Environmental, Social, Governance: ESG
ESG Alphabet Soup: Making Sense of the Regulations that will Define Strategy and Drive Performance
Comparing ESG standards begins with reciting the sustainability alphabet.
In 1988, Friedman’s doctrine exalting shareholders over social responsibility was challenged by a concept called social capital, which persuaded companies their public image could affect profitability as much as the cost of production. The worldwide condemnation of Apartheid and businesses allowing it proved this point.
After the Exxon Valdez oil spill in 1997, companies became acutely aware that environmental disasters not only threatened the ecosystem, the costs of remediation and penalties jeopardized their bottom line. Growing concern about climate change added pressure to reduce their carbon footprint.
Critiques of CEO compensation have been published since the 1980s, but it took the financial crisis of 2007 to turn the spotlight on excessive risk and expose whole industries to accusations of corruption and greed.
The need for organizations to assess environmental, social and governance (ESG) impact on financial performance is matched by the demands of stockholders and the public for transparency and accountability. Over the decades, companies have obliged. In 2021, 95% of S&P 500 companies published detailed ESG data and the rest made high-level policy information available to the public on their websites.
What are ESG reporting frameworks?
The complexity of the issues and the difficulty of comparing performance among companies required standardization of reporting. Investor groups, NGOs, advisory organizations and quasi-governmental agencies stepped up to offer numerous frameworks for identifying issues and recommend standards for implementing programs. The resulting avalanche of acronyms for the numerous and varied standards can overwhelm both companies and interested stakeholders.
Comparing widely used standards can be helpful, and starts with identifying their common purpose. All standards aim to establish transparent, reliable and credible methodologies for analyzing ESG best practices and measuring organizations’ performance. Most specify the type of relevant information companies should disclose and offer a framework for accurate and timely disclosure. They enable stakeholder engagement and comparative analysis across target industries.
Standards vary in compliance requirements and comprehensiveness, the scope of ESG issues they target or the type of organization they address. Fundamentally, standards differ in their methods of achieving sustainability: whether they help companies improve operations and mitigate risk, or require them to disclose financial impact to investors or comply with government regulation.
The following list includes key ESG standard-setting frameworks to track.
GRI – Global Reporting Initiative
The Global Reporting Initiative assesses company activities and supply chains for a wide range of ESG impacts:
- Environmental: climate change, resource depletion, waste and pollution, deforestation.
- Social: working conditions, local communities, conflict, health and safety, employee relations and diversity.
- Governance: Executive pay, bribery and corruption, political lobbying and donations, board diversity and structure, tax strategy.
GRI Standards focus on sustainable development rather than financial disclosure. They identify issues, analyze the social and economic impact, and assess governance costs and benefits. The methodology quantifies and compares ESG performance among companies and over time to measure sustainability development. Reports describe what companies are doing and evaluate how well they are performing, which companies use to benchmark their progress.
The standards apply to any organization in all sectors, public or private, regardless of size. GRI functions as a platform for cooperative effort among thousands of organizations in more than 100 countries that self-assess their ESG impact and report sustainability efforts. Stakeholders use the information in numerous ways.
GRI Standards are mandated by the European Commission for public companies with more than 500 employees and are required by legislation or regulations in the US, France, Brazil, Canada, China, Denmark, Finland, Germany and South Korea. They are also required by many leading institutional investors and development organizations.
SASB – Sustainability Accounting Standards Board
The Sustainability Accounting Standards Board analyzes how companies manage pertinent ESG issues and the effects on financial performance. SASB Standards are designed for disclosing financially material sustainability information to investors and other capital providers, specifically ESG issues that have a direct financial impact on companies or affect long-term enterprise value.
SASB was initially motivated by climate change but now concentrates on the subset of ESG issues relevant to each industry. The Standards are used to implement the framework established by the Task Force for Climate-related Financial Disclosures (TCFD) discussed next and align with GRI Standards.
Any company required to disclose the impact of ESG issues on financial performance and enterprise value can use the SASB Standards. Investors, financial regulators and policymakers rely on SASB to identify and measure ESG impact on an industry or a company’s operations and long-term value.
