While environmental, social, and governance (ESG) issues are getting a lot of attention from investors these days, there is still some question about whether these issues are financially relevant for investors—and a growing volume of literature that suggests they are. Some of the more convincing arguments point to ESG as an additional component of fundamental analysis that can help identify and reduce risks, and aid in assessing the quality of management. Researchers at MSCI point to governance red flags at Volkswagen that preceded the emissions cheating scandal, for example. If investors had heeded warnings of governance malfeasance, perhaps they might have avoided a material financial risk.

However, while agreeing ESG could be a useful input, many investors are also dissatisfied with the quality of ESG disclosures. Much of what is disclosed just doesn’t seem material to investment decision-making, critics say, and ESG often has the distinct appearance of being irrelevant “noise” or, worse, marketing hogwash with little to no bearing on financial outcomes for companies and their shareholders. This leaves investors in the difficult position of recognizing the potential analytical value of ESG but struggling to separate the wheat from the chaff in ESG disclosure.

In June, CFA Society Toronto hosted a seminar to address these issues. The session was led by Katie Schmitz Eulitt, strategic advisor to the Sustainability Accounting Standards Board (SASB), and Deborah Ng, CFA, director, strategy and risk, and head of responsible investing at the Ontario Teachers’ Pension Plan (Ontario Teachers’).

A Pathway to Financially Material ESG Disclosures

The SASB wants to address the disconnect between the ESG information companies produce and the “financially material, decision-useful ESG information” that investors require. It’s pursuing this goal by producing industry-specific standards that companies around the world can use to guide their disclosures to investors and other stakeholders who need financial data. Today, the SASB maintains industry-specific standards for 77 industries in 11 sectors.

“ESG often has the distinct appearance of being irrelevant ‘noise’ or, worse, marketing hogwash with little to no bearing on financial outcomes for companies and their shareholders.”

Although the SASB is distinct from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), these organizations share a guiding principle of following a rigorous standards development process. According to Schmitz Eulitt, “the rigour of the SASB’s standards-setting process—and particularly the SASB’s focus on financial materiality—are among the reasons the SASB has garnered the support of global investors who are seeking better insights into where ESG and corporate performance intersect.”

During the first stage of the SASB’s process, industry research was undertaken to determine evidence of which sustainability-related issues have material financial impact on companies in a given industry. This step in the SASB’s provisional standards-setting process was supported by input from more than 2,800 participants in industry working groups involving companies and investors, as well as public interest groups and intermediaries. (If you’d like to get involved in the SASB’s standards-setting process, see “Resources and Tools for Investors,” page 17.) The SASB vetted the findings, distributed them for public comment, made further revisions, and finally sent them to the SASB Standards Board for approval. The litmus test for disclosure topics included in the standards is that they require both evidence of both investor interest and financial impact.

Practitioners and Investors Are Noticing

Despite its short history, the SASB has garnered significant support from investors who believe in the goal of better disclosure of ESG information to investors. The SASB’s Investor Advisory Group (IAG) currently comprises 32 well-known global asset owners and managers who, between them, control more than $26 trillion in assets and who are encouraging companies to use the SASB standards to communicate their performance on ESG issues to investors. Further, the SASB Foundation Board counts the former chair of the FASB among its members, along with an IFRS Foundation Board trustee and two former chairs of the Securities Exchange Commission.

A series of investor-written case studies documenting the use of SASB standards and tools across asset classes and investment strategies can be found in ESG Integration Insights.

Adopting the SASB Standards

Although investor support is important, the rubber hits the road for the SASB when companies adopt their disclosure standards and incorporate them into their reports. What convinces these companies to make the leap to the standards? Schmitz Eulitt pointed to four key benefits:

• owning the data that investors increasingly use to evaluate companies;
• cost-effectively disclosing progress, strategy, and data using industry-specific metrics;
• benchmarking performance with peers; and
• more effectively meeting investor requests for disclosure of financially material sustainability information.

The presenters also provided some examples of early SASB standards adopters, including jetBlue, which produced a stand-alone SASB report, and Nike, which published an SASB reference guide on the Investor Relations section of its website. Since then, leading global companies such as PSA Group, Merck, and Schneider Electric have begun reporting to investors using SASB standards. To be sure, corporate adoption of these standards is still in its fledgling stage, but momentum is growing.

Ontario Teachers’ Experience

Ng provided some real-world perspective as a user of the SASB approach. The main attraction for her team is that the SASB focuses on financially relevant factors that Ontario Teachers’ analysts and portfolio managers find meaningful to their investment processes. At any given time, Ontario Teachers’ may have holdings in more than 3,000 companies, meaning that the resources available to scour corporate reports for relevant information are limited. “The term ‘ESG’ spans a wide range of issues that have different levels of materiality, depending on the sector,” said Ng. “The SASB’s sector and materiality-based approach helps the investment teams cut to the core of what is important for companies to manage in order to be sustainable. This helps us achieve better investment outcomes.”

To date, Ontario Teachers’ has found three main uses for the SASB standards.

• A tool for internal engagement: Within Ontario Teachers’, Ng’s team has used the SASB as a tool to help improve internal engagement on ESG measures. Specifically, her team has worked collaboratively with the investment teams to walk through each SASB disclosure topic and discuss how analysts have been using this metric to inform their views on a company. This information was used to provide feedback to the SASB on the relevance of its metrics.
• Creating a common understanding: The SASB standards create a framework for common understanding across Ontario Teachers’ public and private investment teams of the types of ESG issues to focus on. In addition, the standards provide guidance on the specific metrics and standards for each material issue. Having portfolio managers consolidate the key ESG issues and metrics not only increases internal engagement but also helps ensure consistency across teams. The standards also help inform the type of ESG-related information portfolio managers request from companies.
• Building guidebooks: Using SASB standards as the foundation, Ontario Teachers’ has created “disclosure guidebooks” that articulate what the pension fund expects from the companies in which it invests. These guidebooks help portfolio managers focus their engagement efforts with companies, as well as provide a guide for companies to consider.

Stepping Forward on ESG Disclosure

For years, practitioners in the ESG field have fought for improved disclosure from corporations. The efforts of the SASB appear to be taking the next step in refining that disclosure so that the information is financially relevant for investors and more impactful for corporations. Communication is easiest when two parties speak the same language, and the SASB standards are an attempt to bridge the communication gap that exists today.

The early signs of adoption of SASB standards by companies like Nike and jetBlue suggest that perhaps more will follow and that the quality of disclosure from “producers” of ESG information will improve. Similarly, the support for the standards from important investors like Ontario Teachers’ and other SASB IAG members points to early traction from “consumers” of ESG information. As long as communication continues to improve, expect the conversation about responsible investing to continue to evolve.

RESOURCES AND TOOLS FOR INVESTORS

• Website: www.sasb.org
• Get Involved in a Standards Advisory Group: https://www.sasb.org/provide-feedback/standards-advisory-group
• SASB Materiality Map™: https://materiality.sasb.org
• Fundamentals of Sustainability Accounting Credential: https://materiality.sasb.org
• ESG Integration Insights: https://library.sasb.org/esg_integration_insights/