An ESG rating measures the exposure a company has to long term Environmental, Social and Governance risks. The idea was first introduced in a 1988 article by James S. Coleman as a way of investing for collective growth rather than for self-interest. The ‘S’ in ESG is the social component – all the ways in which a company interacts with their employees, the communities in which it operates, and the social issues that arise from its operation.
Regulation of ESG is expanding quite rapidly both in Europe and in the US, with new requirements for businesses to report on and prevent adverse impacts. The European Commission has adopted the Corporate Sustainability Due Diligence Directive (CSDDD), which, among other things, is a strong initiative in the EU’s human rights strategy. The Corporate Sustainability Reporting Directive (CSRD) will reinforce the EU’s Non-Financial Reporting Directive. Businesses now need to formally report the three elements of ESG alongside the finance aspects of their operation and should demonstrate how the business aligns its values with its bottom-line aim of making maximum profits. Upcoming legislation will formalise the need for companies to define, track and report on their ESG progress with regulatory consequences for failures in this area.
Social consciousness in investing and operating has been a topic of conversation for a good while now, and has been increasingly applied voluntarily by a great many companies who have perceived it either as the ‘right thing to do’ or, more cynically, as a means to attracting investment and gaining status. It is certainly true that socially conscious investors may use ESG data to determine which companies have risk factors that could affect the social climate. The ESG metric can further help them decide the companies to fund so they can feel good about their investments.
The question that arises next is what criteria should be considered, reported on, and acted upon. Companies need to identify the ESG goals that will align with their mission and vision and also then seek to set benchmarks in the ongoing process of improvement. Because organisations vary widely, there cannot be any one single approach that will function for all. It is also important to note here that regulation of ESG reporting is not universal across all industries.
So, businesses must now seek out ESG metrics, but they face a number of challenges. Firstly, it is much easier to measure environmental sustainability than to deal with the social element. Data is more difficult to obtain and there is a lack of standardisation in the field. Standards need to be set, perhaps with units of impact being considered within areas such as employment or education. But this will entail the setting up of some form of evidence base to present such information to stakeholders, potential investors, and regulatory authorities. The need for some uniformity has led to the establishment of the International Sustainability Standards Board (ISSB) with a mandate to create ESG disclosure rules for companies. Its new sets of standards will certainly help in part to standardise this arena.
In this short article, there follow five suggestions for what needs to be considered and the approaches to gathering and reporting information that may be adopted in your particular situation.
There are a number of firms that operate locally and internationally and will conduct an ESG evaluation and ensure that your investments and record-keeping meet standards set in your jurisdiction. These independent companies create standard reports, which can form the basis for your ESG compliance process. They include:
- Global Reporting Initiative (GRI)
- Sustainability Accounting Standards Board (SASB)
- Global Initiative for Sustainability Rankings (GISR)
- Task Force on Climate-related Financial Disclosures (TCFD)
Warning! It is crucially important to point out that simply handing over all responsibility in this way does leave an organisation at risk of failing to match the assessment and reporting to their own mission and values, and thereby missing out on the opportunity for valuable development.
Limit your scope
Clearly a company must have a grasp on the risk factors that the social effects of their operations have. However, once these vital issues are ‘covered’, in terms of investment and development, it may be prudent to consider the advice offered by Nasdaq Contributor, Betsy Askins, to ‘identify three to five measurable ESG criteria that are material to your businesses and your constituencies, and are aligned with your corporate strategies’. You cannot record and report on everything.
An opportunity for advance
Compliance can advance ESG and also other goals within the business, and in particular those linked to human resources. They may seek to improve company-wide diversity, equity, and inclusion efforts, or invest in mental health, safety or even removing wage gaps. Equally, they could focus on employees’ health and safety, the work environment, and the products a company produces. The key is, as was suggested in the previous point, that they can form a direct and invaluable link with corporate strategy.
Qualitative and quantitative metrics
When collecting metrics, it is useful to gather and present information in both qualitative and quantitative forms. Words can be more valuable than numbers to inform about ESG impact. This might include a company’s strategies, processes and other defining characteristics which cannot be set out in numerical patterns. Of course, quantitative ESG metrics, in statistics and figures, can be inserted into a program to calculate patterns, percentages and other data that can inform company decisions, but it is important to recognise that both categories of metrics have their place.
Comprehensive data will make up a significant sector of the recording and reporting of social metrics, and for that reason it is useful to consider a few pointers to enhancing the value of this data. Firstly, organising the reporting clearly by sector can make it clearer when looking at a company in a specific industry or niche. Secondly, using sector benchmarking can be a valuable way of presenting the acceptable or expected ESG standards for a certain industry and thereby assist in making valid comparisons. Related to this point, it is important to also include scoring standards that explain how to rate ESG metrics against the sector benchmarks. Without these, the data is of little value to anyone. Thirdly, data must be traceable. This emphasises the need to collect sources and follow accepted reporting methods to verify and validate the data used for calculation. Finally, data needs to report in as near to real-time as possible. This will show how ESG metrics and factors are developing and may also ensure prompt intervention where urgent situations arise.