ESG – report, resolve or rethink?

ESG reporting –  ground rules still being written

The market value – and future potential – of a company no longer relies just on financial information and data. There’s a (relatively) new narrative in town … Environmental, social and governance (ESG) criteria are an increasingly important part of the commercial/corporate assessment, validation and decision-making landscape. ESG “rules”/expectations and reporting requirements may only really apply to the big companies right now, but this situation is already having a trickle-down effect on the smaller companies in their supply chains.

Within the peculiarities of the Danish pond, the key legislation that currently applies lies in the Danish Financial Statements Act § 99a, 99b and 99d. The FSR – Danish Auditors trade organisation provides good overviews of the country’s approach to ESG legislation here and here.

Decisions about scope

My company has been involved in preparing multiple ESG reports, and in particular in developing, suggesting and formulating the frameworks for what can be reported and on which topics a company wants to enter into the delicate realm of ESG reporting – and how to make it sound credible and investor/owner attractive.

But when you start delving into the nitty-gritty of all this, it becomes increasingly clear that there are as yet really only limited hard-and-fast rules for what a company has to do. Much-vaunted measures like life cycle assessments (LCAs) are really only an attempt to determine “how bad” the situation is, and the rules and guidelines are mostly about “how” to report on that stuff …

One end of the spectrum of ESG reporting approaches lies in merely reporting that what the company did was “less bad” than the previous year (reductions in CO₂e, etc.), and that attempts are being made in some vaguely desirable direction – largely of the company’s own choosing. At the other end of the “ordinary” spectrum, ESG reporting can extend from lofty aspirations and audience-friendly declarations about reduced negative impacts from specific commercial activities to concrete statements that visibly commit the company to specific targets and actions for future organisational action.

The key thing is that reporting Scope 1 and 2 emissions is now compulsory (according to the EU Corporate Sustainability Reporting Directive (CSRD) Directive 2014/95/EU – also called the Non-Financial Reporting Directive (NFRD) – etc.). This is therefore what organisations are now pouring money into/boasting about. Whereas Scope 3 emissions are (still) voluntary, and by far the most challenging to quantify, monitor and report on, because they encompass the whole supply chain/all suppliers, etc.

Summa summarum, simple, voluntary ESG reporting aspirations and opt-in efforts are no longer sufficient. There are now increasing numbers of companies that help other companies identify, extract and structure and present data to document ESG profiles and any particular metrics a company might choose. These include reporting-focused companies like Clarify, DecideAct, Valified, Live Diligence and Normative, with its science-based carbon accounting engine – positioning itself as an expert in “actionable sustainability intelligence”. However, the big mama in the room, energetically rolling back the “wild west” of early-days ESG reporting, is the Netherlands-based Global Reporting Initiative (GRI), now proudly asserting its role as “the provider of the world’s most widely used standards for sustainability reporting“, while regulators such as the European Union and the SEC are energetically consulting on new rules for possible future implementation. And global ESG standards were an unavoidable hot topic at the May 2022 gathering of the World Economic Forum at Davos.

Low-hanging fruit and trickle-down effects

Once actual numbers have been applied to specific benchmarks and criteria, obligations to continue and to improve kick in, and the proverbial hammer falls. One of the big corporate problems with the “low-hanging fruit” in ESG reporting is that the law of diminishing returns applies. It gets progressively more difficult to maintain the same rate of improvement. As just one example, all electricity production in Denmark will come from renewable energy sources by 2027 – which means the value and impact of highlighting that capability in an ESG report will quickly decline. ESG efforts will then quickly degenerate into mere compliance.

In its first rounds and earlier iterations, ESG measures – and reporting about them – were largely the territory of the big companies. This stemmed from a combination of factors that included the extent of the individual corporate “guilt burden” and access to the considerable resources needed to get such data flows and reporting processes kick-started and implemented, along with pressure from the big accounting companies to open up a juicy new source of revenue.

Supply chain dominos

Once the big companies had set the moral precedent and formulated the PR benchmarks, trickle-down effects began to kick in further down the size pyramid. To help bolster their own ESG profiles and in order to be able to provide the necessary documentation, many larger companies have begun to insist that their suppliers also provide documented ESG reports and accounts, in order to give companies higher up the reporting chain the documentation and benchmarks vital for credible reporting. If supplier X wants to continue to be a supplier to company Y, they have to comply with the ESG reporting game. And these suppliers also pass on the requirement to their suppliers. The amount of wiggle room gets smaller …

Any ESG focus on supply chain and value chain footprints means that the impact of non-financial reporting requirements as well as any future introduction of legislative requirements not only affects companies that are directly subject to such legislation, but will probably also affect out-of-scope companies (often SMEs and small specialists) in their role as suppliers of materials, components and specialist capabilities and services. The big fish can’t allow any weak links in their chain of credentials and documentation.

