Meaningful environmental, social and corporate governance (ESG) reporting is critical for developing an attractive profile that drives investment. ESG reporting can also help companies define and refine a sustainable culture and a public-facing value proposition focused on good corporate stewardship.
Boards of directors have a vital role in guiding their organizations through the intricate processes involved with ESG reporting. Directors must develop an understanding of the modern ESG landscape. While this subject can become quite complicated, the good news is that recent standardization efforts have helped to streamline and centralize the reporting process.
What Is ESG Reporting and Why Does It Matter?
Before embarking on a self-audit or investigation into the accuracy and effectiveness of their ESG reporting, companies should take a step back and reexamine the overarching goals of ESG reporting.
Advocates for ESG reporting work to convince boards of directors and CEOs to report on ESG activities and for investors to evaluate companies based on this reporting. The overarching theory is to encourage mindful investment into companies that are actively working to improve ESG concerns during their day-to-day business activities.
What Are the Principles Behind ESG Reporting?
At the highest level, the United Nations (UN) has advocated for ESG reporting as a kind of self-reported oversight of various environmental, social and governance concerns.
The ESG reporting movement originated as a global initiative by the UN in 2006. That year, the UN developed the following “Six Principles of Responsible Investing” (PRI):
- We will incorporate ESG issues into investment analysis and decision-making processes.
- We will be active owners and incorporate ESG issues into our ownership policies and practices.
- We will seek appropriate disclosure on ESG issues by the entities in which we invest.
- We will promote acceptance and implementation of the Principles within the investment industry.
- We will work together to enhance our effectiveness in implementing the Principles.
- We will each report on our activities and progress toward implementing the Principles.
These guidelines, targeted toward the investment community, build on the United Nations Global Compact’s 10 Principles, a foundational ESG-related framework laid out by the UN in 2000.
Rethinking the ESG Data Challenge
There are 10 principles that are grouped into four subject areas, focused on social responsibility: human rights, labor, the environment, and anti-corruption:
1) Human Rights
Principle 1: Businesses should support and respect the protection of internationally proclaimed human rights; and
Principle 2: make sure that they are not complicit in human rights abuses.
Principle 3: Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining;
Principle 4: The elimination of all forms of forced and compulsory labor;
Principle 5: The effective abolition of child labor; and
Principle 6: The elimination of discrimination in employment and occupation.
Principle 7: Businesses should support a precautionary approach to environmental challenges;
Principle 8: Undertake initiatives to promote greater environmental responsibility; and
Principle 9: Encourage the development and diffusion of environmentally friendly technologies.
Principle 10: Businesses should work against corruption in all its forms, including extortion and bribery.
Together, these two UN frameworks — the PRI and the UN Global Compact’s 10 Principles — comprise the core principles of current ESG reporting guidelines.
ESG reporting, per se, is not currently a regulatory requirement for any industry. Still, ESG proponents, including investors, have petitioned the SEC to enact regulations that would require it.
Typical ESG Reporting Elements
ESG reporting measures performance across three key areas: environmental sustainability, social responsibility and corporate governance. While ESG reporting typically includes key performance indicators (KPIs) and metrics, this report differs from accounting-driven KPIs that focus more on financial performance.
Boards of directors can develop an ESG reporting framework centered on a wide range of issues, depending on the company’s primary business focus and its motivation for creating the report.
Examples of ESG topics across the three categories include:
1) Environmental sustainability reporting topics
- Climate change
- Water conservation
- Sustainable land use
- Recycling efforts
2) Social responsibility topics
- Labor standards
- Domestic and global human rights issues
- Employee relations
- Conflict zone management
3) Governance topics
- Cybersecurity measures
- Data privacy regulatory compliance
- Tax avoidance
- Executive pay
- Director nominations
Top 5 ESG Challenges for Boards (and Tools to Overcome Them)
Related Reporting Requirements
Public companies will find overlap between ESG reporting metrics and many of the disclosures they must regularly produce per SEC regulations.
Item 101(c)(1)(xii) of Regulation S-K, Description of the Business
A portion of this reporting requirement touches on environmental sustainability issues, including “the discharge of materials into the environment, or otherwise relating to the protection of the environment.” A public company also needs to disclose “any material estimated capital expenditures for environmental control facilities for the remainder of its current fiscal year and its succeeding fiscal year.”
Item 103 of Regulation S-K, Legal Proceedings
Companies must disclose administrative or judicial proceedings related to “regulating the discharge of materials into the environment or primarily for the purpose of protecting the environment.”
