Pressure mounts as investors look for ESG compliance
ESG compliance lays out the standards and responsibilities of an organization, to meet the environmental, social, and governance (ESG) needs appropriate to a business, which is communicated with ESG reporting.
To be compliant, there’s mounting pressure on businesses to follow robust ESG frameworks and standards. Investor demand is seemingly the most pressing for many businesses when it comes to ESG reporting, pushing for globally recognized requirements.
If you read our previous article “What is ESG Reporting and Why Is It Important?”, you’d know that ESG and sustainability investments are on the rise, with ESG-linked loans quadrupling in Europe from ~$28.5 billion in 2017, to $108 billion in 2019.
Plus, a recent research report by PwC states that ESG funds will make up between 27-42% of Europe’s private market assets by 2025.
Pushing this trend are major institutional investors, which collectively hold more than 20% stakes in S&P 500 companies, such as BlackRock, State Street, and Vanguard. These investors have introduced their own guidelines in support of ESG frameworks and standards, as explained:
- BlackRock: BlackRock has requested that the companies they invest in publish disclosures in line with industry-specific SASB and TCFD frameworks (two popular ESG frameworks which we will discuss later in this article). Such changes come as BlackRock looks to effectively manage ESG risk in their investment portfolio.
- State Street: State Street developed their own evaluation system called the R-Factor score, which is based on the SASB framework. State Street also issued statements that support the TCFD framework.
- Vanguard: Vanguard publicly discusses their support of ESG investments, and the SASB and TCFD ESG frameworks.
With the backing of the big three, it’s never been more important for organizations to follow the appropriate ESG frameworks and standards, to align with the requirements of major investment organizations. The aim is to produce a comprehensive ESG report that offers full transparency to stakeholders regarding an organization’s environmental, social, and governance performance.
ESG trends: Is ESG reporting compulsory?
The Security Exchange Commission (SEC) recognized the impact of climate change on issuers in the 2010 guidance report, but no requirements were stated in the SEC disclosure regime.
Ten years later, the pressure mounts. In 2020, Senator Elizabeth Warren wrote a letter to urge chairman Clayton to consider ESG-proposed requirements. This was followed by Commissioner Allison Herren Lee, who then opposed the SEC’s inaction when it came to providing climate disclosures from issuers.
As a result, the SEC Investor Advisory Committee recommended the SEC update reporting requirements to endorse ESG disclosure.
Building on this, in 2022 the SEC considered a proposal to improve disclosures by certain investment advisers and funds, especially those who claim to take ESG factors into consideration when making their investment decisions. That is, the SEC requires that all public companies disclose information that’s important to investors, which includes ESG-related risks.
This proposal has come due to the sheer number of reporting frameworks, meaning there’s currently a huge range of what a company might disclose or mean in their ESG claims. Addressing this issue, SEC’s proposal will:
- Advice any fund that states to consider ESG factors, to provide investors with evidence of this fact, detailing what ESG factors the fund considers, and the ESG strategies used.
- Detail the criteria and data used to achieve investment goals and strategies, for ESG-focused funds as identified by SEC’s proposal.
- Require an ESG fund to disclose relevant metrics.
ESG requirements and ESG regulations
Yet despite these developments, currently, there’s no mandatory ESG disclosure at the federal level in the U.S, and hence meeting ESG requirements has predominantly been market-led and not enforced by regulation.
Yet, this regulatory environment within the US is likely to change, and change soon. The President Biden administration issued an executive order requiring the federal government to “drive assessment, disclosure, and mitigation of climate pollution and climate-related risks in every sector of our economy.”
Outside of the US, requirements are tightening when it comes to disclosing ESG-related information. E.g. today, any funds sold into and created in Europe have to be classified as ESG or non-ESG.
The U.S. is lagging behind European countries and Canada when it comes to ESG reporting, yet new rules have very recently been proposed by the SEC inferring this will change in the future. The absence of a clear, globally recognized means of reporting ESG can leave many businesses unaware of how to disclose such information.
With this in mind, in the next section of this article, we aim to shine some light on the most common ESG frameworks and standards to help. Keep in mind that there are no requirements (yet) when it comes to reporting ESG information. But by knowing the different options out there, you can choose the most appropriate ESG frameworks and standards for your business.