As a result, it’s increasingly the case that companies cannot get accepted onto the supplier rosters of the bigger companies unless they, too, can present a solid set of business ethics backed by documented ESG compliance on key specifics.

The ESG-compliant mindset has been less prevalent in the venture capitalist world or in the field of startups, even though it in fact ought to be easier to build ESG accounting/reporting/responsibility into the business model for a startup – there’s less historical ball-and-chain ballast to wade through and battle against. In fact, VCs often feel they’re investing in “clean” startups, rather than emission-chundering old-school industrial concerns. The blithe/naive assumption is that the whole narrative starts from a climate-conscious clean sheet, and is thus fundamentally different.

Embedded thinking and financial motivators

Sustainability, environmental responsibility and ethical business practices focused on net-zero goals shouldn’t be a special project, or one intended primarily for an external audience (hyped or perceived as “branding”, etc.). Instead, it should be embedded in the company’s overall decision-making/prioritising operating and risk management models and processes. This is the kind of thing that measures like The Climate Pledge, the Science Based Targets Initiative (SBTi), the CDP global environmental reporting system and The We Are Still In Declaration are all seeking to address.

According to Deloitte, professionally managed assets in publicly traded companies in which ESG issues are taken into account when deciding on investments or in major shareholder decisions are on track to represent 50% of all professionally managed assets globally by 2024 – at the current growth rate.

The US Turning Point Report, issued by the Deloitte Economics Institute, shares findings that quantify the impact of unchecked climate change on the US economy – albeit in traditional terms only. The report shows that inaction with regard to climate change could cost the US economy $14.5 trillion by 2070. On the flip side, the potential economic gains would amount to $3 trillion over the next 50 years if the chosen path accelerates towards a path of low-emissions growth. The analysis demonstrates that there is only a narrow window of time – the next decade, really – to make the bold decisions needed (read: essential) to change our climate trajectory and reach a turning point.

New cost structures

In the ESG era of accounting for business activities, it’s not just about what things cost to buy upfront, here and now. One of the biggest practical challenges associated with ESG accounting lies in getting people to grasp that you have to consider and account for total cost over the entire service life of the product or setup – including all the costs associated with dismantling, disposal and site remedials/post-operational clean-ups. This means we also have to include the massive, unseen costs lurking below the waterline of corporate and planetary responsibility icebergs.

This results in new perspectives and narratives about costs – which is not easy when competitors’ invoice prices are attractively lower because such life cycle costs are only included in part (or not at all). We need to find new ways and a new conceptual language to deal with the fact that first impressions about purchasing pain do count, regardless of how virtuous and morally compliant the argumentation.

Data and digital transformation

One of the big barriers to credible ESG reporting lies in the lack of actual data on the issues and actions that a company wants to report about. Without solid, reliable company-wide data, any reporting comparisons and the tracking of progress over time are difficult, patchy, unreliable and lack credibility. Without such data, a company’s ESG reporting gets bogged down in the realm of mere aspirations and assertions.

Because it involves greater implementation of digital tools at all levels of operations, digital transformation may well provide a path to the most widespread, more credible adoption of sustainability initiatives and to introducing more responsibility metrics.

However, data isn’t just a neutral, malleable entity. Most of the modern data analytics platforms that are now the sine qua non  – with Snowflake, Amazon, Databricks, Azure and Google’s BigQuery as some of the big honchos – are not structured to conduct future-requirement post-ESG business analytics, including – most importantly – representing the rules that underlie compliance and governance. The omnipresent structured query language (SQL) on which so much of business data is based simply isn’t well-suited for the kinds of massive, complex “recursive” queries essential for solid ESG reporting about the workings of complex, interconnected systems.

Doing less harm is no longer enough

“Less bad” ≠ “good” – rethink opportunities

“Less bad” ≠ “good” – in fact, it smacks (resoundingly) of greenhushing. There is little substantive or moral reward for moving towards “less bad” in only marginally altered business configurations in which various new regulatory definitions of “good” and different flavours of zero-carbon signalling are the agreed norm/target for the future.

At root, ESG reporting is a (decidedly imperfect) measure of the risk against the company of issues such as climate change. It is not a measure of a company’s positive impacts on the environment. ESG reporting and accountability frameworks do not as such necessarily deliver any positive impact on climate or sustainability agendas, or give rise to any substantive, systemic change. In fact, many of the worst polluters and climate killers actually have strong ESG scores, simply because they are able to document what they do. Their often much-vaunted ESG reports are not an evaluation of their activities, mindsets or intentions in so doing.

However, if appropriately conceived and structured – and if linked to commitment-required future action agendas – ESG frameworks can also be moulded to provide a “conceptual language” for new and significantly different approaches to doing business in the future, rather than just accounting for past sins and seeking absolution by alleged transparency and mea culpa admission. The real question lies less in what ESG is than in how ESG reporting requirements and expectations are used, and for what.

Building sustainability and regeneration into ESG-compliant management