Item 303 of Regulation S-K, Management’s Discussion and Analysis of Financial Condition and Results of Operations
This SEC reporting requirement advises a company to provide information about “material trends and events that may affect its financial condition, changes in financial condition and results of operations,” including those related to ESG reporting topics.
Public company boards of directors will also find similarities between ESG reporting and disclosure requirements laid out in the Dodd-Frank Wall Street Reform and Consumer Protection Act. Examples include conflict minerals provisions (Section 1502), resource extraction payments (Section 1504), mine safety and health (Section 1503), and employee and CEO compensation (Section 953[b]).
Common ESG Reporting Issues Facing Boards
Beyond good corporate stewardship, the reality is that investors increasingly examine ESG reporting to determine risk. Problems arise when companies and investors are on different pages regarding standardization and uniformity in reporting.
This is a frustrating concern for companies who have expended a great deal of time and financial resources toward ESG-related goals but cannot clearly demonstrate related successes. Ultimately, investors may lose interest, opting to partner with companies who can better speak their language.
The goals of ESG reporting are largely missed when reputable investors and responsible companies are unable to connect because of the standardization issue. When investors don’t get the right information in the right format, they move on.
ESG Reporting Standardization
In response to this ongoing frustration, several external third-party organizations, institutional investors and ESG proponents have proposed standardization initiatives. Companies can choose to follow guidelines laid out by numerous entities such as:
- Global Reporting Initiative (GRI)
- International Integrated Reporting Committee (IIRC)
- Sustainability Accounting Standards Board (SASB)
- United Nations Sustainability Goals (SDG)
- Carbon Disclosure Project (CDP)
- Task Force on Climate-Related Financial Disclosures (TCFD)
These standards provide a reasonably straightforward framework for reporting on metrics for sustainability and corporate sustainability.
ESG Risks: What Today’s Boards Need to Know
2020 World Economic Forum Metrics
Recently, the World Economic Forum (WEF) released a consultation paper titled Toward Common Metrics and Consistent Reporting of Sustainable Value Creation. The paper proposes two related sets of standard ESG metrics developed in collaboration with major financial firms like Deloitte and PwC.
These new metrics correlate to the existing standards and disclosures listed above:
The paper describes a set of 22 metrics and reporting requirements that can be reported with quantitative methods. These metrics are already reported by many firms, but they’re often in a variety of formats. Primarily, the core metrics focus on “activities within an organization’s own boundaries.”
These less-established metrics focus on a broader scope and are reported via more sophisticated or complex means. For example, expanded metrics include reporting related to monetary concerns, which can become quite detailed and analytically driven. These metrics are more advanced ways of “measuring and communicating sustainable value creation.”
Future ESG Reporting Issues: What Should Boards Expect?
Public companies will continue to feel pressure from outside parties to publish increasingly detailed ESG metrics. Investors, regulators and other corporate partners each benefit from careful, detailed reporting.
This reporting must include context and in-depth analysis that demonstrates how a company is working toward its ESG goals. The expected level of detail related to good corporate stewardship has dramatically increased over the past few decades.
There was a time when it was enough for companies to make a passing reference to human rights issues like child labor, for example. Today, investors often expect these same companies to divulge details about how they are directing resources to protect against global child exploitation. The same is true for environmental concerns like climate change, sea-level rise and sustainable resource allotment.
To meet these reporting expectations, boards of directors will need to guide companies toward a path that bridges the gap between investors and corporations. PwC recommends board work to answer seven strategic ESG reporting questions:
- Are ESG risks included in the company’s ERM program? If so, what are the key ESG risks and how are we addressing them? We would add, is the company aware of it’s ESG risk score and rating?
- How is ESG “baked into” our long-term strategy?
- Do we have a sustainability or corporate responsibility team that can step in to act as a liaison between the company and investors?
- Are we prepared to oversee our ESG strategies and risks? Is the board getting the right metrics to provide adequate monitoring?
- Have we considered using a framework to assess and report ESG metrics at the company level?
- Can we improve transparency in our ESG disclosure processes to meet investors’ expectations?
- Are we telling our ESG story effectively? Is it clear to investors how ESG is related to our company’s overarching strategy? Are directors who are meeting with shareholders equipped to answer these questions?
As boards work to develop or improve on a cohesive ESG reporting strategy, crafting a systematic approach is crucial for success. Organizations will need to track and measure ESG goals, ensure compliance with industry standards and regulations, monitor ongoing risk, and develop strong educational leadership mandates. ESG reporting is a considerable undertaking for any board, but the rewards are well worth the effort. Ready to take the next step with ESG reporting? Download an ESG roadmap from Diligent today.
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