ESG investing needs a hand from regulators: Morningstar

This increased interest in sustainability “creates a rare opportunity” for advisors and asset managers to motivate consumers to invest in their futures and to “enhance the reputation of the asset management and financial advice industry,” the report said.

To capitalize on that opportunity, though, advisors need the ability to assess investors’ sustainability preferences, as well as the tools available to align investors’ portfolios with their preferences, the report said.

The data on sustainability, and the manner in which it is disclosed, needs some work, the paper suggested.

“Using data to ascertain whether an investment aligns with an investor’s values and how much ESG risk is intrinsic to the investment is challenging with the best data,” the report said.

As it stands, issuers’ ESG disclosures “are all too often inconsistent and non-comparable, and material information is not always available,” the report noted.

Too often, disclosure focuses on backward-looking data, which, the report said, tells investors about current operational efficiency “but does not provide much insight as to where a company may be headed on the sustainability issues it faces.”

Additionally, asset managers use terms such as “sustainable” and “ESG” to refer to a wide variety of strategies, and portfolio disclosure by mutual fund managers is inconsistent, the report noted.

Given the pervasive issues with sustainability data and disclosure, the report suggested that regulatory intervention is needed to standardize key data, terminology and disclosure.

In the past few years, there has been an array of efforts to develop ESG reporting standards — including the work of the Global Reporting Initiative (GRI) and the Task Force on Climate-related Financial Disclosures (TCFD) — but “investors still lack complete and consistent ESG data,” the report said.

“Policymakers need to be cautious about stifling innovation, but they also need to help investors by standardizing ESG disclosures to make them more comparable, material and useful,” the report added.

The report called on regulators to embrace standards-setters’ metrics for reporting ESG indicators, “with an emphasis on material and forward-looking disclosures.”

While standards developed by the GRI and TCFD initiatives are widely referenced in both regulations and stock exchanges’ listing requirements, the report said that “regulators need to use their influence to ensure they are better targeted and more useful than they are today.”

Specifically, the report recommended that regulators work with standard-setting organizations to craft legally required disclosures, as they’ve done for financial reporting. The report said regulators “need to harmonize these disclosures as they do so and push issuers to focus on material ESG disclosures.”

“As investors increasingly consider ESG factors, regulators must help the market coalesce around a standard set of ESG disclosures. Investors do not just need more ESG data — they need material, comparable, and timely ESG data that helps them make decisions about their investments,” the report said.

Starting with climate change, regulators “need to nudge markets toward a more standard set of sector-specific disclosures on their environmental impact,” the report said.

As for other aspects of ESG, the report said that “every business should disclose workforce turnover, workforce cost, and workforce safety.”

The report also recommended that regulators require disclosure on board diversity, and that they be mandated to disclose their policies on bribery and corruption, whistle-blowing and their codes of ethics.

“These standardized ESG disclosures must look like other kinds of financial disclosures, and regulators must mandate that ESG data is temporally aligned with financial disclosures and machine-readable in a standard format with a standard taxonomy where appropriate,” the report said.

At the same time, asset managers should be obliged to provide detailed disclosure of their consideration of ESG factors that makes it easy for investors to understand what a portfolio manager is doing.

“Regulators should require funds that include ‘sustainability’ or ‘ESG’ in their names to evaluate all aspects of ESG, both qualitatively and quantitatively,” the report said.

Correction: An earlier version of this story attributed the report to DBRS Morningstar.