For a business to identify its ESG strengths and weaknesses, implement strategies to improve them, calculate risks and opportunities, and demonstrate their value to external stakeholders, it must be able to accurately and consistently report on ESG metrics.
In contrast to traditional financial reporting, however, non-financial ESG reporting lacks standardization and commonly agreed upon metrics. While regulators and international organisations are working to solve this problem, this puts extra burdens on businesses to define, measure, and report their progress.
Poorly implemented ESG reporting can hamper meaningful progress on areas of weakness, and invite criticisms of corporate ‘greenwashing’. This makes robust ESG reporting an important concern for businesses seeking to operate more sustainably, as well as for effectively communicating their commitments and initiatives to do so.
An emerging set of reporting standards
Although there is no consensus about the precise information businesses should prepare for ESG reporting, commonly agreed upon principles are beginning to emerge.
A number of international organisations have published suggested guidelines and frameworks for ESG reporting, including the International Integrated Reporting Council (IIRC), the Global Reporting Initiative (GRI), the Climate Disclosure Standards Board (CDSB), the Sustainability Accounting Standards Board SASB), and the Carbon Disclosure Project (CDP). In September 2020, these five organisations announced that they would work together to promote a shared vision of comprehensive ESG reporting.
In an open letter, they called for a coordinated three-tiered “building block” approach to reporting. The first block concentrates on sustainability disclosures relating to economic performance, risks, and value creation; the second on impacts on the economy, environment, and society; and the third on local jurisdictional and public accountability requirements. Additionally, the organisations seek to harmonise the various frameworks and eliminate duplicate reporting requirements to create a coherent global system for effective ESG communication.
While the effort of these five organisations reflects awareness of the need for common ESG metrics, they are not the only standard-setters. The UN’s Sustainable Development Goals, the European Commission’s Non-Financial Reporting Directive, the World Economic Forum (WEF), the Task Force on Climate-related Financial Disclosures (TCFD), the US Securities and Exchange Commission (SEC), and financial exchanges such as the London Stock Exchange are among the other frameworks and bodies that are engaged in setting standards.
Within this environment, businesses frequently find that the biggest challenges of ESG reporting are the lack of alignment between different reporting frameworks, and difficulties applying them to particular industries and business models. Currently, there is no clear solution to these challenges in the absence of a coherent global framework. Nevertheless, businesses may find it useful to adopt reporting frameworks that are more frequently used by their industry or home country.
ESG metrics and emerging best practices
ESG reporting best practices are fluid, but businesses can take a number of concrete steps to develop robust metrics or prepare for their adoption. Regardless of the specific metrics a company uses, they will be more credible if they are material, consistent, transparent, and comparable. Ultimately, it is the authenticity of reporting by individual companies that makes for meaningful impact, both within the organisation as they seek to operationalize ESG goals, and for ESG reporting to stakeholders.
Developing robust reporting systems starts with expressing ESG priorities within the company’s statement of purpose. Doing so links ESG goals with the company’s core business mission while setting expectations for a sustainable corporate culture throughout the organisation. Companies can further instill ESG principles by linking executive compensation to performance on ESG metrics, as well as assigning representatives to oversee particular ESG categories.
Likewise, disclosing information relating to the diversity and experience of board members offers a signal that the company is committed to ESG at the highest levels. Metrics in this vein include the board’s gender composition and representation of diverse social groups, as well as disclosing each member’s ESG experience and concurrent roles in other organisations. Companies can also disclose executive compensation as a ratio of the compensation of other employees.
Similar metrics can be gathered throughout the organisation to calculate diversity and equality indicators. Companies can disclose employee representation relating to gender, ethnicity, age, disabilities, and other categories, both overall and in particular roles and levels of seniority. For wages, metrics may include pay gaps between different groups, as well as compensation compared to industry and regional averages.
Training is another easily measurable indicator, whether it be for professional skills development, health and wellness, or diversity and social issues. Metrics in this area include average amount of training hours and expenditures per employee, including by employee category.
Greenhouse gas emissions, such as carbon dioxide and methane, are among the most important and in-demand ESG metrics, but measurement methods vary by industry. Nevertheless, all companies can report their alignment with the UN’s Paris Agreement goals, such as setting specific targets and the date they aim to become carbon neutral.
In addition to reporting on scope 1 emissions, which refer to a company’s direct emissions, and scope 2 emissions, which refer to indirect emissions via energy and product consumption, companies can report on how they plan to decrease emissions in their upstream and downstream value chains (or scope 3). Companies can also report on ethical supply chains by seeking certifications for compliance with standards like those set by the Responsible Business Alliance, fair trade associations, and other organisations.
A fluid reporting landscape
ESG reporting is still in its relative infancy, making it an ongoing process for businesses to develop effective systems. Few companies comprehensively report on all ESG areas, though many are improving with each passing year. This means there are opportunities for companies to stand out by taking meaningful and measurable ESG initiatives.
Because it is largely voluntary, businesses have broad discretion to choose what they report – opening the door to accusations that their reporting is selective for marketing or ‘greenwashing’ purposes. Even if a company makes genuine progress in some ESG areas, reporting only on successes and not on deficiencies may give the appearance of self-promotion.
To avoid these criticisms, ESG reporting must be substantive, consistent, and transparent, so that the content accurately reflects the issues and can be compared to other organisations, particularly within their industry. Increasingly, companies are enlisting outside auditors for external assurance to validate the quality of their reporting and emissions data.
However, even when companies collect strong ESG metrics, there is no consensus about how companies should present them. Some opt to incorporate ESG disclosures into filings to regulatory bodies like the SEC, while others create separate ESG reports that are publicly released. Like with financial reporting, companies can create an annual statement to record ESG data and prepare a separate annual report that presents the data with additional qualitative context about the company’s objectives.
As investors expect more in-depth non-financial ESG reporting and regulators develop formal disclosure requirements, companies with mature data collection, validation, and reporting processes will be best placed to adapt and lead in this new reality.
