An introduction to ESG reporting standards, principles, & frameworks
An introduction to ESG reporting standards, principles, & frameworks
As the world continues to recover from the pandemic and grapples with rising temperatures, drought, increased storms, and food insecurity, there is an increasing demand for solutions that have the potential to lead to significant change. ESG (Environmental, Social, Governance) investors and other stakeholders are driving demand for companies to implement resilient and renewable energy sources, workforce diversity, supply chain management, equitable compensation, and executive accountability.
In turn, ESG reporting is becoming a critical communication tool companies can use to reposition themselves to attract stakeholders and build a positive brand reputation, as well as mitigate a wide variety of risks and identify opportunities for improved operations.
The growing demand for ESG
In 1995, the US SIF Foundation (The Forum for Sustainable and Responsible Investment) estimated the size of the sustainable and responsible investment universe in the United States to be $639 billion. Assets have grown more than 18-fold since then, with a compound annual growth rate of 13.6%. According to Bloomberg Intelligence, global ESG assets could reach $41 trillion by 2022 and $50 trillion by 2025, accounting for one-third of global assets under management.
With continued climate-related disasters and variable weather patterns, tighter regulations around GHG emissions, rising demand for renewable energy, biodiversity and supply chain ethics issues, and growing concern over social and governance issues, 2022 is expected to see an even greater expansion of ESG related trends and investments.
As firms and investors gain more power and influence, their actions and decisions have a greater impact on the future. ESG investing's rise can be seen as a proxy for how markets and society are evolving, as well as how valuation principles are responding to these changes. Most businesses face a significant challenge in adapting to a new environment that favors smarter, cleaner, and healthier products and services.
SRI, sustainability, CSR, ESG... What’s the difference?
As we delve into the world of ESG reporting, it’s important to know the difference between socially responsible investing (SRI), sustainability, corporate social responsibility (CSR), and ESG, terms that are often used interchangeably. However, these approaches are each very different.
Socially responsible investing encourages corporate practices that are morally grounded and promotes environmental stewardship, consumer protection, human rights, and racial or gender diversity. For example, some socially responsible investors avoid investing in businesses perceived to have negative social effects such as alcohol, tobacco, gambling, pornography, weapons, and fossil fuel production. Essentially, for socially responsible investors morality trumps the bottom line.
As a blanket investment term, sustainability has become a catch-all for a company’s efforts to “do better” or “do good.” This investment approach is best defined by the three pillars of sustainability: social progress, environmental protection, and economic growth, also referred to as “people, planet, and profits.” In a nutshell, sustainable investing directs capital to companies fighting climate risk and environmental destruction, while promoting corporate responsibility. Ultimately, sustainable investors seek to find companies that are positioned to grow while also doing good and implementing better business practices. This approach blends a focus on return with a desire to do good.
Over the years, sustainability efforts have often been measured using key performance indicators (KPIs) which provide relevant data that is used in annual corporate social responsibility reports meant to showcase the positive impact a company has on its employees, consumers, the environment, and the community at large. Over time, sustainability has matured in value to both the board members and investors. Many companies now include corporate social responsibility at an executive level or have entire departments devoted to sustainability. However, it’s no longer enough to simply follow environmental laws, volunteer, and give donations; here enters ESG.
ESG focuses on three specific, foundational pillars that are crucial to today’s corporate management and investors alike. Environmental, social, and governance issues underpin the framework of disclosures and metrics that helps companies communicate on performance and risk factors that live outside of the traditional balance sheet but can have a significant impact on bottom line profits. Companies can communicate their ESG efforts, metrics, data, and progress via ESG frameworks and reports.
While ESG reports today are used primarily by investors, some companies are embracing opportunities to build campaigns around ESG initiatives and embed ESG into the fabric of the company’s communications and products.
What is ESG reporting & why is it important?
ESG reporting is essential for building a robust portfolio that attracts investment. Organizations can use ESG reporting to better understand, manage, and communicate their impact on people and the environment, as well as identify and mitigate risks, seize new opportunities, and take actions that build brand value and trust.
