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What is ESG? A Guide to Environmental, Social, and Governance
Companies face increasing pressure to disclose their sustainability practices and social responsibility due to growing ESG relevance. Customers, employees, and investors demand organizational transparency. Governments, on the other hand, are enacting regulations that promote ESG and reporting obligations. Failure to take ESG seriously can lead to competitive disadvantage, risk of long-term performance and profitability, as well as regulatory violations.
This article details ESG and how your business can start with ESG reporting.
Contents
ESG is a regulatory framework representing three main pillars: environmental, social, and governance. These pillars are objective criteria for assessing a company or business's sustainability and ethical impact. The assessment process involves various quantitative and qualitative methods, which results in an ESG score.
ESG ratings are directly related to a company's long-term performance and risk management, making them important to stakeholders, investors, analysts, and organizations.
ESG data is becoming a growing concern for the public. Customers, suppliers, and employees of companies are paying attention to issues such as diversity and gender equality. People want to engage with businesses that align with their values and ethics.
Compliance with environmental, social, and governance factors is no longer optional. Governments worldwide require corporations to address these issues through mandatory reporting, legal requirements, stress testing, and other means.
ESG factors, also known as ESG criteria or indicators, are the main elements of the framework. These factors provide a comprehensive understanding of how a company manages its environmental impact, interacts with society, and ensures responsible governance.
Essentially, the environmental criteria to the preservation of the natural world. Companies are encouraged to evaluate their environmental practices and impact on the planet. They are encouraged to commit to sustainability and minimize their carbon footprint by installing key considerations, such as water waste.
Here are some examples of issues that fall under environmental scope:
Social factors refer to a company's impact on its employees, customers, and community. These factors encompass a myriad of issues, starting from labor practices to human rights.
Companies are responsible for fostering a positive corporate culture and building lasting relationships with financial stakeholders and the community. Furthermore, companies need to ensure that they maintain a balance between profitability and corporate social responsibility. This requires constant examination of issues such as:
Governance ESG factor pertains to the management and leadership of the organization. It analyzes whether all levels of the organization engage in responsible and ethical behavior, effective decision-making, and accountability.
Here are some of the most important governance data points:
Sustainability and ESG are often used in the same context or even interchangeably. While similar, these terms have different meanings. Sustainability is a broad term that describes various actions a company can take to mitigate the negative environmental, social, and economic impact caused by its operations.
ESG, on the other hand, is an objective framework often used by investors and regulators to assess a business's sustainability and social and ethical impact.
While both practices involve environmental issues, the overall scope and focus differ. Sustainability encompasses various dimensions and can include any effort taken to prevent the depletion of natural or physical resources. It is concerned with business operations' impact on ecosystems, humans, and the wider economy.
ESG, on the other hand, is more specific. It is a narrower approach that focuses on the environmental issues and social aspects of a company's operations, as well as its corporate governance practices. Unlike sustainability, ESG often excludes the broader economic context from its rankings.
Both sustainability and ESG are concerned with ensuring that organizations' operations do not compromise the livelihood of current and future generations. They serve to ensure ethical, environmentally conscious, and community-focused practices.
However, the ultimate goal and application of these concepts are different. While reporting is an important part of sustainability, it's more focused on determining if companies are actually taking action to ensure sustainability-focused obligations. Various sustainability frameworks are used to determine if companies are serious about minimizing negative impact and monitoring the performance of their sustainability strategy.
ESG is mainly known as the reporting framework. It aids companies in communicating their sustainability initiatives and tracking their performance. This framework allows to identify companies that are likely to be financially successful in the long term because of their strong environmental sustainability and social practices. For this reason, many stakeholders, such as investors, base their investment decisions on ESG data.
Environmental, social, and governance framework is much more than a regulatory demand. It's an important set of practices that addresses a range of ethical, financial, and societal considerations that impact both businesses and the world at large.
Here are several essential reasons why ESG should not be overlooked:
The origins of ESG investing can be traced to the socially responsible investing (SRI) movement that gained traction in the 1960s and 1970s. SRI served as a means of helping people match their financial assets with their personal values. Companies that engaged in socially undesirable activities, including the production of cigarettes or the manufacturing of weapons, were filtered out by SRI funds.
The SRI movement occurred on par with ESG's predecessor, EHS (environment, health, and safety). This regulation was introduced due to the growing concerns about pollution, deforestation, and resource depletion caused by the pursuit of economic growth.
Until ESH was born, many campaigns were launched pressuring companies to ensure environmentally conscious and ethical business practices. Companies even attempted to take charge themselves with the Corporate Sustainability movement. However, their focus often appeared to be more on presenting their environmental practices positively than actually making a difference.
