One of the challenges of indexed investing for investors seeking to fulfill their stewardship responsibilities is that their equity benchmarks include companies with a poor performance track record — on financial returns, as well as on environmental, social and governance practices. As most indexed investors are by nature long-term, ESG practices are a focus because they have considerable potential to affect performance over time. Sound practices in relation to the material environmental and social aspects of a company's business can be a signal of operational excellence and management quality.
ESG risks constitute seven of the top 10 most concerning global risks in the World Economic Forum's annual “Global Risks 2015” report. But they are difficult for investors to incorporate into investment analysis and stewardship activities, as investors do not yet have the complete, consistent and comparable data required to accurately measure how companies are managing them.
If BlackRock (BLK) wants to compare the financial performance of, say, telecom companies in Singapore, the U.S. and Spain, we can rely on a set of widely understood international accounting standards. If we also want to compare the carbon dependency, employee turnover levels or the number of independent directors of those companies, it is either impossible due to lack of disclosure or requires so many assumptions and extrapolations that the output is nigh on meaningless.
Market-led solutions need more support
This problem is not new. BlackRock (BLK) and organizations, such as Boston-based Ceres, which advocates for sustainability leadership by companies and investors, have worked for many years to encourage better corporate reporting. We prefer practitioner-led solutions as they garner buy-in by all those affected by a change in approach. Many large companies have led by example, and a growing number of companies now participate in initiatives such as CDP, formerly Carbon Disclosure Project, a London-based organization that collects data on environmental impacts to assist investors and corporations worldwide with sustainability decision-making, and the Global Reporting Initiative, an Amsterdam-based organization that promotes corporate reporting on sustainability factors. However, the level of ESG disclosure is neither broad-based nor consistent enough to meet investor needs.
The practitioner-led, market-based solution needs more support from a wider base of market players as there is evidence that voluntary regimes are stalling while many regulatory responses are piecemeal. We are seeing more interest from investors, including our clients, in ESG integration, and index providers are responding with new benchmarks.
BlackRock, as a long-term, fiduciary investor, is using the ESG data that is available to benchmark, analyze and value the companies in which we invest on behalf of clients. For the companies we invest in through indexed portfolios, these data are an important input into our engagement or stewardship work. But the data are patchy.
To achieve critical mass, investors need more market participants, particularly those with authority in the markets, such as the stock exchanges, to require ESG disclosure.
Meeting investor demand
Why the stock exchanges? Because they are in a position to collaborate with their global peers to establish consistent guidance and structures across markets.
To that end, investors, including BlackRock (BLK), have been working with Ceres to develop recommendations for the integration of sustainability disclosure requirements into stock exchange listing rules.
Last year, this led to Ceres' detailed guidance titled “Investor Listing Standards Proposal” and, in turn, the United Nation's “Model Guidance on Reporting ESG Information to Investors” Both provide potential foundation stones for a consistent global regime on ESG disclosure standards.
During this work, investors have seen recent progress. The stock exchanges of South Africa and Australia already have listing rules on ESG reporting, and Hong Kong, Singapore and Malaysia have all recently proposed progressive rules on sustainability reporting. But investors need more exchanges to follow suit and to collaborate with their peers so they don't have a patchwork of 100 different ESG reporting regimes.
Companies, investors and stock exchanges agree
Companies, investors and stock exchanges all see the benefits of a more strategic approach that provides consistent standards of disclosure by companies globally of the most material ESG factors.
Some worry that companies will list elsewhere if a stock exchange brings in additional rules on ESG reporting. Conversely, my colleagues and I hear time and again from company executives about how challenging it is for them to respond to multiple ESG reporting regimes and that they would welcome rules and guidance to standardize reporting and reduce “survey fatigue.”
As a shareholder, we at BlackRock (BLK) are concerned about too many surveys and the potential for different representations of the same data to cause confusion. We want to level the playing field to make the data that are reported more useful and to encourage reporting by companies that aren't doing so due to the lack of direction.
And the majority of stock exchanges themselves support this initiative. A report on a survey of major exchanges, “Sustainable Stock Exchanges: A Report on Progress 2014,” for example, found that 76% of stock exchanges agreed they have a responsibility to encourage better corporate disclosure on sustainability, while a third agreed that voluntary initiatives alone would not be adequate. This implies that leadership on the part of the exchanges and their regulators would be welcomed.
Michelle Edkins is San Francisco-based global head of corporate governance and responsible investment at BlackRock (BLK) Inc. (BLK)