The Future of ESG Reporting for Sustainable Companies

ESG Overview

Investors globally are increasingly embracing ESG standards, which focus on factors such as, human wellbeing, the environment, and the welfare of the economy. ESG concept was initially introduced in the United Nations Principles for Responsible Investment in 2006.

Notably, the interconnectedness between the planet, people and profits, has been more revealed during the covid-19 pandemic, which has accelerated the integration of ESG principles into investment and business policies.

What is ESG?

ESG stands for Environmental, Social and Governance issues, which underpin the sustainability, ethical operations and financial performance of an organization. ESG reporting by companies provides data on how their operations influence environmental, social and corporate governance areas. ESG reports are used by potential social conscious investors to screen for beneficial and ethical investments.

ESG factors cover several topics that underpin all organizations and industries, some of the wide scope issues include:

Environmental Issues

The environment is affected by global production processes and consumption, which contribute to environmental concerns such as:

Climate change
Waste and pollution
Water and energy efficiency
Biodiversity
Deforestation
Resource depletion
Greenhouse gas (GHG) emissions

Social Issues

Social factors encompassed in the ESG relate to human wellbeing, which is the responsibility of investors and companies to ensure they concern themselves with social issues such as:

Working conditions
Human rights
Equal opportunities
Employee diversity
Community engagement
Health and safety
Philanthropy
Child labour and slavery

Governance Issues

Governance in ESG relates to control methods that must be observed by organizations, to avoid getting into conflicts with the law, to facilitate long-term benefits for employees, society and shareholders. Some of the corporate governance concerns covered in the ESG include:

Business ethics
Board diversity and structure
Executive pay
Bribery and corruption
Tax strategy
Political lobbying and donations
Compliance

EU Taxonomy in ESG

EU taxonomy is described as a common system of classification for sustainable environmental and economic activities that scale up the implementation of the European Green Deal and sustainable investment. The Taxonomy Regulation established officially in July 2020, provides a framework that must be considered by the EU taxonomy when classifying economic activities that qualify or pass as environmentally sustainable.

The EU Taxonomy Regulation caters for six major environmental objectives that must be adhered to by sustainable organizations;

Climate change mitigation
The sustainable use and protection of water and marine resources
Climate change adaptation
Pollution prevention and control
The transition to a circular economy
The protection and restoration of biodiversity and ecosystems

Importance of Taxonomy in ESG

Taxonomy regulations present a criterion for investors to evaluate an economic activity and see if can be considered environmentally sustainable before investing. Some of the key benefits of ESG Taxonomy to investors and companies include:

Project certification

Investors can certify the validity of a project by evaluating the activities involved and comparing the project’s sustainability with the taxonomy regulation for sustainable investing. The government and legal jurisdiction of a country where an investment is being implemented are involved in project certification, based on its compliance with environmental, social, and economic sustainability provided in taxonomy regulation objectives.

Greater clarity for investors

Taxonomy in ESG is essential in providing greater clarity for investors to understand the various environmentally sustainable objectives, which should be observed in all economic activities undertaken by responsible investors. The taxonomy classification list of sustainable economic and environmental activities points investors to the right activities and projects with lower risks and higher long-term returns.

Sustainable economic activities

Companies can evaluate sustainable economic activities as provided by the ESG taxonomy list before investing in projects. Sustainable economic activities qualify as environmentally friendly or sustainable by meeting the six Taxonomy Regulation objectives.

How ESG Measures Sustainable Impact

The level of observance of ESG principles by organizations and investors can be perceived as a measure of a company’s sustainability. ESG Reporting is relevant in the measurement of sustainability impact, by providing factual quantitative and qualitative data relating to an organization’s operations, and its impact in areas of environmental, social, and corporate governance. ESG reports that indicate positive impacts show that companies are striving towards sustainability and are paying attention to concerns of the environment.

