You’re probably already aware that the acronym ESG stands for “environmental,” “social” and “governance.” You may hear a lot about ESG from an investor’s perspective. As an investor, it’s natural to take a good, long look at how environmental, social and governance (ESG) factors can improve your portfolio. Investors have for years been turning out in droves to invest in these types of funds to meet their personal goals and also return positive returns.
ESG reports, on the other hand, show how well a company does with attention toward socially responsible investing.
When companies report ESG data, they need to share as much data with investors as possible and also show them that they meet their ESG commitments. Just 9% of the companies surveyed use software that supports data collection, analysis and ESG reporting, according to the World Economic Forum.
In this article, we’re veering a little wide of ESG investing and focusing on ESG reporting. Companies that report on ESG and stick to disclosure requirements show regulators, investors and competitors how companies commit to ESG. Let’s dig into ESG reporting in more detail, including the definition of ESG reporting, understanding ESG and the criteria for ESG. We’ll also follow that up with how ESG reporting works and why it’s important.
Let’s dig into why both investors and companies want to see evidence of ESG reporting — but not only that. They want to see ESG reporting done well, with adherence to regulations and good intentions to boot.
What is ESG Reporting?
What is ESG reporting? ESG reporting sounds exactly like what it is — a report published by a company or organization about environmental, social and governance (ESG) impacts. It ultimately shows the risks and opportunities a company faces.
Environmental, social and governance areas give everyone who has a stake in the company a complete, comprehensive idea of how sustainable and responsible a company measures on a wide scale of factors.
About 90% of the companies that are part of the S&P 500 have created annual ESG reports and continue to commit to these types of initiatives every year.
Understanding ESG Reporting
In terms of how companies actually report their ESG factors, they disclose this information on a voluntary basis to consultants and agencies that then use their responses to formulate ESG scores, which include qualitative disclosures and quantitative metrics. These scores explain how well companies perform with relation to ESG.
ESG integrates environmental, social and governance risks and opportunities into a firm’s strategy to build long-term financial sustainability and value creation.
ESG reporting can help a company chart its performance, opportunities and strategies for accomplishments in the future.
We already know that ESG stands for “environmental,” “social” and “corporate governance.” Each word of the acronym serves as a benchmark for social responsibility. But what exactly do each of these terms stand for? Let’s find out.
The “E” in ESG stands for the environment and helps companies determine how they handle their direct operations and values. A company may impact the world by helping to limit climate change through greenhouse gas reduction and achieving net zero carbon emissions. A company may also report how it contributes to environmental contamination or natural resource impact, such as how it uses water, land and how it sources other nonrenewable resources.
The “S” in ESG relates to social factors, which can cover a broad range of issues, such as data privacy and security, human rights, community relations and more. They can also interrelate with environmental factors because if poorly managed environmental factors affect larger social issues, such as social trends, labor and politics, it can negatively affect the reputation, resilience and profitability of a company.
The “G” in ESG refers to governance factors, or issues relating to the frameworks and rules outlining responsibilities, rights and expectations of a company. Some examples of governance issues include executive pay, corruption, bribery, political lobbying, tax strategies as well as board diversity and independence.
How ESG Reporting Works
Companies have to take several steps to create and implement an ESG strategy. They must start with goal-setting and end with the disclosure of this information on agencies that formulate ESG scores.
1. Companies implement an ESG strategy.
After implementing an appropriate sustainability strategy, all teams and departments in a company must follow specific sustainability metrics. The company should gather input needed to create a report related to all the departments and stakeholders using a specific reporting framework. Various frameworks should adhere to exactly what the company wants to report.
2. Companies compile their data and inform the public and stakeholders.
Once all metrics have been put in place, totaled up and measured against goals, the public and stakeholders can discover how all environmental, social and governance-related performance fits into the company’s business strategy. Companies should be extremely transparent when communicating progress, even if they don’t meet specific benchmarks during any given time period.
Understanding how well companies meet their ESG reporting can benefit businesses and help stakeholders understand how well you comply with environmental impact and decision-making issues and how these decisions funnel toward financial performance. Businesses can then gain competitive advantage with investors, customers or employees.
3. Companies share benchmarks through global organizations.
Companies don’t have to find themselves alone when sharing their company’s performance and continued sustainable development. Several task force on climate change organizations can help companies with their business models and shore up corporate social responsibility. Organizations can either use the Global Reporting Initiative standards to prepare a sustainability report to report information for specific users or purposes, such as reporting their climate change impacts for their own investors and consumers.
The SASB Standards Board is an independent board that is accountable for the due process, outcomes, and ratification of the SASB Standards. The Sustainability Accounting Standards Board (SASB) guides the disclosure of financially material sustainability information by companies to their investors. The SASB is currently available for 77 industries and can help companies target the right categories of environmental, social and governance (ESG) issues most relevant to financial performance for individual companies.
As an investor, it’s helpful to know that certain bodies regulate ESG topics and business practices and can direct sustainability issues.
In the future, it’s likely that more and more companies will be required to report ESG information. For example, regulations have made ESG reporting and complying with ESG metrics mandatory in Europe. In April 2021, the EU Commission presented a new proposal for a Corporate Sustainability Reporting Directive (CSRD), which affixes stricter standards to the Non-Financial Reporting Directive (NFRD). Now, up to 50,000 European companies will be required to report on ESG-related factors.
4. Stakeholders can then make appropriate decisions.
In recent years, ESG reporting has only continued to ratchet up in terms of stakeholder priorities and helping investors make investment decisions. People want to work with and invest in companies and providers that put a large priority on methodologies related to sustainability, care for biodiversity and which address climate risk and corporate social responsibility.
A survey from First Insight shows that younger individuals (Gen Z individuals, in particular) want to work and buy from companies that support global sustainability and follow ESG reporting standards. Fidelity Investments reported that financial companies that put a priority on ESG performance also fare better in the financial markets.
Why is ESG Reporting Important?
Should companies invest in ESG for just moral reasons and just to get ahead of regulations? Sure, it’s better for businesses to get ahead of regulations, because corporate ESG data reporting will continue to ramp up. Though the United States has yet to see heavy-handed regulatory ESG requirements, it’s still important for all companies to recognize how much more important ESG factors have become for various stakeholders.
Businesses that leave ESG out of their overall business strategy may even see decreasing returns and cause individuals (especially young people) to choose to buy, invest and work elsewhere. It’s best to have an intrinsic, heartfelt motivation to pursue ESG metrics — stakeholders want to invest in companies who truly do want to change the world. (Consider Blake Mycoskie of Toms shoes, who tried to change the world by donating one pair of shoes for every pair of shoes bought to an underserved individual. Talk about evidence of awesome social governance!)
As ESG continues to break away as an important topic for stakeholders across the world, it’s worth mentioning that adhering to ESG standards might cost companies money. In fact, the Harvard Business Review mentioned that a company that spends large amounts of money trying to address every possible environmental, social and governance issue will likely worsening financial repercussions. However, it’s a tricky matter because companies that focus on material issues tend to outperform companies that don’t try to impact their wider outreach with ESG reporting.