Why incompatible reporting leads to greenwashing/misleading practices

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According to EY’s 2021 Global Corporate Reporting Survey, 76% of the world’s major finance leaders back the need for globally consistent environmental, social and governance (ESG) standards. Stephan Wolf explains why ensuring a holistic entity identification mechanism through a global standard – such as the Legal Entity Identifier (LEI) – is a foundational step towards consistent, compatible and transparent ESG reporting and data exchanges

ESG data and reporting offers companies a useful tool for increasing transparency around issues of resource dependency, operational efficiency, and social and environmental sustainability and consequently many stakeholders globally use ESG data output as the foundation for critical strategic business decisions. Investors, for example, seek to assess the sustainability track record of companies in which they invest; and financial institutions may need to check eligibility for sustainability-linked finance initiatives. ESG data use cases are many and varied.

 

Standardized entity identification: A critical need in ESG reporting

 Yet a key challenge in ESG reporting, data collection and data exchanges today is the lack of standardization for entity identification. This makes it difficult to find, compare and consume ESG data globally – leading to a lack of transparency and inefficiencies. Without machine readable, interoperable, and globally relevant data, ESG reports lose value as a means of evaluating performance indicators and promoting sustainable investment, since without a clear and standardized entity identification system, it is impossible to understand a company’s overall activities. There are innumerable national and regional standards for entity identification across the world and while different identifiers serve national needs, they can create significant conflicts and inefficiencies when reconciling data across geographical borders.

Research conducted by GLEIF and the Data Foundation, indicates that the U.S. federal government alone uses 50 distinct and incompatible entity identification systems. When this fragmentation is amplified, taking into account the volume of different identifiers globally, it is easy to understand the challenges. Users of ESG data will need to engage in name matching and dealing in differences in standards for translation, transliteration and abbreviation – and all of that that can be costly, time consuming and prone to error. Let’s consider how easy it would be for an investor to obtain a clear view of a corporation’s ownership structure or governance framework in the case, for example, of a multinational company with subsidiaries across the globe, each completing regulatory filings in different formats. I would say, not very easy at all.

Furthermore, the lack of globally mandated standards in entity identification and reporting can create opportunity for greenwashing and other misleading practices such as the misallocation of assets. It can also render reported information useless. So, for example, a large multi-national corporate could be requested to provide information on its supplier network. Without a consistent, global identification scheme for the supplier network, authorities’ abilities to do even the most basic analysis would be limited.

 

How the LEI can help

 The LEI on the other hand avoids the negative impact of a siloed approach by responding to the critical need for a universal system of identifying entities across markets, products and regions. Machine readable and relevant across borders – thanks to its utilization in over 200 jurisdictions – it is a powerful tool for those conducting research on an entity’s global strategies, assets, corporate structure and values. Entities are unable to conceal greenwashing activities via subsidiaries, thanks to the 360-degree view afforded by an LEI.

As an international standard and a code which connects entities to key reference information including ownership structure – which is easily accessed via the online Global LEI Index – the LEI tackles data reconciliation problems across borders and promotes an interoperable identity standard. It is also a data connector that allows analysis of corporate information across multiple data sources describing a legal entity and other mapped identifiers such as the Business Identification Number Code (BIC) and International Securities Identification Number (ISIN). The LEI as a connector permits stakeholders, such as investors and financial institutions, to access richer data regarding the entity.

All of these qualities position the LEI perfectly to deliver some critical yet missing components of a robust, efficient and effective global ESG discovery and reporting framework – transparency, consistency and compatibility.

And the LEI can further instill trust in ESG reporting if it is embedded within the digital certificate signing a report and / or the digital signatures of its signing officers. This capability has been demonstrated by GLEIF on multiple occasions in recent years and in the publication of GLEIF’s 2020 annual report.

 

Growing support for the LEI in non-financial reporting: A significant step forward

 In an encouraging development in Q3 2021, the Sustainability Accounting Standards Board (SASB) released its Standards XBRL Taxonomy for companies which have reporting obligations under the European Single Electronic Format (ESEF) reporting guidelines. This included the recommendation to use the Legal Entity Identifier (LEI) in its XBRL Taxonomy – despite the Taxonomy remaining identifier agnostic overall. While not binding, the recommendation to use the LEI in XBRL reporting is a vitally important step toward bringing standardization and compatibility to global ESG reporting. Use of the LEI in XBRL reports will enhance machine readability as well as the comparability and useability of the collected data. It also provides a digital solution for tagging company information at a global level to help build a smooth and efficient ESG taxonomy value chain.

Other supervisors have also already recognized the LEI’s value in non-financial reporting. For example, the Eurosystem highlighted the importance of the LEI for linking financial and non-financial information and other data sources in its response to the European Commission public consultations on the Renewed Sustainable Finance Strategy and the Non-Financial Reporting Directive review. Eurosystem also emphasized that the LEI would enable digital-age innovation and thus foster potential growth in new markets and reduce costs and operational risks of the reporting entities.

Considering existing support for the LEI, GLEIF suggests that the LEI can also help to streamline data collection, aggregation and analysis of ESG risks for private unlisted companies, where there is less systematic coverage compared to publicly listed companies. Inclusion of the LEI in the due diligence checklist by ESG ratings and data products providers can help to assess the information and screen inconsistencies during the pre-validation phase and contribute to investors, informing their investment decisions.

In conclusion, GLEIF suggests that current challenges in accessing reliable, comparable and relevant data that inform on sustainable risks, opportunities and impacts can be greatly reduced by ensuring that ESG data collection and submission starts with the mandatory unique and unambiguous identification of legal entities by the LEI. This is the first foundational step for a consistent, comparable, and transparent ESG reporting and data exchange system that is globally interoperable.