All around us is the drive to net zero.
There is no doubt this is of fundamental importance. However, the net-zero transition probably represents the largest and most challenging navigational journey since the industrial revolution. Greenhouse gas emissions (GHG) are, in particular, underpinning net-zero strategies and used to inform transition planning.
The scarcity of quality GHG data means we are flying in the dark.
Assets will soon – if not already – face increased policy and market interventions to drive decarbonisation across the economy, whether that is more stringent regulation of operational emissions, increased costs under the EU Emissions Trading System (the costs of carbon permits rose more than 150 percent in 2021), or potential future carbon taxes.
Without understanding the source and materiality of emissions, businesses will be unable to identify least-cost carbon mitigation strategies or make informed capital planning decisions.
Many firms will have been asked to provide or request GHG data. But how often is it questioned or confirmed that:
- An appropriate methodology is adopted, such as the Greenhouse Gas Protocol, together with other sector-specific guidance?
- The person completing the GHG reporting is appropriately qualified. Unlike financial accounting, which benefits from readily recognisable qualifications/designation, such as chartered accountant, there are no widely held GHG accounting qualifications. One of the nearest common designations would be chartered environmentalist, although this expertise can range from net zero and GHG accounting, to management of groundwater pollution.
- The data has been third-party reviewed/assured, or certified (ISO 14064 covers carbon footprint validation and verification).
In many cases this detail is lacking in the reporting and exchange of GHG data.
The infra challenge
The infrastructure sector presents its own set of challenges, particularly in the unlisted and small- and mid-cap segment. Infrastructure portfolios can span multiple sectors, with each asset presenting different materiality profiles of sustainability risk. In turn, this often requires bespoke approaches which can limit the ability to leverage learnings and expertise across a portfolio. It is also worth noting that assets may not have previously been required to report on the breadth of data being requested, and that management teams and resources available may be relatively small. This can lead to unqualified team members responding to sustainability data requests (particularly GHG data), often with unsatisfactory outcomes.
Ultimately, however, change is coming. There are drivers in place that will require a shift in the quality of sustainability data.
Continuing with GHG emissions as the example, the Net Zero Asset Owners Alliance and Net Zero Asset Managers Initiative collectively represent 347 signatories and over $70 trillion in assets under management. This is a significant segment of the market which will need to publicly demonstrate verifiable progress on decarbonisation. Quality data is fundamental to this, and as interim target deadlines approach (2030 at the latest), the level of data scrutiny will increase.
A second driver is regulation. Although currently this largely originates from the EU, the global impact of this regulation (whose scope also covers non-EU Financial Market Participants marketing products into the EU) should not be understated. The most pertinent of these regulations are:
- Sustainable Finance Disclosure Regulation, which requires public disclosure of Principal Adverse Impacts. These are sustainability indicators, including GHG emissions, that are reported annually, alongside historical comparisons. The definitions, methodology and historical comparison requirement will focus attention on data accuracy (rather than later explaining erratic data trends). The first set of such data reporting is due by 30 June 2023.
- The Corporate Sustainability Reporting Directive, which requires reporting across a range of sustainability topics and, for the first time, introduces an EU-wide audit requirement for reported sustainability information. The stated objective is to “have a similar level of assurance for financial and sustainability reporting”. Although, a “progressive approach” is needed, this is likely to initiate a paradigm shift in aligning quality expectations of ‘sustainability data’ with those for financial data.
The industry may not be facing data meltdown, but there will be growing pains as the focus increasingly shifts from data to quality data.
At Arjun we regularly speak with investors and peers on how best to support portfolio companies in responding to this change. Asset managers and owners face a balancing act; striving for better data coverage and reporting is key, but this should not be at the expense of data accuracy.
Amid a broader market concern of greenwashing, investors should be transparent about the inherent sustainability data quality challenges and equally, not overly penalised for reporting less-than-perfect data.
Investors also need to be aware that credibly establishing this reporting ability at asset-level will require time, capacity building and a clear commitment by boards/executive management teams.
Early planning and preparation will be key to providing the best data possible and highlighting any limitations clearly.
The ESG data challenge is likely to accelerate in 2023.
Rhyadd Keaney-Watkins is head of ESG at Arjun Infrastructure Partners.