Environmental, Social and Governance Disclosures – Accomplishing Value with Values in Business
Work with integrity, ethically strong, ecologically responsible, social welfare, sensitive to human needs, businesses today are expanding their horizons to imbibe strong values as a step towards sustainability. In the evolving world monetary value is seen much narrow and short-sighted when compared to values in business. Where value is perceived from the perspective of financial returns and governance, values are recognized in terms of environmental and social returns. If we broadly classify the issues wherein environment related issues deal with scarcity of natural resources, impact on climate change, changing demographics; Social issues range from reputation of organization, labour conflict, social impact of certain products/activities. On the other hand, governance issues are more attributed towards poor management practices, board compositions, anti-bribery and corruption policy, participation of shareholders.
Different Stakeholders define these issues based on their outlook. Whereas ecologist look them as a matter of social responsibility, activist as moral responsibility, investment managers take them as fiduciary duty to see the risk and returns are better controlled.
Environmental, Social and Governance popularly known as ESG is not a new phenomenon and was in practice since long with different names like responsible investing, socially responsible investing and was even mandatory to report in many countries. The primary aim for responsible investment was to see more towards investments with moral and societal values rather than looking only for value in form of return on investments. Socially responsible investing look at long term prospective in comparison to value returns that are short term. Even the issues like climate change were seen as burden and left to government and regulators to deal by many businesses. In many countries, green bonds and social impact bonds are being issued in line with progress achieved. In spite of various regulations made and disclosure mandated, the global community always feel challenged to consider ESG issues on account of different reasons such as:
- Methodological and Valuation Deficits: Non availability of any methodology for assigning monetary values to ESG issues like Air Pollution and fitting them into quantitative models (more subjectivity).
- Absence of Global Standards: No Standards for ESG disclosure and disclosures remain unverified.
- Perception of External Responsibility: Organizations always feel that ESG issues are the responsibility of regulators and Governments.
- Horizon Mismatch: ESG issues influence the financial position in long run whereas investors are often concerned for short term gains.
- Quantitative Data Gap: Data related to ESG is not available in quantitative terms. Integration of ESG info with financial statement is a challenge in absence of standards.
- Causal Uncertainty: There was no established causal relationships to link ESG and Financial performance.
- Lack of Uniform Regulation: No Regulatory requirement across the board for disclosure of ESG.
- Capability Constraints: Capability of finance team to account the ESG related issues.
- Regional Inconsistency: There is no uniformity of ESG practices across the organizations and regions.
However, with the passage of time and as outcome of UN supported “principles for Responsible Investments (PRI)” framework, keen interest is being taken taken by regulators, standard developers along with investors for more sustainable investment, ESG has started gaining acceptance. ESG issues are not only looked for mitigating risk, proxy of management quality, reputational benefit but also as moral duty of society towards sustainability. ESG issues inculcate the introspections that organization whose activities/product are not climate or society health friendly, will not get the desired investment. If there will not be good labour relations, product of a company will impact health of society, then the sustainability of the organization in long run will be questionable and will not get the desired resources in term of investment. So, it is beyond values (moral duty) and sustainability will be in question if one will not follow and disclose ESG issues.
Understanding this change, a number of principles, standards, regulatory requirements, conventions are getting developed and number of international forums/organizations are playing important role in this process including UN, IIRC, OECD, WEF and GRI. Based on these principles, even the investment managers develop various methodologies to identify the organization wherein investment will be more sustainable.
Methods like exclusionary screening, best in class selections, thematic Investing, active ownership, impact investing and ESG integration are being used by Investment managers to identify the organizations for more sustainable finance. Out of these, ESG Integration based on certain ESG criterion has become very popular over a period of time.
“Methods like exclusionary screening, best in class selections, thematic Investing, active ownership, impact investing and ESG integration are being used by Investment managers to identify the organizations for more sustainable finance.”
