Everything You Need to Know About ESG Reporting

ESG reporting empowers investors to do good for people and the planet while building long-term wealth. ESG reporting is one more tool investors can use to gauge risk. Look at a company’s ESG report for current performance on environmental, social, and governance issues. These reports provide insight into a company’s long-term strengths and weaknesses and guide informed ESG investing.

Historically, companies with high ESG priorities have shown long-term resilience and growth, making them an obvious choice for investment. For example, the S&P 500 ESG index outperformed the standard S&P 500 index on annual periods over the past 10 years. However, because ESG reporting is not yet standardized, investors will want to check each company’s reporting standards.

What is ESG reporting?

ESG reporting is the methodology used by companies to disclose their activities related to environmental, social, and governance concerns. Standards of ESG reporting are still developing, and there is not yet one accepted standard.

A global standard would increase transparency and enable companies to report their impact in a way that is comparable and credible. Otherwise, some companies may gloss over less favorable points while highlighting their strengths.

In November 2021, the International Financial Reporting Standards Foundation announced a new International Sustainability Standards Board for the purpose of creating a global baseline of sustainability disclosure. This Task Force on Climate-related Financial Disclosures (TCFD) is expected to become the leading ESG reporting standard.

In addition to TCFD, the most common ESG reporting frameworks are:

• Global Reporting Initiative (GRI) standards
• United National Principles for Responsible Investing (PRI)
• SASB Standards.

The reporting frameworks offer in-depth information on specific topics. They also encourage companies to monitor and improve ESG performance. The GRI standards, for example, have three universal standards and three topic-specific standards on economic, environmental, and social issues.

Note that ESG reporting is different from ESG ratings. Although both consider ESG impact, the ratings are issued by third-party certification agencies, while the reports are created by the companies themselves.

Parts of ESG reporting

ESG reporting involves three equal parts: environmental, social, and governance, with detailed information on the activities related to each area. While investors should consider the whole report, some may choose to prioritize one issue, such as environmental impact or governance. We can expect to see further refinement of standards and issues reported in coming years.

Environmental

Increasing pressure for governments to meet environmental and climate targets means many corporations are starting to feel pressure to take responsibility. Businesses that want to highlight sustainability will be expected to step up. Companies that are serious about environmental concerns will often include climate-related financial disclosures and sustainability reports.

Environmental issues encompass four key areas: climate change, preservation of natural resources, reduction of waste and pollution, and utilizing environmental opportunities. The main issues can be subdivided to look at performance in specific subcategories. The issue of climate change, for example, looks at carbon emissions, the carbon footprint of individual products, a company’s climate change vulnerability, and financing for climate impact.

The industry and product offerings will affect each company’s unique environmental impact and whether specific issues are applicable. However, the universal standards of carbon emissions, waste, and environmental opportunities can be addressed by any company committed to sustainability.

For long-term investors, environmental impact can be an important consideration to guide decisions. As demands for environmental standards increase, companies that are already compliant can be expected to more successfully adapt and grow as compared to competitors.

Here is a breakdown of the main issues addressed in the environmental pillar of ESG:

Social

Socially responsible companies take into account the policies and treatment affecting employees and communities. The umbrella of social responsibility is wide, and it often encompasses a company’s mission or higher purpose in the world.

However, in simplest terms, social responsibility involves providing a safe, fair workplace that protects employees, stakeholders, customers, and communities. The social pillar of ESG looks at human capital, product liability, social opportunity, and stakeholder opposition.

The Fair Trade label is an example of one aspect of social responsibility. The label signifies companies committed to providing a living wage for producers and transparent product sourcing. Other areas of social responsibility include privacy and data security, human capital development, and climate change vulnerability of employees or stakeholders.

For investors, companies with strong social values can have lower risks. Strong social values lead to lower employee turnover, hiring costs, and delays, as well as improved public perception.

A company who is weak in social values can face lawsuits and sudden downturns in public perception and stock value. This happened to Tyson Foods (TSN -0.43%) in 2020, when several wrongful death lawsuits were filed by employees’ family members who stated the employees were told to come to work with COVID-19 symptoms.

The social responsibility pillar of ESG considers:

Governance

Good governance covers corporate behavior and management. Companies with a high governance score are good corporate citizens. They avoid corruption, have fair anti-competition practices, and demonstrate strong business ethics.

Strong governance is tied to ethics, board independence, and strong leadership values. Corporate governance also looks at accounting, ownership, executive pay, and tax transparency. A history of stakeholder lawsuits can be a red flag.

Many governance issues center on executives and board members. A company with good governance will have clearly defined policies involving board diversity, board member term length, and deciding votes. These companies also have clear disclosure policies on potential conflicts of interest of board members. Other points to consider for governance include whether shareholders can nominate board candidates and whether the company issues dual-class or multiple-class stocks.

For investors, companies with a commitment to good governance policies will be best positioned to pivot and adapt in changing market conditions. They are less vulnerable to lawsuits or investigations. Investors can look to companies with strong governance for long-term growth.

Here is a governance checklist:

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What is an ESG score?

An ESG score or rating is a third-party certification of a company’s ESG values. Investors can use an ESG score to verify ESG reporting. The scores are a composite of the three values related to environmental, social, and governance. Two of the most widely used ESG scoring systems are Sustainalytics ESG Rating and MSCI.

As of October 2020, MSCI rated more than 680,000 equity and fixed income securities and 8,500 companies globally. MSCI measures risk across 10 areas of environment, social, and governance factors. A company is then given a numerical score from 0 to 10 that corresponds to a rating from CCC to AAA.

Leading ESG companies have scores of AA or AAA. To achieve an AA or AAA score, companies must perform well across all ESG areas. Companies with low or average scores from CCC to BBB may only perform well in one or two areas.

Along with historical market performance and detailed ESG reporting, ESG scores provide third-party verification of a company’s commitment to ESG values and mitigation of potential risks. For example, Adobe (ADBE 0.87%) has an MSCI rating of AAA with five-year and 10-year returns of 194.7%. Taken together, ESG reporting, ESG scores, and historical market performance can often provide investors with relevant insight into a company’s values, risk profile, and performance.