Guide: What is ESG?

Did you know that by 2030, global ESG assets will reach $40 trillion in value and account for 25% of the total assets under management? Whether you’re an investor looking to spend your money more responsibly, a corporate leader struggling to sift through competing frameworks or an employee tasked with reducing risks, we probably don’t need to tell you how important it is to understand the impact of environmental, social and governance (ESG) factors on your and others’ financial decisions.

What Does ESG Stand For: Meaning and Definition
Why Is ESG Important?
What Are ESG Regulations?
What Are ESG Scores?
ESG Requirements: A Checklist To Follow
How Does ESG Fit Into Your GRC Program?
Succeed With the ESG-GRC Hybrid

What Does ESG Stand For: Meaning and Definition

Let’s start with the basics: ESG refers to three types of factors: environmental, social and governance. We’ll dive into each of those subcategories individually in a moment, but first let’s talk about their impact as a whole.

You’re no doubt aware that the sustainability of businesses has only grown more important to conscious investors, directors, clients and the general public over the last few decades. But as commitments to reducing environmental harm become more commonplace, the conversation has naturally shifted to finding ways to actually measure a company’s progress toward keeping those promises.

At the same time, consumers and business owners have grown more conscious of other ways their financial choices can reshape the world we live in, for better or worse. That’s where ESG comes in: Rather than focusing wholly on environmental concerns, like sustainability, ESG makes room for the ways companies can impact the societies that surround them, as well as the people who work directly for or with them.

That makes ESG perfect for conducting a holistic assessment of a particular company’s impact on the world within and outside of its doors. Now, let’s look at the three components of ESG individually.

Environmental

The environmental factors of ESG consider how companies affect the natural environment. It measures how active an organization is in tackling environmental issues, ranging from biodiversity and carbon emissions to climate change and deforestation. It also entails tracking an organization’s existing impact on the planet as well as their progress toward reducing that impact.

If you have any remaining doubts about the importance of charting the ways corporations affect our environmental sustainability, keep in mind that the hidden cost of unsustainable investing can amount to as much as 44% of a company’s profits.

Learn more in our webinar: The E in ESG

Social

The S in ESG is all about how the operations of a particular business impact the people who produce their products, buy their services or live near their factories. This takes sustainability to a whole new level by incorporating not only the damage an organization does or doesn’t do to the environment, but also its precise effects on the people who live and work within it.

More specifically, social factors can include things like efforts to increase inclusion among your staff, protect the people who make up your supply chain or give back to communities that house your facilities. Anyone concerned with human rights, inclusivity or discrimination will pay close attention to these factors before engaging with your business.

Learn more in our webinar: The S in ESG

Governance

While social factors measure a company’s impact on the people who interact with it, whether they’re consumers or business partners, governance focuses on how the organization shapes the lives of those who work within it. This helps potential investors and clients understand how your company is run, its business ethics and whether they find your approach to leadership responsible.

Specifically, that means internal matters like corporate policy, board management, shareholder rights and planning for succession or combatting potential takeover. While it can be nerve-wracking to open these kinds of decisions up to public scrutiny, informed investors are likely to reward transparency with increased commitment to and belief in your business.

Learn more in our webinar: The G in ESG

Why Is ESG Important?

According to a NAVEX global survey, 88% of publicly traded companies and 67% of privately owned firms in the US, UK, France and Germany are working actively on ESG initiatives. But what’s led to this spike in commitment to tracking and shaping ESG metrics?

As we suggested earlier, consumers and investors have grown savvy to the many ways a corporation can impact the environment and people around and within it. On top of that increase in awareness, the last few years have produced some of the clearest consequences of corporate irresponsibility in everything from changing weather patterns and more frequent natural disasters to the exploitation of workers overseas.

To put it simply, companies have started prioritizing ESG because their customers and investors demanded it. And it’s already clear that demonstrating real commitment to reducing potential harm can be financially as well as socially rewarding.

In the past five years, products with ESG-related claims have grown 28% compared to 20% for products without such claims, showing that consumers are ready and willing to shift their spending habits based on ESG factors. As for investors, 98% considered ESG factors before making an investment in 2020, and 72% of those people go as far as conducting structured reviews to go over a company’s ESG metrics.

The bottom line here? In the modern business landscape, gathering and sharing ESG data is no longer optional. As long as you want to keep attracting new customers and investors, ESG is a requirement.

What Are ESG Regulations?

So, there are plenty of reasons to take ESG seriously. But what about the legal repercussions at stake?

ESG regulations are the government-mandated standards that spell out how companies should report their environmental, social and governance performance. Depending on where your company operates, you may be required to provide data explaining your levels of greenhouse gas emissions, your plans to mitigate climate-related risks, the demographic makeup of your leadership and more.

Since many countries and regions have distinct ESG regulations, multinational corporations may end up having to comply with multiple sets of laws. Examples include the Corporate Sustainability Reporting Directive (CSRD), which requires all companies with a physical presence in the European Union to report broadly on climate risk, employee and community impact, human rights standards, corruption and diversity. The Securities and Exchange Commission (SEC) also has climate disclosure rules, which serve a similar role in the United States.

Keep in mind that it’s an organization’s responsibility to understand and comply with whatever ESG regulations apply where they operate. Failure to do so can lead to both legal and financial risk, with most penalties taking the form of fines.

