ESG stands for Environmental, Social, and Governance. It's a framework that helps companies assess and communicate their own impact on the world. ESG is becoming increasingly important in business, and expectations are growing for companies to promote sustainability and responsibility, whether from investors, regulatory bodies or the general public.
What are the three pillars of ESG?
Environmental, Social and Governance are the three pillars of ESG. These three pillars provide a clear overview of a company’s social and environmental responsibility. Let’s break it down.
Environmental
As the name suggests, the environmental pillar considers a company’s impact on the planet. This aims to tackle critical modern environmental issues like climate change, habitat destruction and pollution; for instance:
- How well does the company manage its emissions and energy use?
- Does the company generate an unacceptable level of waste or pollution?
- How does the company use natural resources and raw materials?
Social
The social pillar explores the way in which a company interacts with people, including its own staff and society generally, and whether it has a positive or negative impact. The 21st century has seen a growing expectation for companies to be socially and culturally responsible. This includes the following areas:
- Does the company treat its workforce fairly and offer good working conditions?
- Does the company compensate its staff appropriately?
- Does the company have a diverse workforce and promote inclusion and equal opportunities?
- Does the company give back to the community in which it operates?
Governance
Perhaps the least clear of the three pillars is governance, an area that the general public is likely to be less informed about but is nonetheless essential. Governance refers to how the company itself is led and operated. Factors related to governance include:
- Who are the company leaders, and what is their track record/business history?
- Are executives paid appropriately, considering company performance and staff wages?
- Does the board of directors have strong and diverse representation?
- Does the board of directors have good oversight?
Why is ESG important?
ESG is important, particularly for larger businesses, because it combines the needs and demands of a wide range of stakeholders, society, and the environment. For a company to positively impact the world, ESG is currently the best available framework to measure, evaluate and improve.
Investor demands
ESG investing (or ethical investing) is becoming more popular as investors search for companies that are responsible and sustainable, not just profitable. In addition, a strong commitment to ESG can be seen as a lower-risk investment with potentially greater long-term returns.
Government regulations
In the 2024 Spring Budget, Chancellor of the Exchequer Jeremy Hunt announced that the UK government will start regulating ESG Ratings. This regulation aims to improve clarity and trust in ESG ratings. A full consultation response and legislative steps are scheduled to follow later in 2024.
Environmental concerns and climate change
Climate change and various environmental issues pose significant dangers for both businesses and society as a whole. It is, therefore, becoming crucial for companies to prioritise ESG practices so that they can tackle these pressing issues and contribute to sustainable development.
Social issues
The growing significance and public awareness of social issues, such as inequality and labour rights, is becoming increasingly apparent to consumers and employees. By prioritising ESG initiatives, businesses can demonstrate their commitment to addressing social and environmental concerns, ultimately positioning themselves as responsible and ethical organisations.
What is an ESG rating?
An ESG rating evaluates a company's environmental, social, and governance performance. Investors use these ratings to assess a company's sustainability, ethical practices, and traditional financial metrics.
There are several ways to check a company’s ESG rating, such as:
- Brokerage Platforms & Financial Portals: Many platforms include ESG scores alongside other financial data.
- Rating Agency Websites: An ESG rating agency is an organisation that assesses and assigns ratings to companies based on their ESG practices. Most ESG rating agencies make their ratings publicly available on their websites.
- Company Sustainability Reports: While not a direct score, these reports offer insights into the company's ESG practices.
Can public ESG ratings be trusted?
ESG measurement is still evolving, and there's no universal standard for reporting on ESG performance. If you are researching companies using ESG rating agencies, it is important to take these ratings with a critical eye, considering potential bias and information that you cannot verify.
What is an ESG report?
Companies publish ESG reports, also known as sustainability reports, to share their ESG practices and performance with stakeholders.
This report allows companies to be open about their sustainability efforts and show their continued commitment. Strong ESG performance can attract investors who value sustainability. ESG reports can also help build trust with customers, employees, and communities.
By highlighting potential ESG risks, the report can help companies identify areas for improvement and reduce future risks.
Many companies publish their ESG reports on their websites for the public to see, often in the "Investor Relations" or "Sustainability" sections.
Is ESG reporting mandatory in the UK?
The UK situation regarding mandatory ESG reporting is complex. There is not a single comprehensive law requiring all companies in the UK to produce ESG reports. However, this may change in the future.
The Companies Act 2006 included amendments in 2022 which now requires larger companies to include a non-financial information statement in their annual reports. This statement must cover environmental matters, particularly climate-related aspects like energy usage and carbon emissions.
Trends suggest that mandatory ESG reporting requirements might expand to include smaller companies in the future, especially as the UK strives for net-zero carbon emissions.
How to get started with ESG
If your company has not yet begun reviewing its ESG, now may be a good time to start. The demand for sustainable and ethical business practices is unlikely to diminish over time, and future regulations may eventually mandate ESG reporting for all businesses.
Assess your current ESG practices
To begin with, you should evaluate your company's existing environmental, social, and governance practices to get started. This will help you identify areas for improvement and opportunities to integrate ESG principles. Your auditor may be able to assist with this information gathering and analysis.
Develop a long-term strategy
Next, you must clearly define your ESG goals and develop a roadmap towards achieving them. This could be setting ambitious but realistic targets for emissions reduction, improving diversity and inclusion in your workforce, or reviewing and strengthening your corporate governance practices.
Communicate clearly and transparently
It is important to effectively communicate your ESG goals and progress to stakeholders. It may be wise to publish an ESG report, even if it is not mandatory for your company. You may also wish to explore transparency initiatives such as stakeholder engagement programs to ensure your efforts and progress are well-documented and shared with relevant parties.
Matthew Lewis
Matthew is a Senior Audit & Accounts Manager at Shorts. He is a Chartered Certified Accountant with experience with Big 4 and Top 10 firms. His experience includes audit and financial reporting, across a wide range of businesses and sectors.
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