ESG – Methodology to achieve SDG 2030
ESG disclosure got more relevance in recent past with the evolution of Sustainable Development Goals (SDG 2030) wherein number of goals like good health and well being (SDG 3), gender equality (SDG 5), decent work and economic growth (SDG 8), responsible consumption and production (SDG 12) and climate action (SDG 13) are very closely related to ESG. Being more or less every jurisdiction is the signatory of UN SDG Goals. It is not only the Government and regulators but the organizations also carry the responsibility for promoting sustainability.
Alignment with United Nations Sustainable Development Goals (SDG 2030):
Recent Global Developments
Looking into the importance of ESG reporting, in recent past there are global initiatives to address all the concerns including identification of ESG issues, their quantification, objectivity, and universal applicability. Various International Forums/Organizations laid down the preamble on which not only organizations have started disclosures, various funds are launched for responsible investing but also efforts are on to develop eco-system to standardize the reporting, disclosure and integration of ESG issue with financial reporting.
Initiatives for Harmonise Disclosure Standards
The International Financial Reporting Standards Foundation (IFRS Foundation) formed a working group to focus on harmonizing global sustainability reporting standards in preparation for a potential international sustainability standard board which will offer technical recommendations as a potential basis for the new international sustainability standards board to build on existing initiatives and develop standards for climate-related reporting and other sustainability topics. International financial regulators have been calling for greater consistency among the various environmental, social and governance standards and frameworks as ESG funds grow in popularity with investors, five organizations, i.e., Sustainability Accounting Standards Board (SASB), the International Integrated Reporting Council (IIRC), the Global Reporting Initiative (GRI), the Climate Disclosure Standards Board (CDSB) and the Carbon Disclosure Project (CDP) planned to harmonize their various standards and frameworks to provide more consistency. The World Economic Forum will contribute its work on cross-industry metrics and disclosures that CEOs of a wide variety of large multinational companies have found to be important for disclosure. The IFRS Foundation trustees anticipate that sustainability reporting standards issued by the new board will provide a global sustainability reporting baseline that will allow for better comparability and consistency of application of the standards, while also offering flexibility for coordination on more jurisdictional and multi-stakeholder reporting requirements by taking a “building blocks” approach. A recent statement by Ms. Janet Yellen US Secretary (Treasury) also affirm commitment towards need for initiatives to set climate and sustainability reporting standards. She expressed her support for the International Financial Reporting Standards Foundation’s (IFRS) work to establish a Sustainability Standards Board that will focus first on developing a climate disclosure standard.
EU Extends Mandatory Sustainability Reporting to 50,000+ Large and Listed Companies
In a recent announcement, the European Commission (EC) adopted a comprehensive package of sustainable finance measures, with rules and proposals encompassing ESG reporting requirements for companies, fiduciary duties relating to sustainability risks, and the EU Taxonomy classification system for sustainable investments. According to the Commission, the new package aims to enable investors to re-orient investments towards more sustainable technologies and businesses, helping make Europe climate neutral by 2050. The new package proposes strengthening the rules under the Non-Financial Reporting Directive (NFRD), the EU directive requiring companies to disclose information on the way they operate and manage social and environmental challenges. The proposals extending the NFRD sustainability reporting requirements to all large and listed companies, meaning that nearly 50,000 companies will now need to follow detailed EU sustainability reporting standards. The Commission has also proposed the development of a separate set of proportionate standards for SMEs. The package also contains the EU Taxonomy Climate Delegated Act, which aims to identify which economic activities contribute to meeting the environmental objectives. This package establishes the first set of technical screening criteria for the first two categories, climate change adaptation and climate change mitigation. Additionally, the package contains amendments to the rules relating to investment and insurance advice, fiduciary duties, and product oversight and governance, including requirements for advisors to assess and discuss clients’ sustainability preferences, and financial firms to consider sustainability risks on investments, and to incorporate sustainability factors when designing financial products.