ESG frameworks and standards: What’s the difference?
Before deciding what ESG frameworks and standards to use, it’s important you understand the difference between these two terms, which we explain below:
- ESG framework: A framework is broad in its scope, giving a set of principles to guide and shape understanding of a certain topic. In this case, we’re referring to ESG. An ESG framework will guide the direction of ESG reporting, but will not provide a methodology for the collection of information, data, or the reporting itself. Frameworks are useful to use alongside ESG standards, or when a well-defined standard does not exist.
- ESG standard: Standards are specific in their focus. They contain detailed criteria explaining what needs to be reported. In the context of ESG, this means standards dictate how information and data are collected, and how a report needs to be produced (what topics and business areas to include). Standards make frameworks more actionable by ensuring comparable, consistent, and reliable disclosure.
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ESG frameworks to guide your ESG program
ESG frameworks can be grouped into three categories, which are:
- Voluntary disclosure frameworks,
- Guidance frameworks,
- Third-party aggregators.
We explain these frameworks in more detail below.
Voluntary disclosure frameworks
Under these frameworks, a company actively discloses its sustainability-related policies, practices, performance data, and information related to ESG criteria. It’s common for these frameworks to take the form of a questionnaire. Below we’ve identified the most popular voluntary disclosure frameworks, explaining each:
- Carbon Disclosure Project (CDP): The CDP asks for voluntary disclosures of non-financial data which includes greenhouse gas emissions (GHGs) and company environmental performance. The CDP framework focuses on water security, forest health and preservation, and an organization’s carbon footprint. Industry peers are used as a benchmark, as companies are scored and ranked publicly. This information is available to the public.
- Global Real Estate Industry Benchmark (GRESB): The GRESB is a framework that’s used for buildings. GRESB asks for voluntary disclosures for building-related ESG data, assets, and real-estate portfolios. Results are publicly available.
- Dow Jones Sustainability Indices (DJSI): The DJSI is another building-specific framework that provides a subscription-based survey of building-related ESG data, assets, and real estate portfolios. Again, results are publicly available.
Guidance frameworks provide recommended methodologies and guidance to help companies identify, manage and report on their ESG performance. Below we’ve identified the most popular guidance frameworks, explaining each:
- Sustainability Accounting Standards Board (SASB): The SASB provides voluntary frameworks that focus on financial substantive information that’s relevant to investors. The aim of the SASB is to provide information to the SEC, which investors can then use to compare business performance on critical ESG issues.
- Global Reporting Initiative (GRI): The GRI voluntary disclosures are broad in their aim. These disclosures address a range of ESG topics that are deemed relevant to the organization and all related management approach components. Reporting principles cover the inclusiveness of stakeholders, sustainability, and integrity. GRI standards are divided into universal, sector, and topic-specific standards that can be applied to companies depending on their industry and impact.
- Task Force on Climate-Related Financial Disclosures (TCFD): TCFD provides voluntary disclosures focused on target-related risks to financial systems. The TCFD was established in the wake of 2015’s COP21, with the aim of developing recommendations for more effective climate-related disclosures. TCFD recommendations are based on four thematic areas, which represent the core operating areas of a business: Governance, strategy, risk management, and metrics and targets. The impact climate change has on a business, plus the impact the business has on the climate, are both considered by TCFD.
- Carbon Disclosure Standards Board (CDSB): This is an initiative of the CDP developed to create a holistic view of a company’s performance – according to an organization’s financial performance and impact on natural capital. The CDSB framework aims to standardize the reporting of environmental information. Collaboration on the most widely shared and tested reporting approaches supports this aim.
- International Integrated Reporting Council (IIRC): The IIRC has been developed to accelerate the adoption of integrated reporting. To this end, the IIRC merged with SASB in 2021, producing the Value Reporting Foundation (VRF). The aim is to create a baseline for corporate sustainability disclosure that can be used around the world.
Third-party aggregators refer to frameworks that assess an organization’s performance based on aggregated, and publicly available data. Data is collected from company-sourced filings, publications, company websites, annual reports, and/or sustainability or CSR reports. Listed below are the main third-party aggregator players.
- Bloomberg Terminal ESG Analysis: Public information displayed in annual and sustainability reports, CSR reports, and websites are aggregated and assessed. Data can only be accessed by those with a subscription.
