ESG and Reporting Standards
There are currently over 600 ESG (Environmental, Social, Governance) reporting provisions globally. This is creating a soup of ESG interpretations, muddling what constitutes a sustainable investment vs what does not.
This lack of standardization and interoperability marks a significant challenge for financial institutions globally, which is having a knock-on effect on the businesses looking for investment.
In this article, you’ll learn what ESG reporting is and the challenges it faces. You’ll learn what is being done to create a standardized approach to ESG, and how financial institutions can help create a more sustainable world.
What Is ESG
ESG is an evaluation of a firm’s collective conscientiousness with respect to Environmental, Social, and Governance factors associated with a business’s operations. In 2004, the UN and International Corporate Finance worked together to develop a system that would integrate environmental, social, and governance concerns into capital markets. The resulting 2005 study, titled Who Cares Wins, marked the first use of the term ESG.
Using the principles of ESG, investment decisions are made based on an organization’s Environmental, Social and Governance performance, as explained:
- Environmental performance: Selected criteria are used to evaluate and manage a company’s environmental risks. E looks to reduce a company’s energy use, waste, and pollution while helping to protect natural resources through conservation.
- Social performance: Selected criteria are used to analyze a company’s business and personal relationships. This includes relationships with suppliers, communities, consumers, and employees. S includes labor relations, diversity, inclusion, philanthropy, and charity work, supplier support, and health and safety provision.
- Governance: Here the internal systems and practices that a company adopts to govern itself are examined. G criteria includes whether a company makes effective decisions, complies with the law, meets the needs of external stakeholders, uses accurate and transparent accounting methods, and stakeholders are allowed to vote on important issues. Every company, as a legal entity, requires governance.
For each criterion, there are metrics to report on. Data is collected for each metric, and these metric values are compiled together to give a final ESG score.
Organizations with a good ESG score are considered proactive businesses with lower investment risks.
Why Is ESG Reporting Important
Following ESG guidelines and working towards a strong ESG performance and rating is voluntary in most countries at the present time. But there’s a trend for increased global regulation of corporate ESG data reporting.
For instance, a 2020 report by Carrots and Sticks gives three interesting insights:
- The total number of voluntary and mandatory provisions in different countries has increased significantly since 2006.
- Government and financial regulators remain the most active when issuing reporting requirements and guidance, followed by stock exchanges and industry bodies. Europe has the largest number of reporting provisions, with 245. This is followed by Asia Pacific with 174.
- ESG is gaining momentum worldwide. This is because effective communication of the concept, plus its benefits, is sparking a behavioral shift at the investor table.
- Over 95% of the S&P 500 report ESG results, metrics and accomplishments
Following the 2021 United Nations Climate Change Conference, commonly referred to as COP26, the agenda was set for the participating 23 countries to work to reach net-zero by 2030. There’s intense debate on the best pathway to this net-zero future. What is unmistakable, however, is the role financial institutions will play in this net-zero race.
As such, there’s a heightened pressure for these institutions to act responsibly, that is, to stop financing fossil fuels, pollution, and exploitation. Therefore, the demand for ESG investments is pressing.
Once more, organizations with a good ESG score are looked on favorably by investors due to the financial benefits ESG brings. According to McKinsey and Company, there are 5 main financial benefits associated with ESG. These are as follows:
- Cost reductions: Effective ESG execution helps combat rising operational expenses such as raw material costs. These cost reductions from ESG have been found to boost operating profits by as much as 60%.
- Top-line growth: A strong ESG performance allows organizations to tap into new markets and expand in existing ones. Government bodies are more likely to trust corporate actors with strong ESG metrics.
- Minimal regulatory and legal interventions: ESG strength reduces the risk of adverse government action. Analysis shows that typically ⅓ of a business’s profits are at risk from state intervention through non compliance.
- Higher employee productivity: A strong ESG proposition helps organizations attract, and retain quality employees. It also enhances employee motivation by providing a sense of purpose. Employee satisfaction is positively associated with shareholder return.
- Optimal investment and capital expenditure: Strong ESG propositions can avoid stranded investments that do not pay off in the long term due to regulatory and market shifts. E.g. bans on single-use plastic.
Investors rely on accurate ESG reporting to select investment opportunities that will bring these benefits. Providing a globally recognized reporting framework with robust, comparable, and relevant standards is, therefore, a must.
Communicating ESG Measures Using ESG Reporting
ESG reporting is the disclosure of data to give a snapshot of an organization’s environmental, social, and governance impact. ESG reporting gives transparency to help stakeholders – specifically investors – avoid risky business. For investors, organizations with poor ESG performance pose a greater financial risk.
Reporting is critical for organizations to progress the ESG agenda. Reporting organizes a company’s ESG-related data, which:
- Measures where a company is currently operating: With transparency comes accountability and clarity over goals and targets.
- Marks where a company wants to be: Key milestones are set along with the plans needed to meet these milestones. Companies can use benchmarks to assess their progress and compare how they stack up against industry peers.
- Tracks the organization’s performance: Period reports can be compared to measure an organization’s ESG progress. The use of ESG criteria assesses an organization’s performance accurately and confidently, while avoiding greenwash.
“Without taking sides in the debate around the value of [ESG] measures or the way in which they are reported by directors, it is self-evidently desirable that the published data in this area is trustworthy.” – Sir Donald Brydon, Assess, Assure and Inform
ESG Challenges: Lack of Interoperability Regarding Disparate ESG Reporting Standards
“[ESG frameworks are]…damaging to the prospect of changing the corporate world… for the better.” – Joint Manager at Scottish Mortgage Investment James Anderson, Anderson: ESG frameworks are profoundly damaging
Anderson’s view is not that ESG as a concept is damaging, more the way ESG is used and reported is damaging. This is due to ill-thought-through metrics, distractions, and a lack of standardization and interoperability.
