Making ESG information affect business and investment decisions

 

Interviewee｜ Mr. Robert G. Eccles, Visiting Professor of Management Practice at the Saïd Business School

 

Robert G. Eccles, Visiting Professor of Management Practice at the Saïd Business School, University of Oxford. He is the author of several books on integrated reporting, sustainability and the role of business in society. Professor Eccles’s research focuses on sustainability from the perspectives of both enterprises and investors. He has participated in a variety of activities or initiatives that embed environmental, social, and governance (ESG) issues in real-world decision making. One of them is the Sustainability Accounting Standards Board (SASB), and he is the Founding Chairman of the Sustainability Accounting Standards Board (SASB). Professor Eccles is also one of the founders of the International Integrated Reporting Council (IIRC). In 2013, he was named the first non-accountant Honorary Fellow of the Association of Chartered Certified Accountants (ACCA), one of only nine since 1999.
 
In 2018, Professor Eccles was selected by Barron’s as one of the 20 Most Influential People in ESG Investing, and was awarded with the “Lifetime Achievement CSR Award 2018” at the 8th International Conference on Sustainability and Responsibility (ICSR). In 2014 and 2016 respectively, Ethisphere Institute profiled him twice as one of the "100 Most Influential People in Business Ethics".
 
China Sustainability Tribune interviewed Professor Eccles about the impact of ESG factors to corporate financial performance, with the hope that more enterprises and investors will integrate these factors into corporate decisions and investment strategies.

ESG and financial performance

 

China Sustainability Tribune: You once said that the decisions made by large enterprises and investors can have a major impact on the realization of the Sustainable Development Goals (SDGs).
 
As an expert on integrated reporting and sustainable strategies, could you please share with us what kind of work are you currently working on to change the behaviours of large enterprises and investors, and to promote private sector's contribution to realizing SDGs? What has been the biggest effect so far?
 
Prof. Eccles: One of the key things to change behavior is providing people information that will influence their decision-making process. In this particular case, businesses need to be able to measure and report on their environmental, social, and governance (ESG) performance. Investors can then factor this information into their investment decisions. When investors reward enterprises with good ESG performance, enterprises will have an incentive to improve it. The challenge for investors is the uneven reporting by enterprises — some do, some don’t, and finding this information isn’t easy with it often being buried in a sustainability report or is somewhere on the company’s website. Even when it is reported, it isn’t being done so to a set of standards that are properly audited.
 
Global Reporting Initiative (GRI) has been a leader in developing these standards for stakeholders. The Sustainability Accounting Standards Board (SASB) has done the same for investors, although it is at an earlier stage with its first set of standards published late last year. I was privileged to be the Founding Chairman of SASB and are proud of what we’ve done.
 
A set of standards based on an identification of the material ESG issues in 77 industries (organized into 11 sectors) has been developed. The key thing now is for enterprises to start using them and, eventually, for regulators to encourage them to do so. One suggestion for China is that the China Securities Regulatory Commission (CSRC) study the possible adaptation of SASB’s standards in China for all listed companies. All in all, the governments need to set standards and mandatory reporting requirements for ESG information just as they do for financial information based on accounting standards. Until that happens, ESG information will be a poor cousin to financial information.
 
China Sustainability Tribune: A common debate centering on ESG investing is that incorporating ESG factors into the investment decisions will affect performance. However, some studies show that enterprises with good ESG practices will have a lower cost of capital, lower volatility, and less bribery, corruption and fraud in the long run. Therefore, is the requirement of capital focusing on long-term benefit contrary to the property of capital aiming at seeking profit?
 
How will you help the enterprises and investors overcome the contradiction between long-term benefit and short-term benefit? 
 

Prof. Eccles: You raise two questions here, but they are closely related, that is, the relationship between ESG and financial performance and time frames.
 
First, the body of evidence that ESG helps, doesn’t hurt performance, is now pretty convincing. Professor George Serafeim of the Harvard Business School with various colleagues (including me) has produced the most important body of work here. What is clear is that if enterprises focus on the material ESG issues, i.e., the ones that affect financial performance (as shown by SASB) they will improve their financial performance. The key word here is material. If a company overinvests in every ESG issue of interest to any stakeholder, this will hurt its financial performance. This is no different than overinvesting in advertising, marketing, manufacturing capacity, and R&D. But the proper level of investment in the material ESG issues, which vary by industry, will contribute to financial performance. All these studies and having greater clarity about what ESG integration really means should help both enterprises and investors overcome this false perception.
 
Second, these studies have also shown that it takes years, not months, before ESG performance contributes to financial performance. Thus, both enterprises and investors looking for the benefits from ESG must have a long-term view.
 