What Are ESG Scores?

If you’re relatively new to dealing with ESG, you might find all of these conflicting rulesets and vague requirements a bit confusing. Naturally, many consumers and investors feel the same way, leaving the door open for a solution that simplifies the process of reporting a company’s environmental, social and governmental impact.

That’s exactly the problem ESG scores are meant to solve. By holding all of the companies they analyze to the same standard and scoring them along the same rubric, ESG scoring organizations make it easy for potential clients and investors to compare them directly. They also provide clear and consistent stats that companies can use to prove their commitment to delivering on ESG initiatives.

On the downside, no one ESG scoring format dominates the field, creating a scattershot system of rankings that might be alphabetical or numerical. Some organizations, such as S&P Global, use a scale of 0 to 100, with 0 being the lowest and 100 being the highest score. But others have the opposite rubric, with lower numbers indicating better adherence to ESG standards. Of course, some forgo numbers entirely and stick with the academic sliding score of A through F, with F clearly being the worst possible grade.

Given all of this variation, it’s always best to consult each scorer’s reporting criteria to determine what their grades actually say about the companies they describe.

How Are ESG Scores Calculated?

Like the scores themselves, the various calculations used to determine each grade differ from one organization to the next. Some assign particular weight to certain types of data, while others evaluate all of the information they’re provided on a level playing field.

Let’s return to our earlier example, S&P Global. To determine its ESG scores, S&P asks each company an average of 130 questions based on 1,000 underlying data points. S&P then use the responses to measure the quality, performance, availability and relevance of the company’s ESG initiatives.

For comparison, let’s now look at another ESG scorer, LSEG Data & Analytics. LSEG collects more than 800 data points about each company’s ESG measures, and then groups them into 10 categories based on how they relate to each other. Finally, each company is awarded anywhere from 0 to 100 points in each category, and the average of those numbers becomes the overall score.

To make matters even more complicated, some scorers choose not to disclose their criteria at all. Fortunately, investors tend to trust in scoring methodologies that are available to them more than those that are kept secret.

Who Uses ESG Scores?

ESG scores are probably most important to institutional investors, like asset management companies, who rely on these grades to manage their clients’ investments appropriately.

That said, individual investors can also use ESG scores for similar reasons. Plus, customers may use them to gauge the ethics of a particular organization, while suppliers and other potential partners can use them to help find companies that align with their values and goals.

How Do Companies Disclose ESG Scores?

Since there are few set rules regarding disclosure, there are a few ways you can go about this. If you’re looking for a framework to guide you, you can look to organizations like the Sustainability Accounting Standards Board (SASB), which used input from consumers, investors and companies across 77 industries to create its ESG disclosure recommendations.

If you’re comfortable moving forward without a framework, you have plenty of options. You can list your ESG scores in annual reports to investors, sustainability-specific reports or even publicly available places like your company website.

One note of caution is that some stock exchanges now require listed companies to disclose ESG information alongside financial data, so be sure to look into any rules that apply if you’re running a publicly traded company.

Learn more: How to use ESG standards to build your social strategy

ESG Requirements: A Checklist To Follow

Given all of the competing frameworks and methodologies, how do you find the best path toward tracking and accomplishing your ESG goals? Here’s a step-by-step breakdown you can use as a guide.

Build an ESG Team

The first step toward tackling any major new initiative is assembling the right team for the job. Take a look at your org chart and think about which roles and specialities need to be represented for the ESG team to be successful. Ideally, you’ll end up with a cross-functional roster of stakeholders from investor relations, legal, human resources and other departments.

Conduct Competitor and Peer Analysis

Once you’ve assembled your ESG avengers, it’s time to look to your closest peers for inspiration. Check the websites of leading companies in your industry or direct competitors and download their ESG reports. You and your team can analyze them to determine the types of data they’re using, how they’re reporting it and whether you’ll want to replicate or reject their approach.

Create Your ESG Reporting Framework

With those decisions behind you, it’s time to build a reporting framework that works for your organization. You have plenty of leeway in what that framework looks like, but make sure to include any metrics that are required by law in your areas of operation.

Use Technology to Report Compliance

Since ESG reporting and regulation is only just getting formalized, new rules are bound to spring up after you’ve crafted your ideal framework. Want to skip the hassle of manually updating your reporting structures? Compliance management software can take the hassle out of future-proofing your ESG framework.

How Does ESG Fit Into Your GRC Program?

If you already have a program up and running for handling governance, risk and compliance (GRC), you’re probably wondering about the inevitable overlap between GRC and ESG compliance efforts.

Instead of duplicating work, you’ll want to set up your GRC and ESG strategies to complement each other. In fact, you can use an existing GRC team as the basis for a new ESG task force, as long as you’re careful to add in anyone at the organization responsible for sustainability.

Succeed With the ESG-GRC Hybrid

As ESG expectations develop, it’s only going to get more complicated to navigate the demands of regulatory bodies, investors, business partners and consumers. You can protect your organization by planning ahead to meet those challenges.

How? Account for both ESG and GRC in one platform by using Onspring’s GRC suite to automate processes for both areas. With the entire business ecosystem in a centralized platform, monitoring everything from compliance to risk management becomes easy. Schedule a demo to see Onspring up close and in person.