Sustainability and the Increasing Demand for ESG Reporting in Business
A growing number of investment groups, businesses, employees, and other relevant stakeholders are starting to ask companies about their sustainability and ESG (Environmental Social Governance) metrics. Some companies are even receiving requests to disclose their sustainability performance through various ESG reporting frameworks. Many companies find themselves unprepared to respond to such questions.
To better understand this trend, it is important to understand what sustainability and ESG are. Why should companies care about these concepts? Why are stakeholders asking about sustainability programs and requesting ESG disclosures through reporting frameworks? What are these ESG reporting frameworks? All these questions and more will be answered here.
What is sustainability and ESG?
Sustainability is commonly defined as the ability to meet the needs of the present without jeopardizing the ability of the future to meet its own needs (United Nations Brundtland Commission). While sustainability is usually associated with the environment and topics such as climate change, renewable energy/energy use, and water use, this is only one-third of what makes up sustainability. The other two parts of sustainability consist of the economy and society. These three parts, often referred to as the three pillars or spheres of sustainability, are interconnected. Doing something in one sphere can affect (for better or worse) the other two spheres. The idea of sustainability is to affect all three areas in a positive way.
ESG falls under the umbrella of sustainability and is very similar. So much so that, for all intents and purposes, the terms could be used interchangeably. The difference, however, is that rather than looking at the economic side of things, ESG looks at the governance of an organization through scopes such as data management, anti-corruption, and other policies and procedures. ESG is mostly used in business settings and functions as a more quantifiable type of sustainability, with ESG metrics providing an easy way to measure and compare sustainability performance. ESG disclosure refers to the process of publicly reporting an organization’s sustainability and ESG performance. Organizations tend to either: 1) release a Corporate Social Responsibility report detailing their sustainability performance over the past year, or 2) disclose the relevant information in accordance with one or more ESG reporting frameworks.
Why should companies/organizations care about sustainability and ESG?
Aside from the benefits to the environment and society, sustainability can also benefit the business itself. Many sustainability and ESG-related initiatives are aligned with business goals, at the same time, just as many business-related initiatives can be aligned with sustainability and ESG. The difference lies in the intent behind the initiative. The following are real-world examples of initiatives that address both sustainability and business goals:
Reducing the number of natural resources needed (or wasted) to manufacture a certain product can benefit the environment by conserving those resources but it also benefits the company by reducing overall costs.
Diversity, Equity, and Inclusion initiatives address the governance side of ESG but can also benefit the company itself. As a result of such inclusivity, existing employees may decide to stay and prospective employees may decide to join, thus improving talent acquisition and retention.
Assisting the local community through a food drive or community service event addresses the social side of ESG while also benefiting the company through a positive brand image, possibly helping to cultivate beneficial community connections.
Many environmental regulations are aligned with sustainability to some degree. Therefore, by pursuing certain sustainability initiatives in these areas of regulation companies can be better prepared for any stricter regulations if they come. Furthermore, there is the potential for these companies to qualify for some financial or tax incentives based on different ESG metrics or for implementing different sustainability initiatives.
ESG metrics are important for any organization or business to consider. Various ESG metrics can help identify areas of improvement in a company as well as potential problems before they become serious. ESG metrics are also helpful for tracking progress in a company's sustainability performance. Disclosing ESG metrics and sustainability performance is important for improving transparency, something a greater number of stakeholder groups are looking for in a company.
Sustainability efforts and ESG can also trickle down (or, rather, up) from clients to companies, from companies to their suppliers, and vice versa. If a company or supplier can’t meet their clients’ needs for sustainability, they may lose those clients to another firm that can. Overall, businesses that disclose their ESG performance and/or make efforts to improve their sustainability gain an advantage over their competitors.
What are ESG reporting frameworks?
ESG reporting frameworks help stakeholder groups understand how sustainable a company is by providing measurable and quantitative metrics; thereby enabling comparisons to be made between similar companies as well as displaying measurable improvements to a company’s sustainability efforts.
There are several major ESG reporting frameworks currently being used: GRI Standards, SASB Standards, CDP, and TCFD. Although there are other reporting frameworks out there, those listed above are perhaps the most common.
GRI (Global Reporting Initiative) Standards were some of the first ESG reporting standards to be developed and GRI remains one of the most prevalent ESG frameworks. There are about 32 reporting standards from three sections: environment, economy, and people (though not all of these standards need to be addressed or reported on). Organizations that are reporting in accordance with the GRI standards need only prioritize reporting on their material topics; topics that represent an organization’s most significant impacts on the environment, the economy, and people and their human rights.
SASB (Sustainability Accounting Standards Board) Standards consist of 77 standards for various industries, all of which are focused on the ESG issues most relevant to the financial performance and enterprise value of an organization.
TCFD (Taskforce on Climate-related Financial Disclosures) does not have any standards but rather recommendations for climate-related disclosures around four key company areas: Governance, Strategy, Risk Management, and Metrics and Targets.
CDP (formerly known as Carbon Disclosure Project but now just CDP) consists of three questionnaires for ESG reporting: Climate Change, Water Security, and Forests. An organization can report through one questionnaire or all of them. When completed, organizations are provided a letter grade based on the quantity and quality of questions answered. CDP reporting is completed annually and, in order to qualify for a grade, must be submitted mid-year.
While many of these frameworks differ in the level of detail and information required, they also tend to overlap, working together to achieve their common goal of improved transparency. For example, the climate-change questionnaire for CDP actually addresses all the recommendations from TCFD. This allows organizations to report through CDP while also reporting in line with the TCFD recommendations.
Why are stakeholders asking about sustainability and requesting ESG disclosures through ESG reporting frameworks?
As sustainability has grown in demand, investors, businesses, and other stakeholder groups have started taking it into account when making business decisions. People are becoming more environmentally and socially conscious if only to protect their bottom line. As a result, companies and businesses unable to keep up may lose out on valuable investors, clients, or even employees to competitors that are more sustainable (or at least transparent with their ESG metrics). Companies wanting an extensive sustainability report may request relevant ESG metrics or a complete ESG report from each of their suppliers and distributors in order to determine the full extent of their environmental and social impact. Recently, major automotive companies have requested that their suppliers disclose annual greenhouse gas emissions through an ESG framework or other reporting forum.
Automotive manufacturers, however, aren’t the only ones requesting their suppliers conduct ESG audits. In November, the White House administration proposed a new rule that could roll out in 2023: the Federal Supplier Climate Risks and Resilience Rule. This rule would require federal contractors receiving more than $50 million dollars in annual contracts from the U.S. Federal Government to report their greenhouse gas emissions and assess their climate risks through CDP. Federal contractors with annual contracts between $7.5 and $50 million dollars would only be required to report on their scope 1 and 2 greenhouse gas emissions. On top of this, there is a proposed ruling from the U.S. Securities and Exchange Commission (SEC) about requiring ESG-related metrics in company disclosures.
In general, sustainability and ESG are likely something that companies and organizations will be seeing more of soon, regardless of regulations. Sustainability isn't just about social and environmental impacts, but also about bettering the economy and business as a whole.
