An introduction to environmental, social, and governance concerns
Environmental, social and governance concerns—collectively contained in the ubiquitous acronym “ESG”—lie at the heart of contemporary compliance practice, as the international community expands the regulatory portfolio of organizations to encompass emerging concerns over human rights abuses and environmental degradation issues. While ESG considerations were relegated to the proverbial periphery for much of the last decade, recent legislative and regulatory pressures have combined to elevate the prominence of ESG concerns in relation to corporate practices. Consequently, organizations are charged with knowledge of ESG considerations as part and parcel of their compliance responsibilities.
A definition of ESG
As a preliminary matter, compliance professionals should be aware that there is no one, universally accepted definition of what constitutes ESG concerns. Nonetheless, the building blocks of the ESG framework are commonly referred to in industry literature as some combination of the following:
Environmental: Any factors that implicate an organization’s impact on the environment from both a macroscopic and microscopic perspective. Common concerns include carbon emissions levels, water scarcity and quality issues, deforestation, and renewable energy considerations.
Social: Factors of keen interest to society at large, including human rights abuses, diversity, equity and inclusion issues, equal pay protections, cultural sensitivity concerns, and community engagement.
Governance: Any factors that implicate an organization’s internal decision-making process, especially as those factors pertain to senior management and board-level decisions; contemporary governance concerns range from board diversity and inclusion issues, to consideration of policies and processes that result in more effective board oversight of emerging areas of public interest, including anti-bribery and corruption concerns, supply chain practices, and broader sustainability measures.
While alignment with ESG concerns has its genesis largely in investor demand for more meaningful metrics by which organizations can be assessed, ESG has gained prominence in more recent years as both an internal assessment tool and public reporting framework.
ESG evaluation frameworks
A number of international organizations have issued various frameworks that enable companies to measure the totality of their ESG impact. These frameworks include, but are not limited to, the Recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”), GRI Reporting Standards, GHG Protocol, and World Economic Forum metrics, among others.
By far the most recognizable and impactful set of ESG standards in the contemporary compliance arena are the the TCFD Recommendations—a voluntary framework by which public companies across economic sectors are encouraged to measure their climate-related risk exposure, delineate actions the company has taken or plans to take to mitigate that risk, and publicly report on the status of such efforts in accordance with regulator standardards. Originally issued in 2017, the TCFD Recommendations were supplemented in 2021 by additional guidance concerning specific metrics, targets and transition plans participating companies can adopt in furtherance of their ESG-related responsibilities. Notably, the TCFD Recommendations are predicated on seven essential principles—namely, that climate-related disclosures: (1) present relevant information; (2) be specific and complete; (3) be clear, balanced, and understandable; (4) be consistent over time; (5) be comparable among organizations within a specific sector, industry, or portfolio; (6) be reliable, verifiable, and objective; and (7) be furnished to all relevant stakeholders on a timely basis.
The GRI Reporting Standards are another popular framework for measuring an organization’s overall impact on social and environmental outcomes in particular. Developed by the Global Reporting Initiative—an independent organization dedicated to advancing the concept of corporate sustainability—the GRI Reporting Standards are modular and designed to provide the most inclusive picture possible of an organization’s material concerns, their related impacts, and how those impacts are managed. The GRI Reporting Standards consist of a universal set of principles applicable to all reporting organizations holistically and sector-specific standards that provide a framework for more consistent reporting of industry-specific impacts. GRI has also published a number of topical standards that serve as a practical guide to the adoption and implementation of the universal standards. While TCFD’s Recommendations are considered the gold standard for public reporting of environment-related organizational impacts, GRI’s Reporting Standards fill the niche for a more comprehensive set of standards that assess an organization’s social impact as well.
Two other popular frameworks for measuring ESG impacts are the GHG Protocol and World Economic Forum metrics. The GHG Protocol focuses exclusively on measuring an organization's greenhouse gas emissions output for the purposes of fulfilling accounting and reporting requirements. To that end, the GHG Protocol focuses on both direct GHG emissions from sources owned and controlled by a reporting organization (and from sources of energy purchased by a reporting organization) as well as indirect emissions resulting from activities occurring at any point in the organization’s value chain. The GHG Protocol’s Accounting and Reporting standard is among the most widely-used ESG standards in the world.
Finally, the World Economic Forum (“WEF”) has developed its own set of ESG metrics with the participation of the Big Four accounting firms—namely, Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers (“PwC”). Released in September 2020, the metrics are built on four essential pillars—namely, Principles of Governance, Planet, People, and Prosperity—that were previously identified in the context of the UN’s Sustainable Development Goals and WEF’s own commitment to adopting those principles in the context of aligning corporate conduct with societal expectations. Collectively, the WEF ESG metrics—comprising twenty-one core metrics and disclosures and thirty-four ancillary metrics and disclosures—are designed to serve as a common baseline for organizations interested in establishing detailed quantitative metrics by which ESG information is disclosed and disseminated.
Mandatory disclosure of ESG considerations
While reporting of ESG information has gained in popularity, to date, a little over two dozen international jurisdictions have adopted formal ESG disclosure requirements in connection with existing corporate reporting obligations with varying degrees of success.
At the forefront of the ESG reporting vanguard is the European Union (“EU”), which in 2022 dramatically expanded the obligation of certain organizations to make relevant ESG disclosures. Pursuant to the EU’s new Corporate Sustainability Reporting Directive (“CSRD”), all large companies, whether publicly listed or not—including non-European companies with a net turnover of EUR 150 million and at least one subsidiary or branch physically present in the EU—are required to report on the organization’s management of social and environmental challenges as set forth by the European Financial Reporting Advisory Group (“EFRAG”).
Under an initial set of standards published by EFRAG in November 2022, companies are required to make detailed, periodic disclosures respecting certain environmental considerations, social matters, and governance standards, among other things. An organization’s environmental disclosures must include items addressing climate change, pollution, water and marine sources, biodiversity and ecosystems, and resource use in relation to the circular economy. An organization’s social disclosures must include information concerning the company’s own workforce, the workforce in a company’s complete value chain, affected communities, and consumers/product end-users. Finally, an organization’s governance disclosures must incorporate items concerning the reporting organization’s corporate culture and business conduct. Critical to the concept of reporting under the CSRD is the concept of “double materiality,” pursuant to which an reporting entity is obliged to consider how the company is both affected by, and in turn effects—undesirable social and environmental outcomes.
In the United States, the U.S. Securities and Exchange Commission (“SEC”) issued a proposed rule that would standardize the collection, publication and dissemination of climate-change related disclosures by public companies. Under the new rule, announced in March 2022, public companies would be obliged to provide certain information pertaining to climate change in their registration statements and annual reports. This information includes disclosure of climate-related risks and their actual or likely material impacts on the company’s business, strategy and outlook; how the company manages climate-related risks through relevant risk management processes; and the degree to which the company generates greenhouse gas emissions, among other things. If adopted, the new rule would impose stringent and detailed reporting requirements on companies that may or may not be accustomed to such disclosures in an ESG context.
Why ESG matters
As more governments move to adopt mandatory ESG reporting frameworks, compliance professionals must be familiar with emerging expectations and rise to meet those expectations by adopting internal controls, policies and procedures that reflect prevailing ESG standards. While many mandatory reporting regimes are in their proverbial infancy, compliance professionals can expect these programs to evolve and mature rapidly over time. Familiarity with basic ESG principles is thus an indispensable part of the compliance officer’s ever-expanding portfolio of core responsibilities.