Jurisdictions making ESG Disclosure Mandatory
In recent developments, UK made it to have mandatory disclosure in line with the Task Force on Climate-related Financial Disclosures (TCFD) following the issue of its first ever sovereign green bond. While many companies across the globe have ramped efforts to operate more sustainably in recent years, and investors have increasingly pursued ESG integration in their investment decision-making, many often report that one of the greatest obstacles to these initiatives remains the lack of consistent, reliable data to know where to target efforts and to measure, analyse and track progress. The TCFD was established to help address these issues.
In another development, New Zealand Minister for Climate Change, Mr. James Shaw announced that the country is aiming to become the first in the world to require the financial sector to report on climate risks. Businesses covered by the requirements will have to make annual disclosures, covering governance arrangements, risk management and strategies for mitigating any climate change impacts. The new rules will come into effect by 2023.
ESG Factors/Issues & Industry Level Materiality Map
In spite of all round development and acceptability of ESG issue and adoption for disclosure, still there is always a challenge to capture all ESG issue which need to be reported. Different jurisdictions, regions and even nature of organisation require different parameters to disclose compliance on ESG issues. To illustrate a sample of issues are highlighted in below table:
| Dimension | Issue Category | Infrastructure Relevance |
|---|---|---|
| Environment | GHG Emissions | ■ Likely Material |
| Air Quality | ■ Likely Material | |
| Energy Management | ■ Likely Material | |
| Waste & Wastewater Management | ■ Likely Material | |
| Waste & Hazardous Materials Management | ■ Likely Material | |
| Ecological Impacts | ■ Likely Material | |
| Social Capital | Human Rights & Community Relations | ■ Likely Material |
| Customer Privacy | □ Not Likely Material | |
| Data Security | □ Not Likely Material | |
| Access & Affordability | ■ Likely Material | |
| Product Quality & Safety | ■ Likely Material | |
| Customer Welfare | □ Not Likely Material | |
| Selling Practices & Product Labelling | □ Not Likely Material | |
| Human Capital | Labour Practices | ■ Likely Material |
| Employee Health & Safety | ■ Likely Material | |
| Employee Engagement, Diversity & Inclusion | ■ Likely Material | |
| Business Model & Innovation | Product Design & Lifecycle Management | ■ Likely Material |
| Business Model Resilience | ■ Likely Material | |
| Supply Chain Management | ■ Likely Material | |
| Materials Sourcing & Efficiency | ■ Likely Material | |
| Physical Impacts of Climate Change | ■ Likely Material | |
| Leadership & Governance | Business Ethics | ■ Likely Material |
| Competitive Behaviour | ■ Likely Material | |
| Management of Legal & Regulatory Environment | ■ Likely Material | |
| Critical Incident Risk Management | ■ Likely Material | |
| Systemic Risk Management | □ Not Likely Material |
“While many companies across the globe have ramped efforts to operate more sustainably in recent years, and investors have increasingly pursued ESG integration in their investment decision-making, many often report that one of the greatest obstacles to these initiatives remains the lack of consistent, reliable data to know where to target efforts and to measure, analyse and track progress.”
Initiative of Stock Exchanges across the globe to publish ESG reporting by Listed Companies
58 of the 107 stock exchanges have published ESG reporting guidance for their listed companies. These Stock exchanges made it compulsory for Listed companies to report either on GRI or norms developed by other forums/task force based on importance of different stakeholders, which ESG factors were selected and how; developing such a statement is also an opportunity for the board to reflect on the company’s role in society and contribution to sustainable development.
It can provide transparency regarding the board’s position on and oversight of the company’s ESG risks and opportunities, and strengthen the company’s credibility when communicating on ESG factors. Few of them also issues advisory/guidance for reporting on ESG issues like:
- Singapore Exchange (2011): Guide to Sustainability Reporting for Listed Companies.
- Malaysia (2010): Powering Business Sustainability - A Guide for Directors.
- Budapest Stock Exchange: Published its first ESG Reporting Guide (2021) for Issuers.
