The EU’s 2021 Regulation On Sustainability Disclosures Will Create Big Opportunities For ESG IT Systems
For more than two decades a wide range of not-for-profits have been cajoling firms to collect and disclose their environmental, social and broader sustainability data. The CDP, GRI and more recently SASB can point to high levels of engagement with their annual reporting processes. Approximately 90% of the Fortune 500 now publish an annual sustainability report. The problem? Reporting hasn’t driven significant change in corporate investments. Chief Sustainability Officers generally played the role of a company spokesperson on sustainability matters. They didn’t lead global change programmes which reallocated investment based on sustainability criteria. In effect, the business world gently neutralized the pressure from NGOs. That’s why, in the 2010s, the pro-sustainability lobby focused on the role of investors. This accelerated the rise of Environmental, Social & Governance (ESG) investment criteria. In the last 2 years this has moved into the mainstream with all investment funds and financial advisers integrating ESG factors into their investment calculations.
Predictably enough, ESG ratings, rankings and indices for investors proliferated. Methodologies from firms like Bloomberg, S&P Global and Morningstar-owned Sustainalytics are opaque and proprietary. Unlike credit ratings, ESG ratings are not based on standard data definitions specified by regulators or the accounting profession. Recent studies indicate that there is only a 50% correlation between different ESG ratings for a comparable list of firms. In other words, 50% of the firms with a positive ESG rating from one data provider get a low rating from another provider. That is about to change in a very significant way with the March 2021 entry into force of the EU’s regulation on sustainability-disclosures in the financial services sector. Financial market participants and financial advisers will need to follow harmonized rules on how they integrate sustainability risks in their investment processes and how they disclose those risks to investors.
As data requests cascade down from investors to listed firms, this regulation will drive huge demand from CFOs for software and services which enable them to provide the finance-grade ESG data that investors will request from them. Firms which combine accounting, ESG, climate change and EHS expertise like EY will be in pole position to shape and implement ESG IT projects. Likewise, vendors like Sphera with broad sustainability expertise and EHS software will be in demand. But improved ESG / sustainability risk reporting is just the start. As ESG data quality improves and investors place more reliance on it as a predictor of company valuation, CFOs will need to figure out how they can change their investment decisions to boost their ESG scores. This will put a premium on technology which provides control over industry-specific ESG / sustainability risks.