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Ideological shifts in business demand effective ESG reporting

Climate change, biodiversity, customer relations, supply chains, board management practices, data, and security…these all fall under the ESG heading.

Environmental, Social, and Governance (ESG) have become the language of capital markets, expanding market value by maintaining value for future generations.

As such, today we’ve seen a pivotal moment where the growth in ESG investments has seen an all-time high. For instance, according to a recent survey by the CFA Institute, ESG-linked loans to companies in Europe have more than quadrupled – from ~$28.5 billion in 2017, to $108 billion in 2019.

On top of this, another report by the Global Investment Sustainable Alliance stated that sustainable investments have risen by 15% from 2018 to 2020 (reaching $35 trillion).

This increase in investor attention comes alongside an ideological shift in business, whereby sustainability and citizenship are no longer seen as philanthropic activities, but rather, they are seen to be key aspects of a successful business. As such, they require effective governance to mitigate external business risk.

With this ideological shift, and as the demand for ESG investments rises, business leaders must sit up, take note, and effectively respond using ESG reporting.

With this in mind, the Green Business Bureau will be creating a series of articles focused on ESG reporting. In this series we will explain:

  1. What ESG reporting is
  2. Why ESG reporting is important
  3. How ESG reporting differs from sustainability reporting
  4. ESG reporting requirements, standards, and frameworks
  5. How to get started with ESG reporting (guide)

As the title suggests, this first article details what ESG reporting is, and why ESG reporting is essential for long-term business success.

What is ESG reporting?

ESG reporting is the disclosure of data covering business operations related to the environmental, social, and governance aspects of a business.

By disclosing this information in a report, a company’s progress related to these three fields can be examined against benchmarks and targets. Once more, an ESG report is designed to provide full transparency over an organization’s environmental, social, and governance impact across a multitude of stakeholders, including investors, employees, and customers.

What is ESG risk?

Think of ESG reporting as a form of risk management addressing business, sustainability, and social issues. Examples of ESG-related risks include:

  • Environmental: Climate change, greenhouse gas emissions (GHG), deforestation, biodiversity, waster, waste, and pollution.
  • Social: Customer relations, employee relations, labor, employee wellbeing, community relations, health and safety, supply chains, human rights, and work-life balance.
  • Governance: Board management practices, succession planning, equity and inclusion, diversity, compensation, regulatory compliance, fraud, data, security, and corruption.

These ESG risks are stated to cause material, financial and reputational harm to a business. Failing to report and manage ESG-related issues is risky business that could resort to a ESG-related incident or controversy.

Understanding the ESG concept: Why is ESG important?

As mentioned, ESG reporting is a form of risk management to address business risks across three areas: The environment, society, and governance.

To fully understand the importance of ESG reporting, you must first understand the importance of ESG in a general sense.

ESG gained significant world attention following the publication of the report Who Cares Wins: Connecting Financial Markets to a Changing World.

This report saw its roots in Socially Responsible Investing (SRI), dating back several decades. Evolving from SRI, in 2004, UN Secretary Kofi Annan asked major financial institutions to partner with the UN and the International Finance Corporation. The aim of this partnership was to identify ways to integrate environmental, social, and governance concerns into capital markets. The resulting Who Cares Wins report was published, outlining the concept of ESG and showcasing how ESG investments made good business sense.

Since the publication of the Who Cares Wins report, there’s been a clear pivot in capital markets that environmental issues and social issues directly impact an organization’s bottom line. As such, an effective governance structure is what’s needed to understand, manage and communicate the strategy to protect a business from these downside risks.

Research shows that companies experiencing high to severe ESG incidents lost, on average, ~6% of their market capitalization. Yet, note that this is an average figure. Losses can be far greater, as experienced by the pharmaceutical company Bausch Health (formerly known as Valeant).

Valeant Pharmaceuticals misled investors by improperly accounting for revenue from mail orders. Plus the company was found guilty of aggressive price hikes for a single diabetes drug.

This governance failure led to the company losing 90% of their market value. The company also faced penalties and settlement claims, forking out $45 million to clear U.S. charges.

Had Valeant Pharmaceuticals followed a proper ESG strategy with clear ESG reporting, they would have avoided such controversy. They would have also been better able to respond to the incidents that occurred.

Why is ESG reporting important?

ESG reporting is the documentation side of ESG. In this next section we consider the benefits of this.

ESG reporting creates transparency

Understanding the importance of ESG reporting requires a mindset shift, one that doesn’t consider ESG regulation as a burden, but looks at reporting as a means for transparency. And transparency is a tool to unlock capital and create solutions for the major global challenges organizations face today (e.g. climate change, equality, and data security).

Transparency encourages accountability, and both are essential for collaboration and developing actionable solutions. Plus organizations can track progress, set benchmarks, and communicate when their ESG goals have been met.

ESG reporting attracts investors and financing

Increasingly, investors and lenders will use the transparency given by an ESG report to assess a firm’s risk exposure and determine their possible future financial performance.

