Irwin x Novisto: A practical guide to understanding ESG - Part 1
Know your why
Companies are under increasing pressure from investors and stakeholders to provide detailed information on their environmental, social, and governance (ESG) practices and their impact on the ecosystem. This is because ESG management is seen as a key factor in managing business risks, ensuring long-term financial prospects, and protecting reputational capital. Companies that fail to properly identify and manage their ESG risks may face engagement from shareholders, decreased valuations, and even divestment. Investor Relations Officers (IRO) play a crucial role in communicating a company's ESG efforts and must understand ESG and sustainability to help create value for the company and its stakeholders.
What is ESG
ESG (Environmental, Social, and Governance) is an acronym used to refer to sustainability-related considerations in the finance and investment sector. ESG issues are business issues that are either environmental, social, or governance in nature and are considered alongside traditional financial considerations such as financial returns. Companies focus on ESG issues that matter most to them based on their business activities, location, and value chain. The materiality of ESG issues refers to the relevance and significance of the issues to a company's ability to create, preserve, or erode value.
ESG and sustainability are related terms but have different perspectives and intentions. While ESG focuses on how sustainability-related business issues affect a company's operating and financial performance, sustainability is more of a mindset about conducting business that involves the interdependence between a company and its ecosystem. Corporate purpose is the binding agent between ESG and sustainability, and companies aim to create value by fulfilling unmet needs in society while mitigating negative impacts. The long-term success and competitive advantages of companies are increasingly dependent on both profitability and sustainability.
The need for quality ESG reporting
The quality of ESG reporting is a major concern for capital market participants, as they believe that the sustainability information currently available is inadequate to make effective capital allocation decisions. In response, there have been calls for ESG-related disclosures to be widely available, comparable, and reliable. To meet these demands, companies must shift from a communication-based approach to a reporting-based approach that is regulated, standardized, continuous, scheduled, and verified. This is indeed where market and regulatory trends are heading.
Performance measures, or ESG metrics, are essential components of effective ESG reporting. Companies should determine which issues and performance measures to collect data and report on, with performance metrics related to the material issues identified by and relevant to those tasked with managing the issues. To produce quality ESG data, digitalization of data collection and automation of data processing and reporting can help. Leveraging popular and credible reporting frameworks and standards is also critical to making corporate reporting comparable. Relevant and reliable public corporate reporting also provides valuable inputs to — and sometimes counter— third-party ESG ratings consumed by investors and other stakeholders.