The problem with ESG reporting today stems from the multitude of methodologies, regulations, and standards used. This confuses organizations and undermines collective trust in ESG as a concept.
For instance, there’s roughly 600 different ESG approaches used today, causing a lack of harmonization. This means it’s impossible to get an accurate picture of who is doing what, and what ESG scores, ratings, and performance tells us. The goal is interoperability, that is, companies should be able to collect relevant data once, then report this data in a standard format, one that is recognized as a common ESG language used globally.
Let’s refer back to the COP26 net-zero targets. These targets could be catalysts pushing ESG agendas that focus on carbon accounting and GHG reporting. Yet, measuring business emissions is just one aspect of an organization’s sustainability performance. Such a focused effort could leave out the complexities and wider risks associated with sustainability. Many ESG reports selectively present only the non-financial metrics favorable to them. And with net-zero the new buzzword, this could lead to other important sustainability metrics being glossed over.
With 50% of global GDP reliant on nature, this bias in reporting is something we cannot afford to continue. Although a high priority of GHG reporting is advocated, it’s not to come at the expense of other ESG metrics.
The urgency to create a standardized ESG reporting procedure
The International Business Council (IBC) and the World Economic Forum published their report: Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation.
This 2020 report attempts to standardize ESG metrics and disclosures for interoperable ESG reporting. Provisional metrics and disclosures were set and put forward at the IBCs 2020 Winter Meeting in Davos. The consultation saw more than 200 companies, investors and other stakeholders provide feedback. This feedback was used to refine ESG indicators.
The chosen ESG metrics were selected for their universality across industries and business models. It must be noted, however, that the metrics chosen do not replace relevant sector-specific and company-specific ESG reporting standards.
Given below is a snapshot of some of the core metrics and disclosures chosen:
- Principles of Governance
- Setting purpose: This is the company’s stated purpose, as an expression of how a business proposes solutions to economic, environmental, and social issues. A corporate purpose is to create value for all stakeholders.
- Anti-corruption: The total percentage of governance body members, employees, and business partners who have received training on anti-corruption policies and procedures, broken down by region.
- Principles of Planet
- Greenhouse gas (GHG) emissions: Greenhouse gases are reported in metric tonnes of carbon dioxide equivalent (tCO2e) GHG Protocol Scope 1 and Scope 2 emissions. Scope 3 emission estimations are also given as appropriate.
- Land use and ecological sensitivity: This is reported by the number and area (in hectares) of sites owned, leased, or managed in or adjacent to protected areas and/or key biodiversity areas (KBA).
- Principles of People
The above list gives you an idea of what metrics and disclosures were agreed on. You can access the full report here.
Adding to this, in 2020, reporting organizations CDP, CDSB, BRI, IIRC, and SASB presented their “Statement of Intent to Work Together Towards Comprehensive Corporate Reporting”. This paper is an agreement between the contributing parties, to communicate and collaborate together to produce globally recognized ESG reporting standards.
These efforts are addressing inconsistencies and aim to create a common, global language for ESG. At the moment, there are many guides available. This will, and is changing.
As we know, financial institutions play a vital role in securing a more sustainable future by investing in environmentally and socially responsible businesses. ESG compliance, therefore, is only set to become more critical.
A digital transformation of ESG and sustainability reporting
Coming back to the “Statement of Intent to Work Together Towards Comprehensive Corporate Reporting” paper, technology is pointed out as an enabler for greater connectivity between disclosures and viewers.
Technology is said to bring engagement and offer a user-friendly experience with clear information. This is something to consider for ESG reporting, and also sustainability reporting in a more general sense.
It’s for this reason that the Green Business Bureau is dedicated to providing both online access and support for organizations to improve their performance on the sustainability agenda.
GBB offers a complete online sustainability assessment and certification program that members can use for a comprehensive, credible, and flexible approach to sustainability reporting. GBB offers certification membership with a suite of over 400 initiatives to choose from. But what’s striking here is that GBB reports on an organization’s sustainability credentials, digitally.
This digital reporting has enabled GBB members to connect and collaborate together. For instance, Smog Armor communicated their sustainability initiatives on a B2B level, inspiring suppliers and partners to implement similar agendas. This communication is simple with GBB’s unique, online, EcoProfile. A company’s EcoProfile provides transparency over its sustainability progress, sharing the business’s achievements and initiatives with the world.
Many GBB members have in fact improved their ESG Scores by implementing the GBB sustainability program. For example, the Green Business Bureau helped CyberArk, a publicly traded software company, significantly improve their ESG score. CyberArk first became a Green Business Bureau member when they received a very poor ESG score from Morningstar, and promptly decided that they needed to improve this area of their business to ensure long-term feasibility. With the help of the Green Business Bureau’s online tools CyberArk was able to implement numerous ESG initiatives. The next time Morningstar assessed their ESG performance, they received a top-notch score. This example illustrates that a strong ESG program doesn’t require a lot of time or capital investment if you partner with a company that specializes in the ESG arena.
In addition, businesses scoring highly on GBB’s Eco Assessments, can also score highly on subsequent ESG assessments for financial markets and investment. The GBB EcoAssessment uncovers ESG areas that need to be addressed.
Digitization of ESG and sustainability reporting aims to increase transparency, ensure standardization, and ultimately create a digital community for networking and collaboration.
Imagine a world where businesses speak a common language for sustainable development. A world where organizations are connected and work together for a better, greener future.
About the Author
Jane Courtnell is a Content Writer for Process Street. With a Biology degree from Imperial College London and further studies at Imperial College’s Business School, Jane has an enthusiasm for science communication and how biology can be used to solve business issues, such as employee wellbeing, culture, and business sustainability.