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Environmental, social and governance (ESG) goals have moved center-stage to dominate business conversations around the world. Organizational leaders are taking action to stand up ESG programs and processes, helping all stakeholders — investors, employees and clients — understand the big picture with clear ESG strategies. Beyond that, today’s institutional investors are being tasked with backing up their net-zero pledges and green energy commitments with hard facts and reporting.
Across the pond, leading regulators, including the EU and U.K., have laid down guidance for what businesses are expected to disclose from here on out. Later this year, the SEC will finally debut its overarching disclosure rules, and among them will be the requirement for companies to disclose detailed data on their sustainability strategy, starting with the environment and financing of greenhouse emissions through investments. These disclosures will cover not only the outcomes resulting from the transition to sustainable aligned activities, but also the impact of their supply chain on their ESG ratings.
Yet investors are understandably having a tough time figuring out the processes, procedures and strategies they need to be compliant from day one. Leaders who challenge the status quo and implement measures for compliance will avoid steep financial consequences and unwanted regulatory scrutiny. The lack of standardized criteria makes it challenging to know what makes an investment sustainable. Despite all this, stakeholders agree that their focus must turn to sustainability and data.
To facilitate compliance with disclosure data and achieve ESG goals, here are several tactics that can help institutional investors jumpstart their U.S. ESG financial compliance operations.
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Use Europe as a model
Europe leads the regulatory landscape in ESG, making it a key resource for the U.S. as it prepares for more formalized ESG regulation. While nuances exist between the European regulations — and standardization will undoubtedly be an issue given the historical evidence surrounding global regulation — much of Europe continues to publish more fine-tuned guidance that will likely influence the SEC’s disclosure requirements.
The U.K.’s Financial Conduct Authority (FCA), for example, has laid down increasingly detailed guidance that is prescriptive for numerous investor classes — like public companies and asset managers. The European Insurance and Occupational Pensions Authority (EIOPA) has developed a comprehensive framework for cornerstone investors such as pension funds and insurers. With oversight expanding into more “niche” categories as well, the European Commission (EC) last year passed a clear guidebook around investments in bridge fuels like gas and nuclear.
In light of these recent changes to European frameworks, investors would be well-served to review this guidance as similar oversight comes down the pike in the U.S.
Develop an integrated ESG strategy
To make ESG a core part of the business, investors need to take a step back and think about their ESG reporting in the same way they think about any other organizational function: with clearly stated priorities, goals and outcomes. This begins with asking key questions like:
- What are the ESG criteria that we want — and will likely need — to report on for our investments?
- How do we change organizational structures to integrate sustainability into investment analysis and decision-making?
- What are the short-, medium- and long-term benchmarks we are trying to achieve, and how do they integrate with our operational goals?
- What are the financial benefits of our ESG-focused investments? Does yield in ESG-friendly investments beat non-ESG-friendly investments?
- Is the data that we need at our disposal to make this a reality, and how do we get it?
Companies that communicate their ESG goals to investors and explain how their commitments can achieve their benchmarks have the opportunity to generate meaningful shared value and competitive advantage. By doing so, they increase their chances of successfully implementing environmental and sustainable initiatives.
Data management strategy for ESG reporting
We currently see inconsistency and a greater variety of self-reported ESG data by security issuers, along with varying methodologies for determining metrics. This acute lack of standardization points to many varying factors, including the pool of vendors that supply this data in the marketplace.
Investors are increasingly relying on more than one data vendor to achieve a comprehensive view of ESG factors within investments. Because of this, organizations require scalable technology that can support data aggregation and normalization across third-party data. A consistent data management strategy can help organizational leaders easily report on sustainability metrics to corporate stakeholders and regulators.
Anticipate a crackdown on greenwashing
While ESG has become a bigger decision-making factor and more intertwined with stock prices, discussions around ESG inflation have exposed weaknesses, especially around ESG misstatements and misconduct. To address ESG misconduct, the SEC set up a Climate and ESG Task Force and issued a handful of enforcement actions throughout 2022. As the volume of ESG-related assets under management rapidly increases, currently projected to hit nearly $34 trillion by 2026, according to PwC, we expect regulatory enforcement to follow suit.
To investors, this market size means that the potential risk for exposure is immense. To mitigate ESG risk, robust technology-based capabilities can deliver transparency into data, helping organizations detect greenwashing risks early and often. Technologies like blockchain can help credentialize carbon credits and increase transparency on ESG factors in the supply chain. While this will likely be a challenge for many investors in traditionally slow-moving sectors like insurance and government, now is the time for investors to improve their skills around blockchain and tech automation and fill their ranks with the talent they need to enable better corporate governance.
While ESG enforcement may only be beginning to take shape in the U.S., late adopters who fail to follow best practices could soon face huge repercussions. By looking to European regulations to prepare for upcoming U.S. ESG-related disclosure requirements, organizations can build an integrated ESG and data strategy across business lines and functions, as well as invest in the detection of greenwashing risks so that investors can maintain good standing with regulators. Beyond the thicket of regulations, investors will gain visibility and peace of mind that their ESG investments are indeed being used in the manner with which they were intended.
Sandeep Sahai is CEO at Clearwater Analytics.
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