The financial sector’s growing interest in climate risk and other environmental, social and governance (ESG) factors has led to an information boom. However, many investors are confused about how to interpret and use the vast array of ESG sources. At the Center for International Climate Research (CICERO) in Oslo, Norway, we are working with our subsidiary, Shades of Green, to create methodologies that integrate company reporting on environmental and financial data to help speed up the energy transition.
As the energy transition advances, identifying the best-prepared companies is of increasing interest to the financial sector. But this is no easy task.
Norway, for example, has a large oil and gas sector with a significant number of associated industries, including service and supply companies. These companies are indirectly linked to fossil fuel extraction and its associated high climate risk. Some businesses in these sectors are working strategically to transition their business models. However, since almost all companies have statements to this effect in their sustainability reporting, it is difficult for investors to identify which are truly transitioning. In addition, given the relative novelty of ESG data collection, quantitative reporting from companies is often either lacking or inconsistent.
To assist their analysis, investors can turn to an ESG rating or score. The increased focus on ESG has led to a fertile marketplace of ESG data providers. The consultancy Opimas estimates that the ESG data market is worth as much as $1bn. A single unified ESG score for a company may seem an attractive way to quantify risks that are not easily quantifiable. However, the data quality is variable, given variability in corporate reporting, and a single score may conceal high risks in certain business areas.
Forthcoming EU regulations will soon require that large companies report their share of revenue from “green activities”, as defined by the EU taxonomy for sustainable activities. Across the EU, companies are frantically trying to understand the implications of this regulation.
From red to green
To improve access to information for investors, CICERO initiated its Sustainable Edge research project in 2019 with the goal of exploring the possibility of identifying “green” revenue and investments.
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Our experience in integrating financial and environmental data in close collaboration with corporate first movers provides insights into key challenges and opportunities.
Our methodology, first developed for the green bond market, differs from the EU taxonomy in that we use a scale from dark green to red to provide information on how well-aligned activities are with a low-carbon-resilient future.
Activities that do not contribute to the transition are coloured yellow, while those that have no role to play in a low-carbon and climate-resilient future, such as new infrastructure for oil and gas extraction or investments in coal-fired power plants, are coloured red.
Assessing how green a revenue stream or investment activity is requires the bridging of financial and ESG information, and the sustainability and financial professions. Both present challenges.
Sustainability meets accounting
In general, financial data is not structured in a useful way for environmental analysis. It can be hard to link a figure found in a financial statement to a specific asset. Assessing environmental qualities often requires detailed information about underlying activities and assets.
For example, it is often possible to break down capital expenditure in “property, plant and equipment” to specific investments. However, for environmental analysis, we need to know the energy efficiency of a building. Energy data is typically either tracked in a different data management system or recorded in an unstructured way, and sometimes not tracked at all.
To bridge the data gaps, our work facilitated conversations between sustainability and accounting professionals. Through these conversations, we gained the information needed for our assessments. However, this is a resource-intensive method of data gathering. To expedite the analysis, we need more integrated data systems but also capacity building across professions. To successfully integrate ESG and financial data, sustainability professionals need to understand basic finance and vice versa.
The goal of our project was to provide investors with useful information, but we found the process was also a useful strategic exercise for companies. Stitching together the information needed to assess the greenness of revenues and investments, and assessing environmental governance, proved to be valuable for companies’ risk awareness and to identify gaps in sustainability management. This has proved true even for companies with a green business model, which often have blind spots regarding the environmental risks in their supply chains.
Given the voluntary nature of our assessments, our work so far has focused on companies leading the way on corporate transparency. Some have significant emissions. For instance, we shaded yellow 57% of the 2020 revenue of mineral fertiliser producer Yara.
A similar tale emerged for biotech and krill-harvesting company Aker BioMarine, where we shaded 68% of its revenue yellow.
Our work suggests that in addition to providing useful information to investors, all companies would benefit from integrating ESG and financial data.
Forward-thinking executives could view the forthcoming EU reporting regulation not as an extra burden but as a tool to identify risks and better understand business opportunities.
For transitioning companies in high-emitting sectors, providing transparency on their share of green revenues and investments is the clearest way of communicating their transition journey to investors and avoiding claims of greenwashing.