What is ESG & Why is it Important?
ESG is an acronym that stands for Environmental, Social, and Governance and it encompasses a broad range of factors under the larger umbrella of Sustainability.
- Environmental Factors: climate change strategy, energy management, water stewardship, circular waste strategies, etc.
- Social Factors: human rights and compliance with labor standards in the value chain, employee engagement, diversity equity & inclusion, health and safety, training, community engagement, etc.
- Governance Factors: business ethics, anti-corruption, data privacy, cybersecurity, risk management practices, ESG oversight, and board practices, etc.
While all companies should strive to be more sustainable, not all companies should focus on the same ESG factors as their ESG impact will vary by industry and business model. Put another way, ESG factors are company-specific and should be determined by a materiality assessment. This specificity is why investors value ESG, as they can use it to understand which factors contribute most to an organization’s overall sustainability performance.
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In recent years, ESG has become increasingly mainstream due to a combination of factors. Investors see the value in ESG and are demanding ESG information from companies, regulators are starting to require corporate disclosure on certain ESG issues, the impacts of climate change are growing and readily apparent, and companies are being asked to not only be profitable but do so in a way that minimizes their impacts on people and planet.
To help companies meet the demands for ESG reporting and transparency, several frameworks and standards have been created.
What are ESG Frameworks and Standards?
The terms “framework” and “standard” are often used interchangeably, but they are not the same. While they both aim to help achieve a reliable and relevant ESG disclosure, there are key differences to understand.
Standards provide an agreed level of quality reporting requirements on ESG topics. A standard gives a specific outline of what should be reported on each topic.
Frameworks on the other hand provide the ‘frame’ to contextualize information – they outline how information should be structured. A framework can be thought of as a set of principles providing guidance and shaping people’s thoughts on how to think about ESG topics.
Together, ESG frameworks and standards help companies efficiently disclose high-quality ESG data that can be easily compared across topics and industries. It also helps to create consistency in formatting that creates transparency around key ESG topics.
Evolution of ESG Frameworks and Standards
Over the years, several different frameworks and standards have been developed in response to specific events, needs, and demands. Here is a brief look into what frameworks and standards exist and when they came into play:
The primary audience for these frameworks and standards has been shifting from a broad stakeholder group to the financial community as lenders, agencies, and investors are looking for more visibility into nonfinancial metrics to understand the ESG risks of companies. Frameworks and standards have evolved to meet this audience shift and the need to communicate how ESG will impact corporate financial performance and long-term business strategy.
How to Choose an ESG Framework or Standard?
“Well, it’s all about prioritizing impact versus effort,” states McKenna. “You need to make sure that the framework or standard aligns with the needs of your key stakeholders while also considering the investment in time and resources the company must make to meet the disclosure requirements.”
Impact includes factors such as:
- Alignment with your key users/audiences
- Level of detail provided
- Driver of internal engagement/performance
Effort includes factors such as:
- Information sources used
- Methodology employed
- Alignment with the organization’s sustainability programs, data collection, and reporting/communications
Once you have determined this alignment between your key stakeholders' needs and your organization’s priorities, you can start to figure out which framework or standard is right for you. Below we dive into a few common standards and frameworks:
- Global Reporting Initiative (GRI): A widely used set of ESG standards that help businesses and other organizations report their impacts on the economy, environment, and people to meet the needs of wide variety of different stakeholders.
- Sustainability Accounting Standards Board (SASB): Publishes 77 industry-specific standards to help facilitate the disclosure of financially-material ESG information by companies to an investor audience.
- Task Force on Climate-related Financial Disclosures (TCFD): Provides a framework for corporate disclosure to investors on several climate-related topics including risk management, strategy, governance, and metrics and targets.
The Future of ESG Frameworks and Standards
With the formation of the ISSB in 2022, a global baseline of sustainability-related financial reporting will be developed. These standards will enable companies to provide comprehensive information about sustainability matters to the financial markets. The standards will be developed to facilitate compatibility with requirements that are jurisdiction-specific (for example, the European Union’s planned Corporate Sustainability Reporting Directive as well as the SEC’s proposed climate rules).
Creating a Baseline - ISSB Exposure Drafts
Currently, there are two exposure drafts by the ISSB that are out:
- General Requirements Exposure Draft requires disclosure of significant sustainability risks and opportunities
- Climate Exposure Draft incorporates TCFD recommendations and industry-based requirements from SASB Standards
These drafts were developed based on the demands for enhanced information from companies on sustainability-related risks and opportunities. The drafts outline requirements for the disclosure of material information about a company’s significant sustainability-related risks and opportunities that are necessary for investors to assess a company’s enterprise value. From here, the ISSB is seeking feedback until July 29, 2022. After this, they will review the feedback and plan to issue the new standards by the end of this year.
Key Takeaways
In short, communicating your company’s ESG performance is more important now than ever before, and utilizing frameworks and standards will help you do so in a way that stresses quality, comparability, consistency, and transparency. There has been a significant evolution in the objectives of standards and frameworks over the last two decades as investors have become more involved in the ESG space. These investor-focused frameworks and standards are converging to help streamline the disclosure of ESG information, and while providing this ESG information is voluntary today, regulations are on the horizon – so the time to prepare is now!