The number of companies reporting on sustainability efforts has increased as more investors demand detailed ESG reports. According to the Governance & Accountability Institute, 92% of companies in the S&P 500 Index issued sustainability reports in 2020.
However, while many companies are likely to boast about the ESG goals they are achieving, clear and uniform reporting standards are still in their infancy stage as regulations and investor preferences evolve. The 2019 ESG Global Survey published by BNP Paribas found that 66% of asset owners and asset managers cited data and reporting issues as the biggest barrier to greater adoption of ESG across their portfolios.
As the need for data requirements grows, companies are seeking to better understand what standardized reporting frameworks are available to them and how to execute impactful ESG communications.
ESG requirements, regulations, & reporting standards
While there are currently no mandatory ESG disclosures required at the federal level, the Securities and Exchange Commission (SEC) requires public companies to disclose all material information, including ESG-related risks. However, regulators in the United States are recognizing the need for new disclosure criteria specifically regarding climate-related risks, opportunities, and measures as ESG investments begin to dominate the financial sector.
For example, the SEC voted 3-to-1 to support a proposed rule requiring firms to disclose their climate risks as well as data on greenhouse gas (GHG) emissions in annual SEC filings in 2022, which will make reporting on GHG a requirement. Additionally, the SEC approved a requirement for most Nasdaq-listed companies to have at least two diverse directors on their boards. These rules also require the disclosure of self-identified gender, racial characteristics, and LGBTQ+ status of a company’s board.
As the Biden administration focuses on climate protection policies and infrastructure spending, goals of the administration could include legislation standards for car and truck tailpipe emissions and the reduction of methane. However, making a massive change will require the collective effort of government, companies, and investors alike. Investors willing to shift capital to zero- and negative-carbon investments could make a substantial impact.
Companies and funds can prepare for impending mandates by implementing ESG strategies and frameworks from the top down, starting with understanding the ESG criteria that are key to any ESG reporting efforts.
What should an ESG report include?
ESG focuses on three specific, foundational pillars that are crucial to today’s corporate management and investors alike and should be considered and included in any ESG report.
When considering environmental issues, companies can ask questions such as:
- What is an organization doing to be a steward of the environment?
- How is the company combating climate change?
- How is the company preserving biodiversity, improving air and water quality, combating deforestation, or responsibly managing its waste?
The environmental umbrella covers issues such as:
- Carbon emissions
- Climate change vulnerability
- Water sourcing
- Biodiversity & land use
- Toxic emissions & waste
- Packaging material & waste
- Electronic waste
When considering social issues, companies can ask questions such as:
- What is our organization doing to improve lives?
- How are we nurturing our people & workplace?
- What gender, BIPOC, and LGBTQ+ inclusivity initiatives have we launched?
- How does our employee engagement rank?
- Are we properly managing data protection & privacy?
- What is our impact on the community?
- Do we have appropriate human rights & labor standards in place?
The social umbrella covers issues such as:
- Diversity, equity, & inclusion (DEI)
- Labor management
- Worker safety training
- Supply chain labor standards
- Product safety & quality
- Consumer financial protection
When considering environmental issues, companies can ask questions such as:
- What is our organization doing to stay ahead of corruption and ensure its investments remain sustainable in the future?
- Do we have appropriate policies, principles, and procedures governing leadership, board composition, executive compensation, audit committee structure, shareholder rights, bribery, lobbying, political contributions, and whistleblower programs?
The governance umbrella covers issues such as:
- Composition of the board in terms of diversity & independence
- Executive compensation
- Accounting practices
- Business ethics
- Tax transparency
Core principles for ESG reporting
The United Nations (UN) has advocated for corporate sustainability and sustainable investments for decades. To help companies embed a principles-based approach to doing business, the UN provided Ten Principles of the UN Global Compact to help companies uphold their basic responsibilities to people and the planet while supporting long-term success. The Ten Principles are grouped as follows:
- 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 respect of 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.
What ESG reporting frameworks should you use?
