By Marc Blythe and Sal Sarabosing, Jr.
Investors are increasingly evaluating companies based on environmental, social and governance (ESG) metrics. ESG is a set of standards for company operations that helps investors make strategic and socially conscious decisions about where to put their money. Many investors are including ESG factors in the investment evaluation process in addition to traditional financial analysis.
Global challenges such as climate risk, privacy and data security, demographic shifts and regulatory pressures are accelerating interest in ESG. The desire of millennials to align their values with where they put their money is also driving significant focus on investing with ESG in mind.
What Does ESG Evaluate?
ESG assessments result in independent ratings that allow investors to evaluate a company’s performance relating to environmental impact, social factors and governance. Some criteria that may be used to evaluate ESG include:
- Environmental: This can include the amount of pollution generated, energy use, waste disposal, manufacturing processes and the sustainability of the supply chain.
- Social: Everything from diversity, equity and inclusion programs to relationships with employees, suppliers and customers can be considered. Social criteria also evaluate the company’s social impact in the broader community through activities such as volunteering or donating a percentage of profits to a local nonprofit.
- Governance: This can include executive pay, quality of leadership, audits and internal controls. The specific factors assessed typically include annual reports, corporate sustainability measures, employee and financial management, board structure and compensation.
Leading global sustainability organizations include CDP (originally the Carbon Disclosure Project), Climate Disclosure Standards Board (CDSB), Global Reporting Initiative (GRI), International Integrated Reporting Council (IIRC) and Sustainability Accounting Standards Board (SASB).
Each organization has different ESG frameworks; however, there are areas where there is duplication. In September 2020, the organizations jointly announced their intent to develop a more unified and comprehensive corporate reporting system. This has yet to happen.
How To Get Started
- Choose a framework/regulating body. The first step toward preparing to meet ESG requirements is to choose which framework or methodology your company will use. The GRI is currently the most used ESG reporting framework in North America. The European Financial Reporting Advisory Group (EFRAG) framework has gained significant traction in Europe and has higher standards than the GRI.
- Get support from leadership. Governance should guide a company’s ESG focus, create accountability and develop processes for implementation. As companies start to incorporate ESG into their overall strategy, they will require input and oversight from the board of directors regarding strategy, risk and opportunity. They will need to assign the various aspects of oversight to an ESG committee or task force, regularly reporting back to the entire board.
- Create an ESG committee. Set up a cross-functional ESG steering committee to develop strategies, implement initiatives and monitor progress related to ESG. Members should include executives representing each ESG category (environmental, social and governance) and human resources, finance, legal, IT, administration and other areas as applicable.
This committee will be responsible for setting up and evaluating ESG-related requirements and activities throughout the company. In addition, it will be responsible for communicating goals and progress to employees, investors and other key stakeholders.
- Develop measurable criteria and goals. Start by identifying and evaluating areas of potential risk across the business. I recommend focusing on five potential risk areas and setting measurable goals connected to value creation for each one. Determine the criteria for success and which methods will be used to track progress. An external consulting firm can add value by developing processes, designing controls, ensuring compliance and monitoring progress.
- Document and communicate. Determine which methods and metrics will be used to track each of the five risk areas. Activity in each area should be documented, including an initial assessment, current status and any required remediation steps. These metrics need to be designed, documented and tested to ensure they function as intended.
Once you have a basic program in place, an accounting firm can audit the program and results and certify that the data collection resulted in an accurate outcome. The ESG information a company discloses should be collected and consolidated with the same diligence as financial information.
After the data collection and outcomes are confirmed, it’s time to communicate the results to an external audience, including interested parties and key stakeholders. The ESG committee is responsible for communicating goals and progress to internal and external audiences.
Where ESG Is Going
Companies with a focus on factors associated with ESG create value for their investors and reduce risk. ESG is likely to evolve significantly over the next several years as investors demand more transparency regarding business practices. An evolution from multiple ESG frameworks to one cohesive overall framework that incorporates key elements from each is anticipated to make significant headway in the near future.
I recommend companies start laying the groundwork now for future ESG compliance. Over the next three to five years, companies that modify their behavior according to ESG principles and effectively communicate the results will likely be considered significantly more attractive to investors.
This article originally appeared on 2 March 2022 at forbes.com
Forbes Finance Council Is An Invitation-Only Organization For Senior-Level Financial Services Executives And Leaders. Members are respected leaders and executives who are selected for the council based on the depth and diversity of experience in the financial services industry.
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