Charting the evolution of environmentally focused corporate citizenship
What does a new focus on environmental, social, and corporate governance mean for the future of corporate social responsibility?
Recent years have seen an increased focus on environmental, social, and corporate governance (ESG) as companies and their stakeholders move away from the historic principles and reporting frameworks of corporate social responsibility (CSR).
But it's overly simplistic to assume one philosophy and approach is better than the other or that this is merely a shift from an “old way” to a new, improved way of measuring a company’s environmental and social impact.
The reality is, without CSR, ESG would not exist. That said, the two approaches are not interchangeable—nor are they mutually exclusive.
CSR refers to any effort a company makes to conduct their business in a way that is ethical, taking account of their social, economic, and environmental impact, and consideration of human rights.
The notion of CSR has been around for decades; historically, it referred to a company’s commitment to sustainability or philanthropic initiatives. Today, company CSR efforts vary widely, from community-based programs and philanthropic giving to holistic strategies integrated into the company’s operations, growth, and overall purpose.
There are many driving factors for companies to develop CSR strategies and programs, from mitigating risk and engaging employees and stakeholders to enhancing their reputation and reach—sometimes as a requirement of doing business. This, along with the fact that CSR is a self-regulated endeavor, results in extensive variance across effort, strategies, programming, and measurement.
The Global Reporting Initiative (GRI) is an independent international organization that seeks to create a consistent language and approach for organizations to report their impacts. The GRI takes into consideration the UN’s Sustainable Development Goals and the Sustainability Accounting Standards Board’s (SASB) within its framework, and it has since become the foundation for the ESG reporting framework.
But it's important to note that the GRI does not promote consistency in focus, prioritization, or effort across industries or entities. Quite the opposite, in fact. GRI reporting aligns with CSR philosophy, which allows companies to consider and prioritize issues based on what is most material to them. A CSR strategy and report uniquely serves the company, its stakeholders, and the communities in which it operates; it rarely appears in regulatory documents filed with the U.S. Securities and Exchange Commission.
Given this highly tailored approach, it can be difficult to truly compare one company’s impact to the next. This subjectivity and inconsistency, along with increased investor focus on companies with strong sustainable and social impact, drove the creation of ESG.
ESG is a key assessment marker for investors to objectively compare the effectiveness of corporate efforts addressing environmental, social, and corporate governance issues.
The United Nations’ Principles for Responsible Investment, a voluntary program launched in 2006 encouraging investors to incorporate ESG values into their decision-making process, partially drove the shift to ESG.
According to the Forum for Sustainable and Responsible Investment’s (US SIF) 2020 Trends Report, sustainable investing in the U.S. is expanding rapidly. Since 1995, when the Forum first measured the size of the U.S. sustainable investment universe at $639 billion, assets have increased more than 25-fold. And at the start of 2020, the total amount of U.S.-domiciled assets under management using sustainable investing strategies was $17.1 trillion, an increase of 42% since 2018.
In Europe, the end of 2019 saw €10.7 trillion in invested assets after an ESG selection strategy, accounting for nearly 45% of total assets under management. These assets included the exclusion of sectors or companies from investment due to unacceptable activities, and integration, or the evaluation of ESG risks and opportunities alongside traditional financial analysis.
However, products that specifically target sustainable development objectives were a smaller segment of the EU market, accounting for €2 trillion, or 11% of assets under management. We anticipate further significant growth due to the progressive sustainable finance agenda, including the new EU Taxonomy and Disclosures Regulations.
Given the increased awareness and preference toward socially responsible investing, the ESG framework outlines criteria across three key focus areas for evaluating a company/investment:
- Environmental criteria evaluate a company’s energy use, waste, pollution, natural resource conservation, and animal treatment. These criteria take into consideration the company’s operations in addition to its supply chain and future state.
- Social criteria evaluate everything from LGBTQ+ equality, to racial diversity among leadership and employees, to community programming and philanthropic giving. These criteria also take into consideration how a company advocates for social good beyond its limited sphere of business.
- Governance criteria evaluate a company’s use of transparent and accurate accounting methods, how it navigates conflicts of interest, its board composition, and other operational considerations.
ESG research firms score companies based on the above criteria. Scores generally follow a 100-point scale: the higher the score, the better a company performs in fulfilling different ESG criteria, thus making it a more socially responsible investment. Scores may vary among firms, which can leverage different metrics and weighting schemes.
While ESG certainly creates a consistent means for investors to compare companies’ environmental and social impacts, it should serve as a lens through which to view and enhance the measurable impact of existing CSR efforts, especially since it stems from the GRI.
CSR and ESG inform one another, and companies should not consider them as exclusive. While CSR aims to make a business more sustainable and socially responsible, ESG criteria make those efforts more consistent and, in some cases, more measurable.
