ESG standards are changing the business game. Environmental, social, and governance (ESG) themes have been around for decades, but they have taken on a fresh urgency. In recent years, demand for ESG-related transparency and accountability has increased exponentially in business and investor circles. As a result, ESG standards are in the limelight, serving as a guiding post for the industry.
In many ways, ESG standards, which serve as a basis for sustainability-related disclosures, are still evolving. However, the industry has matured enough to where various ESG standards have emerged as the go-to frameworks by which businesses can operate. Climate fintech is a great field to look at for this.
Even as these frameworks continue to be formalized and streamlined, businesses don’t have to wait around to implement them. In fact, the sooner that they begin reporting their ESG commitments on a voluntary basis, the more prepared they will be when these practices are increasingly made mandatory.
In this blog, we will explore how far ESG standards have come, as well as the latest trends that are shaping the industry.
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ESG standards continue to evolve. To see how far they have come, you’ve got to begin in Europe. It was in the U.K. when ESG reporting rules first surfaced when the Companies Act of 2006 was crafted. One section of the act placed the responsibility on board directors to share the long-term impact of the decisions they were making would have on the environment.
Seven years later, ESG reporting went to the next level. This was when fresh regulations came into play that expanded the extent of mandatory non-financial reporting on matters such as carbon emissions. These rules continued to be strengthened until 2018, when a regulation was passed requiring that boards of publicly traded companies include ESG reporting metrics in their annual reports.
Also in 2006, the UN’s Principles for Responsible Investment (PRI) report was introduced, thrusting ESG criteria into the asset management spotlight. The impetus around this surrounded sustainable investment strategies as investment management firms increasingly shifted their focus to ESG-related issues. Today this report boasts thousands of signatories across over $103 trillion of assets.
Institutional investors and asset managers have influenced the formalization of standards as they increasingly require that the companies they choose to back make their devotion to ESG reporting crystal clear. This commitment should be apparent in ESG reporting across areas like corporate diversity (e.g., having women represented on male-dominated boards), lowering carbon emissions, and more.
For any business to be competitive, it must make some commitment to ESG standards, regardless of the sector in which they operate. Otherwise, they risk getting left behind. There’s no one-size-fits-all sustainability measurement. But some of the common metrics can be grouped into one of three buckets – environmental, social, and governance.
The environment represents the “E” in ESG and is perhaps the most widely recognized component of sustainability. It encompasses everything from air to water pollution and mitigating one’s carbon footprint. This can be reflected in metrics such as the amount of carbon that a company is responsible for emitting or any water contamination due to the production of its products and services.
Under the social bucket, you’ll find issues like diversity, equity, and inclusion (DEI), which is a major area of focus for big corporations. For them, ESG and DEI go hand and hand.
The mindset is such that even when a company or the broader economy is in a downturn, it’s not a good idea to stop investing in DEI. Continuing to make investments in this area could have a positive impact on an organization’s bottom line.
The non-white population among Americans hovers at 100 million. Executives say failing to consider this in areas like marketing can be costly in what is considered a multicultural market. Companies from Coca-Cola to NBC Universal have all identified DEI as a top priority.
As for governance, this includes areas like board composition. In the U.K., regulators have made it so the composition of corporate boards must be 40% women and ethnic minorities. Companies should also have ESG represented on their boards or risk-facing shareholder activism.
Governance also shines a light on transparency for financial and non-financial reporting, including in the area of ESG. As companies choose to make these disclosures public, they are likely to experience a lower cost associated with access to capital and more generous lending requirements, not to mention the boost to their reputation and customer loyalty.
There’s currently no one-size fits all ESG rulebook for businesses to follow. Instead, various different frameworks have emerged over the years to satisfy the growing interest.
These individual frameworks have resulted in a patchwork of standards that have left some organizations on the sidelines. However, the International Financial Reporting Standards Foundation (IFRS) is currently in the process of consolidating them into a streamlined version.
These sustainability and climate-related standards are set to become effective in 2024. They are global reporting standards by which businesses can begin reporting in 2025. However, organizations don’t have to wait for it and can begin implementing ESG reporting now through any number of frameworks that currently exist.
