With investors, customers and society increasingly expecting businesses to be able to prove they are acting in a way that protects the environment and people, accurate and credible ESG reporting is rapidly gaining in importance.
Lately, three letters have dominated the conversation around sustainability reporting: ‘ESG’. Environmental, social and governance (ESG) is essentially a framework for assessing the impact of the sustainability and ethical practices of a company.
It was derived from the ‘Triple Bottom Line’, also known as the ‘People, Planet and Profits’ (PPP), a concept introduced in the 1990s. The rationale behind PPP was that businesses should focus on each of the three ‘P’s and not just on ‘Profits’, since all three were (and remain) equally important for any commercial enterprise to be sustainable.
This concept evolved into ESG, which today is the bedrock of Sustainable and Responsible Investing (SRI). Today, investors (such as stock market fund managers who purchase shares and invest finance in companies on behalf of organisations like pension funds), business partners and customers are much more focused on the ethical practices of a business.
This means areas such as the management of environmental and social impacts and challenges, fair treatment of employees, respect for human rights, anti-corruption practices and diversity on company boards.
As a result, companies that have a poor record of ESG practices are coming under increasing scrutiny from investors, business partners, customers and activists like environmental non-governmental organisations (NGOs), trade unions and labour rights campaigners. Also, the number of investment funds that fully consider the ESG factors arising from a company’s activities when making their investment decisions is growing rapidly and is expected to continue rising significantly over the next decade.
The key ESG areas that a company must assess, manage and publicly report on to demonstrate they are adopting a responsible approach to their business include the following.
Environmental criteria may include a company’s energy use, waste, pollution, natural resource conservation and treatment of animals. The criteria can also be used to evaluate any environmental risks a company might face and how the company is managing those risks. ESG reporting criteria focus on areas such as a company’s approach to managing and minimising waste and pollution, resource depletion, greenhouse gas emissions, deforestation and climate change, for example.
Social criteria essentially mean how a company manages relationships with employees, suppliers, customers and the communities where they operate. It also means examining, reporting and demonstrating that the company actually lives and meets the social responsibility values it claims to hold and achieve.
Examples include, does the company donate a percentage of its profits to the local community or other corporate social responsibility projects? Does it encourage employees to perform volunteer work?
Another key example is whether the company’s working conditions genuinely ensure that the health and safety of the workforce is protected and enhanced and whether the company’s business model and operations take into account (and avoid a negative impact) on other stakeholders, such as the fair treatment of workers in the supply chains.
Companies will also wish (and need) to avoid negative environmental impacts during the sourcing of materials, goods, services and people used in their business model.
From a governance angle, investors will generally want to know that a organisation uses accurate and transparent financial accounting methods and that stakeholders are allowed to vote on important issues that relate to all aspects of the business, including its ESG performance.
They may also want assurances that companies avoid conflicts of interest in their choice of board members; have suitable anti-corruption and bribery policies, procedures and safeguards; have a suitably diverse company board (in terms of age, gender, educational and professional background); do not use political contributions to obtain unduly favourable treatment and, of course, don’t engage in illegal practices.
Why address and publicly report on ESG issues?
Increasingly, when private individuals are looking to invest in companies through practices like buying shares (or asking where their pension contributions are being invested), they are looking to invest in companies with good or excellent ESG credentials.
Taking account of an organisation’s ESG performance is most likely to be an investing approach used by millennials, who will comprise 75 per cent of the workforce by 2025. Morgan Stanley Bank recently conducted a survey that found that nearly 90 per cent of millennial investors were interested in pursuing investments that more closely reflect the ESG values they hold.
According to EcoVadis, a business sustainability ratings platform, 91 per cent of companies take sustainability into account when making purchasing decisions, and 85 per cent of consumers are now more likely to purchase from a company with a reputation for sustainability and social diversity.
Addressing and improving the company’s approach to ESG issues (such as improving sustainability, protecting the environment and being socially responsible), can bring a number of important benefits for a business. These include:
- Facilitating growth
- Cost reductions
- Increasing employee productivity and engagement
- Investment and asset optimisation
1. Facilitating growth
A strong approach to ESG issues can help a company tap new markets and expand into existing ones while attracting ethically minded investors and customers. And when governing and regulatory authorities trust corporations, they are more likely to award them the access, approvals and licenses that afford new opportunities for growth.
Good ESG performance can also drive consumer preference. McKinsey research has shown that customers are willing to pay to ‘go green’, and found that upwards of 70 per cent of consumers surveyed on purchases in the automotive, building, electronics and packaging categories said they would pay an additional five per cent for a green product if it met the same performance standards as a non-green alternative.
2. Cost reductions
When implemented, effective ESG policies and processes can also substantially reduce CapEx (capital expenditures) and OPEX (operating expenses) in areas such as raw material and resource use. This includes better management and minimisation of increasingly expensive and depleting resources, such as water and energy.