Another way to think of it: CSR is an internal reflection, and ESG is an external evaluation.
Companies internally create and execute CSR programs, and individuals within the company measure and report on the success of these programs. Alternatively, analysts use ESG to objectively measure and compare the effectiveness of companies’ programming and efforts.
Net-net, CSR and ESG efforts are helping companies do good, while doing well. A report by Babson College reviewed hundreds of CSR programs and found they have a strong positive impact on market value and overall brand reputation, while also reducing company risk. The report's findings included the potential of CSR programs to:
Regardless of the philosophy or framework a company leverages, what’s most important is that a company embeds CSR and ESG into its DNA. This not only ensures authenticity but adds the most value and creates the greatest impact.
Sustainable finance, which uses ESG factors to ensure investments only support sustainable economic activities and projects, has an important role in mobilizing the necessary capital to deliver on these policy objectives.
Furthermore, as BlackRock CEO Larry Fink recently stated, “There is no company whose business model won't be profoundly affected by the transition to a net-zero economy.”
To that end, organizations that recognize and adapt to the new social and environmental paradigm permeating national and local net-zero objectives will not only adapt quicker but will flourish through sustainable business practices.
ESG is an important step in achieving these goals. First, delivering a net-zero ambition requires transparency to be effective and meaningful. ESG provides a framework to not only monitor but ensure alignment of business activities (e.g., strategy, communications, procurement, research and development) with environmental and social impact, resilience, and long-term value creation.
The growing stakeholder interest in ESG reflects the view that environmental, social, and corporate governance issues (including risks and opportunities) affect business performance and are important considerations in decision-making.
Finance was a key early mover for various reasons. Insurers needed to address their liability, and regulators (concerned about collateral held in assets) pressured banks and investors. For corporations, the growing interest in ESG is about performance and a long-term approach to drive growth, innovation, and transformational change during this period of transition to a low-carbon economy.
As such, ESG provides a mechanism to manage risk in the business and supply chain and to measure and communicate progress and success.
Why green recovery is essential to Tesco's business
Underpinning this is increasing and more stringent regulation. In the European Union, we see this in four key ESG regulations integral to the EU Green Deal:
- Taxonomy regulation (which prescribes sustainability definitions and requirements)
- Sustainability disclosure regulation
- Climate benchmarks regulation
- A proposed green bond standard
Several pre-existing legislative texts complement these measures. While not dedicated solely to ESG matters, these texts nevertheless incorporate ESG-related obligations which introduce ESG investment strategy, corporate engagement, and disclosure obligations.
For example, the Non-Financial Reporting Directive (NFRD) requires large corporations to publish annual ESG related disclosures. In the U.S., the SEC is considering ESG disclosure and naming funds with ESG-investment mandates. In Japan, to improve corporate disclosure, the Ministry of Economy, Trade, and Industry established a label to identify companies that report on ESG performance.
Even with this progress, demand for ESG disclosure, ratings, funds, and investment has led to an increasing awareness that ESG methods need to be robust and comprehensive to capture growing expectations on risks, social values, and corporate governance, as well as to maintain trust. Various frameworks have evolved to assess the use and consistency of ESG information, its materiality across industries, and how this information should be prioritized and scored (see Table 1).
- The Task Force on Climate-related Financial Disclosures (TCFD)
- The Global Reporting Initiative (GRI)
- The Sustainability Accounting Standards Board (SASB)
- The International Integrated Reporting Council (IIRC)
Despite progress to improve ESG disclosure, there is still a need to ensure consistency, relevance, and comparability across the various ESG reporting frameworks to provide stakeholders a clear view of the issues likely to impact an organization.
As such, there is increasing discussion between these bodies to coordinate ideas and approaches. For example, SASB recently announced a merger with IIRC by mid-2021 to form an organization called the Value Reporting Foundation. This follows on the back of CDP, the Climate Disclosure Standards Board (CDSB), GRI, IIRC, and SASB agreeing to develop a comprehensive global corporate reporting system for sustainability disclosure.
The COVID-19 pandemic and the heightening climate crisis have crystallized the need to address growing environmental, economic, and social challenges.
Sustainable growth and inclusive economic recovery are critical to meeting the objectives of the Paris Agreement and must rest on the foundations of ESG-linked investment decisions.
However, due to the different sustainable investment approaches and standards available in the market, a true consistent and comparable definition of sustainable investment is still hard to quantify. Nonetheless, the market is growing as investors increasingly look to ensure their assets are protected and can grow in the face of increasing stakeholder expectations, regulatory pressures, and challenging economics.
The next stage of development will involve regulatory clarity, the standardization of ESG frameworks, and increasing transparency and disclosure. Companies will need to underpin all of these measures by understanding, assessing, and responding to evolving ESG-related risks and opportunities.
