[author: Charlotte Emerson]*
What is ESG and how is it measured?
Environmental, social and governance (ESG) is frequently covered in the news – especially given the growing attention paid by investors and stakeholders to how businesses operate. More and more, investors use ESG reports to consider a company’s sustainability, societal impact, and governance practices before investing in them. However, where responsibility for ESG should reside, disclosure regulations, where organisations should focus their efforts, and what information should be published remains in flux.
ESG information can be compiled and disclosed through several channels, including through a company’s internal teams, or by using an outside ESG reporting agency that uses a point-based “ESG Scoring” system to rate performance on the pre-defined factors. Scoring systems consider several ESG factors that vary depending on the industry, company size and reporting structure.
There are no legal policies surrounding how many points are appointed to each ESG factor or the best approach an organisation should take to address ESG. Individual companies can decide what value each aspect has attached to it, what elements are examined, and to whom the reports go to. Below are examples of common ESG scoring factors.
Environmental scoring factors may include:
- Climate change
- Treatment of animals
- Soil and water contamination
- Renewable energy
- Carbon and gas emissions
- Environmental policy
Social scoring factors may include:
- Workplace diversity, equity and inclusion
- Mental health
- Ethical treatment of local and abroad workers
- Salary expectations and fairness
- Safe and monitored facilities
- Charity work
- Labor standards
Governance scoring factors may include:
- Legal and compliance issues
- Local, state and federal laws
- Diversity within the board of directors
- Executive and non-executive compensation
- Tax Strategy
- Company structure
- Hiring and onboarding best practices
- Whistleblower reporting
Increased social and investor attention
The importance of ESG for both investors and consumers is on the rise, increasing the reputational and financial risks of getting it wrong.
The general population is growing more concerned and knowledgeable about ESG matters. And with that, consumers who are increasingly aware of climate change and human rights issues want to know where their products come from, who made them, and what materials were used. In short, people want to know that the companies they buy from care about doing things the right way, and are ethically and sustainably producing products. The ‘E’ and ‘S’ have never been so important. If a company behaves unethically, it may find itself hitting news and media headlines, taking a huge reputational hit.
Though sometimes seen as controversial, investors increasingly view ESG as a vital indicator of whether a company will be successful in the long run and often request holistic reports before deciding whether the company is worth investing in. For example, if a company does not fully monitor its supply chains and production sustainability levels, it may lose out on potential business and funding.
Currently, there is no overarching piece of legislation covering all ESG factors anywhere in the world. However, the landscape of ESG compliance is complicated, with some regulations being optional and others mandatory for specific ESG factors. At present, companies must follow specific laws on certain ESG factors such as code of conduct, bribery, modern slavery, greenhouse gas reporting, etc. In addition, many new ESG policies and pieces of legislation are currently in development. The following are examples of current ESG legislation across the world.
- Sustainability Disclosure Requirements (SDR) and Investment Labels by Financial Conduct Authority (FCA)
- Diversity and Inclusion on Company Boards and Executive Committees by FCA
- Climate-related Disclosure Requirements by FCA
- Climate Disclosures for Public Companies by the Securities and Exchange Commission (SEC)
- California – Climate Corporate Accountability Act (CCAA) by California Secretary of State Office
- Climate-related Financial Risks and Insurers by U.S. Federal Insurance Office (FIO)
- Mandatory Task Force on Climate-Related Financial Disclosures (TCFD) reporting for prime segment listed companies by regulatory body, Japan Financial Services Agency (FSA)
However, these legal changes to the regulatory landscape are more than just a compliance requirement. They are an opportunity for businesses to make fundamental choices and changes as to how they approach their long-term ESG business strategy. Abiding by new laws, and openly communicating their approach to employees and customers shows dedication to doing things right.
Third- party risk monitoring
As the importance of monitoring and addressing ESG risks grows, so does the attention needed when monitoring third parties. Third parties are a massive part of any company’s supply chain, from materials and packaging to shipment – and working with them is the reality of business. However, any risk introduced by third-party providers is the responsibility of the company that hired them, including how a third-party handles ESG factors.
Today, whom a company works with and associates with can have a great impact. Reputational consequences can be great should something go wrong with a third party or vendor’s business practices. Businesses must ensure third parties uphold the same values expected internally while acting responsibly and actively promoting sustainability in their own operations. It is wise for businesses to assess all potential third parties’ ESG performance across the spectrum, and benchmark results against a broader pool of suppliers before deciding who to work with.
However, any risk introduced by third-party providers is the responsibility of the company that hired them, including how a third-party handles ESG factors.