The acronym “ESG” stands for “Environmental social and governance.” This topic relates to an organization’s operations and risks in three distinct areas:
- Environmental stewardship
- Social responsibility
- And corporate governance
For transparency, organizations disclose these non-financial details via reporting, which leads us to the question, what is ESG reporting?
ESG Reporting, Defined
ESG (Environmental, Social & Governance) reporting is the process of disclosing information covering the mentioned distinct areas (environmental stewardship, social responsibility, and corporate governance).
ESG reporting exists in practically all sectors, from real estate and energy to pharmaceuticals and financial services. As certain sectors tend to rank better than others in the “E,” “S,” or “G” category, organizations tend to benchmark their results to peers within their industry. The following are descriptions of ESG’s three components:
The environmental category consists of data and information on how companies consume energy and manage their environmental impacts as stewards of the planet. These climate-related measurements determine the company’s environmental footprint. Measurements include; GHG carbon emissions, long-term effects on climate change, waste disposal, recycling, renewable energy consumption or production, and resource depletion.
Social issues include how an organization fosters its people and culture and the types of impacts it has on the communities in which it operates. Examples include diversity and inclusion, discrimination, training, and promotion from within, political contributions, human rights, and community relations.
Governance measures how an organization is directed and managed and to what extent its leaders are held accountable. Examples include executive compensation, shareholder rights, takeover defense, staggered boards, board elections, and independent directors.
ESG and Supply Chain Management
It is important to note that ESG does not solely reflect the company’s actions but rather is inclusive of its entire supply chain. A business should ensure its vendors and others along the chain are also ESG compliant as its risk management and reputation depend on those entities to fulfill its operations and functions.
For example, according to the GHG Protocol Corporate Standard, a company’s greenhouse gas emissions are classified into three scopes:
- Scope 1 refers to direct emissions
- Scope 2 consists of indirect emissions — owned
- Scope 3 is indirect emissions — not owned
Scope 1 and 2 are mandatory to report, whereas scope 3 is voluntary and the hardest to monitor. However, companies succeeding in reporting all three scopes will gain a sustainable competitive advantage.
To Whom Is ESG Reporting Relative?
Environmental, social, and governance reporting is relevant to multiple constituents of a business or organization. In other words, many groups pay attention to the findings of an organization’s ESG report.
Some of these groups are as follows:
- Customers: Customers of an organization’s goods or services look to ESG reports determining if their dollars are supporting a company whose values align with theirs. ESG is more relevant now than ever as social media and the growing number of online influencers have opened doors to shared consumer views and opinions — both positive and negative.
- Employees: Employees are increasingly choosing to work for companies with strong ESG reportings and rankings. Thus, responsible reporting and positive findings attract more talent and enhance employee retention rates.
- Investors: Both retail and institutional investors of companies seek out qualitative and quantitative information to help them screen investment opportunities. From a retail standpoint, individual investors may choose to invest in companies that speak to their corporate ESG concerns, while institutional investors create sustainable portfolios and indices tailored to their ESG-minded clients. Lack of reporting and/or poor ESG scores increase the probability of shareholder activism.
- Supply Chains: A company’s service providers and vendors will be encouraged to do business with ESG-compliant companies, reflecting better on their business model and practice. Furthermore, the company may be able to negotiate better contracts with its vendors when its ESG rankings are high relative to industry standards.
- Creditors: Strong ESG rankings put a business in a position better to negotiate rates and terms with its lenders and creditors.
- Communities: Carrying out activities sustainably with the communities in which an organization operates tends to enhance relationships with the local clientele, local policy-makers, utilities, and other regional partners who strive to work together for its success.
It is important to note that ESG sustainability is not just about meeting numbers to please constituents. In fact, sustainability initiatives at corporations have shown to drive better financial performance and competitive advantage due to mediating factors, including improved risk management and enhanced innovation.
ESG Criteria and Reporting Standards
ESG reporting is now recognized as a significant function for businesses. Here are some examples of widely used organizations that define and classify ESG reporting standards:
- The IFRS Foundation is a not-for-profit, public interest organization established to develop a single set of high-quality, understandable, enforceable, and globally accepted accounting and sustainability disclosure standards — IFRS Standards — and to promote and facilitate the adoption of the standards. The IFRS Standards are developed by two standard-setting boards, the International Accounting Standards Board (IASB) and the newly created International Sustainability Standards Board (ISSB). The IASB sets IFRS Accounting Standards, and the ISSB sets IFRS Sustainability Disclosure Standards.
