Why Should My Company Care about ESG Reporting?

Environmental, social and governance concerns — ESG — have been influencing the investing world, with trillions of dollars already committed to “impact investing.” If advocates have their way, boards and CEOs will increasingly have to report on their ESG activities. Is this a public relations initiative or a regulatory reporting requirement?

Activists and investors have petitioned the SEC to make it a requirement.

How Did ESG Reporting Begin?

The start of the latest ESG movement was globally organized and investment-centric, with a top-down approach to persuading companies to doing the right thing. The United Nations led the way for a second time in 2006. They developed “Six Principles of Responsible Investing” (PRI) aimed at the investing community, which was a different focus from the 2000 Global Compact’s 10 Principles aimed at management.

The PRI Six Principles of Responsible Investing

1. We will incorporate ESG issues into investment analysis and decision-making processes.
2. We will be active owners and incorporate ESG issues into our ownership policies and practices.
3. We will seek appropriate disclosure on ESG issues by the entities in which we invest.
4. We will promote acceptance and implementation of the Principles within the investment industry.
5. We will work together to enhance our effectiveness in implementing the Principles.
6. We will each report on our activities and progress toward implementing the Principles.

Although the target was different, the underlying ESG principles from the United Nations were still based on the original 2000 Global Compact model. That compact promoted 10 principles grounded in four subject areas central to corporate social responsibility: human rights, labor, the environment and anti-corruption.

The United Nations Global Compact’s 10 Principles

Human Rights

• Principle 1: Businesses should support and respect the protection of internationally proclaimed human rights and
• Principle 2: make sure that they are not complicit in human rights abuses.

Labor

• Principle 3: Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining,
• Principle 4: the elimination of all forms of forced and compulsory labor,
• Principle 5: the effective abolition of child labor and
• Principle 6: the elimination of discrimination in employment and occupation.

Environment

• Principle 7: Businesses should support a precautionary approach to environmental challenges,
• Principle 8: undertake initiatives to promote greater environmental responsibility and
• Principle 9: encourage the development and diffusion of environmentally friendly technologies.

Anti-Corruption

• Principle 10: Businesses should work against corruption in all its forms, including extortion and bribery.

Combined, these two United Nations frameworks have become the core principles of today’s ESG frameworks.

What’s Included in ESG Reporting?

As implied by its name, ESG accounting is concerned with measuring firm performance in three very different domains: environmental sustainability, social responsibility and corporate governance. The key measures used to document and report a company’s performance will differ significantly from one company to another, and more importantly, from traditional accounting measures focused on financial performance.

As of today, ESG reporting is not a regulatory requirement. The principles are voluntary and aspirational; therefore, companies provide these reports to satisfy external pressures and voluntary CEO commitment to the Board and stakeholders.

Examples of ESG Issues

Environmental issues

• Climate change
• Water
• Sustainable land use
• Fracking
• Methane
• Plastics

Social issues

• Human rights and labor standards
• Employee relations
• Conflict zones

Governance issues

• Tax avoidance
• Executive pay
• Corruption
• Director nominations
• Cybersecurity

What Is Required Now? Should We Expect More Explicit ESG Requirements in the Future?

The SEC has not adopted specific disclosure requirements applicable to environmental, social and governance issues. Today, such reporting relies on the concepts of applicability and materiality: Issues that are material to a company’s financial condition or results of operations must be disclosed. Similarly, ESG disclosures are required whenever they are necessary to prevent other financial statement disclosures from being materially incomplete or misleading and to inform investors’ proxy decisions.

For public companies, there are disclosure requirements that drive management to address disclosures related to environmental protection issues:

• Item 101(c)(1)(xii) of Regulation S-K, Description of the Business, requires companies to disclose, as part of the description of the business, “the material effects that compliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, may have upon the capital expenditures, earnings and competitive position of the [company] and its subsidiaries. The [company] shall disclose any material estimated capital expenditures for environmental control facilities for the remainder of its current fiscal year and its succeeding fiscal year and for such further periods as the [company] may deem material.”
• Item 103 of Regulation S-K, Legal proceedings, requires companies to disclose “administrative or judicial proceeding[s] arising under any federal, state or local provisions that have been enacted or adopted regulating the discharge of materials into the environment or primarily for the purpose of protecting the environment” if the proceeding is material to the business or financial condition of the registrant and certain thresholds are met.
• Item 303 of Regulation S-K, Management’s discussion and analysis of financial condition and results of operations, requires companies to provide information about material trends and events that may affect its financial condition, changes in financial condition and results of operations.
• Item 105 of Regulation S-K, Risk factors, requires disclosure of the most significant factors that make an investment in a company speculative or risky.
• In the Dodd–Frank Wall Street Reform and Consumer Protection Act, Congress mandated the SEC to adopt various disclosure requirements pertaining to ESG topics such as conflict minerals provisions (Section 1502), resource extraction payments (Section 1504), mine safety and health (Section 1503), and employee and CEO compensation (Section 953[b]).

External parties, including institutional investors and activists, continue to express concerns with the lack of specific ESG reporting requirements, particularly due to the difficulty in making comparisons across companies. Therefore, several groups are vying for the authoritative position. The current landscape for ESG reporting has become more difficult to navigate as numerous companies have adopted environmental and sustainability disclosure frameworks, such as:

• Global Reporting Initiative (GRI)
• International Integrated Reporting Committee (IIRC)
• Sustainability Accounting Standards Board (SASB)
• United Nations Sustainability Goals (SDG)
• Carbon Disclosure Project (CDP)
• Task Force on Climate-Related Financial Disclosures (TCFD)

Thus far, GRI and SASB have been the most widely frameworks, with further alignment to other criteria based on specific subjects, like climate change and water management. As more and more companies issue ESG reports, disclosure is expanding from information that is financially material to the inclusion of idealistic metrics for sustainability and corporate social responsibility.

In the U.S., the reporting remains voluntary. Globally, investors in countries that have already made ESG reporting mandatory, such as the United Kingdom and Sweden, proclaim the benefits of validation and comparability. Although reporting may be required in select jurisdictions, standardization and validation will continue to evolve. Many organizations are being proactive in obtaining external validation and even publishing the auditor’s report.

What Should My Company Do Now?

Public companies in the U.S. should expect increasing pressure to publish ESG data, whether that pressure comes from investors or from regulators. Ten or 20 years ago, it might have been enough to demonstrate your company was not buying goods made with child labor; today’s investors and activists are looking at global contributions to climate change, preparation for sea level rise and perceived fairness of executive compensation, among other concerns. Easing into ESG reporting before it is required will arm companies with data for activist investors and equip them to satisfy future regulatory requirements if — or when —they are instituted.

Self-reported ESG information, without external validation, may not always be accepted. Third-party assurance provided by a CPA firm is perceived as more objective and reliable. In addition, an external firm with experience in ESG issues can provide your company with guidance on the most important issues to be examined, how to extract the right data from your existing systems and reports, and how to present the information in a clear, understandable and useful format.

If you’re interested in exploring ESG reporting for your company, either public or private, Weaver can assist. Find out more about current standards and the issues involved in environmental, social and governance reporting at weaver.com.

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