SASB: The Sustainability Accounting Standards Board, or SASB, gives organizations a way to report sustainability disclosures around ESG risks and opportunities that influence their enterprise value and financial performance. The SASB has identified the most relevant ESG issues as they pertain to dozens of sectors across consumer goods, financial services, healthcare, etc. The standards focus on the following aspects of ESG: “environment, social capital, human capital, business model and innovation, and leadership and governance.”
This organization is now part of the IFRS.
Other standards to consider:
- The Task Force on Climate-Related Financial Disclosures (TCFD) – This group was developed by the Financial Stability Board to make recommendations on the type of ESG criteria investors, insurers, and lenders are seeking from companies to make proper climate change-related risk assessments.
- Global Reporting Initiative (GRI) Standards – An early mover in the ESG standard industry. As a result, many of the early adopters of ESG reporting use this model.
- The UN’s Sustainable Development Goals – The UN has identified 17 sustainable development goals aimed at efforts like eliminating poverty and hunger while ensuring quality education for all.
ESG reporting is becoming increasingly important for organizations to perform as the pendulum continues to shift in this direction. There is a wide range of benefits to making ESG-related disclosures, not least of which involves the transparency that it provides to stakeholders in an organization.
In addition, ESG reporting and disclosures alert organizations to any risks that they might be facing as it pertains to sustainability issues. As a result, the organization has a greater chance of creating more efficiencies. Otherwise, these risks might have gone unnoticed and cost more down the road.
ESG reporting also affects things like a brand’s reputation and customer loyalty, both of which have an impact on financial performance. While ESG reporting is still in many ways voluntary in the U.S., it is moving in the direction of being required. So, becoming compliant early would work in a company’s favor.
That’s not to say that there aren’t challenges around ESG reporting. Chief among them is the lack of standardization for ESG reporting on a global scale. This results in varying standards and can make it difficult to make apples-to-apples comparisons.
In addition, ESG standards are new for many organizations and, therefore, can take time not only to master but also to quantify. Data management systems are designed to help, but they can be complicated.
Data management systems require a wide breadth of data that not all organizations have a habit of gathering. Take the EU’s Sustainable Finance Disclosure Regulation. It makes it mandatory for financial market players to report their ESG disclosures, but the database is complex.
For example, it commands measurements on over a dozen metrics related to the environment and social standards. Plus, they must choose certain voluntary sustainable and social indicators to share on top of the mandatory ones.
It’s not uncommon for many Fortune 500 companies to publish their ESG disclosures. These major businesses are setting a standard for other companies to emulate.
E-commerce giant Amazon takes ESG reporting to the next level. In addition to environmental factors, it also discloses data in the areas of social justice and governance. The company calls it a “win for the planet, for business, for our customers, and for our communities.”
Amazon is working toward a goal of decarbonization and boasts 85% renewable energy usage across the organization. They’re making a push toward electric vehicles, cargo bikes, and even delivery on foot. In 2021, they delivered 100 million packages via zero-emission vehicles. Amazon adheres to several ESG-reporting frameworks, including the SASB, TCFD, and UNGP.
A company that operates in the steel industry shared its experience adopting ESG-reporting standards as a smaller organization. This particular company, called Schnitzer, identified sustainability as a critical long-term goal and opted to disclose ESG performance with the SASB on a voluntary basis. Schnitzer pivoted from previously using the GRI Standards and wanted something more robust.
This company shared how adopting ESG reporting in practice can be an uphill climb for a smaller organization due to the limited expertise and resources they usually possess. They advise other companies in a similar position not to attempt to “reinvent the wheel” and instead take small steps. Rely on the reporting disclosures of companies with a similar business model to learn from and build from there.
In Schnitzer’s case, they said they made the leap to SASB reporting after evaluating the extra cost and determining it would be “minimal.” In exchange for the added effort and cost, they say there’s been a “net-positive impact of our operations,” benefits to its products and services, and “the company’s overall ESG value.”
ESG reporting is increasingly becoming part of the fabric of corporate America. While there’s currently a patchwork of ESG standards, looking at climate fintech, the streamlining of these metrics will make it easier for organizations to participate. Smaller companies can move at their own pace and are likely to find that there are a host of benefits that extend from a company’s reputation to its bottom line.