Introduction
Sustainable business practices extend beyond building revenue and profits. In today’s business climate, organizations need a holistic approach to build and maintain brand loyalty. Organizations need to watch how their activities affect their environment, society and the law. This helps prospective and existing customers understand that the ethics governing an organization aren’t to exploit and make their money but rather to introduce growth and development across the board.
What is ESG?
The abbreviation ESG is used to describe Environmental, Social and Governance criteria. This system sets a standard for organizations to abide by in order to encourage socially conscious investors to pay attention to the organization.
The environment criteria assess how the organization interacts with the surrounding ecosystems. The social criteria understands how the business engages personnel and stakeholders both internally and externally along with communities around the areas of operation. The final criteria, governance, assesses the organization’s capabilities with regard to compliance, regulations and laws.
Over the past few years, millennial investors in particular, have expressed higher likelihoods of investing in organizations that follow ESG criteria. According to a report from the US SIF Foundation, investors held US$11.6 trillion based on ESG criteria, up from US$8.1 from two years prior.
When investors are assessing ESG factors, they decide how to prioritize their importance. Not all organizations are going to hold excellent ratings across all three categories even with the willingness to consider them. However, based on the investors’ areas of consideration, companies get classified as “bad” and “good”. It is important to note however that badly rated companies may still perform well stock price wise. Well rated companies are more likely to perform better in the long run and avoid involvement in scandals and negative publicity. ESG considerate firms are likely to gain better traction, especially with larger firms in the financial services sector including JPMorgan Chase, Wells Fargo and Goldman Sachs.
What is ESG Data?
ESG data are the metrics and measuring tools used to understand a business’s impact on the government, environment and social matters. The data accumulated is compiled into a reporting structure pre-determined by regulatory bodies. While the frameworks aren’t iron clad as of yet, it can safely be said businesses need a way to gather and understand ESG data moving forward. However, a more structured approach to validating an organization’s ESG position is slowly taking shape. Within the US for example, the Securities and Exchange Commision (SEC) has introduced an advisor for ESG matters, as in the case of Europe and the Sustainable Financial Disclosure Regulation (SFDR).
This information is critical to understanding what a business stands for beyond profit and revenue generation. Information around social impact for example could cover the interactions an organization has with other organizations, and, the community from a bird’s eye perspective. This helps identify a business with certain values, standards and ethics. In order to best assess the likelihood of a business succeeding, ensuring compliance and support from all stakeholders would be the best course of action. ESG data helps guide this process.
Qualitative Vs Quantitative
As of 2020, the US SIF has witnessed an increase of ESG investing by 42% over the past two years. The investment figure was USD $17 trillion as of 2020 with steady projected growth rates. With more companies paying attention to sustainability related practices, investors have been using quantitative ESG data to detect ESG compliant organizations. However this method means there is a lack of uniformity. Without a uniform method to deduce this information how can investors and organizations alike attest to their validity? Enter quality ESG data.
Quality ESG data can be acquired through;
1. Standardizing Information
With the large, varied number of reporting platforms, standards and requirements meeting investor or company standards for ESG requirements are likely to differ. The need for standardized data displays including report structure and compliance requirements must be established and unified.
As of 2020, the Task Force on Climate-related Financial Disclosures (TCFD) reported a mandatory framework for signatories compliant with the UN Principles for Responsible Investing. This is expected to begin in countries like the UK, New Zealand and possibly the US before moving to other areas of the globe.
Additionally the Sustainability Accounting Standards Board (SASB) has been actively working towards creating a reporting structure and has released 77-industry specific accounting standards for investors to understand how material sustainability concerns affect organizational performance. The SASB and Global Reporting Initiative (GRI) standards are currently used by 75% of the 250 largest organizations in the world.
In order to adequately identify an organization as ESG compliant, choosing the lead reporting standard and ensuring all information distributed is unified across all organizations in terms of questions asked is the best verification method.
2. Consistent Scoring
The scoring system for ESG compliance is also non-standardized, posing an issue around assessment. ESG scoring hopes to reach a single metric investors are able to use to understand how companies behave around ESG concerns. The scores provide a system for grading and understanding. The concerns around ESG scores using a one size fits all system affect the unequal weighting of the different ESG factors.
In order to address this concern, investment management firms assign their own scores to public organizations based on information that they believe has an impact on different sectors, industries, companies and their investment vision. The objective is not just to create a unified system to score companies but to ensure they are relevant to the investor.
3. Consumable Data
While reporting standards and material reporting data is critical to understanding an organization’s ESG performance, this data can sometimes get overwhelming. In order for the information to be used with efficiency and effectiveness it must be translated into a more consumer friendly format.
A study conducted by Danske Bank across 100 of the largest organizations in Norway’s ESG reports found they had over 21,000 different points of assessment with only 1000 overlaps. As a result they recommended the breakdown of ESG disclosures into four key categories;
- Financial Materiality: Information covering points of concern for the organization.
- Comparability: Information that can be cross referenced across various companies and industries.
- Accessibility: Information around accessibility to investors provided in various formats.
- Reliability: Ensuing the data has high quality assurances.
Without strong and relevant assessment mechanisms, it becomes impossible to credit ESG ratings to any organizations. Even if the standardization occurs internally (within the investors organization), as long as a system is established to ensure that businesses are judged fairly and with consideration, assessment methods are likely to be a success.
In order to best report ESG data, businesses can focus on the following:
- Identifying the range of stakeholder and organizational impact.
- Understanding material sustainability issues around relevant business and stakeholder groups including carbon emissions and gender diversity.
- Understand the importance of issues stakeholder groups have and how to best translate relevant information to understand the same.
- Implement an ESG framework centered around understanding key ESG issues, performance metrics, targets, initiatives, reporting standards and structures.
- Introduce the best possible resources gathered internally, from teams or data pools that fill in the blanks around your ESG reporting structure.
- Circulate your businesses ESG performance using the developed structure.
- Continue to keep an ear to the ground and engage stakeholders, gather feedback and keep tabs on issues around sustainability that could affect your organization.
Conclusion
As consumers and stakeholders become more conscious of business activities, it is up to the organization to maintain strong relationships internally and externally. Minimizing the negative impact an organization could have on surrounding factors is likely to leave a positive effect on the environment, society and governance, leading to more sustainable business activities.
Creating a standardized method to understand this impact using ESG data is critical to the future corporate landscape and the best possible investments.
