TAIPEI (Taiwan News) — We recently discussed how Taiwan’s listed companies are progressing with their Environmental, Social and Governance (ESG) reports based on the Taiwan Stock Exchange (TWSE) ESG reporting mandate for listed companies on both the TWSE and the Taipei Exchange (TPEx) announced in June 2022.
This reporting mandate has made many companies seek assistance in collating and preparing their ESG reports. This means that Taiwan’s listed companies are becoming reliant on third party rating agencies to help them evaluate not only their performance but the performance of all companies or entities in their supply chain.
No one ever said that ESG reporting would be easy.
With increasing reliance by reporting companies on rating agencies, it is timely then to put those same rating agencies under the microscope. At the extreme “end” of the microscope are the ESG pundits who are already calling for regulation of the rating agencies, but there has been no evidence, to date, of that in Taiwan.
It is important to understand that, as Taiwanese investors begin to evaluate the ESG reports of listed companies, these same investors, be they retail, corporate or from the asset management industry, are also becoming reliant on the work of the ESG rating agencies.
Investor demands for ESG reports can be quite varied depending on the nature of their investment profiles. However, they will also be wanting and demanding an easily interpreted and thorough report.
E, S and G
Typically, the rating agency reports should cover, at their most basic, an overall ESG score and a breakdown into the E,S and G aspects of that score. Effective rating agencies will also provide clear details on how the rated company scores against the U.N.’s Sustainable Development goals and will highlight any concerns with the supply chain.
For example, if a company within the supply chain scores poorly because of the production of dual-use goods, then this must be highlighted and understood. Rating agencies have an obligation to provide their customers — and ultimately the investors — with this transparency.
Rating agencies must also be able to identify “greenwashing” either by their own client or by part of the client’s supply chain. Failure to do so again fails the client and the investors.
Some rating agencies may even be able to inform investors about how the reporting company treats their employees and the practical steps that the reporting company takes to create positive value for society. These are value-added services but may be of some interest to investors.
However, even ESG rating agencies must be practical in terms of the reports they provide, as each report often covers diverse and intangible issues. Also, it obviously takes time and considerable professional expertise.
There are some issues that rating agencies need to address now, before they become major issues. Conflict of interest is one such issue. This is where the rating agency provides ESG reports to the company or investors but is at the same time advising the reporting company on how to improve their rating or report.
Investor expectations
This is basically benefitting from both sides of the equation and should not occur. This type of activity is one which attracts calls for regulation.
Rating agencies use different methods to create an ESG score for the rated company. This is not surprising as the technology used by rating agencies will typically differ, but the very existence of different scores can create confusion.
However, provided the differential in the scores is not fundamentally unreasonable, it could simply be likened to different prices for the same goods at different stores. It really depends on investor expectations, but it also does rely on rating agencies ensuring their systems are up to date and always providing, defendable, and dependable scores.
The solution to the score differential can also be greater transparency about what the investors want, what the rated company expects and a clear understanding of the methodology used by any given rating agency to produce the scores.
Standardization of the rating methodology is unlikely to be the answer and, without rigid regulation, it would be impossible to impose. Nor would it benefit the ESG reporting market at this stage of its development.
At this early stage, it is important to ensure a competitive market inclusive of foreign service providers. It is possible that some core metrics can be identified, and rating agencies could be encouraged to adopt these metrics.
This would give all parties some assurance but still allow the market to find its preferred future course.
If Taiwan’s regulators have concerns, then they should create mechanisms for these concerns to be flagged. The regulators can, instead of rigid regulation, at this stage, adopt risk-based approach guidelines that will provide an open and fair ESG reporting industry.
ESG reporting is in its infancy in Taiwan. Let us watch it grow.