Good ESG management can also lead to financial savings by helping to prevent the creation of waste from a business and help to control potentially indirect costs associated with ESG-related liabilities.
3. Increasing employee productivity and engagement
A strong approach to and effective management system for ESG can help companies attract and retain quality employees, enhance employee motivation and increase productivity overall.
Employee satisfaction is positively correlated with shareholder returns. For example, a London Business School report found that the companies that made Fortune’s ‘100 Best Companies to Work For’ list generated 2.3 per cent to 3.8 per cent higher stock returns per year than their peers.
Sustainability actions often lift a company’s reputation and status, leading many job seekers to believe they’d feel proud to work for an organisation admired for its sustainability performance. A recent study across number of career fairs found that attendees considered an organisation’s sustainability credentials as a key factor when assessing their employment options.
4. Investment and asset optimisation
Continuing to rely on energy-hungry plants and equipment, for example, is a large financial burden for many organisations.
Although the investment required to update equipment, plant and buildings so they are more sustainable, use less energy and create less carbon emissions may be substantial, choosing to postpone or delay such upgrades for short-term financial reasons can be the most expensive option of all.
The rules of the game are shifting: regulatory responses to emissions and energy security issues – as seen during the Ukraine conflict – affect both energy costs and balance sheets in carbon-intensive industries. Also, bans or limitations on materials and items like single-use plastics or diesel and petrol-fuelled cars will introduce new constraints on multiple businesses. This could leave many businesses struggling to catch up with new duties, rules and restrictions around ESG issues like sustainability, climate change and environmental protection.
Implementing ESG management and reporting into business
When an organisation is seeking to address and manage ESG issues – and report on their performance in this area – there are five main steps to follow.
1. Establish a ESG baseline
An organisation should engage with all its stakeholders to understand what is most important to them and how those priorities align to the business.
Next, the organisation will need to define its metrics, goals and targets for improving ESG performance. It then needs to decide on the most appropriate reporting standard to follow – such as the Global Reporting Initiative Reporting guidelines, for example. These provide a framework of ESG KPIs that an organisation can measure itself against and report on. The organisation can also review the UN Sustainable Development Goals to assess which goals meet the ESG priorities and align the goals to their business sustainability strategy.
2. Assess the current ESG status
The organisation should examine its current processes and procedures to determine if there are already suitable and adequate ESG controls in place. If there are gaps in the ESG controls, the organisation should draw up a plan of action to address them and put in place additional policies, procedures and processes to close them.
3. Design and implementation of an ESG
This phase is about deciding how to implement controls and who will be responsible to implementing, managing and monitoring them.
For example, if an organisation decides that one of its ESG goals is to measure and minimise greenhouse gases (GHGs) – and has decided on the metrics it will use to set targets and assess its progress – it will need to ensure the data collection process for GHG measurement is accurate and correctly scoped. It will also need to ensure this is the case for all other relevant ESG reporting KPIs.
4. Sustain ESG
Once an organisation begins collecting ESG data, it needs to ensure continuous monitoring, auditing and inspections of the whole ESG process and ESG data.
This may include having controls tested throughout the year and making sure there is evidence to support audit trails or certifications. In other words, ensuring the ESG policies and processes are being followed – and ensuring there is adequate data and documentary proof the ESG performance targets are actually being met.
If any gaps in ESG performance or expected achievements of ESG targets emerge during the monitoring process, they must be addressed at the earliest opportunity.
5. Assurance of ESG
The onset of mandatory non-financial reporting of ESG issues by large businesses means it is now essential that investors and the public have the confidence that an organisation’s ESG reporting is accurate, reliable and credible.
It is therefore vital that all data an organisation reports on is accurate, comparable and based upon robust reliable data and information. Although the reporting can be done internally, stakeholders like investors often want assurance that the organisation’s ESG data and reporting is accurate from an independent, external, third-party assessment body.
The future for ESG looks promising, with more organisations feeling the need to publish ESG reports so they can maintain a proactive and positive relationship with their internal and external stakeholders and fulfil their ESG policies, strategies, targets and promises.
International frameworks, indices and initiatives – such as the UN 2030 agenda, the UN Sustainable Development Goals and the Paris and COP26 Glasgow Climate Change Agreements – mean the number of ESG topics that are already being reported (and will have to be reported in future) by organisations is increasing and deepening.
As a result, different frameworks, standards, ratings and indexes with international recognition have started to guide ESG reporting.
In the future, it is envisaged that all types and sizes of companies globally will be consistently reporting their ESG activities in some form. There are already software solutions that make this process easier by connecting data streams and automating responses using the data provided.
The number of companies reporting on ESG is increasing all the time, and the existing regulations already set minimum requirements for the standard and content of ESG reporting. So, if a company should be reporting because its investors, business partners and customers are already expecting to see reliable ESG data from the business – but fails to do so – it risks losing market share, investor confidence and customer loyalty.
Dr Keith Whitehead CEnv is senior environmental consultant at the British Safety Council
Contact Dr Keith Whitehead at:
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