Since there are no mandatory reporting standards in the US, companies have a lot of autonomy when it comes to ESG disclosures and can present ESG information in whatever way they consider to be most useful. However, the world is beginning to demand reporting standardization, and many key players, such as BlackRock’s CEO Larry Fink, are encouraging the use of recognized ESG reporting frameworks. Some examples include:
The SASB Standards provide industry-specific sustainability accounting standards. These standards were created to drive the adoption of ESG reporting and are designed for investors who need access to sustainability information that is material to companies’ financial valuations. SASB provides a comprehensive set of 77 standards covering 26 general ESG issue categories that support reporting standards for different industries. Companies worldwide use the SASB Standards to share their performance with investors through a variety of disclosure channels such as websites and ESG or corporate sustainability reports.
The Global Reporting Initiative (GRI) was founded in 1997 following the public outcry over the environmental damage of the Exxon Valdez oil spill with a goal to create an accountability mechanism that would ensure companies adhere to responsible environmental conduct. The GRI reporting framework offers 30 environmental performance indicators that can be used for environmental sustainability reporting. These performance indicators are divided into nine primary categories: materials; energy; water; biodiversity; emotions, effluents, waste; products and services; compliance; transport; and overall environmental protection expenses and investments. These universal GRI standards and topics provide a platform that organizations can use to prepare and report on information that showcases significant sustainability impacts.
The Task Force on Climate-related Financial Disclosures (TCFD) framework provides key guidance on what companies and investors should be focusing on to minimize climate risk, including transitional risk, physical risk, and litigation risk, accelerate environmentally friendly governance, and transition to low-carbon operations. These recommendations were designed to support better-informed investment, credit, and insurance underwriting decisions while ensuring stakeholders are cognizant of the exposure to climate-related risks and carbon-related assets.
CDP (formerly the Carbon Disclosure Project) is an international nonprofit organization that helps companies and cities disclose their environmental impact and seeks to make environmental reporting and risk management a business norm. With over 9,600 companies on board, CDP holds the world’s largest and most comprehensive dataset on environmental action. Companies can disclose information through CDP’s three corporate questionnaires on climate change, water security, and forests. This helps companies provide environmental information to their investors, customers, and other stakeholders, including governance and policy, risk and opportunity management, and environmental goals and strategies.
What are ESG metrics?
While many companies are inclined to brag about their ESG accomplishments, clear and consistent reporting ensures transparency and accountability. To support the demand for standardized ESG frameworks, the World Economic Forum unveiled a set of metrics companies can use in reporting methodology that provides a common set of disclosures and support more coherent, comprehensive ESG reporting systems. The metrics are centered on four pillars:
- People: This represents a company’s equity and its treatment of employees and includes metrics centered around diversity reporting, wage gaps, and health and safety.
- Planet: This reflects a company’s dependencies and impacts on the natural environment and includes metrics such as greenhouse gas emissions, land protection, and water use.
- Prosperity: This represents how a company affects the financial well-being of its community and measures metrics such as employment and wealth generation, taxes paid, and research and development expenses.
- Principles of governance: This reflects a company’s purpose, strategy, and accountability and includes criteria that measure risk and ethical behavior.
Companies can utilize these pillars and an expanded set of "Stakeholder Capitalism Metrics" and disclosures to align their ESG performance and reporting indicators on a consistent basis.
What is ESG data
ESG data includes any indicators that shed light into the sustainability context of an asset, facility, company, or region, whether historic, current, or expected. ESG data is collected under the three primary categories:
- Environmental data should capture environmental information such as annual carbon emissions and energy consumption, water usage, and waste and pollution output.
- Social data focuses on statistics related to workforce diversity, gender equity and human rights.
- Governance data tracks company input regarding corruption, labor practices and gender composition of the board of directors.
Big data can generate useful insights that support environmental sustainability and help companies improve business operations throughout the value chain. As technology improves, companies are turning to data providers to track and integrate qualitative ESG data into their operations. This data can play an important role in the investment process by gathering and assessing information about companies’ ESG practices and offering equity screens, portfolio construction and analysis, relative value analysis, competitive benchmarking, and risk analysis.
Sharing your ESG story
Beyond using ESG frameworks for reporting and disclosures, companies can take the extra step of crafting communications that tell their ESG story through a printed or digital ESG report or websites.