- Panama Stock Exchange (BVP): Presented the “Guide (2021) for Reporting and Voluntary Disclosure of Environmental, Social and Corporate Governance Factors (ASG)”.
- UN Global Compact (2015): Board Programme: Unlocking the Value of Corporate Sustainability.
On the similar lines in 2012, Securities and Exchange Board of India (SEBI) issued a circular that made it mandatory for the largest 100 listed companies to publish an annual business responsibility report. In a recent move on 9th May 2021, SEBI issued a fresh circular to make it mandatory for 1000 top listed companies in India.
World Federation of Exchanges launched Metrics for ESG disclosure
Based on the SSE (Sustainability Stock Exchanges) Model Guidance, the World Federation of Exchanges has created a set of recommendations to its member exchanges on how to implement their own sustainability policies. The WFE Guidance & Recommendations identifies material ESG metrics which exchanges can incorporate into disclosure guidance to companies listed on their market. The metrics lay out 34 key performance indicators that are built off of the SSE guidance.
| ID | Category | Metric | Calculation | Guidance |
|---|---|---|---|---|
| E1 | Environmental | GHG Emissions | E1.1) Total amount, in CO2 equivalents, for Scope 1 (if applicable) E1.2) Total amount, in CO2 equivalents, for Scope 2 (if applicable) E1.3) Total amount, in CO2 equivalents, for Scope 3 (if applicable) |
Please use the WRI/WBCSD GHG protocol. |
| E2 | Environmental | Emissions Intensity | E2.1) Total GHG emissions per output scaling factor E2.2) Total non-GHG emissions per output scaling factor |
Scaling factors set by reporting company. Examples include: Revenues, sales, production units. |
| E3 | Environmental | Energy Usage | E3.1) Total amount of energy directly consumed E3.2) Total amount of energy indirectly consumed |
Reported in MWh or GJ. |
| E4 | Environmental | Energy Intensity | Total direct energy usage per output scaling factor | Scaling factors set by reporting company. Examples include: Physical space, FTEs, revenues. |
| E5 | Environmental | Energy Mix | Percentage: Energy usage by generation type | Examples include: Renewables, hydro, coal, oil, natural gas. |
| E6 | Environmental | Water Usage | E6.1) Total amount of water consumed E6.2) Total amount of water reclaimed |
Reported in gallons or square meters (m3). |
| E7 | Environmental | Environmental Operations | E7.1) Does your company follow a formal Environmental Policy? Yes, No E7.2) Does your company follow specific waste, water, energy, and/or recycling polices? Yes/No E7.3) Does your company use a recognized energy management system? Yes/No |
Cite public content, if available. ISO 50001, for example. |
| E8 | Environmental | Environmental Oversight | Does your Board/Management Team oversee and/or manage climate-related risks? Yes/No | Cite public content, if available. |
| E9 | Environmental | Environmental Oversight | Does your Board/Management Team oversee and/or manage other sustainability issues? Yes/No | Cite public content, if available. |
| E10 | Environmental | Climate Risk Mitigation | Total amount invested, annually, in climate-related infrastructure, resilience, and product development? | Reported in USD, if possible. |
| S1 | Social | CEO Pay Ratio | S1.1) Ratio: CEO total compensation to median FTE total compensation S1.2) Does your company report this metric in regulatory filings? Yes/No |
Use total compensation, including all bonus and incentives. For example: Dodd-Frank regulations (US). |
| S2 | Social | Gender Pay Ratio | Ratio: Median male compensation to median female compensation | Reported for FTEs only. Use total compensation, including all bonus and incentives. |
| S3 | Social | Employee Turnover | S3.1) Percentage: Year-over-year change for full-time employees S3.2) Percentage: Year-over-year change for part-time employees S3.3) Percentage: Year-over-year change for contractors and/or consultants |
Percentage tracking by employment category. |
| S4 | Social | Gender Diversity | S4.1) Percentage: Total enterprise headcount held by men and women S4.2) Percentage: Entry- and mid-level positions held by men and women S4.3) Percentage: Senior- and executive-level positions held by men and women |
Gender breakdown across organizational hierarchy. |
| S5 | Social | Temporary Worker Ratio | S5.1) Percentage: Total enterprise headcount held by part-time employees S5.2) Percentage: Total enterprise headcount held by contractors and/or consultants |
