ESG, Environmental, Social, and Governance, is garnering increased attention across industries by investors, regulators, customers and employees. Much like the recent focus on cybersecurity and privacy regulation, ESG impacts at a board level, executive level, and within day-to-day operations. ESG requires awareness and understanding across all areas of an organization by all stakeholders.
Specifically, ESG embodies three key components to assess an organization’s impact on environmental, social, and governance matters. ESG’s greatest value is to establish consistency, rigor, and transparency in understanding these environmental, social, and governance issues. Organizations need to address these issues in order to keep operating as sustainable organizations.
Transparent and consistent ESG performance is good for society and building companies that balance shareholders, employees, suppliers, and communities in the right way.
Large asset managers are onboard with ESG. In July 2018, BlackRock published its “ESG Integration Statement” stating that ESG information is necessary for any robust investment process and will be integrated into its approach going forward. As a result, public companies and companies with public capital / shareholder base are aligning to ESG. Approximately 90% of companies in the S&P 500 issued sustainability reports in the past year, up about 20% over the prior year1.
While ESG efforts ramp up, there currently is a lack of standardized disclosure requirements which gives organizations fairly broad discretion over the type and depth of information shared externally in these reports. There are many ESG reporting frameworks. Future convergence of these reporting frameworks will significantly improve rigorous benchmarking, assessment, and compliance of companies across the industry.
Unpacking ESG
Multiple ESG reporting frameworks exist for ESG disclosures by organizations. While a singular set of metrics do not exist, we have identified some commonalities. Types of ESG metrics include disclosures on:
Environmental -
- Climate change opportunity and risk
- Greenhouse gas emissions
- Environmental policy
- Energy usage
- Environmental management systems
Social -
- Supply chain - ensuring suppliers have strong social practices and code of conduct
- Health, safety, and wellbeing of employees, contractors, and suppliers
- Stakeholder engagement
- Workforce development and human capital
- Diversity and equal opportunity
Governance -
- Compensation policy
- Governance policy
- ESG reporting standards
- Board-level oversight of ESG performance
- Governance of risk assessments across multiple risk types
ESG Reporting Frameworks
Currently, there are more than 10 ESG reporting frameworks. Frameworks are not regulations, but are structured approaches to disclosing ESG information with KPIs to enable an organization to identify, measure, assess, and monitor a set of goals. There are three main framework categories - vertical-specific, guidance, and third-party providers.
Vertical-Specific Frameworks guide organizations to voluntarily disclose ESG policies, processes, performance, and data. These frameworks are tailored to the nuances of a specific vertical such as geography, industry, or organizational size. A few examples of voluntary disclosure frameworks include:
- CDP - a UK-based non-profit that leads a disclosure system on environmental impact.
- GRESB - The Global Real Estate Sustainability Benchmark is used for real estate assets.
- Dow Jones Sustainability Indexes - the top 10% of the Dow Jones / S&P assessments are included in the indexes.
Guidance Frameworks provide specific methodologies to help organizations explore, identify, assess, and monitor ESG performance. These are issued by non-profit organizations or standards boards that seek to create reporting harmonization across verticals.
- SASB - The Sustainability Accounting Standards Board, a non-profit, developed a Sustainable Industry Classification system to categorize companies in 77 sectors. SASB also provides sector-specific sustainability and social KPIs. SASB recently announced it will be merging with the IIRC to further standardize industry frameworks.
- TCFD - The Task Force on Climate Related Financial Disclosures provides a framework to allow public companies to disclose climate-related risks and opportunities. Areas of focus include risks of physical change, opportunities for value creation, alternative energy and resilience efficiencies.
- GRI - The Global Report Initiative is a standards organization to help organizations understand and communicate impacts on climate change, human rights, and corruption. GRI standards include Universal Standards and Topic Standards.
SASB and TCFD frameworks have garnered strong support from regulators and investors because of their prescriptive standards and specific metric recommendations. This contrasts with the GRI which focuses on the materiality of ESG impacts, leaving disclosure at the discretion of the issuer.
Third Party Providers create their own proprietary ESG assessment frameworks to lend transparency and comparability across the complex landscape. These vendors measure ESG performance by calculating ratings based on third-party aggregated data from sources such as company filings and news. Examples of these data providers include:
- Bloomberg - The market data company launched ESG scores for 252 companies in the Oil & Gas sector. They also provide Board Composition scores for over 4000 companies.
- MSCI - Offers ESG ratings to measure a company’s ESG risks. The ESG ratings range from AAA-AA (leader), A-BBB-BB (average) to B-CCC (laggard).
- ISS - The Institutional Shareholder Services offer ratings and rankings as well as services.
- Sustainalytics - A Morningstar company, provides ESG Risk Ratings.
This is just a subsection of the third party provider market. It’s estimated that there are over 125 ESG data providers.
Using ESG Frameworks
ESG frameworks and ratings are used across a variety of stakeholder groups. They were first embraced by global asset management firms which incorporate ESG information to influence investment decisions. In fact, over one third of all professional assets under management are assessed using ESG criteria2.
Notable asset management firms are leading the way in making ESG evaluation a standard way of work. BlackRock, for example, has recommended that its portfolio companies use SASB and TCFD frameworks going forward. The company is very focused on how organizations manage ESG risks and price performance into investment decisions. State Street, another large investor, has developed its own proprietary ESG score based on the SASB framework. The company emphasizes that laggard performers should improve ESG performance or risk losing investor support.
Government regulators are also putting pressure on public companies to increase transparency around ESG disclosures. The EU, UK, and Hong Kong have each announced new ESG requirements for public companies that will go into effect in the near term. In contrast, disclosure in the US remains voluntary - the SEC only requires that material impacts be disclosed within public company financial statements. The incoming Biden administration may bring clearer ESG reporting recommendations and/or requirements given its focus on climate change.
While disclosures have historically impacted publicly-traded companies, we are seeing a trickle down effect to private companies as well. On the investment front, university endowments are calling on their fund managers and portfolio companies to disclose ESG metrics and performance. Traditional venture investors are also taking note of the ESG space and are funneling more early-stage funding to social impact companies.
Large organizations are requiring transparency across their supply chains and ask suppliers and other vendors to disclose ESG information. Employees are choosing organizations that align with their values - ESG is now critical for employee recruitment and retention. Most importantly, customers care about ESG and will put their spending power behind it.
Initial Considerations when Adopting ESG Frameworks
ESG strategy and disclosures are critical for all organizations, no matter the size, industry, or purpose. Now is the time to invest in developing your organization’s strategy and put it in action.
- Level up your ESG knowledge - Take time to understand the details, similarities, and differences across the various frameworks and ratings. What do your stakeholders - your shareholders, clients, and regulators - expect of you today? And in the future?
- Develop an ESG strategy and end-to-end management process - ESG is not a one-time exercise. It requires adoption and attention on an ongoing basis and should be embedded into all aspects of your organization.
- Ensure you have the right resources allocated - Do you have the talent, skills and resources to manage your ESG initiatives? Include ESG initiatives in your financial planning to ensure that you have sufficient human capital and resources to execute ESG initiatives and reporting.
- Implement rigor - Ensure that ESG disclosures are comprehensive and accurate.
Organizations that invest in developing strategies, tracking performance, and making their ESG progress transparent will create long-term value and will be rewarded across the stakeholder universe.
To learn more, contact the Understory Team for additional insights.
[1] The Wall Street Journal. Companies Could Face Pressure to Disclose More ESG Data. December 6, 2020.
[2] Marketwatch. ESG investing now accounts for one-third of total U.S. assets under management. November 17, 2020.
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