by Bergin Fisniku, Robert Stevens, Austin Miller, Blake Patterson

Regulations surrounding environmental, social, and governance (ESG) reporting and oversight have been an increasingly hot-button issue internationally, but have only recently made their way to the United States. As a result, financial institutions, public companies, and even private sector organizations are pivoting to find more sustainable and socially conscious ways to operate. Thousands of businesses may be impacted by proposed new rules and need to find ways to proactively assess, remediate, and monitor the associated ESG risks. On March 21, 2022, the Securities and Exchange Commission (SEC) proposed rule changes that would require registrants to disclose “information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements” as well as its direct greenhouse gas (GHG) emissions, other indirect energy emission metrics, and GHG emissions from its upstream and downstream value chain activities.

While the current focus in the United States appears to be on climate change, ESG includes several factors that should also be considered, including other environmental (e.g., waste and water management, pollution, energy efficiency, and other environmental sustainability legislation), social (e.g., supply chain management, gender and diversity, community relations, human rights, labor standards, and customer satisfaction), and governance (e.g., board/audit committee composition, bribery and corruption, executive compensation, lobbying and political contributions, cybersecurity, and whistleblower programs) considerations. The inherent complexity of these factors will require businesses to begin performing assessments of the current state of their ESG factors, metrics, risks, and oversight to develop a strategy to reach their ESG maturity goals.

What Businesses Does It Impact?

Recently proposed climate-related disclosures apply only to current SEC registrants, although there would be some indirect impacts to non-registrants with respect to GHG emissions. However, experts fully expect these requirements to be rolled out to government entities and other private sector organizations within the next few years. Investors have begun placing significant value on companies with mature ESG programs, which will likely put pressure on privately held companies to be proactive with ESG initiatives. In an example of pressure from the market, Allianz, a leading multinational financial services group, recently stated that by 2025 it will require all its suppliers to have a net-zero GHG emissions commitment.1  In addition to the recent climate-related disclosure proposal, public companies are preparing for increased demand for other environmental, social, and governance reporting and disclosure requirements soon.

What About ESG Standards?

Standards provide specific, detailed, and replicable requirements for what information/metrics should be reported. Standards make frameworks actionable, ensuring comparable, consistent, and reliable disclosure. The most prevalent ESG standards are:

  • Global Reporting Initiative (GRI)
  • Sustainability Accounting Standards Board (SASB)
  • UN Sustainable Development Goals (SDGs)
  • International Finance Corporation (IFC) Performance Standards
  • International Organization for Standardization (ISO)
  • Climate Disclosure Standards Board (CDSB)

What Factors Fall Within ESG?

Due to the evolving nature of ESG, there may never be a comprehensive list of factors that can be measured. However, below are several key examples of current ESG factors.

Environmental

  • Climate change
  • Greenhouse gas emissions
  • Other energy emissions
  • Air and water pollution
  • Biodiversity
  • Deforestation
  • Energy efficiency
  • Recycling and waste management
  • Water scarcity

Social

  • Company culture
  • Customer satisfaction
  • Data privacy and security
  • Gender policies and metrics
  • Diversity policies and metrics
  • Employee engagement
  • Community relations
  • Human rights
  • Labor standards and employee safety
  • Ethical supply chain
  • Product safety

Governance

  • Board composition
  • Audit committee structure
  • Shareholder rights
  • Bribery and corruption
  • Executive compensation
  • Lobbying and political contributions
  • Litigation transparency
  • Whistleblower programs

Why Does This Matter?

The current business landscape continues to place increased value on the environmental and social awareness of companies and business leaders. Compliance with SEC requirements is reason enough to care about ESG, however, there are several other factors that are driving companies to set ambitious ESG goals and milestones. A recent Environmental Defense Fund (EDF) report demonstrated that companies are feeling increased stakeholder pressure to address environmental impacts; 93% of consumers, 85% of investors, and 85% of employees stated that they would hold businesses more accountable for their impact on the environment.

Not only do the upcoming regulations and stakeholder pressures create incentive for companies to start thinking more seriously about ESG, but there can also be a substantial return on investment (ROI) for these efforts. A recent NYU study revealed that:

  • Improved financial performance due to ESG becomes more noticeable over longer time horizons
  • ESG integration as an investment strategy performs better than negative screening approaches
  • ESG investing provides downside protection, especially during a social or economic crisis
  • Sustainability initiatives at corporations appear to drive better financial performance due to mediating factors such as improved risk management and more innovation
  • Managing for a low-carbon future improves financial performance
  • ESG disclosure without an accompanying strategy does not drive financial performance

Here is an example of a US-based private company that generated a nearly 10x ROI on ESG investments. The company identified the following financial and cultural upside due to its focus and investments in ESG:

  • $440k annual materials savings due to scrap usage
  • 15% reduction in energy costs
  • $106K annual purchasing cost savings
  • 25-50% reduction in employee turnover and a 55% increase in employee satisfaction, leading to 90-200% reduction in replacement costs
  • 55% increase in employee satisfaction
  • 10-20% revenue increase
  • 4-6% increase in market value

We Can Help

The ESG requirements are extensive, complicated, and evolving, and businesses cannot afford to postpone efforts to address these challenges. While these recently proposed requirements only apply to SEC registrants, they may soon directly or indirectly impact many other non-public businesses across the country and the globe.

The consultants at Elliott Davis work with organizations to develop a holistic ESG strategy to address the issues that are most impactful and material to the business and their ESG implementations. Since the path to ESG compliance is a continuous and ever-evolving process, our team will be there to assist you and your business every step of the way.

Here is how we do that:

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.