Ratio of non-permanent workforce. |
| S6 | Social | Non-Discrimination | Does your company follow a sexual harassment and/or non-discrimination policy? Yes/No | Cite public content, if available. |
| S7 | Social | Injury Rate | Percentage: Frequency of injury events relative to total workforce time | Reference ILO & UNDHR standards, if possible. |
| S8 | Social | Global Health & Safety | Does your company follow an occupational health and/or global health & safety policy? Yes/No | Cite public content, if available. |
| S9 | Social | Child & Forced Labor | S9.1) Does your company follow a child and/or forced labor policy? Yes/No S9.2) If yes, does your child and/or forced labor policy also cover suppliers and vendors? Yes/No |
Cite public content, if available. Reference ILO & UNDHR standards, if possible. |
| S10 | Social | Human Rights | S10.1) Does your company follow a human rights policy? Yes/No S10.2) If yes, does your human rights policy also cover suppliers and vendors? Yes/No |
Cite public content, if available. Reference ILO & UNDHR standards, if possible. |
| G1 | Governance | Board Diversity | G1.1) Percentage: Total board seats occupied by men and women G1.2) Percentage: Committee chairs occupied by men and women |
Boardroom representation metrics. |
| G2 | Governance | Board Independence | G2.1) Does company prohibit CEO from serving as board chair? Yes/No G2.2) Percentage: Total board seats occupied by independents |
Cite public content, if available. |
| G3 | Governance | Incentivized Pay | Are executives formally incentivized to perform on sustainability? Yes/No | Cite public content, if available. |
| G4 | Governance | Collective Bargaining | Percentage: Total enterprise headcount covered by collective bargaining agreement(s) | Unionization / collective pact coverage. |
| G5 | Governance | Supplier Code of Conduct | G5.1) Are your vendors or suppliers required to follow a Code of Conduct? Yes/No G5.2) If yes, what percentage of your suppliers have formally certified their compliance with the code? |
Cite public content, if available. “Percentage” can be defined by number or expenditure. |
| G6 | Governance | Ethics & Anti-Corruption | G6.1) Does your company follow an Ethics and/or Anti-Corruption policy? Yes/No G6.2) If yes, what percentage of your workforce has formally certified its compliance with the policy? |
Cite public content, if available. “Percentage” is defined by total FTE headcount. |
| G7 | Governance | Data Privacy | G7.1) Does your company follow a Data Privacy policy? Yes/No G7.2) Has your company taken steps to comply with GDPR rules? Yes/No |
Cite public content, if available. General Data Protection Regulation (GDPR). |
| G8 | Governance | Sustainability Reporting | G8.1) Does your company publish a sustainability report? Yes/No G8.2) Is sustainability data included in your regulatory filings? Yes/No |
Cite public content, if available. |
| G9 | Governance | Disclosure Practices | G9.1) Does your company provide sustainability data to sustainability reporting frameworks? Yes/No G9.2) Does your company focus on specific UN Sustainable Development Goals (SDGs)? Yes/No G9.3) Does your company set targets and report progress on the UN SDGs? Yes/No |
If yes, cite frameworks used. Cite public content, if available. |
| G10 | Governance | External Assurance | Are your sustainability disclosures assured or validated by a third party? Yes/No | Cite third party assurance partner. |
Global economy moved establishing Sustainable funds/Bonds
Sustainable funds are those that use environmental, social, and corporate governance (ESG) criteria to evaluate investments or assess their societal impact. They may pursue a sustainability-related theme or explicitly aim to create measurable social impact. Sustainable funds invest with two lenses, they analyze company performance with regard to ESG criteria (environmental, social, and governance) alongside traditional factors such as valuations and earnings growth. Similarly, ESG bonds are debt instruments that encourage investments based on the issuer addressing certain ESG criteria. Climate change concerns in recent years have pushed both investors and companies to incorporate ESG into their corporate operations or investment portfolios. On the same line the first ESG mutual fund was launched by the State Bank of India i.e., SBI Magnum Equity ESG Fund.
