This article is sponsored by IsoMetrix.
Stakeholder demands for companies to disclose non-financial figures have increased exponentially in recent years. Primarily this focused on data on environmental and social impact, but also on corporate governance – or how committed they are to environmental, social and governance (ESG). While ESG has received increased attention in business and investment circles since 2020, its origins go back much further to concepts such as corporate social responsibility and environmental sustainability.
To help companies report social and environmental information, multiple frameworks have emerged, including the Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), Taskforce on Carbon Related Financial Disclosures (TCFD), CDP and others. Some of these focus on climate impact, while others collect metrics that span the ESG spectrum.
While most organizations looking to disclose ESG information through reporting are now familiar with these reporting methodologies, I was surprised to learn that some large companies are instead using frameworks they have created themselves. Usually the justification would be that the regular standards were not fully applicable to their business, and that because some items were not important, the entire standard did not work for their business.
Since every company is different and has a unique ESG context, using a proprietary reporting framework may sound tempting. But organizations looking to create a world-class ESG strategy and reporting program must avoid this temptation and embrace the formal frameworks.
Standardization makes relevance possible
Similar to the General Approved Accounting Principles (GAAP) in the US and the International Financial Reporting Standards (IFRS) in more than 100 other countries and territories, carbon accounting and ESG reporting must be standardized to be relevant. Although dollars and cents are binary, concepts such as depreciation and revenue recognition are measured in a number of different ways, which is detrimental to shareholders and other stakeholders if not done in good faith. Similarly, when ESG measures are chosen and omitted at the reporting organization’s discretion, there is a risk that only part of the story is disclosed – usually the side that favors the reporting organization. Regardless of intent, observers will question whether they are getting the full story of a company’s performance if the data is incomplete relative to their expectations.
Assuming all reporting is done in good faith, understanding the nuances in ESG reporting can still be a mixed bag. A 2021 study found that only 24 percent of retail investor respondents could identify the meaning of the ESG acronym. While its prominence may have increased since then, inconsistent reporting does not help investors, or other stakeholders, make informed decisions about a company’s status. Unfortunately, because investors are likely to find little value in the uncertainty, non-standardized ESG reporting becomes little more than a PR activity with limited benefit.
Top ESG performers embrace standards and frameworks
Companies that excel in their ESG strategies often also demonstrate better business performance. Research shows that ESG high performers do less volatile earnings over time, benefit from lower capital costs And see more productivity from their employees. The companies that benefit most from their ESG reputation are the ones that make it easy for investors to compare them with other potential investments. Some of this is measured by ESG ratings, which have different methodologies but mainly focus on information released by the company.
The best performing companies also typically align with several of the common standards and frameworks, to provide a well-rounded view of how they approach ESG while exposing both strengths and weaknesses. When getting started, a reliable approach is to take one standard and use it as a basis for assessing topics that matter to your organization. For example, there is a section in the GRI report that asks questions about water treatment: if your company does not treat water, this may be considered unimportant in the company report.
Because there are many standards and frameworks against which an organization can measure itself, it can be difficult to decide which standards to start with. identify which one to start with. A good place to start is to identify the frameworks your company needs to report on. New ESG and climate information regulations in Europe, Canada, Australia and California mean that if you or your supply chain partners do business in any of these places, you need to report. If your organization does not have mandatory disclosure requirements, a good exercise is to assess which standards are most relevant or common in your industry. Checking the methodologies that your peers or competitors use is often a good way to see what is common in your industry, but some internet research can also provide relevant guidance. An ESG consultancy can also be helpful in this regard, because they have broad exposure to different companies and sectors and are often well positioned to provide advice on this.
ESG and sustainability information is here to stay
While some companies may hope that disclosure of ESG and sustainability information will quietly disappear, market momentum suggests that reporting expectations and requirements will only become more formalized and sustainable. Recently, an advisor to a transportation and manufacturing company told me that his company’s motivation to improve its ESG reporting came from questions it received from insurance companies and banks. There were no penalties for his company’s lack of robust ESG metrics, but chances are the insurance and loan rates he received were higher than if he had been able to demonstrate a comprehensive and actively implemented ESG strategy.
A similar scenario exists within private investments. With venture capital dollars becoming much more difficult to raise than in years past, investors are considering ESG-related risks in how to allocate their capital. A PepsiCo leader recently said at a conference that sustainability is a variable used to measure bid prices in mergers and acquisitions, for example.
Costs and access to capital can be an effective motivation for companies to get started with ESG reporting. Fortunately, voluntary reporting carries less liability than mandates and allows organizations to explain reporting gaps. With a focus on continuous improvement regarding disclosures and reporting infrastructure, companies can learn from each other’s best practices without fear of punitive action. Ideally, voluntary reporting will help companies achieve meaningful change and improvement in their overall ESG performance.
While the idea of companies developing their own ESG reporting frameworks may seem appealing in light of their unique circumstances, it ultimately falls short in providing the transparency and consistency needed in the rapidly evolving world of ESG information. Standardization remains a critical part of ESG reporting, ensuring stakeholders can make meaningful comparisons and informed decisions. As global regulatory requirements for ESG reporting increase, embracing recognized standards becomes not only a necessity but also a competitive advantage.