Sustainable finance industry faces transparency and disclosure challenges despite its rising appeal

Sustainable investing has a 'scoring bias' in favour of large-cap companies at the expense of SMEs, OECD says

Strengthening the regulatory environment around ESG disclosures and transparency will further boost the growth of sustainable finance. AFP

The size of the sustainable investment market has grown rapidly in the past decade, exceeding $30 trillion in assets last year, but challenges around scoring methodologies, transparency and corporate disclosures are hampering its development, according to a new study.

Sustainable investing has an environment, social and governance (ESG) "scoring bias" in favour of large-cap companies at the expense of small and medium-sized enterprises, a phenomenon that may "unfairly penalise SME issuers" with higher costs of capital, the Organisation for Economic Co-operation and Development (OECD) said in its Business and Finance 2020 Outlook report released on Tuesday.

Market participants across the board are still missing verifiable ESG data, critical for due diligence, managing risks and measuring outcomes in long-term sustainable investing, the OECD said.

Despite some improvements, the reporting of ESG factors by companies still have considerable shortcomings with respect to consistency, comparability and quality that undermines its usefulness to investors.

“There is still more to be done to ensure that issuers can rely on core criteria and metrics for E, S and G disclosures that are relevant to a wide body of equity and debt investors, and are supported by stock exchanges and disclosure organisations,” the OECD said.

The lack of agreed definitions, adequate disclosures and data is a hindrance to growth and problem for all actors in the the sustainable finance world, Angel Gurría, secretary general of the OECD told a webinar held to discuss the findings of the report on Tuesday evening.

"We often say at the OECD if you can’t measure it you can’t manage it," he said.

The sixth edition of the OECD report underlines the need for close engagement of regulators and policymakers with the industry, including institutional investors, lenders, ratings agencies and index providers and international standard setters. It is "critical" to make ESG investing "fairer and efficient to create long-term value creation", according to the OECD report.

The economic shock in the wake of the Covid-19 pandemic has highlighted gaps in the resilience of the global economy. The crisis that is afflicting global health systems, value chains and financial markets, means a recovery needs to sustainable, Mr Gurria said.

"Now, as we look to the recovery it is clear that it is both an opportunity and duty to build back better," he said.

"Many governments are mobilising public resources in support of a green sustainable recovery, sometimes at an impressive scale. This is welcome, just as it is necessary."

ESG investing has become increasingly important over the past decade, with both equity and debt investors showing more interest. Tens of trillions of investment dollars are being poured into companies touting robust ESG standards. However, there are major concerns about standardisation and disclosure requirements.

Financial institutions, index compilers and funds have developed their own methodologies to gauge a company’s robustness on ESG. There is divergence, however, in their standards and their ESG scores for companies. The World Economic Forum (WEF), earlier this month released a set of universal key metrics for companies to use when reporting on their ESG impact – regardless of their industry or location.

With the Covid-19 pandemic causing disruption to so many industries, investors are increasingly putting their money into companies committed to ESG priorities that uphold transparency, diversity and sustainability, according to the WEF.

"Finance has a role to play as large flows of private capital will need to be directed to new sectors and new activities in the face of current and upcoming economic realities," Mr Gurria said. "The good news is that finance is able to play that role."

The sustainable investment market has grown by more than 30 per cent since 2016. Globally, almost $1tn of assets were held in sustainable funds, of which around 75 per cent were held by institutional investors and the remaining by retail investors, the report said.

The majority of sustainable investments are allocated in public equities (51 per cent) and fixed income (36 per cent) assets, with the remaining share divided among real estate, private equity and other assets, the OECD said, citing Global Sustainable Investment Alliance data.

Demand for sustainable investments is particularly high in markets such as Europe, the US, Canada, Japan, Australia and New Zealand.

BlackRock’s chief executive Larry Fink in his January 2020 letter to chief executives of some of world’s biggest corporations said his firm is exiting investments with sustainability risks. The environment, he said, will be at the core of all new investments by the world’s biggest asset manager.

Despite studies suggesting ESG investments outperform conventional investment portfolios, the OECD said “there is mixed evidence thus far about the prospect of ESG investing meeting or exceeding the performance of traditional investment indices”.

This “suggests the benefits of ESG disclosures to unlock forward-looking information that is financially material is still at an early stage of development”, according to the OECD report. “Strengthening the link between ESG ratings and financial materiality over the medium to long-term” is needed to further grow the market, it added.

Strengthening the regulatory environment and developing good practice across global markets are also important to support consistency and resilience, it said.

“To unlock the potential benefits of ESG investing for long-term sustainable finance, greater attention and efforts are needed to improve transparency, international consistency, alignment with materiality and clarity in fund strategies as they relate to sustainable finance,” the OECD said.

It will add to the integrity of sustainable finance through global financial markets and will “contribute to resilient and inclusive economic growth”.