Following on from my previous piece on “ESG Reporting – The Business Value Add” – I thought we could take a look at the components that go to make up Environmental, Social & Governance (ESG). Yet, just before we do that, we need to ask the questions, why has this become so important, and why are organisations investing in the capability to deliver and report on these goals?
ESG was established to meet the needs of the corporate and investment worlds, where investors would have the necessary information to make environmentally sound investment decisions. ESG data and reporting highlights an organisation’s environmental and social risks, and what they are doing to mitigate those risks. Exposure to such risks equates to financial risk, and sustainable investors seek to minimize risks to their returns that such societal factors may threaten. So, with the theme of Sustainability running as the foundation of every aspect, ESG asks, what is the organisation’s environmental and social impacts, both locally and globally, and are they being transparent and prioritising these responsibilities?
Initial work carried out with a focus on Corporate Social Responsibility (CSR), established a set of criteria. However, such criteria has proved to be extremely subjective, given the diverse nature of the topics, leaving reporting open to claims of “greenwashing”. Over time, however, more objective, credible metrics for a company to report against its performance in terms of ESG policies and achievements are evolving, helped greatly by having the United Nations’ Sustainability Development Goals (17 SDG’s) to use as a foundation.
In years gone by, our perception of how “good” a corporation was was created in a great part by how good an organisation’s public relations department were. In today’s world, this is no longer enough – corporate responsibility and accountability are required. This is where a number of specialist consultancies and services companies are now able to assist with the implementation of broad ESG policies and practices.
ESG Environmental Component
This looks at an organisation’s use of energy resources, how it manages waste, and the impact of pollution as a result of its operations.
ESG Social Component
This component covers a broad range of potential issues, including how the organisation operates and its general business ethics. Although focus is currently mostly on the relationship an organisation has with its employees, this component also covers the communities in which it operates and the wider supply chain and other stakeholders. So concepts such as providing employees with a safe and healthy working environment, and covering all aspects from pay and benefits, to diversity, inclusion and the prevention of harassment in the workplace are included, as are looking at how investment is made into the communities in which it operates. With this in mind, with some industries, this accountability will also extend to their wider supply chain impacts, such as human rights issues associated with sourcing raw materials, such as cocoa, palm oil, cotton, etc, and child labour standards, as just a few examples.
ESG Governance Component
Financial and accounting transparency are well established and key elements of good corporate governance. The late Milton Friedman, a leading economist, argued that evaluation of company stock should focus on the company’s financial value and bottom-line profits – period – and that socially responsible corporate expenditure was nearly always a non-essential expense, that erode corporate and shareholder profits. This is no longer the held position of socially conscious investors, who argue that it’s the right thing to do, and in the long run will be the best possible risk adjusted ROI (Return on Investment).
Although many of the metrics that a company has are not currently part of financial reporting for Public Listed Companies, there is a growing number of companies including them in their reported statements, or separately as part of the EU Non-Financial Reporting Directive 95/14. This optionality is, I envision, set to change, with stronger rules and wider coverage on social and sustainability measures set to be incorporated within the next two years at most. So, whilst there is no standard compliance requirement at present, this must surely be only a matter of time!…
So, what do we do, and where do we start our ESG journey? I will look at these questions in my next piece.