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Future of ESG part 1: Three Letters Transforming Business

E-S-G. These three letters have been transforming the conversation around sustainability reporting. ESG stands for Environment, Social, and Governance. The letters alone might not mean much, but together they represent an entity’s behavior on environmental issues, its engagement with society, and the strength of its governance.

The concept of ESG first arose in 2001, when the index provider FTSE began integrating environmental and sustainability factors into its indices. At first, ESG reporting was not common practice among companies and was almost exclusively associated with morally-driven investment decisions. The information disclosed also varied significantly, with no structure, guidance, or consistency.

However, with time, ESG information has generated more attention from investors and stakeholders, who’ve begun attributing economic value to ESG principles. This has had the radical effect of influencing more companies to disclose their ESG efforts and in more structured and consistent reports. Today, there is greater attention on ESG performance, which in the past appeared in only one or two annexed pages of the entity's annual report, now often grab the spotlight. With this increased awareness, though, comes increased scrutiny.

Watch our on-demand webinar, From Requirement to Opportunity: The Evolving World of ESG, to hear more from companies and investors on how ESG disclosure is driving industry forward.

The rise of ESG regulations and policies

As the number of corporate ESG disclosures soars, geographies around the world are confronting the challenge of standardizing and ensuring the legitimacy of sustainability communications. The Carrots & Sticks 2020 report, which assesses the regulatory landscape of non-financial and sustainability reporting, published three interesting insights related to this trend:

  • The total number of voluntary and mandatory provisions in different countries has been increasing considerably since 2006.
  • Governments and financial regulators remain the most active in issuing reporting requirements and guidance (reporting provisions), followed by stock exchanges and industry bodies.
  • Europe is the region with the largest number of reporting provisions with 245, followed by the Asia Pacific with 174.

Arguably, the most ambitious upcoming regulation is the European Green Deal, which aims to achieve climate neutrality by the year 2050. In order to achieve this goal, the European Commission has published several ESG-related measures, including the non-financial reporting directive, the Sustainable Finance Disclosure Regulation, and the Taxonomy Regulation.

To keep pace, the European Financial Reporting Advisory Group (EFRAG) and EFRAG’s Project Task Force published a report recently that proposes a roadmap for the development of EU sustainability reporting standards beyond the implementation of the aforementioned instruments.

The United States is also moving to enforce ESG reporting compliance. The SEC has announced a new task force dedicated to rooting out and addressing false or invalid ESG and climate claims and misconduct. Ensuring sustainability and environmental claims are legitimate enables investors to increase their focus and reliance on ESG-related disclosures to inform investment decisions. The Biden administration has also enacted a number of executive orders associated with ESG, the most recent of which requires the federal government to assess and build a strategy to disclose and act on climate risks.

ESG reporting definitions and standards

International frameworks, indices, and initiatives, such as the UN 2030 agenda, sustainable development goals, and the Paris Climate Agreement are increasing and deepening the number of ESG topics that companies report on. As a result, different frameworks, standards, ratings, and indexes with international recognition have started to guide ESG reporting, and have continued to evolve ever since. These four instruments are complementary and can work alongside each other. It’s important to note that no one instrument or tool is required as of today. Schneider's sustainability team defines these instruments as below:

  • Standards are metrics based on processes that provide specific rules for ESG measurement and disclosure. ESG Standards dictate what data and information companies should report.
  • Frameworks are high-level guidelines that provide principles and guidance for how data and information should be disclosed.
  • Rating agencies develop surveys and methodologies to gather ESG data and information from companies.
  • Indexes compile data and information into a single metric and represent a particular market or strategy. Indexes allow investors to track the performance of a company concerning their ESG efforts.

Some of the most relevant ESG tools that are paving the road for sustainability reporting are depicted below:

The fact that so many of these tools exist reflects the importance and evolution of ESG disclosure. However, understanding and following different guidelines can be quite confusing for companies. This is especially true as reporting standards not only become more numerous, but also more sophisticated and mature. With this continuously evolving complexity, it can be challenging to identify the most suitable frameworks and standards for disclosure for your business and how to best use them to communicate your company’s ESG profile to institutional and, increasingly, retail investors.

Click here for part 2 of this blog to learn more about the convergence of ESG reporting schemes, and get 3 tips for making the most of your ESG communications strategy.