What is ESG and why does it matter?

Climate, and its impact upon our environment, will dominate our post-Covid business and social lives. It will surpass the pandemic in cost and resultant upheaval. However, it’s only part of the equation: it’s time for everyone in business to understand ESG – Environment, Social, Governance – and how these three themes will affect every organisation.

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The world watched the 26th United Nations Climate Change Conference, COP26, (Glasgow, November 2021) where the climate emergency was debated, and resolutions variously passed and procrastinated. No matter the actual decisions, this still remains the inflection point: change is now established as a global priority.

The history of ESG

ESG has contributed to this debate since its 2005 debut within the U.N. report, ‘Who Cares Wins’. This stated that ‘Environment, Social, and Governance’ factors must influence corporate investment processes and decision making.

Originally a tool for the financial markets, ESG defines how organisations shall report their contribution – positively or negatively – to the maintenance of a healthy and sustainable workplace, to the wider society affected by the organisation’s activities, and the extent to which their activities impact our climate. Think of it as enhanced CSR.

What is double materiality?

ESG focusses on how every social, commercial, and government entity operates. It poses two questions: what is an organisation’s impact upon the environment and, conversely, what impacts might a changing environment have upon the organisation itself? We call this ‘double materiality’, and the implications are significant.

The E in ESG is for Environment

The ‘E’ of ESG refers specifically to the environment, but merely understanding the emissions, waste, and raw materials consumed is insufficient. How does an enterprise interact with the wider natural environment, and what quantifiable actions mitigate any harms?

ESG is demands a new depth of reporting. Since all products and processes consume natural resources and influence the environment, we must measure their impact across the entire supply chain, and through to their lifetime utilisation by end-users where applicable.

The S in ESG is for Social

Environment, however, is so more than our natural world: it is a social concept too. Whatever the activity of an organisation, it operates within a human context. It employs people whose health and wellbeing are intertwined with their employer’s activities. Corporate anti-slavery statements were born out of such thinking.

Customers, neighbours, entire communities near and far, and society at large are affected. Consider the negative impact a chewing gum manufacturer can have on those who might live at any distance from the firm itself: their gum has a societal impact which indirectly leads to wasted resources through efforts to remove product disposed of carelessly.

The ‘Social’ pillar fits within the ESG agenda to explore the organisational policies and practices on topics as diverse as human rights, business ethics, diversity and inclusion, supply chain management. It reveals the social impact of a corporation’s operations.

The G in ESG is for Governance

Corporate governance concerns risk and honesty, and encompasses almost all corporate activities, including board and management structures as well as policies, standards, information disclosure, financial auditing, and compliance. For example, investors want to know that a company’s accounting is both accurate and transparent and that its business practices are ethical.

Honesty and transparency are fundamentals, and one need only think of Volkswagen whose emissions scandal highlighted the impact of corporate malfeasance. Similarly, commitments to privacy and anti-bribery are universally accepted ethical imperatives.

Governance hinges also upon risk awareness. Could labour laws or environment factors such as a drought create a material risk to business continuity which should be reported to the institution’s investors? Absolutely!

ESG Reporting vs. ‘Greenwashing’

We’ve all seen pithy corporate statements designed to convince us that a producer cares ‘passionately’ for the environment. Generally, these are all just so much hokum and unsubstantiated advertising fluff. Such ‘Greenwashing’ is now unacceptable, and it’s fast becoming illegal.

A grocery chain might sell certified organic broccoli, but what good is that if the pickers employed by the farmer further down the supply chain are paid less than the legal minimum wage? Would the customers be so willing to make their purchases if they knew the reality? The world is changing fast, and consumers and institutional investors, are voting with their wallets.

Materiality is key to ESG

By reporting ESG data within a certified framework, we can be assured everyone from consumers to pension funds are basing their decisions on legitimate understandings. This is the basis of ‘materiality’ and it’s a central tenet of ESG.

Materiality concerns information which is ‘decision-useful’. It’s information which, if omitted or misstated, could have changed the decision taken by a stakeholder, customer, investor, or even a potential employee’s decision apply for a role.

ESG enforcement in the E.U. via CSRD

Materiality is enshrined within the European Commission’s Corporate Sustainability Reporting Directive (CSRD). This major legislation will be adopted into law in early 2022 and be enforced from 2023. Under the CSRD, making a false statement can be an imprisonable offence.

CSRD will quadruple the number of businesses will fall within scope of ESG reporting requirements. Initially affecting 40,000 firms, it’s reasonable to expect such regulations to encompass the entire SME sector beyond micro-enterprises.

ESG Enforcement in the UK via PPN 09/16

The UK’s approach is lagging, but with Public Procurement Notice PPN 09/16 the writing is on the wall: from 1 January 2021, ESG reporting carries a 10 percent weighting within almost all government procurement contracts.

PPN 09/16 applies to all construction, infrastructure, and capital investment procurements with a value of over £10m. While mandatory for lead bidders, the government has pointedly urged participation by SMEs and Voluntary, Community and Social Enterprise Organisations (VCSEs). PPN 06/20 added evaluation of social value too.

The rules are strict: ESG statements must be verified, and inaccuracies can lead to severe penalties. At the very least, bidders that exaggerate or misrepresent their ESG credentials may be subject to exclusion from relevant tender processes for three years.

ESG hinges upon reporting accuracy

Although there are many reporting standards, the most authoritative is from the Global Reporting Initiative (GRI), an independent international organisation.

The standards are not self-supporting. To produce an acceptable report is fearsomely complex, not least of all because all claims must be evidentiary based. ESG reporting is not a one-off ‘check list’ exercise: it’s a significant undertaking which requires knowledgeable support and the best management software. As such, early efforts to make a head-start before deadlines are imposed are highly recommended.

author avatar
Humperdinck Jackman
Leads the daily operations at ESG PRO, he specialises in matters of corporate governance. Humperdinck hails from Bermuda, has twice sailed the Atlantic solo, and recently devoted a few years to fighting poachers in Kenya. Writing about business matters, he’s a published author, and his articles have been published in The Times, The Telegraph and various business journals.


Matt Whiteman

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