- Institutional Shareholder Services (ISS E&S) Quality Score (ISS): Sustainability and CSR reports, integrated reports, publicly available company policies, and information are aggregated and assessed. The results from these assessments are publicly available.
- MSCI: MSCI aggregates data from 100+ specialized datasets from governments, NGOs, and models, plus company disclosures which include: Sustainability reports; proxy reports; 10-K reports (which provide a full description of a company’s annual financial activity), and 1,600 media sources. The aim of MSCI is to show a company’s exposure to ESG risks and how it compares to industry competitors. Subscriptions are needed for this data to be accessed.
- Sustainalytics: Sustainalytics aggregates and assesses company data based on public company-sourced findings and media reports.
ESG reporting standards to direct your ESG program
- European Financial Reporting Advisory Group (EFRAG): The EFRAG is made up of two pillars, one focuses on sustainability whereas the other is focused on financial reporting. The EFRAG presented the first set of finalized standards which were released in March 2022. The aim next is to release additional sector-specific standards for small and medium enterprises (SME), by mid-2023. Once finalized, the European Commission will enforce the EFRAG standards in all European countries.
- International Sustainability Standards Board (ISSB): The International Sustainability Standards Board’s (ISSB) goal is to develop a single set of globally recognized accounting disclosure standards to bring transparency to financial markets. This work has involved collaboration between a multitude of different organizations such as the World Economic Forum (WWF). The IFRS Foundation has also signed a collaborative agreement with the GRI to coordinate the activities of both organizations.
On the road to a uniform set of ESG frameworks and standards?
As we’ve mentioned, the problem with ESG reporting is the lack of globally recognized standards and frameworks, making it confusing for business leaders like you to understand how you should be reporting the relevant ESG criteria.
To solve this issue, the four leading ESG framework organizations – GRI, SASB, CDP, CDSB, and the IIRC – are working to change this.
For now, it’s clear that, although the above-mentioned frameworks and standards deal with ESG-related information, the specific focus of each differs, and some are more relevant to certain industries than others. Choosing the right frameworks and standards is therefore business-specific.
It’s also worth mentioning that many standards and frameworks complement each other, and results are optimized when they’re used together. For instance:
- The SASB framework supports the TCFD framework: Best results are obtained when these frameworks are used together.
- The SASB framework supports IIRC: As previously mentioned, the SASB and IIRC announced their intention to merge into a unified organization, named the Value Reporting Foundation (VRF). The VRF’s aim is to provide a suite of resources to help organizations and investors establish enterprise value.
- SASB framework and GRI: SASB and GRI aim to show how organizations can use these standards together for the best results.
Use a sustainability scorecard to track your performance and improve your ESG reporting
Creating an ESG report, regardless of what frameworks or standards you use, demands easy access to the relevant company information. As such, you need a way of keeping track of your organization’s ESG-related initiatives, and a sustainability scorecard can help you do just that.
A sustainability scorecard is an entirely initiative-based tool. Organizations can use the scorecard to record and track implemented sustainability initiatives. Numerical scores are then given to indicate an organization’s performance regarding the social, environmental, and economic aspects of the business.
The Green Business Bureau (GBB) uses a scorecard assessment approach. GBB’s EcoPlanner and EcoAssessment house 400+ green initiatives which are ordered by cost and impact. The EcoAssessment uses a point-based approach whereby a business receives points for every initiative that’s completed. This way, entities can keep track of what practices their putting in place to support the environment. This information is needed to fulfill the environmental aspect of an ESG report. Plus, by implementing these green initiatives, organizations will perform better on ESG-related criteria when assessed.
You can find out more about the Green Business Bureau‘s sustainability tools and membership here!
For more information on ESG reporting, check out our previous articles listed below:
- ESG Reporting: How Does It Differ From Sustainability Reporting?
- ESG vs Sustaniability: What’s the Difference?
- ESG Reporting: What Is ESG Reporting and Why Is It Important?
- ESG Reporting: Standards, Frameworks, Challenges and Benefits
- ESG and Sustainability: How to Improve Your ESG Score
- ESG and Sustainability: Your 101 Guide for Understanding Corporate Sustainability