ESG and long-termism are two sides of the same coin. Solving the problem of excessive short-termism in the capital markets, which is especially pronounced in the U.S. and China (probably even more so) isn’t something ESG alone can solve. Asset owners need to give asset managers mandates that encourage ESG integration and that are sufficiently long term. Governments need to consider tax incentives that encourage long-termism. Boards of directors need to support CEOs who have a long-term view. So must fiduciaries of fund managers. This is a really complicated problem to solve.
 

 

Long-term investors and short-term gamblers

 

"I actually think the basic challenges in China and other emerging markets are basically the same — overcoming the mistaken belief that ESG hurts financial performance; getting high quality, relevant, and reliable ESG information, and having time frames that support ESG integration."
 
China Sustainability Tribune: You have participated in a variety of activities or initiatives that embed ESG issues in real-world decision making. But in emerging markets and China, the concept of ESG is relatively new and has not been widely accepted by enterprises and investors. So, could you please tell us the importance of ESG for the enterprises and investors, and the challenges that ESG currently faces in the world, especially in emerging markets economies?
 
Prof. Eccles: I actually think the basic challenges in China and other emerging markets are basically the same — overcoming the mistaken belief that ESG hurts financial performance; getting high quality, relevant, and reliable ESG information, and having time frames that support ESG integration.
 
However, there are specific issues in emerging markets. ESG data from data vendors is still being developed. Company reporting is even less developed. Investors are less sophisticated about ESG. (Whereas around 50% of assets in Europe have some kind of sustainable investing strategy, a third in Canada, and 20% in the U.S., this figure is less than 5% — probably a lot less — in China.) A particular challenge in China is that the asset management industry is still fairly young, like around 20 years old if I remember it right. So these firms are still learning and developing. But, like everything in China, they will do so very quickly. Evidence of this is the training session sponsored by the Asset Management Association of China in Beijing on February 21.
 
Unlike developed markets, asset owners — who give the mandate to asset manager —are even less aware of ESG. China does not have a large number of pension funds like in the U.S. and Canada. There's the Social Security Fund and CIC (the sovereign welath fund), but I hear they aren't advocating for ESG integration like the big pension funds are doing in the west. My sense is that the same is true for the national SOEs that own stock in many enterprises. This leaves the Chinese capital markets as largely a retail play outside of State ownership and some international investors who are probably the biggest source of pressure on Chinese enterprises regarding ESG. Retail investors in China aren't really investors; they are shot-term gamblers.
 
From a company perspective, the focus in China has been on Corporate Social Responsibility (CSR). Although it is a good thing, this is not something investors care about. The notion of materiality is way underdeveloped in China. The underdevelopment of ESG in China represents a great opportunity for both enterprises and investors since the market remains very inefficient on these factors. Investors who understand the importance of ESG factors and can find ways, however imperfect, of assessing a company’s performance can generate a lot of alpha. Enterprises that can clearly articulate their view of the material ESG issues for their sector and strategy and how they are related to financial performance and who communicate about them to investors who care will benefit. Those most likely to do so will be those who have big international investors like BlackRock, State Street, and Vanguard. 
 

Integrated reporting and nonfinancial information disclosure

 

China Sustainability Tribune: As we learned, you have been working hard to promote integrated reporting and hope to use it as a lever to integrate ESG into corporate strategy decisions and investors' decisions, and make use of capital market to promote sustainable development. But for most people who engage in sustainable development, especially those in China and other entities, "integrated reporting" is still a new term. So could you please briefly introduce the origin of "integrated reporting"? What is the importance of integrated reporting to both the enterprises and investors?
 
Prof. Eccles: I need to separate it into two related questions. Right now it is a stretch to relate integrated reporting to sustainable development but I will explain that more below.
 
Sustainable development is about making the world a better place which will support all future generations to come. Integrated reporting is about giving investors the information they need so they can determine which enterprises will be the best long-term investments. But let me get back to integrated reporting. An integrated report is a concise document through which the company explains to its investors (and other stakeholders who want a holistic perspective) about how the company will create value over the short, medium, and long term.
 
An integrated report explains how a company is using and affecting, for better or worse, the "Six Capitals" — financial, manufactured, natural, human, intellectual, and social and relationship. Done right, an integrated report is where the company identifies the material ESG issues that contribute to financial perfomance and provides information on how they are doing so. This will be incredibly helpful to investors who are still learning about how to think about the relationship between ESG and financial performance. At the highest level, integrated reporting has the opportunity to completely reshape the nature of the conversation between enterprises and investors.
 
