclosures are either not available or inadequate for meaningful comparison with those of other companies. Investors say that there is a lot of disclosure about formal governance documents, policies and practices that are in place, but what is missing are measures of accountability – information on how nonfinancial metrics are established and managed. Investors look to companies to identify the environmental and social factors that are important to helping them achieve their strategic objectives and to set the targets that will be relevant over that time horizon.

Companies disclosure of ESG risks is improving – especially governance

Investors say that most companies are able to assess the materiality of governance factors, with 87% reporting that most (78%) or nearly all (9%) of the companies they follow assess ESG materiality adequately.

Compliance and risk management are motivators

Overwhelmingly, investors report that they believe regulatory compliance (90%), followed by risk management (87%), most motivates companies to report details on nonfinancial and ESG activities. Strategy for long-term value (78%) and competitive pressure (70%) were deemed to be other compelling reasons.

Key ESG factors

Investors in this year’s study report that the main ESG factors in investment decision-making have to do with risks related to governance, supply chain, human rights and climate change.

The risk or history of poor governance practices would cause 63% to rule out an investment immediately.  Similarly, supply chain risks tied to ESG (52%), risk or history of poor human rights practices (49%), and risk from climate change (48%) are also triggers to avoid an investment. This compares to the 2017 Global Climate Change and Sustainability Services investor survey, where investors reported that they would rule out an investment immediately based on governance (38%), human rights (32%), ability to verify ESG data and claims (20%), and supply chain (15%). Climate change was the lowest-scoring factor, at only 8%.

Transition risk versus physical risk in climate change

Investors continue to tell us that climate change is consistently one of the most material issues identified by reporters. However, in this survey they told us they are more concerned about the physical implications of climate change risk than the transitional risks such as those tied to adapting to new regulations, practices and processes. Seventy percent say that, over the next two years, they will pay a fair amount or a great deal of time and attention to physical risks. Forty-eight percent say the same of transition risk.

Negative and positive screening

Investors who responded to the survey say that negative screening yields excess return (85%) and lowers risk (67%) versus a benchmark or target.  Investors also said that positive screening lowers risk (79%) and achieves the important nonfinancial objectives of a portfolio (73%).

A call for standards

Investors express an urgent need for prescriptive nonfinancial accounting standards. Fifty-nine percent said that prescriptive accounting standards for nonfinancial information would be very beneficial. This is a rise of 26 percentage points since the 2017 Global Climate Change and Sustainability Services investor survey.

Furthermore, the relative demand for standards has overshadowed that for the next three factors ranked by importance: integrated reports that follow the International Integrated Reporting Council (IIRC) framework, company disclosures based on what management believes is most material to the company’s value creation strategy, and company-defined reports that integrate financial and nonfinancial information.

A call for state-led efforts

Investors responded saying that national regulators are best suited (70%) to lead efforts to close the gap between investors’ demand for nonfinancial information and the information actually provided by issuers. Others that should play a role include international organizations and NGOs (60%), and investors and asset managers themselves (56%). Only 20% of respondents think issuers or private sector trade organizations should take the lead.

It is believed there are four main areas organizations should consider:

1. Establishing a structured materiality analysis process
2. Measuring and reporting social and environmental outcomes
3. Measuring and reporting long-term value
4. Reporting more comprehensively on all climate risks and engaging with stakeholders, including investors