Within the investment world, ESG (Environmental, Social, Governance) issues have grown increasingly important. Investors are applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities. For example, 87% of limited partners polled by Private Equity International, ESG has become a significant component of their decision-making process.
The demand for ESG and sustainable investing is being driven by factors like environmental risks, such as increased greenhouse gas emissions and natural disasters, as well as the rise of socially conscious investors. As millennials become employees, buyers, and investors, they’re taking note of corporations dedicated to sustainability and rewarding them with loyalty. According to Morgan Stanley, 86% of millennials are interested in sustainable investing, and a Sustainable Brands survey found millennial investors are more likely to integrate sustainability into their consumer behavior. In turn, the number of companies reporting on sustainability efforts has increased as more investors demand detailed ESG reports. According to the Governance & Accountability Institute, 90% of companies in the S&P 500 Index issued sustainability reports in 2020.
UNDERSTANDING SUSTAINABILITY METRICS
Today’s investors need precise tools to quantify ESG performance and guide the investment process, especially now that sustainable investing is valued so highly. To succeed, investors and businesses require clear, aligned guidance on which measures will help them define and achieve effective ESG outcomes.
When defining metrics, it’s important to understand the three main categories of ESG. Each industry and organization will have different metrics that are material to their business, but metrics commonly tracked include:
- Environmental metrics including reductions in electricity usage, changes in fuel consumption for company vehicles, carbon emissions reductions, gallons of water saved, and increased waste diversion
- Social metrics focused on employees and occupants, health & wellbeing, diversity & inclusion, and supply chain management
- Governance metrics that are determined by the existence of policies on a wide range of issues such as company values and business resilience plans
These metrics aid in predicting a company's future financial performance and give corporations and asset managers a way to communicate with stakeholders, demonstrate commitment to fundamental principles, and assess environmental and ethical impact.
DEFINING ESG METRICS WORTH TRACKING
ESG data and reporting standards are moving from voluntary "nice-to-haves" to mandatory "must-haves" as firms compete for sustainability-focused investment resources. While many companies are inclined to brag about their ESG accomplishments, clear and consistent reporting ensures transparency and accountability.
To support the demand for standardized ESG frameworks, the World Economic Forum (September 2020) unveiled a set of metrics companies can use in reporting methodology that provides a common set of disclosures and support more coherent, comprehensive ESG reporting systems.
The metrics and disclosures were developed in collaboration with major accounting firms as well as representatives from corporations, investors, standard-setters, non-governmental and international organizations, and leading reporting frameworks. The metrics are centered on four pillars:
- Principles of governance: This reflects a company’s purpose, strategy, and accountability and includes criteria that measure risk and ethical behavior.
- Planet: This reflects a company’s dependencies and impacts on the natural environment and includes metrics such as greenhouse gas emissions, land protection, and water use.
- People: This represents a company’s equity and its treatment of employees and includes metrics centered around diversity reporting, wage gaps, and health and safety.
- Prosperity: This represents how a company affects the financial wellbeing of its community and measures metrics such as employment and wealth generation, taxes paid, and research and development expenses.
Companies can utilize these pillars and an expanded set of "Stakeholder Capitalism Metrics" and disclosures to align their ESG performance and reporting indicators on a consistent basis.
SEEKING COMMITMENT TO ESG
Other also attempted to define metrics commonly demanded by private equity fund investors. In a private survey, they found that while investors are prioritizing ESG, general partners and portfolio companies struggle to identify, collect, and report relevant data.
However, the survey was able to identify 10 common ESG standards and metrics that are typically most relevant to private equity investors during the due diligence and investment oversight processes. These include:
- The presence of a formal ESG policy
- The distribution of responsibility related to ESG integration across the organization
- The presence of a formal code of business ethics
- The presence of litigation on environmental, social, and ethical affairs
- Diversity among employees, board members, and management
- The net employee composition, including the ratios of part-time and contract workers
- The presence of a formal environmental policy
- The ability to estimate the organization’s direct and indirect greenhouse gas emissions
- The number of data and cybersecurity incidents
- The number of health and safety events
Investors may better manage risk, produce value, and differentiate portfolio performance by collecting and tracking key metrics throughout the investment lifecycle. While the process can be time-consuming without technology, ESG reporting solutions can help consolidate portfolio data and provide reliable ESG performance benchmarks.
PREPARING FOR A SOCIALLY RESPONSIBLE FUTURE
Given the recent increase in investor demand for ESG, businesses should move quickly to capitalize on the ESG opportunity. The efficiency of the ESG data value chain can be improved by providing consistent definitions for "environmental", "social", and "governance" metrics and lead to more effective investor interactions.
This demands a fundamental revision of how the system works and requires businesses to be agile and adaptable, embrace higher levels of resilience, and adopt a global perspective. ESG frameworks ensure businesses can mitigate risk, from climate change to environmental degradation and mass extinctions to global pandemics, as well as capitalize on opportunities that offer long-term, sustainable growth.
ESG MATERIALITY ASSESSMENTS
With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.
An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks.