ESG 101: Key Definitions and Insights
As the business world continues to place more emphasis on sustainable operations, you may hear the term “ESG” more frequently…. but what exactly is ESG and are you aware of the key concepts around it? In this article, we will provide some definitions and insights to some of those questions.
ESG stands for Environmental, Social, Governance, which are three categories of topics that can be used to measure a company’s performance beyond the standard financial reporting.
Environmental factors indicate how a company manages risks and opportunities related to climate, natural resources, pollution, waste and other environmental risk factors.
Social includes information about a company’s values and business relationships. Social factors cover many topics such as labor and supply-chain standards, health and safety standards, product quality, privacy and data security, and diversity and inclusion efforts.
Governance encompasses information about a company’s corporate governance, including the structure and diversity of the board of directors, executive compensation, critical event responsiveness, corporate resilience and policies and practices on lobbying, political contributions, and bribery and corruption.
There are many ways to assess, measure, and report on ESG, which include both qualitative and quantitative metrics. The breadth of scope for ESG issues can be quite large, however, so the following information is provided to help clarify some frequently asked questions that BNN hears from our clients:
Why are we hearing so much more about ESG now?
Although it may seem like a novel topic that is just now coming to light, ESG topics and the related frameworks and standards used to disclose company performance on these issues has been around for over 20 years. The last 10 years have seen a flurry of activity of new standards organizations being founded. Those groups have been developing perspectives on ESG metrics and reporting; however, until recently, even the knowledge of the existence of these groups was limited to those working specifically in Sustainability or Corporate Responsibility professions.
The last two years have created much more buzz around ESG, particularly because of some key regulatory and Non-Governmental Organization (NGO) activity driving interest for investors, as well as increased consumer interest in the topics. Of important note for American companies are the proposed regulations and guidelines published in 2022 by the Securities and Exchange Commission (SEC) and the Federal Deposit Insurance Corporation (FDIC). This, combined with increased media attention from reports like those from the United Nations, has driven much more market interest in how companies are performing from an ESG perspective.
What are some of the key terms and definitions critical to ESG?
Beyond the definition of the ESG acronym itself, there are several other important terms and acronyms that can be useful to know as companies navigate their need for ESG reporting and disclosure:
ESG Framework – a guideline giving a broad set of concepts for how ESG information should be structured and prepared, with what topics should be covered, aka “How to Disclose”
ESG Standards – specific guidance and detailed metrics, aka “What to Disclose”
TCFD – Task Force for Climate-related Financial Disclosures is an organization started by the Financial Stability Board that developed an ESG framework being adopted by several financial and investor focused companies.
VRF – Value Reporting Foundation is a recently consolidated entity between the Sustainability Accounting Standards Board (SASB) and the Integrated Reporting Framework (IRF). SASB ESG standards and metrics tend to focus on investor and value creation needs, with issues that are material to adjusting corporate valuations.
GRI – Global Reporting Initiative is a more comprehensive set of ESG standards, focused on overall impact of companies and more closely aligned with the UN Sustainable Development Goals (SDGs).
Stakeholders – Defined in 1984 by Richard Freeman as “any group or individual who can affect or is affected by the achievement of the firm’s objectives,” this group typically includes customers, shareholders, employees, and communities that a company operates in. Stakeholders are considered during ESG reporting and strategy development to ensure that a company’s impact is understood from multiple perspectives.
Materiality – In a sustainability and ESG context, materiality relates to where an organization has significant impacts or issues on environmental, social, or governance topics, and where the firm’s performance in these areas could substantively influence the decision making and views of stakeholders.
What value can ESG reporting bring to my organization?
ESG standards and practices can bring added value to stakeholders across your organization. Conversations around ESG are migrating from simply a matter of corporate responsibility to business competition and an opportunity to attract and retain talent. Multiple studies have shown that companies with strong ESG management have increased revenue, higher employee retention, and greater customer loyalty and satisfaction. Additionally, there is research pointing towards increased diversity in the workplace directly correlating with increased business resiliency. The community and stakeholders value transparency and a focus on ESG may help your organization become more attractive to investors, customers and prospective employees.
A financial institution also has the potential to reduce its credit risk profile by further evaluating their ESG factors. These considerations include climate factors that may have a direct impact on portfolio risk. Climate has the potential to impact credit risk in many facets; therefore integrating climate risk metrics into regular credit risk management could be a huge step forward in the financial institution industry.
As ESG regulations, references, and tools are changing rather frequently, BNN will continue to publish content relevant to these issues to help educate clients. In the coming months, you can expect to see additional questions answered and more information on considerations for implementing ESG reporting.
For more information or a discussion on how this may impact you, please contact Jordin Milano, or your BNN advisor at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.