Impact of Financial Investment in ESG

ESG investing has significantly increased especially with the recent 2020 Covid-19 pandemic that has caused uncertainty and market disruption, pushing investors into giving high priority to ESG funding to increase resiliency. According to BCG, $30.7 trillion was invested globally in 2018 to mitigate negative corporate engagement, with an increase of 34% of the amount in the following two years. The first three months of the Covid-19 pandemic saw about $45.6 billion flow into the ESG funds.

More investors are evaluating ESG reports produced by companies before investing to measure the level of sustainability supported in their compliance with ESG regulations. Portfolios that feature higher investment in ESG sustainability are deemed to perform better financially due to higher returns on ESG funds invested as a result of higher resilience against market disruptions.

4 Key Factors that Improve ESG Reporting

ESG reporting was initially done by companies to boost their brand and for PR. However, now ESG reporting has become a mandatory organizational function since regulators tapped into the importance of ESG data. Recommendations to improve ESG data reported by companies have been presented below aimed at shaping and impacting the future of ESG reporting.

Focus on Universal Disclosures

Lack of comparability in ESG reports has long been a challenge, where companies can randomly pick ESG factor that affects them and the ones that do not. This leads to companies presenting a jumble of useless ESG data. Europe has presented new proposals relating to Universal Disclosure, where regulators select a subset of about 20 ESG topics that all companies will be required to report on. Universal disclosure is estimated to improve the quality of ESG data presented by companies globally to measure their compliance with ESG standards.

Allowing Sector Disclosures

In as much as universal disclosure is considered vital for streamlining ESG reporting globally, some ESG issues have been reported to be irrelevant to some business sectors. The Sustainability Accounting Standards Board (SASB), has emphasized the implementation of sector standards in ESG reporting to increase specificity in reports obtained from various industries globally.

Introduction of Dual Materiality

Materiality is deemed to influence the ESG topics that companies opt to report on, but proposals from Europe suggest that regulators should decide on the ESG topics that should be discussed by companies based on dual materiality. The dual materiality concept reflects on investors’ interest as well as ESG sustainability, where both aspects are considered important. For example, employees’ poor working condition may have no financial significance to investors, but when addressed materially it undermines the standards of social responsibility in ESG principles.

Convergence of ESG Reporting Standards

Different countries portray different ESG reporting standards, which affect uniformity and consistency. Overlapping standards presented by various companies increase the confusion, which has driven the IFRS to suggest the convergence to one acceptable reporting standard internationally.

How ESG Adds Value to Organizations

ESG is often looked at from the scope of the company's responsibility to the society, but fail to recognize various significant values presented by ESG to companies.

Company Growth

Compliance with ESG standards builds the company’s reputation and recognition, allowing the company to drive greater consumer preference and acceptance hence expanding its market gap. Companies that conform to ESG guidelines find it easier to expand since they can gain government approval and licenses to tap into new opportunities.

Reduction of Operation Costs

Implementation of ESG standards and investing in risk mitigation policies help minimize expenses that arise from risk occurrence. Part of ESG standards includes establishing resource efficiency like using renewable forms of energy, which significantly improves financial performance.

Reduces Legal Intervention

Complying with environmental, social and corporate governance guidelines keeps organizations safe from lawsuits, closure and fines which are habitable for investors. Also, companies that obey the law are bound to attract government subsidies and support which advantageous to the profitability of the company.

Increased Employee Performance

Organizations thrive greatly when they can attract skilled talents and retain high-quality employees. Providing suitable working conditions, training, motivation, diversity and inclusivity are part of social responsibility actions recommended by ESG that stimulate improved performance from the organizational workforce.

High Returns from Sustainability Investment

Investing in strong ESG policies can extensively increase capital to more sustainable and promising opportunities such as waste reduction can increase resource efficiency. Investment in ESG standards helps companies avoid stagnant projects that may be stranded by environmental issues.

Conclusion

ESG standards present ethical social and environmental responsibilities that companies globally must comply with in their transactions. ESG compliance has also become a factor of consideration by investors who purpose to gain long-term benefits. Companies benefit immensely from their adherence to ESG standards, which necessitate most organizations to implement the ESG principles.