- The Sustainability Accounting Standards Board (SASB) guides the disclosure of financially material sustainability information by companies to their investors. Available for 77 industries, the Standards identify the subset of ESG issues most relevant to financial performance in each industry. SASB Standards are maintained under the auspices of the Value Reporting Foundation, a global nonprofit organization that offers a comprehensive suite of resources designed to help businesses and investors develop a shared understanding of enterprise value — how it is created, preserved, or eroded. The resources — including Integrated Thinking Principles, the Integrated Reporting Framework, and SASB Standards—can be used alone or in combination, depending on business needs.
- The Global Reporting Initiative (GRI) is a provider of the global best practice for impact reporting. Its mission is to deliver the highest level of transparency for organizational impacts on the economy, the environment, and people. The Standards are designed as an easy-to-use modular set, delivering an inclusive picture of an organization’s material topics, their related impacts, and how they are managed.
There is, nevertheless, some concern and confusion among those tasked with providing disclosure, specifically around the number of competing reporting standards — choosing which one to adopt, and understanding the intended beneficiaries of the disclosure. Recently, there has been a series of initiatives to address these concerns and unify some competing standards.
Developments in ESG Reporting
In September of 2020, five leading standard setters for voluntary ESG reporting, including the GRI, SASB, the Climate Disclosure Standards Board (CDSB), the International Integrated Reporting Council (IIRC), and CDP (formerly, the Carbon Disclosure Project), issued a joint statement of intent, announcing a commitment to working together to create a comprehensive corporate reporting system.
Soon thereafter, the World Economic Forum’s (WEF) International Business Council (IBC), in collaboration with the “Big Four” accounting firms, released its recommended set of universal ESG metrics and disclosures to measure stakeholder capitalism that companies can report on, regardless of their region or industry.
On November 1, 2021, CFA Institute issued the first voluntary global standards for disclosing how ESG issues are considered in an investment product’s objectives, investment process, and stewardship activities. Three advantages the standards provide, according to the Institute, are as follows:
- Relevance: The standards help investors, consultants, advisors, and distributors better understand, compare, and evaluate investment products and diminish the potential for “greenwashing.”
- Flexible: The standards are designed to accommodate the full range of investment vehicles, asset classes, and ESG approaches offered in markets around the world.
- Complementary: The standards address current gaps in regulation and help harmonize disclosure practices in different markets.
The standards include a section entitled, Fundamentals of Compliance, followed by Investment Product ESG Disclosures.It also includes an ESG Terminology Glossary. Its appendix includes such relevant topics as, Determining the Applicability of Provisions, Sample ESG Disclosure Statements, Development of the Global ESG Disclosure Standards for Investment Products, and Relationship to Regulations and Other Codes and Standards.
The Growth in Environmental, Social, and Governance (ESG) Reporting
According to the 2021 E&Y Report, The Future of Reporting Sustainability Standards, the number of ESG regulations and standards globally has nearly doubled from the previous five years. Accompanying this rise are various reporting frameworks led by the “Group of Five” standard-setting organizations. In addition, there are over 600 ESG reporting provisions globally, with many offering interpretations of sustainability.
ESG Reporting has and looks to continue to grow due to its rising demand. For example, in a Workiva survey of 1,000 adults in the U.S., U.K., Germany, and France, in the Spring of 2021, over 50% of adults wanted to know that their moral beliefs align with a company before investing. Sixty-four percent agreed that ordinary investors should pressure companies to be more transparent, and 68% shared that they want ESG data they can trust.
Over the last decade, several service providers have formed to help companies and industries track, measure, and report their ESG scores. Additionally, many provide ESG reporting software and consulting services helping organizations not only to monitor their ESG scores but to enhance them and improve their rankings. ESG findings affect the internal practices, decision-making, and long-term strategy of an organization.
Many of these third-party providers have ESG reporting templates, frameworks, and tutorials. For example, a company looking to assess, measure, report, and reduce its carbon footprint, will seek out energy benchmarking, energy dashboards, and energy analytics tools. Similar tools are available specific to other ESG factors such as executive remuneration, sustainable property management, supply management, and more.
In sum, many organizations are taking steps to provide stakeholders with relevant, measurable, and comparable information to accurately assess an organization’s ESG performance relative to its industry. Unified standards may be established soon, although their exact form is still unknown. Companies should closely monitor developments and prepare for the potential for an enhanced ESG disclosure economy, whether required by regulators or when addressing market pressures.