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Why is ESG so difficult in practice? Understanding the challenges of ESG disclosure

Why is ESG so difficult in practice? Understanding the challenges of ESG disclosure

By SMU City Perspectives team

Published 13 January, 2023


“One will have information only when you have data, and then you will know who is accountable. From there, you can set a target and start to take action.”  

Cheng Qiang

Dean, School of Accountancy; Lee Kong Chian Chair Professor of Accounting

In brief

  • While Environmental, Social and Governance (ESG) reporting has emerged as a tangible way for organisations to communicate their sustainability efforts to investors, the practice of ESG disclosure comes with many challenges.
  • Companies have the difficult task of deriving insights from unstructured data, and the current lack of standards means that the information that is voluntarily disclosed is often incomplete. ESG data providers play an important role for the time being but face the same challenges. 
  • Nevertheless, the future of ESG remains bright as unified reporting frameworks and technological developments in the near future will allow for more consistent and higher quality ESG reporting.   

Climate change concerns, social activism and demands for transparency have pushed businesses to build sustainability and accountability into their DNA, either retrospectively or from the onset. Within the business and financial sectors, Environmental, Social and Governance (ESG) reporting has emerged as a tangible way for organisations to communicate their efforts, and attract investors who are committed to sustainable financing. In 2021, the ESG sector achieved a major milestone when the International Sustainability Standards Board (ISSB) was established to create a global baseline of sustainability-related disclosure standards. Other signs of progress include the introduction of mandatory ESG requirements for certain types of companies, by countries like Singapore and the United Kingdom.  

However, even while headway is being made on a macro level, the practice of ESG reporting remains a challenging one. Professor Cheng Qiang, Dean of SMU School of Accountancy shares, “At this point, ESG disclosure is quite messy. Different governments and exchanges have different requirements and there are no unified reporting frameworks at present”. This has led to gaps in the process, which affect the quantity and quality of information investors are seeking.  

He highlights three key challenges in the practice of ESG disclosure today:

1. The challenge of unstructured data 

Unlike financial reports which come down to dollars and cents, much of the information in ESG reports cannot be easily calculated or quantified. Both structured and unstructured data play a critical role, even if it only leads to estimates and subjective evaluations. While a manufacturing company is generally able to use structured data to calculate their carbon emissions, an insurance company might have to turn to unstructured data (e.g., images) to estimate the level of damage caused by a flood. Companies might also turn to alternative sources like social media to assess the level of union support among its workers. 

Prof Cheng explains the two challenges of using unstructured data. The first one is that the evaluation or the ability to glean information or insights from unstructured data requires judgment. He says, “Looking at the same picture, two individuals might have varying opinions or perspectives”. The second challenge is in linking unstructured data to a quantifiable figure such as a dollar amount. This is something that is heavily dependent on past experiences, for example the financial, social and biodiversity impact of a similar wildfire in a particular area. He adds, “people can agree on the risk, but disagree on the magnitude of the risk, leading to contention between parties such as managers and auditors”. 

2. The challenges of voluntary and mandatory disclosure 

Within the ESG space, the debate over ‘voluntary versus mandatory disclosure’ continues to be discussed. While mandatory disclosure might seem beneficial from an investor’s point of view, Prof Cheng highlights three types of costs that come with ESG reporting that need to be taken into consideration. The first is the preparation cost. This is the time taken to collect the data needed or the service fee for a third party to do the necessary work. The second is the proprietary cost, which is the information that a competitor can make use of for its own advantage. Finally, there are the litigation costs that can occur when more individuals become aware of company practices. While large companies might have the resources to absorb such costs, the same cannot be said for small-medium enterprises (SMEs). 

Voluntary disclosure, on the other hand, gives firms the option to act within their means. However, it also allows them to be selective with the information that is revealed. This might result in an incomplete picture where, for example, only positive ESG information is shared while negative information is kept from view. Prof Cheng shares that biased practices like this will result in reporting divergence across companies, making it difficult to evaluate one company’s ESG performance against another.  

While the ISSB is attempting to fix this problem through its proposed standards, it comes with its own limitations. Prof Cheng says “the mentality of standard setters like the ISSB is to get companies to provide information, and then let the investors make their own judgement call. For example, it might require companies to disclose their carbon emission number. But what ISSB is not requiring companies to do, is to tell investors how bad the situation is. A company might disclose five million tonnes of carbon dioxide, but is that number good or bad?” Ultimately, investors still need to make their own judgement calls based on their knowledge of the topic and personal values. 

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3. The limitations of third-party data providers 

Recent years have seen an influx of ESG data and rating providers who are attempting to plug the gap by providing investors with ESG information about specific companies. Prof Cheng says, “ESG data providers do an important job because investors don’t have other means to aggregate information to evaluate a company’s ESG performance. But at the same time, they are still businesses with their own incentives”.  

ESG data providers might feel the need to tread lightly in order to gather information from these companies on an ongoing basis. Furthermore, they too are subject to the same limitations that come with unstructured data and other difficulties in measuring ESG metrics.  He says “the limited sets of information will definitely reduce the value of the ESG ratings, and what’s worse is that different providers might have different sets of information. Even when they have the same information, they might make a different judgement”. For this reason, he encourages investors to engage multiple ESG rating providers to assess a company’s ESG performance, instead of depending on just one.  

The future of ESG 

At the 27th Conference of the Parties to the United Nations Framework Convention on Climate Change (COP 27) in November 2022, the ISSB announced its five-year timeline for the implementation of its standards. Prof Cheng shares, “ISSB’s initiatives to involve many partners to build the capacity and to get buy-in from many jurisdictions and its ambition to have quality adoption of the ISSB’s ESG disclosure standards are commendable. These also highlight the urgency of the need for climate-related disclosures.”  He is optimistic that present-day challenges in ESG disclosure can soon be overcome, especially as standard setters and governments work on the standards for ESG reporting, and technological advancements open new possibilities for gleaning quality ESG insights for companies, investors and other stakeholders.  

Methodology & References
  • Alberti, A. (Nov 2022). COP27: ISSB advances global climate disclosure baseline mission with fresh partnerships. Accountancy Age. Retrieved from: {https://www.accountancyage.com/2022/11/09/cop27-issb-advances-global-climate-disclosure-baseline-mission-with-fresh-partnerships/} 
  • Hanna, K & Stedman, C. unstructured data. Tech Target. Retrieved from {https://www.techtarget.com/searchbusinessanalytics/definition/unstructured-data} 
  • Alipio, O. (Apr 2022). Navigating through SGX's ESG Disclosure Requirements. Azeus Convene. Retrieved from: {https://www.azeusconvene.com/esg/articles/navigating-through-sgxs-esg-disclosure-requirements#:~:text=Climate%2DRelated%20Disclosures&text=Climate%20reporting%20will%20be%20mandatory,reporting%20mandated%20by%20FY%202024} 
  • Countries affected by mandatory ESG reporting – here’s the list. World Favor. Retrieved from: {https://blog.worldfavor.com/countries-affected-by-mandatory-esg-reporting-here-is-the-list#:~:text=Certain%20large%20co}