by Belinda Ng
In the past few years, there has been a strong increase in ESG reporting requirements around the world [4]. ESG stands for Environmental, Social, and Governance. They are a set of standards for a company’s operations that have become a popular way to indicate a firm’s sustainability performance [1]. There are various issues reported by companies under each of the three pillars, comprising a variety of metrics. The environmental criterion considers how companies manage their environmental impact and use resources [2]. Some of the factors include greenhouse gas emissions, water use, land-use, biodiversity, pollution management, and climate change adaptation. Social criteria focus on how the company fosters its people and engages with the wider society [2]. Examples of social criteria include workforce diversity and inclusion, community engagement, customer satisfaction, and human rights [2]. Governance considers the company’s internal system of practices and policies. Factors include business ethics and code of conduct, risk governance, supply chain management, and tax strategy [3].
Drivers of increased ESG reporting
ESG reporting is important for companies for several reasons. First, companies with strong ESG performance have demonstrated higher returns on investment, lower risk, and better resiliency during crises; this has been particularly well reflected during the Covid-19 pandemic [1]. More importantly, investors are increasingly using ESG criteria to make strategic investment decisions in order to avoid companies that might pose a greater financial risk in the long term [5]. This is accompanied by the rising trend of asset owners choosing sustainable investment opportunities due to their potential for attractive financial performance [6]. For example, major investor BlackRock set out the expectation that companies in its portfolio should have an ESG report that aligns with ESG reporting frameworks like the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-Related Financial Disclosures (TCFD) [7]. Consequently, more companies are voluntarily providing ESG data in their annual reporting; some are also forming ESG steering groups to coordinate action to maximise effective investor communication [4].
In addition, evolving legislation across various geographies is contributing towards the greater prevalence of compulsory ESG disclosure and/or reporting. In Europe, the non-Financial Reporting Directive (NFRD) aims to establish a minimum standard for ESG reporting across the European Union as part of efforts to address the United Nations 2030 Sustainable Development Goals and the 2015 Paris Agreement [4]. Furthermore, and relevant for companies who want to be listed, 54 stock exchanges across the world now also have ESG listing requirements [4]. In the United Kingdom, listed companies must disclose carbon emissions, human rights, and diversity reporting with statutory annual reports [4]. Moreover, prominent rating agencies including Standard & Poor’s, Moody’s and Fitch Ratings have incorporated ESG themes into their credit rating methodologies [8].
Pit-falls of current ESG reporting practices
Notably, the focus placed on each of the three ESG pillars by different stakeholders is uneven and continues to evolve. The governance pillar has often been emphasised by investors and rating agencies as a proxy for performance in the environmental and social pillars [4]. In comparison to the social pillar, the environmental pillar is relatively more easily defined and measured in material ways [9]. However, against the backdrop of the Covid-19 pandemic, the social pillar has increased in importance due to the impact of the pandemic on employees and the wider community [9].
It is also important to acknowledge that there remain various limitations to ESG reporting. There remains a global lack of consistency and comparability of ESG data stemming from the wide variety of international standards and disclosure frameworks [10]. This contributes towards the disparity of ratings between ESG data providers [11]. For example, whilst some rating agencies will give companies like Tesla high ESG scores based on their environmental metrics, others rate them poorly due to governance shortcomings [11]. Furthermore, some ESG issues continue to lack comprehensive metrics and/or data for companies.This contributes towards ESG reporting being skewed towards some pillars [10]. Ultimately, whether companies see it as a box-ticking exercise, or whether they choose to radically integrate ESG issues into their core business model, the growing importance of ESG transparency and disclosure by various stakeholders renders it an important component of companies’ strategy and future performance.
Born and raised in Hong Kong, Belinda recently graduated with a BA in Geography from the University of Cambridge, and is currently studying for an MSc in Environmental Technology at Imperial College London. Passionate about climate change issues in relation to food security, she has led various sustainable food initiatives at university, In her spare time, she runs a Hong-Kong based youth-led sustainability podcast called ‘Sustain-A-Pod’, and represents Hong Kong as a member of the World Oceans Day Youth Advisory Council and Act4Food international youth-led campaign.
References:
[1] Sphera’s Editorial Team, What is ESG Reporting and Why Is It Important? Sphera, https://sphera.com/glossary/what-is-esg-reporting-and-why-is-it-important/, accessed 9th Aug 2021.[2] What is ESG (Environmental, Social, and Governance)? CFI, Accessed 10th Aug 2021. https://corporatefinanceinstitute.com/resources/knowledge/other/esg-environmental-social-governance/
[3] Kelly Tang, Exploring the G in ESG: Governance in Greater Detail- Part I, S&P Global, https://www.spglobal.com/en/research-insights/articles/exploring-the-g-in-esg-governance-in-greater-detail-part-i, Accessed 10th Aug 2021.
[4] Georgie Erangey, Weaving the golden thread between ESG and investors, BRODIE Consulting Ltd, https://static1.squarespace.com/static/5d1f083a0b4f4100012c59cb/t/5f1ff30eb0f22821568ce295/1595929363406/BRODIE_Practical_Actions_ESG_Edition_Book.pdf, Accessed 11th Aug 2021.
[5] James Chen, Environmental, Social, and Governance (ESG) Criteria, Investopedia, https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp, Accessed 11th Aug 2021.
[6] 7 Insights from Asset Owners on the Rise of Sustainable Investing, Morgan Stanley, https://www.morganstanley.com/ideas/sustainability-investing-institutional-asset-owners, Accessed 11th Aug 2021
[7] Larry Fink, A Fundamental Reshaping of Finance, BlackRock, https://www.blackrock.com/us/individual/larry-fink-ceo-letter, Accessed 11th Aug 2021.
[8] Nadége Tillier, ESG and credit rating agencies: The pressure accelerates, ING Ratings, https://think.ing.com/articles/esg-and-credit-ratings-the-pressure-has-accelerated/, Accessed 11th Aug 2021.
[9] Jonathan Neilan et al, Time to Rethink the S in ESG, FTI Consulting, https://corpgov.law.harvard.edu/2020/06/28/time-to-rethink-the-s-in-esg/ Accessed 10th Aug 2021
[10] Chrysa Alexandraki, ESG Data and Reporting in the Forefront of Sustainability: Challenges and the Way Forward, Blogdroiteuropéen, https://blogdroiteuropeen.com/2020/12/16/esg-data-and-reporting-in-the-forefront-of-sustainability-challenges-and-the-way-forward-by-chrysa-alexandraki/, Accessed 11th Aug 2021.
[11] Emily Platt, Inconsistencies in the ESG Metrics, Wealthspire Advisors, https://www.wealthspire.com/blog/inconsistencies-esg-metrics/ Accessed 11th Aug 2021
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