Globally, in 2020 ESG funds getting unparalleled popularity for such strategies. Investors have poured money into these funds as concern for sustainability, social good, and responsible governance spreads. Even the World Bank launched equity-linked index bonds that link returns to the performance of companies advancing global development priorities set out in the Sustainable Development Goals. According to a report by Morningstar, ESG funds took in USD 51bn of net inflows last year, double the total for 2019 and almost 10 times more than in 2018. Even the Investors are getting good return on their investment in various Funds:
| Fund Name | 2020 One-Year Total Return |
|---|---|
| USD 255.9m Shelton Green Alpha fund | 113.9% |
| USD 4.5bn Eventide Gilead fund | 55.1% |
| USD 566m Putnam Sustainable Future fund | 52.7% |
| USD 45.1m Reynders McVeigh Core Equity fund | 46.4% |
| USD 263.8m Nuveen ESG Mid Cap Growth ETF | 45.6% |
| USD 16m River bridge Eco Leaders fund | 44.4% |
| USD 13.2m Impact Shares YWCA Women’s empowerment ETF | 39.8% |
| USD 4.8bn Brown Advisory Sustainable Growth fund | 39.1% |
Increasing Trend of Sustainable Investment for AUM – Sustainable Bond Market
There is growing evidence that suggests that ESG factors, when integrated into investment analysis and portfolio construction, may offer investors potential long-term performance advantages. In the continuing research conducted by Bloomberg report that ESG assets may hit USD 53 trillion by 2025, a third of global Asset under Management (AUM). As per reported Global ESG assets are on track to exceed USD 53 trillion by 2025, representing more than a third of the USD 140.5 trillion in projected total assets under management. A perfect storm created by the pandemic and the green recovery in the many countries will likely reveal how ESG can help assess a new set of financial risks and harness capital markets.
“The World Bank launched equity-linked index bonds that link returns to the performance of companies advancing global development priorities set out in the Sustainable Development Goals.”
Way Forward
Various factors, like recent pandemic, constant climate change and collapse of various big-name organizations in recent past, re-emphasised the need to accelerate the adoption of ESG disclosures. In a proactive manner, ICAI in recent past established Sustainability Reporting Standards Board to benchmark Indian sustainability reporting to global best practices.
There are challenges with uniformity, subjectivity and quantification, still the progress made in various jurisdictions and forums give us a way forward to implement ESG mechanism at an early stage. Adoption can be achieved by initiating small steps, like, imparting training to staff on ESG, study of ESG issues prevalent in the relevant industry, regular monitoring & reporting, etc. Few steps that can benefit are:
- Identify Material Factors: Identify the ESG factors related to nature of organisation. Determine the positive value of factors. Consider stakeholders for various factors.
- Define Goal Horizons: Set overall goals for each of ESG Factor and divide them into short term and long term.
- Budgeting and Execution: Create a budget and decide timelines to implement strategies.
- Cross-Functional Capacity: Build a sustainability team fully equipped to understand the ESG framework.
- Evaluation Metrics: Define success - evaluate the progress on parameters.
- Active Communication: Promote your performance.
Brian Rogers Loop rightly observed, “do what today others won’t, so tomorrow, you can do what others can’t”. There is an emerging need for the companies to be proactive in adopting and implementing ESG disclosures in the current scenario which will entail many benefits to an organization like, giving an edge over competitors in market, gaining confidence of stakeholders, improved compliances, better availability of funds, rating, reputation and many others.