What To Do To Prepare for the Shift in Environmental, Social, and Governance (ESG) Investing and Reporting
May 27, 2021
By Michael Santiago
Cash flow, revenue, and return on investment (ROI) – just a few traditional metrics investors employ to make well-informed decisions. But more and more investors are becoming conscious of the environmental and societal impact of organizations and their operations. This signifies the growing need for sustainable business practices and information related to environmental, social, and governance (ESG) data. Investors and society alike are transitioning to a mindset of requiring organizations to implement business practices that create long-term value and contribute to societal and environmental goals. There is a growing demand for organizations to contribute to a better, sustainable world.
Corporate social responsibility (CSR) and ESG are not analogous; they are two concepts bound by the rooted principles of society. CSR has long been a self-regulating business practice adopted by organizations of all sizes to enable contribution to the well-being of the surrounding communities and society. Organizations have funneled efforts into attempting to create tangible results as opposed to aligning their societal and environmental initiatives with the organization’s mission and values. This alignment can capture useful data that demonstrates the organization’s commitment to society.
ESG matters have become more than just a trend as more investors continue to value organizations that yield profitable returns and embody the social values and principles of the investor and surrounding communities. Environmental, social, and governance are the three central factors utilized to measure the sustainable and social impact of investments; they aid in measuring the long-term risk and return of an investment. According to the Forum for Sustainable and Responsible Investment’s 2020 Report on US Sustainable and Impact Investing Trends, investors considered ESG factors across $16.6 trillion of professionally managed assets, representing a 42% increase since 2018. Investors are increasingly leveraging these factors in investment decisions, strengthening the need for ESG related data.
ESG is becoming ever more important as the digital age has enabled news related to environmental and social misconduct or vulnerabilities to be available -- and shared globally -- at the click of a button. Organizations operating in today’s information era can benefit from support from the top to enable proactive identification of ESG activities such as diversity and inclusion (D&I), socially and environmentally conscious investments, and reduced energy consumption. This aids in boosting employee morale and motivation, and can be a source to enable the retention of top talent. The ESG factors -- and sufficient reporting -- are vital to the public’s perception and can be a driving force in determining whether the organization is successful in the long term.
To navigate the market, regulatory, and social shifts associated with ESG, organizations would benefit from proactively:
- Performing comprehensive risk assessments to identify ESG risks;
- Implementing sustainable business practices and control processes;
- Designing and automating business processes to capture ESG data utilized by investors to make decisions and enable transparency.
ESG reporting and transparency can be the difference in a dynamic environment wherein social and environmental events are impacting organizations in ways not previously measured. The shift in investor and societal expectations is powered by the reinforced awareness that ESG factors affect global economic growth, organizational development, and the health of the financial market.
New York University’s Stern Center for Sustainable Business’s ESG and Financial Performance: Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published between 2015 – 2020 report quantifies the correlation between ESG and financial performance. The report reveals that for 58% of the corporate studies wherein the focus was on metrics such as return on equity, return on assets, or stock price, there was a positive relationship between ESG and financial performance. Only 8% of the corporate studies, using the operational metrics identified, revealed a negative relationship.
Further, ESG investing during a social or economic crisis outperformed their counterparts. In the first quarter of the COVID-19 pandemic, 24 of 26 ESG index funds outperformed their conventional counterparts. Organizations can benefit from implementing a robust ESG strategy as investors continue to utilize non-financial data to assess the risk of investment. S&P Global’s assessment of creditworthiness incorporates ESG data, and their analysis of an entitys credit resulted in 225 corporate credit rating changes between 2015 and 2017.1 This credit rating is a tool investor’s use in their decision-making process and can indicate the long-term outlook of an organization’s ability to generate capital and optimize the cost of funding.
ESG disclosure and reporting have proven to be difficult due to the variety and sometimes questionable veracity of data ESG initiatives and practices produce. Organizations must identify and collect a wide array of data sets for various ESG initiatives such as D&I and carbon emissions. Frequently, these data sets require organizations to capture data from varied financial and non-financial sources. To adequately report on the success of their ESG practices, complete and useful data must be sourced to enable transparent reporting. (Organizations can enable sufficient reporting by leveraging cloud platforms to automate the collection of data and directly connect to a multitude of source systems; robotic process automation (RPA) can be used to identify and extract ESG-related data.)
The need for data, digital tools, and metrics that demonstrate greater transparency and organizational accountability is vital. An explicit example of this shift is BlackRock’s commitment to sustainability and net-zero transition. BlackRock embodied and initiated a multitude of actions and commitments evidencing the ideation that sustainability is a key risk to consider in investment decisions. As a result, BlackRock launched a risk assessment tool, Aladdin Climate, to evaluate environmental risk present in a multitude of investment portfolios. BlackRock also incorporated over 1,000 sustainability metrics and key performance indicators (KPIs) to assist clients in understanding climate risk.
As more investors shift to socially responsible investing, there will be an ensuing transformation in the regulatory and compliance environment to adapt to the change in investment behavior, reporting metrics and data utilized by investors. The need for organizations of all sizes to be proactive and ensure ESG factors and risks are innate in various organizational assessments is heightened. The regulatory and political uncertainty regarding ESG factors provides an additional opportunity for organizations to implement sustainable business practices and reporting. In March 2021, the SEC announced the creation of a Climate and ESG Task Force within the Division of Enforcement. The task force’s goal is to identify ESG misconduct utilizing data analysis to mine and assess information to identify potential violations.2 The creation of this task force further corroborates the growing importance of organizations implementing sustainable business practices and the need for efficient data gathering, reporting, and disclosure related to ESG. The implementation of a robust ESG strategy and technological tools can assist organizations in proactively preparing for the looming shift in the regulatory environment.
Proactively implementing a comprehensive ESG strategy to create long-term value and adapt to the shifts in the external environment may appear to be a daunting endeavor. But with organizational buy-in and proactive ESG strategy implementation, organizations can effectively generate positive returns while simultaneously demonstrating their contribution to societal and environmental well-being.
1Exploring Links to Corporate Financial Performance, April 2019. S&P Global Ratings.
2SEC Press Release, SEC Announces Enforcement Task Force Focused on Climate and ESG Issues, 2021. Securities and Exchange Commission.