Investors face a challenge when looking for sustainable investing strategies. There is no one global standard for ESG data. Companies can follow several different reporting frameworks to provide details on their ESG-related risks, and multiple data providers offer their own way of analysing those disclosures to assess a company’s sustainability.
That is why it is critical for investors to look closely at the methodology asset managers use to construct sustainable investing portfolios. FlexShares ETFs is part of Northern Trust Asset Management, which has seen how the ESG reporting and data landscape has evolved over the 30 years we have been managing sustainable investing strategies. Based on that experience, we believe investors should focus on these relevant and financially material considerations when assessing how well a strategy’s methodology evaluates sustainability risks and opportunities.
Leading disclosure frameworks for risk assessment
There are key differences among the reporting frameworks that companies use to measure and disclose their ESG related risks and impacts. Some do not cover all three pillars of environmental, social and governance. Others provide universal guidelines that apply to all companies and are aimed at a broader base of potential stakeholders, including regulators and customers.
We believe investors should focus on the specific sustainability issues most likely to affect a company’s financial or operating performance. For that information, the Sustainable Account Standards Board (SASB) standards provide a proven, reliable framework.
Standards that enable comparisons across industries
SASB has produced the most thorough assessment of industry specific material ESG issues. This approach is critical because the risks that are most important to an energy company, for example, can differ significantly from the risks that are most important to a retail or technology company.
This approach allows asset managers to make better comparisons between companies within each industry, identifying potential sustainability leaders. It’s also becoming a global standard: In 2022, the International Sustainability Standards Board adopted SASB’s standards into its efforts to codify a new, global framework for reporting industry-specific material sustainability issues.
A forward-looking framework
Another persistent challenge with ESG reporting is that much of the information is historical. But investors are just as concerned about how sustainability issues may affect a company’s future performance.
The reporting framework provided by the Task Force on Climate-Related Financial Disclosures (TCFD) helps provide a forward-looking assessment of how companies are managing their material sustainability risks, and guidelines for the type of information companies should disclose relative to their climaterelated financial risks. Its disclosure recommendations are organised around four key elements:
Governance – the company’s governance around climate-related risks and opportunities.
Strategy – the potential impacts of climate-related risks and opportunities on company’s businesses, strategy and financial planning.
Risk management – how the organisation identifies, assesses and manages climaterelated risks.
Metrics and targets – the numbers companies use to assess and manage relevant climate-related risks and opportunities.
The power of combining frameworks
While each of these leading frameworks delivers valuable insights, combining them offers investors a more complete look at a company’s sustainability risks and opportunities. That is why FlexShares ETFs uses both frameworks in our proprietary sustainability scoring methodology called the Northern Trust ESG Scoring Methodology.
This approach starts with SASB standards to tell us what material sustainability risks to focus on for a company based on its industry. Then, we’ve adapted the core elements of the TCFD framework to cover all of a company’s ESG-related issues (not just climate-related risks) to assess how the company’s sustainability risks may affect future performance.
For example, two companies in the carbon-intensive cement industry may have similar sustainability risks. But if one of those companies has quantified its carbon footprint, set specific carbon reduction goals and submitted those goals to a qualified third-party like the Carbon Disclosure Project, we would assign that company a higher score on the Northern Trust ESG Scoring Methodology.
Choosing the right data to analyse
Any sustainable investing methodology needs good ESG data to produce accurate comparisons between companies. The data provider that we believe offers the best information on a company’s climate profile currently available to ESG investors is Institutional Shareholder Services (ISS).
ISS has been collecting ESG-related company data for more than a decade. Its leadership position in the sustainable investing space means that we now have standardised, comparable data on important issues such as the full scope of a company’s carbon emissions.
However, we realise that the growth of sustainable investing will compel companies to report even more ESG data. Investors should look for sustainable strategies that can accommodate new data sources and integrate more detailed information in their portfolio construction process. FlexShares’ strategies are already positioned to capitalise on the increasing availability of ESG data. The Northern Trust ESG Scoring Methodology uses an open data architecture, meaning that our ETFs can easily incorporate new data sources that emerge if they offer even better ways to compare companies.
The importance of a strong, scalable methodology
Investors are rightfully demanding more transparency into how investment strategies intend to deliver on their sustainability goals and financial objectives. We believe that looking for strategies that use a clearly defined sustainable investing methodology based on complementary reporting frameworks and reliable data sources can give investors more confidence in the sustainable strategies they choose.
Find out more about FlexShares and our ETFs: https://go.flexshares.com/en/sustainablefunds
This article first appeared in ESG Unlocked: Europe out in front, an ESG report. To access the full report, click here.
Please refer to the prospectus and to the KIID before making any final investment decisions. This information does not constitute a recommendation for any investment strategy or product described herein. This information is not intended as investment advice and does not take into account an investor’s individual circumstances. Investing involves risk – no investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Northern Trust Asset Management (NTAM) is composed of Northern Trust Investments, Inc. (NTI), Northern Trust Global Investments Limited (NTGIL), Northern Trust Fund Managers (Ireland) Limited (NTFMIL), Northern Trust Global Investments Japan, K.K. (NTKK), NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Belvedere Advisors LLC, Northern Trust Asset Management Australia Pty Ltd and investment personnel of The Northern Trust Company of Hong Kong Limited (TNTCHK) and The Northern Trust Company (TNTC).© 2022 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Issued in the United Kingdom by Northern Trust Global Investments Limited. Issued in the EEA by Northern Trust Fund Managers (Ireland) Limited.