Think just having environmental and greater good programs are enough to keep investors, employees and customers content?
Try delivering hard data around your environmental, social and governance, or ESG, initiative. ESG is considered a quantitative way to determine a company’s improvement in its environmental, social and corporate governance efforts over time using data. And it’s what stakeholders — from investors to customers — are increasingly calling for.
What Is Environmental, Social and Governance?
What Is Environmental, Social and Governance (ESG)?
Environmental, social and governance is a measurable metric that investors, regulators, customers and other stakeholders can use to evaluate a company’s long-term sustainability efforts, its support to various communities, and its ability to assess risks and govern the organization transparently.
The overall goal of ESG is to show where a company stands regarding these endeavors. Companies voluntarily collect their ESG data, following guidelines or frameworks they believe are most relevant and appropriate for their company and industry.
For retailers, for example, an ESG framework could include assessing, monitoring and engaging their supply chain vendors. “Retailer supply chains extend across the globe and the power of social media to highlight risks can erode consumer trust or lead to consumer boycotts. Emerging consumer, investor and regulatory expectations are leading retailers to understand and mitigate the ESG risks throughout their supply chains,” the National Retail Federation trade group stated in a report.
ESG data can show over time if a company has improved in its focus areas and how it compares to its peers and other industry players. Organizations can then decide to share the information as they see fit.
Many choose to provide the data to ESG rating agencies, which can rate companies based on their own research whether or not a company has provided them with their ESG data. There are a number of ESG rating agencies a company can use — like MSCI, Institutional Shareholder Services ESG and Morningstar Sustainalytic, to name a few. Some ESG rating agencies rank companies numerically while others assign a letter grade.
Fund managers and others who are seeking to invest in companies with high ESG metrics will often turn to these rating agencies to see where an organization ranks before investing in them.
Companies, in a move to be transparent and hold themselves accountable, can also share this information with the public, ranging from employees to customers. Some companies will go as far as publicizing the release of their ESG report versus quietly posting it, especially if the results are good.
Environmental, Social and Governance vs. Corporate Social Responsibility
The push by investors for quantitative data to compare companies not only resulted in the creation of ESG, but also its most distinguishing difference from corporate social responsibility, which is viewed as qualitative. CSR covers areas such as diversity programs or green efforts a company has underway, Christine DiBartolo, senior managing director and Americas head for FTI Consulting’s corporate reputation practice, told Built In.
“You need both. There isn’t one versus the other. ESG is data-driven, disclosure-oriented and quantitative metrics around those three areas, whereas CSR is the programs and engagement you have around some of those same issues,” she said.
For example, a company may measure its diversity among its workforce as part of its ESG data gathering, but also sponsor workshops on combating cultural and racial biases as part of its CSR strategy.
But these days, company investors are demanding to see the ESG component in the mix.
3 Examples of ESG
Enterprise software company ServiceNow has had a busy time with its ESG efforts, according to its 2022 Global Impact Report. Last year, it established a net-zero carbon dioxide emissions target for 2030, two decades ahead of the global climate sustainability goal established in the Paris Agreement. As part of its social responsibility efforts, ServiceNow fully distributed its $100 million Racial Equity Fund, which invests in homeownership, entrepreneurship and neighborhood revitalization in Black communities across 10 regions in the United States.
ServiceNow’s governance work included tying executive compensation to environmental and diversity goals. As part of its cash incentive payout bonus program, ServiceNow C-suite executives may earn more if they can “accelerate” the company’s ESG impact on its products, operations and ecosystem, according to ServiceNow’s 2022 proxy statement filed with the Securities and Exchange Commission.
Apple, as noted in its 2022 ESG report, achieved a carbon-neutral status at its corporate operations in 2020, and expects to make carbon-neutral products by 2030. Among its social efforts, it builds accessibility into its technology and seeks a diverse and inclusive workforce through the programs and benefits it offers to support the development of team members. In terms of governance, it also strives to deliver transparency and accountability across all levels of the company.
For instance, Apple created its business conduct policy to provide guidance to employees regarding the company’s ethical requirements, such as honesty, respect, confidentiality and compliance. Apple ranked fifth in Investor’s Business Daily’s 100 Best ESG Companies for 2022.
IBM is planning to divert 90 percent of its non-hazardous waste from landfills and incineration by 2025 to help the environment, according to the 2021 IBM ESG Report. The company also plans to dedicate 15 percent of its spending on first-tier suppliers to Black-owned suppliers by 2025, and reach 1,000 ecosystem partners trained in technology ethics by the end of 2022, per the report.
The Importance of ESG Today
ESG emerged in early 2000, spawned by the United Nation’s efforts to prompt companies to be more active in protecting the environment by tying it to the strength of their operations, which in turn could yield greater long-term gains for those companies and attract investors.
Now, global sustainable fund assets have reached $2.77 trillion in early 2022, according to a report by Morningstar, a market research firm.
