Environmental, social, and governance (ESG) is an investment framework based on standards, reporting organizations, and regulations that help investors, companies, and other stakeholders assess a company’s risks and opportunities. Most companies are rated on their ESG performance by several different agencies. Investors use these ratings to supplement financial reporting and better understand the potential long-term, financially relevant ESG risks a company may face.
Recently, however, these ratings are increasingly used by customers, employees, and potential candidates to understand how a company aligns to their values and goals. And that’s not all. Reporting frameworks continue to prove themselves useful in helping companies develop and mature their strategies. In many cases, they’ve even become a key motivational tool in ensuring the company delivers its best possible plan.
The ESG regulatory tsunami
ESG regulation is accelerating on a global level. The Security Exchange Commission is crafting guidelines to make ESG more transparent, while the European Financial Reporting Advisory Group is preparing for the launch of their 2024 regulatory requirements. In fact, the number of regulatory initiatives over the past 10 years across all ESG pillars has grown exponentially, resulting in 34 times the number of regulations in 2022 compared to 2012 (see chart below).
Despite uncertainty about the regulation’s final scope and timings, companies are already being encouraged to comply with existing frameworks such as Task Force on Climate-Related Financial Disclosures (TCFD) in preparation for the upcoming implementation. This is coupled with the belief that European requirements will likely be more demanding than those in the United States (same as with General Data Protection Regulation), which obviously has massive implications for global organizations.
We need to get ready, and we need to do it now. But first, and most important, we must see this as an opportunity rather than an obstacle. By assessing stakeholder priorities and aligning with ESG frameworks, we can advance the sustainability strategies of our organizations while simultaneously improving their external performance.
Here’s how—and why.
1. Demonstrating measurable impact
We all know that what gets measured gets managed. ESG reporting helps leverage data such as gender balance, greenhouse gas emissions, and water and waste metrics in support of us better identifying and managing these risks. Simply put, reporting holds a company accountable for their sustainability practices by providing a framework for measuring progress towards those goals. This accountability can help ensure companies prioritize sustainability and take action to improve their impact.
For example, enabling and enhancing diversity, equity, and inclusion is a key component of social sustainability. One element of that is gender equality. Despite continued efforts, female participation levels in the energy sector remain low—below 25%. Attracting more women is not enough to address the challenge and neither is building a more inclusive environment. What’s essential at this point is that women are supported, positioned, and compensated for increasingly senior roles in our companies.
Transparency benefits your external stakeholders as much as it does your internal ones and holds you accountable for acting with impact.
Some organizations (speaking of accountability) can be seen setting future milestones on their road to gender equality or even publishing gender diversity benchmark reports that include pay. These kinds of public declarations, information, and guidance set a precedent for how the rest of the industry should behave when it comes to responsibility and transparency.
Another example relates to emissions reduction reporting. We, for example, made our commitment to net zero inclusive of scope 3 emissions by 2050, with interim goals to track progress. And we’re not the only ones, but it’s the reporting in alignment with sustainability frameworks that will allow all of us to demonstrate our progress, benchmark with our peers, and plan—sometimes collectively—for the future.
2. Making more informed decisions
ESG rating agencies typically use publicly available information such as 10-Ks, websites, proxy statements, and sustainability reports to measure ESG exposure. Reporting on your ESG efforts and results provides transparency into your organization’s sustainability practices, enabling stakeholders to better understand your environmental and social impact. Such increased transparency can help identify additional areas for improvement and encourage changes that have a positive impact across the board.
3. Managing risk and exposure
Given that enterprise-level risks are generally similar across an industry, understanding and dealing with those risks across multiple time horizons can very well become your competitive advantage. And ESG frameworks can help you do that. Taking a data-centric and scenario-based approach to climate and transition risk, for example, helps you better understand how climate change and energy transition will affect your business and that of your partners. Fortunately, in this case, several valuable frameworks already exist. (We selected both the TCFD and Sustainability Accounting Standards Board disclosure frameworks as methodology guides.)
What is a portfolio strategy without strong ESG considerations?
Today, climate-related scenarios are an integral part of one’s portfolio strategy. Our approach includes reviewing different scenarios to evaluate our business resilience and confirm our portfolio’s alignment with our energy transition ambitions when it comes to those scenarios. For example, both the 2-Degree Scenario of the Paris Agreement and the International Energy Association’s Net Zero Emissions by 2050 Scenario were invaluable to our understanding of the role that carbon capture, utilization, and sequestration would play in the path to net zero. While carbon capture is not unfamiliar to us, the scenarios gave us confidence that the potential addressable market warranted its continued investment and integration into our business. To give you another example, IHS Markit (now part of S&P Global) and Rystad Energy both had scenarios that informed our view on local distribution of the energy mix, ultimately influencing our region-specific tech strategies.
4. Attracting the right stakeholders
Companies that not only prioritize sustainability but also their reporting of it attract investors, employees, partners, and customers that share similar ESG values. This should be one of the biggest incentives for companies to communicate how their sustainability practices are driving impact.
And as you can see, ESG reporting is not as daunting as it seems—it can actually accelerate sustainability impact in multiple ways. It provides investors with an independent opinion of your ESG performance and risk exposure, while simultaneously leveraging that same transparency to build more trust and engagement with other stakeholders such as your customers and employees. Meanwhile, your company benefits from having a solid framework for better managing risks and opportunities, ultimately driving longer-term strategic thinking and value creation. Win, win!
