According to EY’s Global Corporate Reporting 2021 survey, 76% of the world’s leading financial players support the need for consistent global environmental, social and governance (ESG) standards. Stephan Wolf explains why ensuring a holistic mechanism for identifying companies through a global standard – such as the Legal Entity Identifier (LEI) – is a fundamental step towards consistent, compatible and transparent ESG reporting and data sharing.
ESG data and reports are a useful tool for companies to increase transparency on resource dependence, operational efficiency, social and environmental sustainability. As a result, many stakeholders around the world use ESG data to inform key strategic business decisions. For example, investors seek to assess the sustainability performance of companies in which they invest, and financial institutions may need to consider whether they are eligible for sustainability-related financing initiatives. The use cases for ESG data are numerous and diverse.
Standardized identification of companies: A critical need in ESG reporting
However, a key problem with ESG reporting, data collection and sharing is the lack of standardization in identifying companies. This makes it difficult to find, compare and use ESG data globally, leading to a lack of transparency and inefficiency. Without machine-readable, interoperable and globally relevant data, ESG reports lose their value as a means of assessing performance indicators and promoting sustainable investment, as it is impossible to understand a company’s overall activities without a clear and standardized system for identifying companies. There are countless national and regional standards for identifying companies around the world, and while different identifications serve national needs, they can lead to significant conflicts and inefficiencies when matching data across geographical boundaries.
Research conducted by GLEIF and the Data Foundation shows that the US federal government alone uses 50 different and incompatible business identification systems. Magnify this fragmentation and consider the amount of different identifiers around the world, and the challenges are easy to understand. ESG data users have to match names and deal with different standards for translation, transliteration and abbreviations – and all of this can be costly, time-consuming and error-prone. Consider how easy it would be for an investor to get a clear view of a company’s ownership or governance structure if it were, say, a multinational company with subsidiaries around the world, each filling out regulatory filings in different formats. I would say it is not that easy.
Furthermore, the lack of globally binding standards for company identification and reporting can lead to greenwashing and other misleading practices such as asset misallocation. It can also lead to reported information becoming unusable. For example, a large multinational corporation might be required to submit information on its supplier network. Without a uniform, global identification scheme for the supplier network, authorities would be limited in their ability to conduct even the most basic analysis.
How the LEI can help
The LEI, on the other hand, avoids the negative effects of an isolated approach by responding to the urgent need for a universal system to identify companies across markets, products and regions. It is machine-readable and relevant across borders – thanks to its use in over 200 jurisdictions – and is a powerful tool for those examining a company’s global strategies, assets, corporate structure and values. Thanks to the 360-degree view that an LEI provides, companies cannot hide their greenwashing activities through subsidiaries.
As an international standard and a code that links companies to key reference information, including ownership structure – easily accessible online through the global LEI index – the LEI solves cross-border data matching problems and promotes an interoperable identity standard. It is also a data connector that enables the analysis of corporate information across multiple data sources describing a legal entity and other associated identifiers such as the Business Identification Number Code (BIC) and the International Securities Identification Number (ISIN). The LEI as a connector enables stakeholders such as investors and financial institutions to access more comprehensive data about the company.
All these features position the LEI perfectly to provide some critical but missing components of a robust, efficient and effective global ESG disclosure and reporting framework – transparency, consistency and compatibility.
And the LEI can further enhance trust in ESG reporting when embedded in the digital certificate used to sign a report and/or in the digital signatures of its signatories. This is a capability that GLEIF has demonstrated many times in recent years and in the publication of GLEIF’s 2020 Annual Report.
Growing support for LEI in non-financial reporting: an important step forward
In the second quarter of 2021, the Sustainability Accounting Standards Board (SASB) published its standard XBRL taxonomy for entities reporting under the European Single Electronic Format (ESEF) reporting guidelines, an encouraging development. This included the recommendation to use the Legal Entity Identifier (LEI) in its XBRL taxonomy – although the taxonomy remains identifier agnostic overall. The recommendation to use the LEI in XBRL reporting, while not binding, is an extremely important step towards standardization and compatibility of global ESG reporting. The use of the LEI in XBRL reports will improve machine readability as well as the comparability and usability of the data collected. It also provides a digital solution for tagging corporate information at the global level, helping to build a smooth and efficient value chain for ESG taxonomy.
Other regulators have also already recognized the value of the LEI for non-financial reporting. For example, in its response to the European Commission’s public consultations on the renewed Sustainable Finance Strategy and the revision of the Non-Financial Reporting Directive, the Eurosystem highlighted the importance of the LEI for linking financial and non-financial information and other data sources. The Eurosystem also stressed that the LEI would enable innovation in the digital age, thereby fostering potential growth in new markets and reducing costs and operational risks for reporting entities.
In light of existing support for the LEI, GLEIF suggests that the LEI can also help streamline data collection, aggregation and analysis of ESG risks for private, unlisted companies, which are less systematically collected compared to listed companies. Including the LEI in the due diligence checklist of ESG rating and data product providers can help assess the information and identify inconsistencies at the pre-validation stage and help investors in their investment decisions.
In conclusion, GLEIF suggests that the current challenges in accessing reliable, comparable and relevant data that informs sustainable risks, opportunities and impacts can be greatly reduced by ensuring that the collection and transmission of ESG data begins with the mandatory unique and unambiguous identification of legal entities through the LEI. This is the first fundamental step towards a uniform, comparable and transparent ESG reporting and data exchange system that is interoperable worldwide.