The evolution of ESG reporting
With a swathe of regulation coming into force, requiring businesses to demonstrate how environmental, social and governance (ESG) issues are managed, companies are under increasing pressure to report on a wide range of areas, but without an agreed framework for doing so. As such there is considerable disparity between the reporting methodologies, particularly against social and governance criteria. There is also a danger that box-ticking or window-dressing might drive the agenda, rather than a deeper integration of ESG issues into business strategies that would effect meaningful change at an operational level.
So how are businesses reporting on ESG and why does this matter?
Why is ESG important?
There is a clear case for integrating Environmental, Social and Governance topics into business practices. Investors are increasingly attracted by the ability of companies to identify their non-financial risks, viewing their capacity to actively mitigate and manage these risks as indicators both of long-term sustainability and strong, progressive management. Banks are linking their interest rates on loans to ESG performance, suggesting that those companies with clear and meaningful data on their ESG performance will be advantaged in the future.
There is also a moral case: it is better to be better. ESG encompasses a range of topics across the ‘E, S and G’ spheres covering complex issues such as greenhouse gas (GHG) emissions, human rights, and corruption, the careful management of which has clear prosocial benefits. As the legislative landscape evolves and more global regulators and governments require ESG disclosures, greater transparency on how these issues are being managed will be fundamental.
Achieving a good ESG performance will mean considering ESG holistically, rather than adopting a ‘pick and mix’ approach. Taking a box-ticking approach will hinder a company’s ability to reap the benefits of a properly integrated and effective ESG strategy. Instead, companies should concentrate on developing such a strategy, with clear metrics for measurement and reporting. Taking a passive approach to ESG is no longer an option.
Emerging trends in ESG reporting.
Currently, there is no universal framework or method to measure ESG performance, just as there is no exhaustive list of ESG topics. The former may change. The latter is unlikely to.
As part of our ESG services, GoodCorporation has developed an ESG benchmarking tool, which assesses how ESG targets are set, measured and reported on. This allows us to help companies compare and evaluate their ESG performance against that of competitors or peers.
GoodCorporation’s ESG benchmark is based on our assessment of ESG best practice and draws on recommended environmental frameworks, universally recognised standards such as the UN Guiding Principles (UNGPs) and emerging legislation. Any ESG analysis will be specific to an individual organisation and the nature of its operations, as such some measures may not apply to every organisation. Our benchmark indicates that certain trends are emerging, in particular where targets are being set and where businesses are focusing their efforts. Most commonly, businesses set more environmental targets than they do for social or governance issues. This is in-part because businesses have been measuring environmental impacts for far longer, and as such there are a number of established metrics and associated methodologies, particularly for greenhouse gas emissions (GHGs).
Reporting on societal impacts and good governance is relatively new and while this will require data equivalent to that provided for financial management, this is very much in an embryonic stage, and is reflected as such in our benchmark.
Greater maturity in environmental reporting for ESG
The steady increase in public concern over climate change, mainly focused on mitigation, has made reporting and targeting GHG emission reduction indispensable for investors. This societal push has also led to the creation of legislation targeting GHGs. For instance, since 2013, the UK government requires all quoted companies to report on GHG emissions annually. In France, companies of over 500 employees must publish their GHG emissions every four years. As such, not only do all companies in our benchmark report on their emissions, they also set clear GHG targets. However, other important environmental considerations are omitted from both reporting and target-setting, in particular around air quality, with none of the businesses setting targets for improvement in this area.
As attention focuses on the causes of climate change and the urgent measures needed to mitigate our environmental impact, issues such as air quality are likely to come to the fore, with ensuing pressure on companies to demonstrate how they can improve in this area.
Our benchmark also shows that few businesses consider the consequences of their environmental impacts on local populations and ecosystems. Our blog on the sixth IPCC report, highlights the role of business in contributing to the physical and human impacts of climate change and the need for adaptation measures that avoid the risk of further irreparable damage to communities.
Studies show that economically, socially and geographically marginalised groups are more likely to bear the brunt of the consequences of climate change such as displacement, food and water shortages and inflation rates. In evaluating their environmental impacts for the purposes of ESG reporting, businesses will increasingly need to consider the societal impact on local populations of any damage their activities cause to the planet. Businesses that have committed to mitigating the harmful consequences that their activities may have on local populations will find their credibility challenged if they fail to consider socio-environmental risks.
This will require a change in how companies measure and report on their ESG impacts. Currently, this is done in silos, without considering any crossovers such as the societal impacts of environmental damage. It is interesting therefore to note that in our benchmark, significantly less focus has been placed on the management of air pollution and both hazardous and non-hazardous waste, all of which would have potentially damaging human and societal impacts when not carefully managed.
