What is ESG?
Today we’re here to talk about ESG reporting.
In the past year we’ve been talking a lot about communicating your impact to your audience. Remember in our golden rules to effectively communicate your impact, we talked about communicating your why and your how. But is that it?
The answer most certainly is no. With the increased problem in greenwashing, there is one topic that is becoming the center of attention: Reporting standards. More specifically, Environmental, Social Governance (ESG) reporting.
ESG reporting is creating, verifying, and publishing information related to ESG issues in two directions: how ESG impacts the business and how the business impacts the ESG aspects. Over the years similar work has been called integrated reporting, non-financial information disclosure, etc.
These reporting standards help companies back up their claims in their communication. It helps their stakeholders verify what they say and how they achieve it. More importantly, having the ability to report on ESG helps decision makers of the company make strategic decisions based on measurable, and comparable data.
The “G” in ESG
As an impact-maker, the “E” and the “S” in ESG is most certainly already embedded into your business model, however the “G” is much less talked about.
Governance in this context can refer to many things but we want to focus on the decision making, policy setting and disclosure process of the company. The governance of a company is something that is very important to the key stakeholders of the company when the company starts to grow and go beyond just being you and yourself.
Like we mentioned earlier, customers care about your why and your how. But it’s more complex than that. Where do you get your numbers from? How do you support that claim?
Customers care about it because the decisions made by this small part of the company changes the direction the company operates in, and hence the decision in whether they would like to continue being a customer of this brand, or another.
Investors care about it because it directly drives customers to or from its consumption, impacting the revenue of the company. They also care because every investor wants to know what risk they will bear by investing their trust and money into this company. Is the company on borderline doing money laundering activities? Do they disclose their revenues honestly to authorities? The consequences of not doing so properly will most certainly impact their return on investment.
The list goes on…
ESG is a mere representation of a company’s values?
ESG is not really about the values that a company carries, but about the way they can create (and keep creating) long-term value, managing the risks and opportunities that come with them. This is why, risk analysts and investor advisors are also looking for ways to benchmark companies and their ESG claims.
For example, how does a company respond to a natural resource crisis that could cause loss of supply in part of their supply chain? These are important risks that go beyond whether a company’s values incorporate care for the environment, however most of the time the mitigation of these risks are achieved by being a socially and environmentally responsible organization.
Currently, large corporates are finding ways to measure and back up their environmental and social claims, and the need for standards that will help investors, consumers, and authorities to recognize those efforts is becoming increasingly important.
Challenges with ESG reporting
Can you guess what the main issue is here? Lack of standards.
Let’s for a second think about financial accounting and imagine if we lived in a world where international financial reporting standards (IFRS) did not exist. How could a potential investor, or the tax authority, or even the owners themselves, be able to compare the performance against companies, and their financial health?
This globally understood language called accounting certainly still has a lot of local variations. However, it allows the public to be able to obtain at least a very high-level common understanding of the situation at the very least. These standards took over 20 years to build, and refine, until it has reached its maturity today.
Warren Buffet once mentioned that “Accounting is the language of business”.
In today’s world we require a more holistic way to talk about business, and that language needs to change from financial accounting to ESG reporting.
Until now, ESG has been largely voluntary. With the increase attention on the role that businesses have towards our sustainability objectives, this will soon no longer be the case, and companies will need to adopt some reporting mechanism or the other. For instance, under the European Green Deal, we already witnessed the first steps with the Non-financial Reporting Directive – Corporate Sustainability Reporting Directive.
As a small annotation, there are also many companies that offer ESG ratings at present. These companies are such as Dow Jones, Bloomberg, etc. From our point of view, whilst these are reputable companies with large teams of analysts, the rating frameworks are vastly different and rarely comparable against each other. This is only another confirmation that the overall measurement and reporting of ESG still has a lot of room for interpretation.
Having said that, we are seeing tremendous efforts in trying to align these interpretations. For example, the “Big 4” consultancy firms (PWC KPMG EY Deloitte) have joined forces to create a common ESG framework with common key components. The future for a more standardized approach is looking promising.