Right now it is a short-term one focused only on financial results. ESG and time frames beyond the next four quarters hardly ever come up. This needs to change. Integrated reporting is a way to make that change, and to facilitate a more long-term conversation that integrates ESG. It needs to start with enterprises since it is their report. They then need to educate investors on how to understand it. Most investors won’t. European investors are the most willing to do so, with U.S. investors getting on board, and Chinese investors are still early on the learning curve.
 

 

China Sustainability Tribune: Compared with the forms of traditional financial report, sustainability report or environmental report or CSR report, what are the unique advantages of integrated reporting in ESG information disclosure? What is the biggest value of integrated reporting for promoting sustainable development? What improvements to integrated report in terms of disclosure of long-term value creation?
 
Prof. Eccles: I am a big supporter of all of these forms of “nonfinancial reporting.” Some of this information will be important to investors. Some of it won’t be, at least for now. Stakeholders beyond investors are the “Canary in the Coal Mine” who identify issues that investors will have to eventually care about due to changing social expectations and the recognition of planetary resource boundaries. I’ve already said a lot about why I think integrated reporting is important. Much room for improvement exists in how enterprises communicate their long-term strategies for value creation. Here I think the work that CECP is doing with its Strategic Investor Initiative (SII) is very important. Integrated reporting can support the SII.
 
Integrated reporting is how the company explains how it is creating value over the short, medium, and long term. It is investor-focused and in this sense quite distinct from sustainability reporting which is more about issues that matter to a wide range of stakeholders. The step from integrated reporting to supporting sustainable development is a big one. The audience for sustainable development is the world, not just investors (although they care too as explained above).
 
For integrated reporting to support sustainable development it must include impact metrics as well as ESG metrics. We are a long way from being able to report on impact. There is the further challenge of showing how impact contributes or not to sustainable development. Let’s be honest, enterprises in nearly all industries create negative externalities from the perspective of the SDGs. Reducing these negative impacts could hurt shareholders, at least in the short term. Yes, there are those rare circumstances, such as renewable energy enterprises, where the products are intended to have positive impact and create value for shareholders but these are the exception, not the rule.
 

ESG and its impact

 

"Without standards and reporting requirements supported by the government, nonfinancial information will never have the quality, utility, and legitimacy of financial information."
 
China Sustainability Tribune: Do you think that mandatory reporting standards are the prerequisite for enterprises to effectively disclose "sustainability" or "nonfinancial information"? Is it possible for nonfinancial information to have the same credibility and utility as financial information? What impacts will the information technology and corporate reporting websites have on nonfinancial information disclosure?
 
Prof. Eccles: I can be brief here. The answer is "Yes." Without standards and reporting requirements supported by the government, nonfinancial information will never have the quality, utility, and legitimacy of financial information. See the paper I wrote with Professor Richard Barker "Should FASB and IASB Set Standards for Nonfinancial Information?" and the debate we had at The Oxford Union. Information technology, especially AI and big data, can substitute for the lack of standards and mandated reporting in the short term. Corporate websites are obviously important if they are interactive tools (like SAP's integrated reporting website) and not just places to post a PDF.
 

 

China Sustainability Tribune: Are there any other messages or information that you would like to express or convey to the readers?

Prof. Eccles: Yes, and thank you for asking. I just want to emphasize the difference between ESG and impact metrics. ESG is about a company’s activities. The company has or can get the data to report on ESG. ESG is about outputs that lead to outcomes. Impact is outcomes in context (the impact of a wind farm in Beijing is a lot greater than in Norway). This requires data from outside the company’s walls. Impact measurement, often seen through the lens of the Sustainable Development Goals, is the frontier in measurement and reporting. Here I want to make your readers aware of the work of the Impact Management Project. China really needs to get involved in this project.
 
China Sustainability Tribune: We find that you describe yourself as "dedicated weight lifter", "sustainability advocator" and "capital market activist” in the social networks such as LinkedIn and Twitter. I am really interested in the item "dedicated weight lifter". What does it mean? Your hobby or a metaphor?
 
Prof. Eccles: Weight lifting is no metaphor. I took this up at 60 years old when my son who rowed crew at Princeton bought weights one summer to stay in shape. I’m now 67. This won’t mean much to your audience, but my personal record for the bench is 170 pounds (not very good), for the squat is 280 pounds (pretty good for a man my age who is not a natural athlete by any means), and for the dead lift at 390 pounds. I’m pretty proud of this but it doesn’t come close to the world record of 500 kg set by my hero Eddie Hall.
 
(Source: China Sustainability Tribune）