To demonstrate this investor shift, we turn to the reports published by the Principles for Responsible Investment (PRI). The PRI is a group of investor signatories that began in 2006, supported by the United Nations. The aim was to aid investors in integrating ESG factors into the investment process, and so the PRI established a set of specific, voluntary, and aspirational principles for investors to follow.

As investor interest in ESG rises, the number of signatories of the PRI follows suit. According to the PRI, in 2006 the organization had 63 signatories commanding $6.5 trillion in assets under management (AUM). In 2021, this figure increased to 3826 signatures, controlling $121.3 trillion in AUM.

In addition, the Deloitte Center for Financial Services expects ESG-mandated assets in the United States to account for 50% of all professionally managed investments by 2025.

In summary, investors avoid companies that lack ESG reporting, with reduced transparency being a major concern.

ESG reporting meets stakeholder demand

Yet it’s not just investors that demand greater transparency when it comes to environmental and social concerns in business. Consumers are also demanding responsible brands. For instance, a survey from First Insight found that customers, particularly Gen Z, are more willing to support brands with an effective ESG strategy.

62% of Gen Z would prefer to buy from a sustainable brand, and 73% of them are willing to spend up to 10% more for a more sustainable product/service.

And we have a similar scenario when it comes to the employee. First Insight found that 76% of millennials consider the sustainability agenda of an employer before making their career choices. As such, reporting ESG will boost an organization’s chances of attracting new talent.

ESG reporting responds to regulation change

Regulatory forces are also applying pressure on companies to produce ESG reports. Proactive and future-focused brands will understand the importance of meeting ESG criteria to respond to the changing business landscape.

As such, it comes with little surprise to learn that 92% of companies in the S&P 500, and 70% of the Russell 1000 companies have already published their annual ESG reports.

Current regulations and policies are leaning towards mandatory reporting on ESG. And the European Green Agreement seems the most ambitious of these new regulations.

Between 2000 and 2017, the European Corporate Governance Institution (ECGI) study identified 25 countries that had introduced mandates for firms to disclose ESG information.

Countries included are Australia, China, South Africa, and the United Kingdom. Yet, to date, these mandatory regulations only apply to state-owned companies, large corporations, and listed companies.

And the trend points toward the likelihood that more companies will be obliged to publish sustainability information. For instance, in March 2022, the Securities and Exchange Commission disclosed a new climate disclosure proposal. This now represents the broadest federally mandated corporate ESG data disclosure ever required in the US. The aim is to address climate-related risks and improve reporting consistency, quality, and comparability.

Using ESG reporting to devise an effective ESG strategy

Companies need to set clear targets to reduce environmental, social, and governance risks. And to then measure their progress and report in a transparent manner.

It’s clear that businesses across the globe have advanced, from simply asking customers to recycle their plastic containers to embedding sustainability into the core of their business. This means creating sustainable practices and processes, developing ethical products, and leading a business strategy developed from a clear ESG strategy.

A good example of a business that’s done this right is Patagonia. Patagonia operates with a very strong ESG score. This is because ESG values have been effectively embedded into the core of Patagonia’s business model.

For instance, the company urges conscious consumption from its consumers. E.g. Instead of constantly pushing sales, Patagonia offers repair services, and markets against fast fashion encouraging minimalism. As of 2020, the company still generated a gross profit of $6.6 million.

To devise an effective ESG strategy, like Patagonia, organizations need to:

  • Action item 1: Use ESG reporting for transparency and accountability, to set benchmarks and targets, and to communicate ESG-related achievements.
  • Action item 2: Set actionable initiatives that will support ESG compliance and an organization’s ESG strategy.

Thinking about action item 1, understanding ESG reporting – how to produce an ESG report is the foundation of your ESG strategy. As such, the Green Business Bureau will be producing a set of articles to build on this piece and help you produce an effective ESG report.

Moving onto action item 2, you can use the Green Business Bureau to set actionable initiatives to meet ESG demands, and again support your ESG strategy.

Use the Green Business Bureau to support your ESG strategy

Your ESG strategy is all about meeting the environmental, social, and governance demands on a business.

You can use your ESG reporting to track your progress and set targets, but it can be difficult to translate these targets into actionable solutions. And this is where the Green Business Bureau can help.

Think of the Green Business Bureau as an online database of sustainable initiatives. On signing up, organizations can access GBB’s EcoAssessment and EcoPlanner where they can choose sustainable solutions to support their ESG strategy and targets.

As such, the GBBs platform keeps track of where a company is at supporting the reporting process while also executing real sustainable change.

Many initiatives focus on creating a green culture, mission, and values to embed sustainability into the core of an organization. From here, it’s easier for businesses to progress toward their ESG-related goals.

Businesses are awarded a Green Seal of Approval once they’ve completed their EcoAssessment, which will ultimately support ESG compliance.

You can sign up for the Green Business Bureau here to create sustainable operations and devise an effective ESG strategy.

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