And the number of investment managers with at least one ESG fund in their portfolio has skyrocketed roughly 300 percent since 2016, according to a report by consulting firm Deloitte. The study also found that ESG-related assets could account for 50 percent of all professionally managed assets by 2024.
Investors putting their funds into companies that are making headway with ESG efforts can greatly increase the odds of moving the needle on climate change, diversity, equity and inclusion, cybersecurity and other risk management issues.
“We need to move capital at a rate and size the world probably hasn’t experienced before in order to finance the low carbon transition. That’s where ESG can really make a huge impact in providing investors information,” said Simon Fischweicher, head of corporations and supply chains for CDP North America, a non-profit that provides ratings on how companies, governments and organizations are managing their impact on the environment.
Another sign of why ESG is important can be seen in the regulatory climate.
Earlier this year, the Securities and Exchange Commission issued a proposed rule change that, if approved, would require companies to disclose their climate sustainability data and actions in their annual report. It marks the biggest regulatory action proposed to date around climate change, Fischweicher said. If the rule is finalized next year, it would go into effect for large companies starting in 2024.
The SEC also proposed to amend its names rule to include ESG funds. Currently, under the names rule of the Investment Act of 1940, if a fund has a certain name that implies its focus, the fund would need to adopt a policy to invest 80 percent of its assets in investments that are related to the fund name. The proposed names rule amendment would specifically include ESG funds to the mix, Fischweicher said.
ESG is also an important topic on earnings calls for companies.
Two years ago, ESG received little discussion during quarterly earnings calls for public companies, but now the topic is raised in 90 percent of these calls, said Edua Dickerson, vice president of ESG and finance strategy at ServiceNow.
“That’s because it is really so important to investors and to folks who are listening to the call and thinking about an organization. I would say ESG has completely come front and center,” she said.
How to Develop an ESG Strategy
Given the importance and attention that ESG is generating, companies are increasingly interested in jumping aboard this data-gathering exercise. FTI’s DiBartolo offers this advice to those looking to develop an ESG strategy:
- Step 1: Take an assessment of where you stand with your ESG reporting. What data are you currently collecting? Where are you sharing this information?
- Step 2: Talk to stakeholders to determine what ESG issues they care most about when it comes to your company. Do your investors care most about your carbon footprint? Or does the ethnic and gender composition of your board of directors weigh higher?
- Step 3: Look for the holes. If your stakeholders are particularly interested in certain areas where you have no ESG data, let that guide your ESG strategy on the data you should start collecting. Study ESG frameworks that fall in the area that your stakeholders are interested in to help guide you on the types of data to collect.
- Step 4: Use this newly collected information to leverage the other ESG data you already have and present it to relevant ESG rating agencies to help bolster your ratings with them.
“Rating agencies determine what your rating is based on the information you disclose. So it goes back to what kind of information you have to disclose,” DiBartolo said. “If a company is not disclosing information, there are times rating agencies assume that you’re not taking any steps, when in fact you might be.”
For ServiceNow, the first step it took to developing an ESG strategy came with selecting an executive to oversee its ESG efforts and determining which department to house those efforts, Dickerson told Built In. ServiceNow named its chief financial officer, Gina Mastantuono, to lead those efforts.
“You need to think about the executive and where ESG will sit in the organization, so it can get the support, emphasis and focus it needs to be truly part of your culture,” said Dickerson, who reports into Mastantuono.
The second step was to form a steering committee with an executive from every department. Committee members developed ways to propel the strategy forward and took the information back to their respective departments.
ServiceNow also focused on delivering consistent ESG communication back to employees, like during companywide meetings to discuss the importance of ESG. And, when demonstrating its enterprise software products with customers and conference attendees, ServiceNow also talks about how its products address its ESG strategy and efforts.
Challenges to Creating an ESG Strategy (and How to Address Them)
Developing an ESG strategy can come with challenges, like which of the many frameworks and ESG rating agencies to use, DiBartolo said.
For example, an automaker may select an emissions framework to guide them on what environmental data to collect for their ESG report, while an agriculture company may choose a water management framework for its ESG report data.
The best course of action is to consider the type of company you have, the industry you play in and what data your stakeholders want to see, DiBartolo said.
A rising variety in stakeholders is also creating unique challenges with ESG reporting, said Chris Steuer, senior fellow at the ICF Climate Center, a climate consulting and solutions company.
A company’s stakeholders who are interested in its ESG report, for instance, now increasingly extend beyond investors and include employees, customers and competitors who all come with varying expectations and information needs, Steuer told Built In. As a result, prioritizing information can be a complex process of decision-making for a company.
Traditionally, ESG reporting was more closely connected to the company’s branding, customer engagement and environmental performance, and not necessarily targeted to meet the information needs of investors and financial analysts who, for the most part, depend on quantitative metrics and data analytics platforms, Steuer said.
This has led investors to point to information gaps and challenges by comparing ESG performance across companies, he said. As a result, companies are actively trying to bridge these information gaps using better data management and software solutions, and by more thoroughly aligning with ESG disclosure frameworks.