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Why Corporate Sustainability Reporting Needs a Major Overhaul, According to McKinsey

A company that brands itself as sustainable may be well and good, but diffuse “values” do little to inform sound investment decisions, a new report claims.

In fact, investors say they cannot “readily use” companies’ current sustainability disclosures because they don’t conform to shared standards, according to a recent survey by McKinsey & Company. Because companies can choose from nearly a dozen major frameworks for sustainability reporting, investors must harmonize individual corporate sustainability disclosures before even attempting to make comparisons.

“The scope and depth of these disclosures differ considerably as a result of the subjective choices companies make about their approaches to sustainability reporting: which frameworks and standards to follow, which stakeholders to address, and which information to make public,” McKinsey said.

Of the 164 investors, executives, asset managers and asset owners polled by McKinsey across Europe and the United States, 89 percent of investors and 86 percent of executives said there should be fewer sustainability reporting standards than today, and 75 percent of investors and 58 percent of executives said there should just be a single sustainability reporting standard.

Among investors, 85 percent said greater standardization would help their firms allocate capital more effectively, while 83 percent said it would allow their firms to manage risk more effectively. For executives, 80 percent said greater standardization would enable their companies to benchmark themselves against their peers, and 68 percent said it would enhance their companies’ abilities to create value or mitigate risk.

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McKinsey said it was “striking” to learn that 82 percent of investors and 68 percent of executives supported legal mandates requiring companies to issue sustainability reports, much like they do today with financial disclosures.

Different stakeholders mine sustainability reports for different information; what investors desire most from companies is an increase in sustainability disclosures pertinent to financial performance. As one top 20 asset manager griped to McKinsey, corporations “do not provide systematic data on one-third of the sustainability factors [that we consider] material.”

The lack of standardization in reporting techniques can also lead to inconsistencies and discrepancies when comparing data sets from different companies. These problems are drawn into focus when investors obtain sustainability data from third-party services that collate individual reports to various degrees of success.

“Some services normalize sustainability information, replacing actual performance data (such as measurements of greenhouse-gas emissions) with performance scores calculated by methods the services don’t reveal,” McKinsey said. “Research shows a low level of correlation among the data providers’ ratings of performance on the same sustainability factor.”

It doesn’t help that proprietary indexes and rankings of sustainable companies, which some asset managers refer to when constructing index-fund portfolios, can have wildly different assessments. “It is not unusual for a company to be rated a top sustainability performer by one index and a poor performer by another,” McKinsey said.

Another issue investors are leery of? Reliability. “Many companies do not have the systems in place to collect quality data for [sustainability] reporting,” the head of responsible investing for one of the world’s five largest pension funds told McKinsey. Though performance measurements for tangible factors like greenhouse-gas emissions are usually well-established, those for others, such as corporate culture, human capital and diversity and inclusion, are “more elusive.”

The paucity of corporate sustainability disclosures that undergo third-party audits can also engender doubt. Nearly all the investors McKinsey surveyed—97 percent—said that sustainability disclosures should be audited “in some way,” and 67 percent said that sustainability audits should be “as rigorous as financial audits.”

But investors, McKinsey noted, are a part of the problem. While reducing the number of reporting frameworks and standards will involve years of effort by businesses, investors, and standard-setting organization, many investors said they avoid participating in standard-setting efforts because they “feel that standard setting should address their needs as a matter of course.”

“Until investors clarify which sustainability disclosures they want and help to rationalize frameworks and standards, sustainability reports might continue to deliver less material information than they would like,” McKinsey added.

Plus, investors who participate in efforts to improve sustainability-reporting practices could “gain an edge” over their less-involved peers. That goes double for the companies themselves.

“Executives and board members should stay attuned to these efforts, and even participate in them, to maintain their companies’ standing with shareholders,” McKinsey said.