ESG...but what do companies actually have to do?

Larry Fink's annual letter to CEOs announced that 'climate risk is investment risk' and suggests that his view of a 'fundamental reshaping of finance' is well and truly on its way. The BlackRock CEO's announcement has brought ESG to the forefront of discussions. Companies are now under pressure to review their practices and the threat of capital relocating has made the business community take note.

But what do companies actually have to do in terms of ESG? Are there suggested practices, and how should companies communicate with their owners?

What do companies have to do?

With regards to codified legislation and regulations for companies to follow, surprisingly, there is not a great deal that companies are obliged to adhere to.

As of 1 October 2019, new disclosure rules have come into force relating to UK pension funds' considerations of ESG factors. The new rules mean that trustees have a legal duty to (amongst others):

- report on their considerations of ESG when making an investment;

- explain how they have accounted for financially material matters, including climate change; and

- explain their stewardship of investments and their engagement with investee companies.

It is hoped that this will lead to more engagement between pension funds and investment companies on environmental issues. The developments are seen as an important first step in engagement with environmental and social factors.

A Law Society review in 2014 concluded that it was part of investment intermediaries' fiduciary duties to take ESG issues into account, where they think they are financially material. However, this was guidance and the report did not focus on recommendations for legislation.

Suggested best practice?

The London Stock Exchange has released useful guidance for companies on ESG reporting and factors to consider when communicating with investors.

Investors will be most concerned with factors that they consider as material to a company's long term prospects. It is now widely accepted that consideration of ESG factors are now vital for the sustained success of a business. Therefore, companies should focus on explaining to their shareholders which ESG factors they consider to be material to their business. They should also explain how ESG factors may affect their business, in the context of financial performance or business strategy.

What ESG Standards should businesses be reporting on? 

The volume of standards, frameworks and data requirements in relation to ESG can seem overwhelming. We are some way from a global consensus on reporting standards, however the following frameworks are the most widely cited by investors:

The Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), the Sustainability Accounting Standards Board (SASB), the UN Global Compact, the CDP (formerly the Carbon Disclosure Project), the Climate Disclosure Standards Board, and the FSB Task Force on Climate-Related Financial Disclosures. 

Increasing use of global standards and frameworks by companies has a key role to play in making information more consistent and reliable. According to KPMG’s 2015 Survey of Corporate Responsibility Reporting, 61% of European corporate responsibility reporters used the GRI framework.

Looking closer at this framework, the GRI Standards are structured as a set of interrelated standards. They help an organisation prepare a sustainability report on its economic, environmental, and/or social impacts, and hence its contributions – positive or negative – towards the goal of sustainable development. Through this process, an organisation identifies its significant impacts on the economy, the environment, and/or society and discloses them in accordance with a globally-accepted standard.

Structure 

The GRI Standards are divided into two main areas:

1) Universal standards, which include general disclosures and the management approach, and

2) Topic-specific standards, which consist of economic, environmental and social disclosures.

There are three Universal Standards:

GRI 101: sets out the Reporting Principles for defining report content and quality. It includes requirements for preparing a sustainability report in accordance with the GRI Standards and describes how they can be used and referenced.

GRI 102: General Disclosures is used to report contextual information about an organisation and its sustainability reporting practices. This includes information about an organisation’s profile, strategy, ethics and integrity, governance, stakeholder engagement practices, and reporting process.

GRI 103: Management Approach is used to report information about how an organisation manages a material topically. It is designed to be used for each material topic in a sustainability report, including those covered by the topic-specific GRI Standards (series 200, 300, and 400) and other material topics. Applying GRI 103 with each material topic allows the organisation to provide a narrative explanation of why the topic is material, where the impacts occur, and how the organisation manages the impacts.

Topic Specific Standards

The 200, 300, and 400 series include numerous topic-specific Standards. These are used to report information on an organisation’s impacts related to economic, environmental, and social topics (e.g., Indirect Economic Impacts, Water, or Employment).

200 Series: Economic 

The economic dimension of sustainability concerns an organisation’s impacts on the economic conditions of its stakeholders, and on economic systems at local, national, and global levels. Reporting requirements under this series include:

300 Series: Environmental 

The environmental dimension of sustainability concerns an organisation’s impacts on living and non-living natural systems, including land, air, water, and ecosystems. Reporting requirements under this series include:

400 Series: Social 

The social dimension of sustainability concerns an organisation’s impacts on the social systems within which it operates. Reporting requirements under this series include:

Companies can report ESG information in their annual report, in a standalone sustainability report or in an integrated report. The choice of reporting formats may involve trade-offs between breadth and depth, between focusing on material issues and covering a wider horizon that addresses the relationship between ESG and business strategy.

In 1987, the World Commission on Environment and Development set out an aspirational goal of sustainable development – describing it as ‘development which meets the needs of the present without compromising the ability of future generations to meet their own needs.’ Through their activities and relationships, all organisations make positive and negative contributions toward the goal of sustainable development and therefore have a key role to play in achieving it.

If you have any questions regarding ESG reporting and best practices, please contact Jonathan Cohen or a member of our Energy Team.