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ESG explained: What companies need to know
December 19, 2022
Authored by RSM Canada LLP
Joel A. Humphrey, CPA, CA shared this article
ARTICLE | December 19, 2022
Environmental, social, and governance—simply known as ESG—has become a key success measure for many companies. ESG can present significant issues, risks, and opportunities for all organizations, but many may not yet fully grasp what ESG entails and how it can influence critical business functions and operations.
“The ESG landscape is always evolving,” states Trish Beltran, RSM US LLP ESG advisory services practice manager, “meaning companies need to proactively monitor how this affects their strategy and operations. However, as leaders in the middle market, most of our clients are just starting out on their ESG journey and need to first understand what it is, what is material to them and their industry, and lastly, how ESG overall impacts them before they can sustainably implement a comprehensive program.”
Jake Salpeter, RSM Canada ESG advisory services manager, sees many companies that have a head start. “When it comes to ESG, it can be daunting to embark on the journey, but in most cases, we find that companies—especially those in the middle market—already conduct ESG-related initiatives,” he said. “They have just not formalized plans and assigned key performance indicators to start making decisions based on their data. RSM views ESG as an ongoing process whereby companies should continuously enhance and integrate ESG into their business. It doesn’t happen overnight, but it’s about starting somewhere.”
The following are frequently asked questions that many of our middle market clients ask about ESG and about establishing effective processes.
What is ESG?
ESG—often synonymous with sustainability—is a growing topic shaping both internal and external stakeholder expectations, helping employees, investors, partners, clients, and customers understand not only what a company does, but why it does it. It is one way a company can demonstrate its commitment to core values. Over the last 10 years, ESG has grown significantly in global importance. What used to be known as corporate social responsibility is now under the more holistic concept of ESG.
"When it comes to ESG, it can be daunting to embark on the journey, but in most cases, we find that companies—especially those in the middle market—already conduct ESG-related initiatives. They have just not formalized plans and assigned key performance indicators to start making decisions based on their data. RSM views ESG as an ongoing process whereby companies should continuously enhance and integrate ESG into their business. It doesn’t happen overnight, but it’s about starting somewhere"
Jake Salpeter, RSM Canada ESG advisory services manager
What are the benefits of ESG?
Once considered a differentiator, ESG is now becoming an essential component of organizational business models and strategy, in both the public and private sectors, due to changing stakeholder expectations.
At RSM, we believe embedding ESG into a company's strategy and operations in an intentional and meaningful way not only creates alignment with societal objectives but also results in substantial improvements in financial performance. It can address risks such as being accused of greenwashing—falsely promoting something as environmentally sound—while moving companies along their ESG maturity journey.
In practice, ESG can deliver real financial value through:
- Lowering the cost of capital
- Accessing more favorable lending terms
- Proactively mitigating emerging risks
- Attracting investors and customers
- Increasing workforce productivity
- Prioritizing innovation and continuous improvement
What is driving ESG?
While the demand for sustainable corporate efforts in North America has historically stemmed from stakeholder requirements and expectations, an emerging?top-down push?is?expected to further drive the future of sustainable business practices, reporting, and the evolution of ESG standards—while increasing bottom-up market expectations.
Most notably, in the United States, the SEC’s proposed rules on climate change disclosures will require listed entities to report, at minimum, their Scope 1 and 2 greenhouse gas emissions, and include disclosures on climate risks, political spending, tax jurisdiction, and executive pay within their public filings.
Globally, regulations are increasing through other notable developments, including:
- The International Sustainability Standards Board was created by the International Financial Reporting Standards Foundation, which consolidated with the?Climate Disclosure Standards Board and Value Reporting Foundation, and collaborated with the Task Force Climate-Related Financial Disclosures and the World Economic?Forum, to create a global baseline for sustainability reporting and will mandate Scope 3 (up- and down-stream greenhouse gas emissions) reporting.
- The Corporate Sustainability Reporting Directive was adopted in the EU in November 2022 to introduce more detailed reporting requirements for companies with ESG requirements, aligned to criteria within the EU’s climate goals. The CSRD will apply to large listed and non-listed EU companies, small and medium-sized listed EU companies (in a phased approach), as well as non-EU companies with substantial activity in the EU—with the first set of standards to be adopted in June 2023.
How are organizations implementing ESG?
Whether mandated or not, ESG is being implemented in organizations primarily through ESG reporting. Information is typically disclosed through ESG or sustainability reports which focus on quantitative and qualitative disclosures of data, providing metrics around the environment, social and human capital, leadership and governance, and business models and innovation. These reports typically align with several of the myriad ESG standards and frameworks that exist, including, but not limited to:
- Sustainability Accounting Standards Board
- Global Reporting Initiative
- Taskforce on Climate-related Financial Disclosure
- UN Sustainable Development Goals
Organizations may also develop governance documents, such as policies and procedures, undertake operational changes, and set targets leveraging industry-specific standards and frameworks that provide additional guidance on how to further embed ESG. These can include:
- Principles for responsible investment
- Principles for responsible banking
- Science-based targets initiatives
Furthermore, as stakeholders increasingly look for ways to evaluate the performance of organizations, ESG ratings, and scores (both voluntary and involuntary) are being used to make decisions—especially those involving investments.
What is an ESG score?
ESG scoring is a process designed to assess an organization’s ESG?performance or perceived risk, benchmarked against other organizations in the same industry. The score is calculated, by methods proprietary to the respective rating body, through an analysis of a company’s publicly disclosed ESG data or at times through a voluntary intake process.
Though an ESG score is meant to approximate a firm’s entire ESG profile into one number or letter, it is not meant to be used as an exhaustive metric—in fact, the use of ESG scores is hotly debated due to perceived inconsistent methodologies, lack of available data and lack of data assurance. Nonetheless, ESG scores help stakeholders quickly categorize and comprehend the state of a firm’s ESG performance and make decisions based on that performance. The exact methods of calculation and presentation vary by rating body. These rating and scoring providers include, but are not limited to:
- Morgan Stanley Capital International
- S&P Global
- Morningstar Sustainalytics
- CDP (formerly known as Carbon Disclosure Project)
Whether you are taking your first ESG steps or enhancing your existing ESG program, RSM can support your organization along this critical journey to sustainably reach your organizational goals, create value and generate societal impact.
This content was originally published on RSMUS.com.
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This article was written by Jake Salpeter and originally appeared on 2022-12-19 RSM Canada, and is available online at https://rsmcanada.com/insights/services/business-strategy-operations/esg-explained-what-companies-need-to-know.html.
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