ESG and Sustainability Reporting, a road under construction
After talking to multiple clients and colleagues about ESG Reporting, I noticed there is still some confusion about its scope. ESG, also called Sustainability Reporting, is becoming increasingly popular. But this trend is not new, as some finance professionals and organizations have been advocating its adoption for years.
In this post I offer my view on two questions I’m being asked frequently: 1) What is ESG or Sustainability Reporting? and 2) How might it evolve in the near future?
First, let’s define what ESG means. It is an acronym for Environment, Social and Governance.
What is ESG or Sustainability Reporting?
It is a mix of qualitative and quantitative metrics, across 3 pillars: Environment, Social and Governance. Environment relates to the impact to the planet, Social relates to the impact on people and communities, and Governance relates to how a company is run.
An example of a quantitative metric can be found under Environment, with “Percentage of renewable energy” consumption. While a qualitative one can be found under Governance, with the existence of an ESG Committee.
Let’s now illustrate this with a practical case. Imagine company ACME has set a target to consume 100% of its energy from renewable sources by 2035; the current measure of the metric could be 35% renewable to 65% non-renewable, and the strategy could be to switch electricity providers or update electricity plans once current contracts expire.
Companies produce Sustainability reports to disclose three things mainly: a) targets, b) strategies to achieve them and c) measures of mostly non-financial performance. These three elements combined, help companies to manage risks related to climate change, reputation, transition to a carbon net zero economy and others.
Disclosures in this area are a reality, and regulations are starting to emerge. To the point that those who fail to disclose, could risk their license to operate as a business. Companies are expanding the coverage of this topic in annual reports and are producing specific documents on it; sometimes included as part of the Corporate Social Responsibility agenda.
One challenge in this space is that there are multiple players proposing a solution, but there is a lack of consensus. Adoption is low as incentives and regulations are slow to develop. This flexibility leads to optionality across those who report, and frustration for those that consume the reports, as they are not comparable.
How might ESG or Sustainability reporting evolve?
In most cases, disclosures are limited to some metrics and strategies, covering some aspects of sustainability. In other words, reports often come with gaps, challenges with data or blind spots.
Part of the sustainable finance community claim that this kind of reports often lack financial impact. Because the current financial accounting systems ignore the effect on people, communities and the environment. The value of these impacts should be integrated to the traditional measure of financial value; reflecting on the financial statements.
Multiple parties are taking action to develop common frameworks for universal reporting standards. For example, the involvement of the IFRS (International Financial Reporting Standards), is a good sign of the intention to accelerate a global language.
Developing a common framework is the way to go, but will take time. In the interim, business leaders and companies need to continue the path towards improved reporting transparency, more disclosures, and better attempts to integrate Sustainability with traditional Finance. This is no small ask. After all, ESG Reporting is still a road under construction.