Effective ESG reporting needs to address a wider range of social issues
In the social sphere, businesses demonstrate best practice by setting achievable employee engagement, diversity, and inclusion targets. As with GHGs, diversity, equity and inclusion topics (DEI) have been pushed to the front of the investor agenda by social movements, such as Black Lives Matter, or Me Too, which have nudged forward the passing of legislation. In the UK, reporting on the gender pay gap is mandatory for companies and charities with over 250 employees. Board and executive diversity targets are required for listed companies, as mandated by the FCA. In France, companies with over 50 employees must publish a yearly gender equality index and comply with a specified target to be reached within 3 years of the legislation being passed. European law also states that companies with over 500 employees must report on diversity on company boards.
All businesses benchmarked demonstrate best practice for DEI. However, less than 50% set targets for other social issues, such as labour practices or human rights.
Customer welfare is similarly neglected. For instance, while businesses have data protection policies, few set measurable targets for maintaining or improving data security and privacy. Again, this is an emerging issue, with many businesses perhaps reluctant to set goals for this relatively challenging area. The difficulty notwithstanding, this will need to be addressed. Controversies such as the Facebook-Cambridge Analytica scandal have heightened public concern over data. Similarly, the sharing of data by period-tracking apps following the overturn of Roe v Wade in the US once more placed consumer protection in the spotlight.
Product quality and safety should also come under the social category, however none of the businesses in our benchmark set targets. Samsung’s recall of their Galaxy Note 7 in 2016 showcases the importance of considering product quality and safety. It is also a good indicator of why businesses should go beyond industry standards, and – where possible – set targets for future improvement.
As ESG reporting matures, businesses will need to give equal thought to all their material ESG risks, setting clear and sensible goals across all ESG issues to demonstrate real commitment and to secure a competitive advantage.
Evidencing good governance is a critical part of ESG and key to business sustainability
With investors and regulators increasingly demanding to see how companies manage their material ESG issues, having an effective ESG strategy in place has become a fundamental requirement for most businesses. This is partially because implementing an effective ESG strategy takes time. It also needs to be meaningfully integrated into the business activities across all areas of operation. For instance, by having good supply chain management, a business is better able to ensure that its ethical culture is implemented throughout its operations. The standards set in a business’ Code of Business Conduct are a public declaration of the ethical standards the company pledges to abide by. By publishing these, businesses demonstrate their commitment to these standards, whilst also giving the public an opportunity to hold them to account.
While many companies do publish their codes of conduct, few set targets or report on how their governance is measured and evaluated. Although tricky to measure, companies should try to understand how best to evaluate their governance, rather than giving it a wide berth. By setting standards and goals regarding governance, companies demonstrate that they are serious about engaging with ESG in its entirety; how are the E and the S to succeed without an effective system in place to govern and monitor progress?
To ensure that this is done properly, it requires senior commitment; senior members of an organisation can ensure that their ethics and compliance programme is sufficiently resourced. Having top-level commitment acts as a barrier towards the threat of greenwashing. For a company to have a strong ESG performance, ethics and compliance must be at the core of their governance structure. Businesses must address any harmful impacts that their policies and practices have on internal and external stakeholders. The processes deployed and outcomes achieved must be measured and independently verified to be credible.
Developing an effective ESG framework is the key to ESG reporting
To demonstrate a meaningful approach to ESG, businesses need to devote equal attention to all three areas, rather than focussing solely on the E, with its more established metrics and reporting mechanisms. This requires the development of an effective ESG strategy that is fully integrated across all areas of business operations. This includes the gathering of data that shows the social and governance as well as environmental risks a company faces, analysing how well they are managed, and how this information can be verified.
Such a strategy should align with a company’s overall aims, purpose and values, with goals and targets that are both ambitious and achievable. From our work in this area, we know that the best companies are developing ESG frameworks that specify the good practice needed to ensure that their ESG strategy can be fully implemented across the organisation.
Such a framework will also provide the basis for a robust measurement system that will enable an organisation to track progress over time and create useful information for future reporting. Our benchmark shows that when businesses are mandated to report and mechanisms for monitoring and reporting are in place, the credibility of an organisation’s ESG credentials are enhanced. However, investors and now regulators are pushing for more.
Many of our clients are at the vanguard of developing best practice in this area. Many more are recognising that the effective management of ESG risks reduces risk overall, producing long-term business benefits that increases profitability and sustainability. Businesses are starting to acknowledge that creating clear and transparent systems for identifying and managing ESG risks keeps them in the driving seat, while providing societal benefits that meet the requirements of both investors and regulators. Regular monitoring of our ESG benchmark will enable us to track improvements in this area, identifying trends and best practice as they emerge. This will enable our clients to stay at the forefront of ESG best practice as we continue to support their ESG programmes.
Contributors: Louis Stapleton English, analyst; Elisa Benham, analyst; Laura Chevrot, intern and Sally McGeachie, PR.