"ESG", or Environment, Social and Governance is the latest acronym that all businesses now have to deal with. The decoding of the letters is the easy part, but what does this actually mean for businesses, their staff, customers and supply chains?
What is ESG and why bother?
Originally an umbrella term for a broad range of environmental, social and governance factors against which investors can assess the behaviour of the entities they are considering for investment, the concept has now permeated across the corporate universe, and has implications for large and small businesses.
Even for businesses not directly impacted by the growing raft of legislation and reporting requirements referred to below, there is a growing emphasis on ESG from a range of quarters. In many sectors, being able to articulate clear ESG objectives and demonstrate performance against them is a pre-qualification requirement for any tender: buyers want to know the ESG credentials of the providers of the goods and services they buy and employees want to work within businesses whose ethical standards meet their own.
How is ESG different from CSR?
ESG has largely, but not always, replaced Corporate, Social, Responsibility (CSR) as the term used most frequently. The change is driven by the fact that ESG appears to be the term of choice for investors, which in turn has been passed on to private equity firms and then portfolio companies and other companies. CSR is intended to stand for the conscientious conduct of business, which leads to positive results for everyone involved. This is what companies do, as opposed to how investors measure it. Nevertheless, the terms ESG and CSR are sometimes used interchangeably.
What is it for?
It is used to determine whether (based on different criteria and metrics) companies are adhering to a standard of behaviour that is deemed to comply with certain pre-defined environmental, social or governance goals. These goals may be set either by companies themselves or by external entities such as investors, lenders and regulators, and may help investors to decide whether investments meet Ethical investment criteria, or pose an unacceptable risk of loss because they do not adequately tackle risk factors such as climate change.
Crucial point of ESG
One crucial and much more far reaching aspect of ESG is that it is not simply about seeking compliance with current regulations, even if there is little to no risk of enforcement. ESG has also become about instilling a cultural commitment in a company that seeks to have a reduced impact on the key ESG factors associated with its activities. This is irrespective of whether or not that company is heavily regulated. ESG focuses on the potential for a company to have a more positive impact alongside seeking to make a financial return, and has become increasingly important for businesses as customer and stakeholder pressure to show change continues to grow.
Is ESG Compliance mandatory?
Some elements of ESG have already been incorporated into or are respected by law, such as the Modern Slavery Act 2015, the Equality Act 2010 and the associated Gender Pay Gap Reporting obligations of 2017, and numerous items of Environmental legislation.
Amid concerns about “greenwashing” and inconsistencies of approach, there are now moves afoot to improve and standardise the way in which businesses set and record their performance against ESG objectives in relation to climate change
The Financial Stability Board’s (FSB’s) Taskforce on Climate-related Financial Disclosures (TCFD) final report and recommendations, published in June 2017, set out information that companies should disclose to enable investors, lenders and insurance underwriters to better understand how companies oversee and manage climate-related financial risks. The TCFD recommendations aim to strike a balance between the need to raise existing climate disclosure standards and the desire to achieve widespread adoption. The recommendations are emerging as the lead framework for climate change reporting, and governments, the EU and NGOs have promoted them extensively.
The UK Government has made reporting in line with the TCFD recommendations mandatory for companies with a premium listing on the London Stock Exchange, and intends to make it mandatory for large companies and financial institutions across the UK economy to make climate-related disclosures aligned with the TCFD recommendations by 2025.
Advice for clients
Ideally you will already have procedures in place to ensure compliance with ESG related laws, such as those noted above, and will have taken legal advice on your specific obligations.
As regards the wider ESG world, it’s helpful not to treat it as a separate policy matter, but rather a series of threads that will run through a wide range of activities in a business. So the start point will be to gain an understanding of what you do already and see where you may already be adopting policies and procedures that would align with an ESG agenda. Some of this may be driven by requirements of suppliers and customers as well as by the need to be an attractive employer.
Each business will adopt a different approach: some have a formal ESG committee tasked with reviewing the ESG performance across the business, others have a less centralised approach based on ensuring that all managers apply an ESG Lens to their activities. It’s important to note that ESG goes much, much wider than law, and certainly does not require that it is administered by the legal function in the business. Lawyers may have a role to play, depending on the nature of your business, but equally important are those with operational responsibilities within the business.
Unless you are a larger business you are unlikely to find yourself with overarching ESG reporting obligations at present, although it is expected that these requirements will become more widely applicable. What you choose to disclose/report at an early stage may principally be a matter of what is required by your supply chain, or of the need to market your business in a particular way to your potential customers and employees. You should ensure that you are able to back up any claims you make with empirical evidence.
There are ESG Consultants who will review your business and advise on next steps, particularly as regards Net Zero and other climate related objectives, but you can make significant progress without the need for expensive consultants, and you also need to make sure that any objectives you do set are realistic both in terms of scale and time frame. Bear in mind that the ultimate purpose of ESG for business is to drive a more sustainable, resilient and ultimately profitable business model for all, so you need to move at a pace that is achievable – but you do need to move!
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