Steps to Take Before Investing in an Expensive ESG System
There is no hotter buzzword in the world of compliance than ESG. Our clients ask us about ESG all the time, and typically there is a lack of clarity around their purpose for ESG reporting. They were just “told to do it.”
Though we are still learning the implications of the reporting process and what it means, ESG does matter and global sustainability challenges, privacy and data security, demographic shifts, and regulatory pressures are introducing new risk factors for investors that may not have been seen previously.
There are three primary reasons why ESG reporting is becoming more and more relevant:
The world is changing. Global challenges such as climate risk, increased regulatory pressures, social and demographic shifts, and privacy and data security concerns represent new or increasing risks for investors. The economic pressure the COVID-19 pandemic has placed on some industries has affected companies’ exposure to ESG risks and their ability to manage them, opening them up to greater scrutiny if they fail.
A new generation of investors. The interest from millennial investors around the world has already helped drive the rapid growth in ESG investment. In a 2018 survey, Bank of America Merrill Lynch said that they could "conservatively estimate" USD 20 trillion of assets growth in U.S.-domiciled ESG funds alone over the next two decades.
Better data and technology for more meaningful insights. Advanced technology, including artificial intelligence (AI) and alternative data extraction techniques, help minimize our reliance on voluntary disclosure from companies. Machine learning and natural language processing help us increase the timeliness and precision of data collection, analysis, and validation to deliver dynamic content and financially relevant ESG insights.
WHAT IS ESG, EXACTLY?
ESG, or Environmental, Social, and Governance reporting, is a way of scoring investments or investment opportunities by using a group of non-financial metrics. Most of us understand the financial metrics around the value and stability of a business – things like gross margin, profitability, earnings per share, debt, cash position, etc. These are revealed by various types of financial reporting and modeling. They’re well established, have clearly defined accounting standards, and the information is available on most companies to review for purposes of determining investment worthiness or using a comparable for a business being evaluated for investment. Historically, these metrics were the big drivers, all financial at their core.
ESG is a breath of fresh air that now allows companies to define their value with non-financial metrics. Interestingly, the KPIs that fall into ESG can often represent risk factors that could result in a negative financial impact if not monitored and addressed.
WITHOUT STANDARDS, REVERT TO PURPOSE
It's intrinsically obvious to most that these non-financial factors are critical in the overall trajectory of a business. By default, when you invest in a business you are investing in the future potential of the business to allow you to make money. Some would argue that risks revealed through transparent ESG reporting can cause harm to a business in terms of financial damage, reputation damage, and a slew of liabilities if left unmitigated.
Let’s accept the grander goal of better-informed investors who take a more informed position in your business. Minimizing risk speaks to the long-term financial health of the company and that’s what investors want, right?
Why then, has ESG been so mysterious? Mainly because it does not have the same type of binding standards that financial metrics do. There is no GAAP for ESG like there is for accounting. Without universally accepted standards, it’s best to revert to purpose, and ESG’s purpose is better informed investors.
At the core of all Environmental, Social, and Governance reporting, transparency reigns.
TRANSPARENCY
Clear and transparent reporting is core to ESG, especially while we are still in the era of no commonly accepted standards.
There are critical financial “truths” and specific, well-defined ways for financial reporting, especially for publicly traded companies. Because they are clear, companies can manage their processes around them and have benchmarking analysis available to use as a valid comparison.
In contrast, ESG metrics are not there yet, and they represent evolving standards. It’s early in the process, but they are a worthy set of metrics to build and measure a sustainable business. In the interim, there are several approaches companies can take. One is the implementation of some of these new reporting systems with a focus on ESG. These systems are for the large part immature and unproven, and consistently expensive and challenging to fully implement.
AFFORDABLE ESG
There is, however, an effective and affordable alternative. Implementing well-designed policies regarding these issues, informing employees, and utilizing an internal reporting tool are all ways to set your company up for ESG success. It is critical to have these fundamentals in place before investing in an overarching system.
Putting these building blocks in place for a successful ESG program is critical, affordable, and achievable. These efforts will demonstrate your company’s commitment to the higher goals of ESG and provide the clear and transparent evidence you need to demonstrate that commitment publicly. As ESG evolves and global standards emerge, you’ll have the baseline data to feed the much more complex and daunting systems in the future.
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MEET THE AUTHOR
J Rollins is the co-founder and CEO of ETHIX360. J is a well known leader and innovator who has served on senior leadership teams ranging in responsibility from Chief Revenue Officer, Chief Marketing Officer, SVP of Product Strategy and Chief Operating Officer.
ABOUT ETHIX360
At ETHIX360, our goal is simple: to provide an affordable, flexible, and comprehensive answer to employee communication, policy management, corporate training and case management on issues related to corporate ethics, code of conduct, fraud, bribery, and workplace violence.
