This article is part of our Sustainability 101 series. We created this collection to provide an introduction for those entering the sustainability space for the first time.
ESG stands for environmental, social and (corporate) governance.
The term is often used to conflate two different functions: sustainability reporting and sustainability investing. In this article, we’ll discuss both in more detail.
What is ESG reporting?
ESG, or ‘sustainability reporting’, describes the process of collating, quantifying and reporting on data related to an organisation’s environmental, social and governance-based practices.
Reporting allows companies to measure key operational factors (such as energy efficiency, pollution levels, or labour standards) linked to these three areas by helping them to:
- set realistic goals
- track their overall progress
- demonstrate their performance to governments, investors, employees, and customers.
Is ESG reporting mandatory?
Yes and no.
In April 2022, the UK government enacted two new ESG laws affecting registered companies and Limited Liability Partnerships (LLPs) that have over 500 employees and annual revenue of more than £500 million.
In the EU, the Corporate Sustainability Reporting Directive (CSRD) has officially taken effect and looks to strengthen and modernise the regulations governing the reporting of social and environmental information by companies.
Companies not within the scope of these regulations aren’t currently required to report on climate-related data. But it is often recommended that they do so in any case, given the benefits reporting can provide. As they say: ‘if you can measure it, you can manage it.’
What’s included in an ESG report?
The specific factors in each of the three categories may vary depending on the type of work the organisation performs, or the framework used to create the report.
But there are some common topics companies usually report on. Let’s look at these in more detail.
Category 1: Environmental
The first category covers the environmental impact: how well the business conserves the natural world, and how they’re working to protect the future of the planet.
Key areas include a company’s:
|waste disposal strategy
|natural resource preservation
Governments are implementing strict environmental targets in light of the threat of global warming and climate crisis, including reporting on the breakdown of a business’s emission scopes. This makes reporting on and tracking this category more critical than ever.
Category 2: Social
The second category covers the social impact: how well the business operates with (and within) the community.
|diversity and inclusion
Companies may also report on the standing and social values of any suppliers they affiliate with.
Category 3: Governance
The third category covers governance: the standards used by the company’s leaders to operate it from the top.
Key areas include:
|board member composition
|stockholder voting rights
|any clandestine dealings or conflicts of interest
It also covers the general purpose of the organisation and what it stands for.
What is ESG investing?
By leveraging the data aggregated from ESG reporting and using a particular methodology, a rating can be applied to a company that summarises its overall sustainability performance.
Financial institutions can use this rating to determine the ethical and financial value of investing in that business.
- If a company achieves a positive ESG rating based on the data they’ve reported, investors can feel confident they’re financing a business with a positive social and environmental impact.
- On the flip side, if a company rates poorly, ethical investors can steer clear to avoid indirectly contributing to the climate crisis or social injustice.
Investing based on a company’s ESG rating may also help to reduce the risk of capital loss due to unethical practices within the organisation. This was illustrated by Amplify Energy’s catastrophic oil spill in October 2021, which saw the stock price plummet by over 50 per cent, costing investors considerably in associated losses.
As a result, the number of investment funds integrating ESG factors into their decision-making has been growing rapidly since the beginning of the decade, with the expectation for it to continue over the decade to come.
Who decides how to evaluate the business data?
There are over 600 independent frameworks used to determine a company’s sustainability rating, and each framework is free to choose their own standards for assessing the data.
With such a wide variety of ways to assess the data, companies can receive different ESG ratings depending on the providers performing the evaluation.
UK regulators have recently brought this lack of consistency into the spotlight, with talks for the Financial Conduct Authority to regulate the ESG criteria and evaluation process in the future.
ESG reporting is a powerful way for organisations to work towards a more sustainable future and, whether motivated by ethical or financial reasons, ESG investing encourages companies to do the same.
But ESG isn’t a perfect solution. A lack of clarity and consistency between criteria and independent rating bodies leaves the system open to misuse.
In any event, working towards becoming more sustainable is a step in the right direction. With more focus from regulatory bodies and governments, ESG can become a powerful tool to help align business goals with sustainable causes.
We are sorry that this post was not useful for you!
Let us improve this post!
Tell us how we can improve this post?