According to Bloomberg, a study of quarterly earnings reports among companies in the S&P Energy index revealed an increase in use of Environmental, Social and Governance (ESG) related terms.
Is this indicative of an increase in the importance of ESG among these companies? Compared to the first quarter of 2020, the increase of such terms had increased close to 10x!
The events of 2020 had a big impact on what company boards see as important in shareholder reporting. Many companies were caught off guard because they had not anticipated a pandemic in their risk reporting. Is there an attempt to be more aware now that shareholders are more watchful than before?
Besides the pandemic, 2020 presented other conversations around ESG. There were wildfires that highlighted climate challenges that the world faces and there were protests of racial discrimination.
So what changes are ESG issues bringing to businesses in 2021?
ESG is changing business reporting
First, companies are changing the way they report their risk as it relates to environmental, social, and governance issues.
Initially, a majority of ESG reporting was done on a voluntary basis by companies. This reporting has been enhanced by frameworks such as GRI to guide companies on ESG reporting.
Today, there are a number of leading frameworks including:
- Global Reporting Initiative (GRI)
- Sustainability Accounting Standards Board (SASB)
- Taskforce for Climate-related Financial Disclosure (TCFD)
- World Economic Forum Compact for Responsive and Responsible Leadership (WEF-CRRL)
- Science Based Targets Initiative (SBTi)
These standards aid companies with consistent recognized approaches that help stakeholders make year-on-year assessment of financial and non-financial risks.
Five of the leading standards organizations – Climate Disclosure Project, Climate Disclosure Standards Board, GRI, International Integrated Reporting Council, and SASB – recently issued a joint statement indicating an intention to develop a harmonized reporting system. Such creations help enable comparison across companies in different countries and sectors.
ESG is changing disclosure regulations
With the realization of just how important ESG issues are to investors and society, regulators are enacting enhanced publishing disclosure regulations.
In the US, the new administration has made commitments to restore regulations that were relaxed under its predecessor with a new aim to achieve net-zero emissions in all sectors of the economy by 2050.
At the state level, California has recently passed a law requiring companies to increase diversity in their board composition within the next two years.
And, various regulatory bodies are enacting policy. The Nasdaq stock exchange, for instance, is considering a requirement for disclosing board diversity before listing any new company.
In the UK, there is an initiative to make disclosure requirements for companies in at least seven critical sectors of the economy within the next five years.
In the European Union, there is a movement to require companies to protect human rights and the environment throughout their supply chains.
This would mean mandatory due diligence requirements on environmental and human rights risks for all businesses including the financial sector and state-owned undertakings within the EU and those companies that supply them.
So if a supplier to an EU company caused an oil spill, the EU company could be held responsible for failing to exercise due diligence over their supply chain.
ESG is changing investment decision-making
Asset management companies are taking the lead in ESG conversations in companies they invest in.
Recent open letters from CEOs of companies including BlackRock and Strategic Global Advisors (SGA) are a sign of the proactiveness asset management companies have in pushing for reforms in reporting, board leadership, disclosures, and company actions.
Asset managers are increasingly more rigorous when performing diligence on new investment opportunities. One reason is that transparent ESG reporting enables them to more accurately assess risks to the business. Another reason is the growing recognition that companies with strong ESG capabilities outperform their peers.
In fact, a recent analysis highlighted that companies with poor ESG controls experienced higher ESG-related incident rates. This in turn resulted in an -3.5% annual underperformance of stock price vs sector peers in the US and an -2.5% underperformance in EU based companies.
ESG is changing workforce and board composition
The conversation around ESG issues has contributed to companies having more women and people of color at the board level.
Today, all S&P 500 companies have at least one woman in their board. 28% of all board members in those companies are women, which is nearly double of what the number was a decade ago.
That is not a coincidence. Companies want to be seen as inclusive, especially by customers and potential investors.
To increase diversity within companies, there is a trend backed by boards to link executive bonuses to inclusivity and diversity goals.
Starbucks, for instance, has committed to giving 30% of corporate roles to African Americans, indigenous people, and other minority groups.
Such moves are meant to ensure that companies do not just market themselves as progressive but make staffing decisions to reflect their values and the communities they operate in.
Many companies do not have information about a significant and growing number of workers in their business. These are ‘contingent workers’ or those employed on a contract basis.
For a typical business, contingent workers can represent between 30% – 50% of all workers.
These workers often ‘fly under the radar’ when it comes to being represented in workforce composition and reporting.
ESG increases the need for data management capabilities
Your business’s stakeholders want transparency. The need for transparency is different for different stakeholders. But, there’s no argument that business transparency is more important now than ever before.
Reporting on ESG impacts and business risk, which are referred to as “materiality,” is increasingly important for business stakeholders. And, it’s especially for business investors. This is because ESG transparency is directly correlated to superior business performance.
The amount and type of data that companies need to disclose will continue to increase. This trend is expected to accelerate as technology advances. These advances will generate more information about the operations and impacts of business.
Businesses will need new data management capabilities. These capabilities will make it possible to collect, manage, analyze, and report ESG data from direct operations and the operations of supply chain partners.
In the past, businesses have used email and spreadsheets to collect data and manage data. These tools may be ok for small businesses. For enterprise businesses today, they are outdated.
Businesses are using platform-based tools to collect, consolidate, and normalize data in order to provide the transparency needed by stakeholders.
Today’s ESG data management platforms have tools that automate data management. And, they continually analyze data identifying compliance issues and tracking progress, which makes reporting much more efficient.