These standards are not mandated by legislation or regulation but are used to identify and report financially material issues subject to mandatory disclosure.
TCFD – Task Force on Climate-Related Financial Disclosures
The Financial Stability Board established the Task Force on Climate-Related Financial Disclosures to create guidelines for disclosing a specific ESG issue to financial entities. Climate-related risk arises from increased operational costs due to a range of threats, including scarcity of resources and disrupted supply chains. TCFD aims to make climate change mitigation efforts an integral part of companies’ risk management and strategic planning.
Any company exposed to climate-related financial risk can use TCFD guidelines to report to investors, lenders and insurance underwriters that assess value and price risks.
Mandatory reporting requirements aligned with TCFD were introduced in the United Kingdom and New Zealand. By 2025, 1300 registered companies in the UK must disclose climate-related financial information. TCFD is endorsed by the G7 and G20 and supported by more than 2,200 organizations. The International Sustainability Standards Board (ISSB) uses TCFD recommendations.
SFDR – Sustainable Finance Disclosure Regulation
The Sustainable Finance Disclosure Regulation imposes ESG disclosure obligations on asset managers and other financial advisors in the European Union and United Kingdom.
SFDR requires transparency of a range of ESG risks impacting the financial industry but focuses on “climate change, resource depletion and other sustainability-related issues.” It aims to eliminate the “greenwashing” of financial products and advice and steer investments toward a sustainable economy by enabling informed financial decisions. SFDR classifies funds from those that do not consider sustainability risks to those that have sustainability as a core objective.
All EU and UK financial funds and firms are mandated to disclose ESG impacts to investors and improve operations to comply with SFDR terms. SFDR doesn’t apply to the U.S. financial market, but all asset managers who raise money, offer funds or market their products in the EU or UK must comply. Furthermore, SFDR is a model for ESG disclosure that encourages US regulators and other governments to develop similar standards.
GHGRP – Greenhouse Gas Reporting Program
The US Environmental Protection Agency instituted its Greenhouse Gas Reporting Program to require the submission of relevant information about greenhouse gas (GHG) emissions from 8,000 sources. The GHGRP aims to monitor 85% of emissions in the country, supplying data for analysis by all stakeholders and policy decisions by legislative and regulatory agencies. Reports are required annually and made publically available. The data can be sorted by facility, location, industry or gas.
Reporting is mandatory for vehicle and engine manufacturers, industrial and fossil fuel suppliers, and any facility emitting 5,000 metric tons or more of GHG annually. The extensive list of regulated entities includes commercial, industrial, residential, and agricultural facilities.
PCAF – Partnership for Carbon Accounting Financials
The Partnership for Carbon Accounting Financials is a worldwide group of 269 banks, asset managers and insurance companies that collaborated with stakeholders to develop greenhouse gas disclosure guidelines for their industry. Their Global GHG Accounting and Reporting Standards help financial institutions assess and disclose greenhouse gas emissions of entities receiving their loans and investments.
Although the standards are not mandatory, the SEC is proposing to mandate climate-related disclosures that include GHG emissions in registration statements and periodic reports. Worldwide, other regulators are considering similar steps.
GFANZ – Glasgow Financial Alliance for Net Zero
Another effort by the financial industry to reduce carbon emissions is the Glasgow Financial Alliance for Net Zero. GFANZ specifically pressures financial service firms and G20 governments to achieve the objectives of the Paris Agreement (Paris Climate Accords). It focuses on reaching investment benchmarks and issues reports on progress. GFANZ offers a Net Zero Financing Roadmaps tool for analyzing financial industry support, organized by financing types, sectors and geography.
GFANZ is not mandatory, but the Paris Agreement is a legally binding treaty negotiated by 196 parties and ratified by 193, including the EU and United States.
Understanding your social, financial and regulatory obligations and the operational benefits of sustainable practices can be overwhelming. Fortunately, specialists that have studied ESG impact and standards can help define your ESG strategy and improve performance.
Learn how SAI360 supports ESG assessment, management and reporting.