To effectively articulate your company's story, consider sharing:
- Core issues that are material to your company
- A breakdown of each of the material issues within each aspect of ESG
- The metrics and KPIs being used to assess and measure progress on these key issues
- ESG goals and long-term strategy
- The processes used to track and measure progress against those target goals, including what governance structures and processes are in place to ensure oversight of ESG issues
- ESG teams and/or company leadership
- Your reporting framework breakdowns (i.e., GRI or TCFD) along with any ESG policies your company has adopted
Along with what to include, there are some suggested “do-nots”. Do not:
- Add a long list of ESG metrics that appear unconnected to your company & how you operate
- Share different metrics, information, or data depending on a different audience
- Greenwash or rainbow-wash your information
- Overcomplicate your report: A concise, well-thought communication can be as compelling as a lengthy publication
With all this accomplished, one question still remains: how do frameworks, metrics, data, and reporting impact your ESG score?
What is an ESG score?
An ESG score is a measure of a company's exposure to long-term environmental, social, and governance risks that are often overlooked during traditional financial analyses. Company news and disclosures along with ESG data collected and published by non-governmental organizations such as the GRI, SASB, CDP, and the UN Sustainable Development Goals (SDGs) is a significant source of data for most rating providers.
What is an ESG rating?
A strong ESG rating indicates that a company manages its ESG risks well in comparison to its peers, whereas a poor ESG rating indicates that the company has comparatively higher unmanaged ESG risk exposure. ESG evaluations and scores, when combined with financial analysis, can help investors gain a better understanding of a company's long-term potential.
What do ESG scores measure?
ESG scores are based on ESG factors such as biodiversity and land use, labor and supply chain management, business ethics standards, and executive pay. ESG rating companies also consider the opportunities within different ESG categories. For example, environmental opportunities can include clean technology, green building, and renewable energy while some social opportunities can be better access to communication, finance, or healthcare.
Who calculates & assigns ESG scores?
ESG rating agencies are third-party companies that specialize in ESG scoring. While there are hundreds of rating agencies that provide ESG scores, some of the prominent ESG score providers include Bloomberg ESG Data Services, Dow Jones Sustainability Index, MSCI ESG Research, Sustainalytics, Thomson Reuters ESG Research Data, S&P Global, ISS ESG, Vigeo/EIRIS, Fitch Ratings, and Moody’s Investors Service.
How is an ESG score calculated?
Using analysts and algorithms, the scoring companies convert ESG metrics and data like a company's carbon emissions, board diversity, or safety procedures into siloed environmental, social, and governance scores, which are then merged into a single primary rating. For example, MSCI examines hundreds of metrics and assigns a score of 0 to 10 to corporations on each important issue. After assigning percentage weights to ESG risks, companies are compared to their peers and given a final rating.
Why do ESG scores matter?
ESG scores allow investors to gauge the company's intentions and actions, from how they treat their employees to how the board decisions are made or if environmental issues are being prioritized. Investors prefer companies with higher overall ESG scores because they typically have fewer liabilities, making it easier to acquire capital and hire top talent. These companies also often have successful stakeholder relationships and a brand reputation. All of these factors have an impact on the profitability and bottom line of a business.
ESG scoring is not a one-size-fits-all system. As such, it’s important to be cognizant of which scoring methodologies or frameworks are most relevant and impactful to your organization.
The future is ESG
ESG is expected to continue growing in 2022 and beyond, especially after a watershed year. 2021 saw a record $649 billion poured into ESG-focused funds worldwide, and 61% of Morningstar’s ESG-screened indexes outperformed their broad market counterparts globally and across all markets, so it's no surprise that potential shareholders are looking for ESG-friendly investments and businesses are trying to capitalize on the increased popularity of sustainability.
As a result, investors, asset managers, and businesses are all seeking ways to prioritize and integrate ESG into their investment decisions and corporate strategies. While there’s no one-size-fits-all approach to ESG integration, the best place to begin is by asking, "What do we want to achieve? What are our company's ESG and sustainability goals?”. From there, choosing the right frameworks, data capture, metrics, and goals will put your company on the path to building a strong reporting structure.
ESG materiality assessments
With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.
An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.