The term ESG was first coined in a 2004 report by the United Nations called Who Cares Wins. The report argued that ESG investing could help to improve the long-term financial performance of investments, as well as address some of the world's most pressing environmental and social challenges.
In 2016, the Global Reporting Initiative (GRI) introduced its sustainability reporting guidelines, providing a framework for companies to disclose ESG information. During this time, sustainable and impact investing started gaining momentum, with more institutional investors now seeking to align their portfolios with ESG principles.
The significance of ESG was further emphasized when The Paris Agreement was adopted in 2015, setting ambitious goals to combat climate change. Later on, regulatory bodies increased ESG requirements.
Currently, ESG's importance is growing. In 2021, the European Commission adopted the sustainable finance package, increasing the scope of ESG reporting, affecting more companies than ever.
ESG investing, also known as sustainable investing or socially responsible investing, is an investment approach that considers environmental, social, and governance factors alongside traditional financial criteria when making investment decisions. ESG investment research and investors believe that companies with strong ESG practices are better managed, more resilient, and better positioned for long-term success.
As more investors become aware of ESG and its benefits, its importance will likely grow.
Here are the main benefits of ESG investing:
However, ESG investing also comes with challenges. Currently, there is no one ESG investing standard, making it difficult to compare different funds. Additionally, ESG funds may have higher fees than traditional funds. It's worth considering that some companies may make misleading claims about their ESG practices, known as greenwashing.
ESG and sustainable investing contribute to a more responsible and impactful investment landscape. ESG investing and sustainable investing aim to integrate environmental, social, and governance considerations into investment decisions, but they approach this goal differently.
ESG investing evaluates companies based on performance in the three ESG dimensions: environmental, social, and governance. Sustainable investing takes a broader approach by considering both ESG factors and broader societal and ethical criteria for investment choices.
With the rising demand for ESG-related information, reporting is vital for transparency and regulatory compliance. ESG reporting is a way to disclose a company's environmental, social, and governance performance data. The report needs to provide factors and metrics related to what the company has done or is planning to do in terms of ESG responsibilities.
While primarily ESG reporting is most relevant for ESG investors and regulatory bodies, the scope of stakeholders has expanded. Nowadays, ESG reports are relevant to employees, suppliers, regulators, and even an organization's community members.
An ESG reporting framework is a broad set of guidelines and methodologies that can be applied in the ESG reporting process. ESG frameworks often provide a structure for companies to assess their unique ESG-related impacts and initiatives, allowing them to tailor their strategies according to their industry, size, and specific challenges.
Currently, there is no single ESG reporting framework. As a result, companies may opt to create their reporting structure based on criteria relevant to their industry. However, they can also benefit from various available reporting frameworks. For instance, Microsoft is using TCFD and GRI frameworks. What are they? Let's take a look at the most common ESG reporting frameworks.
Global Reporting Initiative is an independent organization that issues standards and frameworks for companies to report non-financial information. In 2010, it released the GRI Standards framework, which provides comprehensive guidelines for sustainability reporting.
This widely recognized and used set of guidelines provides a structured approach for companies to disclose their economic, environmental, social, and governance impact and initiatives to various stakeholders, including investors, customers, employees, regulators, and the general public.
The Standards are designed as an easy-to-use modular set that conforms to the relevant company's industry and needs. It consists of universal standards, which applies to all organizations, sector standards that help report sector-specific impact, and topic standards, which is a list of disclosures related to a particular topic.
The Financial Stability Board (FSB), an international body for promoting global financial stability, issued the Task Force on Climate-related Financial Disclosures (TCFD) framework in 2015. This initiative promotes consistent and effective disclosure of climate-related financial risks and opportunities by companies and organizations.
The TCFD framework is designed to help companies provide transparent, useful, and decision-useful information to investors, lenders, insurers, and other stakeholders. It encourages organizations to integrate climate-related considerations into their financial planning and reporting processes.
The framework consists of 4 key elements:
Launched by the United Nations in 2000, The United Nations Global Compact (UNGC) is a non-binding UN pact encouraging businesses and organizations to adopt sustainable and socially responsible policies and practices.
The UNGC provides a framework for companies to demonstrate their commitment to responsible business conduct and contribute to achieving sustainable development goals.
This framework is based on ten principles that are divided in 4 areas:
Human Rights:
Labor:
Environment:
Anti-Corruption:
ESG software is designed to streamline data collection, analysis, reporting, and decision-making related to sustainability and responsible business practices.
It can contribute to ESG performance by:
Flanco ESG solution can help you achieve your ESG performance and reporting goals. Data shows that the building operations sector is the biggest culprit of global CO2 emissions. By implementing Flanco building operations digitization, your company can track ESG metrics and make data-driven decisions. Get in touch, to learn how our ESG data management solution can optimize sustainability performance, attract investors, and drive profitability.
