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The role of regulation in improving investor reporting

Simon Messenger writes about how to develop good reporting practices to integrate climate change into institutional investments.

In the past few weeks, I have attended a number of meetings between regulators, investors and companies where the discussions focused on how to develop good reporting practices to help integrate climate change into institutional investment. The market remains a long way from being aligned with 2 degrees and there is a growing discussion that many climate change models actually under-report the impact of climate change on businesses.

As the providers of a framework for environmental reporting, we are well aware of some of the often repeated messages, such as the need for investor-grade data, the need for increased engagement between companies and investors, as well as the perceived lack of Board-level fluency on climate change.

On the other hand, we are also seeing a steady increase in the amount of data being disclosed by companies through the various initiatives and organisations working in this field, with regular news coming through about companies shifting their business models to prepare for the low-carbon transition. 

And, while this information is not yet as comparable, consistent or assured as we’d all like it to be, there is a wealth of data already publicly available for investors to make decisions about their future investments and engagement activities towards organisations that are becoming more resilient to future changes in the climate.

What can be done to unlock the change?

First of all, both investors and companies need to engage more on this subject: the data is there, but investment analysts do not always understand its relevance or materiality to the company, and companies do not commonly know how the data is fed into investment decisions.

Until this subject is brought up more regularly at Capital Markets Day, it will not receive the attention it deserves. There are a number of recent examples, in particular with the oil & gas industry, highlighting how improved engagement leads to enhanced disclosure of decision-useful data.

Secondly, regulation will be a decisive element of this equation, but it’s important not to focus only on one side of the coin.

Research from the Reporting Exchange shows that governments, financial regulators and stock exchanges across the G20 have developed over 150 guidance provisions to help companies report climate-related information. But voluntary guidance can only drive the market to a certain extent: we need clear mandatory regulation to create a level-playing field, supported by good supervision and enforcement, to ensure an effective implementation.

The question is not whether to regulate, but how to regulate well. We have seen a decade of voluntary attempts (if not more) and the best examples of market disclosure that we have nowadays are in markets that are regulated, such as the UK, France and the EU.

However, there are different ways policymakers can send the right signals. For instance, a key next step is the clarification and alignment of market response, as well as the definition of a clear taxonomy to define what is classified as a green or sustainable asset. This would help investors make sense of the data that companies are currently disclosing, and allow for better decision-making.

Securities regulators and other market regulators also have a key role to play in providing ongoing feedback to markets about their reporting practices. Constructive feedback could be in the form of published reviews of reporting practices across the market they regulate, as well as one-to-one engagement with individual organisations, providing feedback on what they need to do to be in full compliance with existing regulation and provide decision-useful information to investors.

This remains one of the biggest gaps in the current market, as we do not yet see many supervisors with the expertise or the capacity to do so. It is therefore critical for governments to clarify the mandates of such supervisors to include the supervision of climate-related financial matters, as well as to ensure that they are provided with the adequate financial resources and expertise to incorporate this remit into their work.

A good example of engagement can be seen, for example, in provincial regulators in Canada, where every year a sample of companies is reviewed and provided with suggestions for improvement, when needed. The UK’s Financial Reporting Council also produces guidance on various topics, including on reporting and corporate governance, to support companies, although – as highlighted in the recent consultation with the Environmental Audit Committee – much more could be done with the right mandate and resources.

Steps forward for investors

So what can investors do now? Firstly, they should outline their expectations on climate change, and the type of analysis and data they need to see. Meanwhile, pushing for 2-degree (or lower) scenarios to help create a benchmark for performance and help reduce risks will help corporates understand what to disclose.

Investors also need to work with shareholders to get more and better resolutions on climate disclosure. Collaborating with pension funds is critical to ensure that protection for climate change is a consumer and saver protection issue.

Finally, investors should look at their peers. Investors paying portfolio managers on short, medium and long-term results are helping to recognize long-term issues such as climate change.

It is pleasing to see that good practices on reporting are emerging at the corporate, investor and regulatory level. However, significant gaps remain. We can only achieve the transition to a low carbon economy if there is better coordination and engagement on all sides. If you aren’t already engaging with your portfolio, you are risking locking in your investments in unsustainable assets.