Businesses are increasingly at crossroads, where maximising profits can no longer be at the cost of our planet. The planet is overused, and we can feel soaring temperatures, rising risks of climate threats and resultant impacts on people. The Environmental, Social and Governance (ESG) landscape has exploded in the current years with an inherent need for connecting the dots; Environment – society – governance.
The need for saving the environment from climate risks has been an established fact long back. It has been recognised as early as the 1990s or even before, and we did see the globally ratified Montreal Protocol in 1987, that regulates production and consumption of 100 man-made chemicals referred to as ozone-depleting substances. The refrigeration, air-conditioning, and foam application industries did step up to meet the norms and phase out/commit to phase out the chloroflurocarbons (CFCs) and hydrochloroflurocarbons (HCFCs).
This was followed by setting up of the United Nations Framework Convention on Climate Change (UNFCCC), which established the regime of climate science, its impacts on the planet, and enforcing commitments by nations to tackle climate change through mitigation and adaptation. The Kyoto Protocol and the Paris Agreement followed. The Conference of Parties (CoP), the supreme decision-making arm of UNFCCC, meets every year to annually assess progress of nations in dealing with climate change. Country goals set by the CoP obviously trickles down to responsible actions being taken by businesses. Thus, we need businesses committing to net zero carbon goals or being carbon positive, a cumulative effort to limit rising global temperature to 2 degrees C.
Another set of goals, namely, the Sustainable Development Goals (SDG) or Global Goals are a collection of 17 interlinked global goals designed to be a “blueprint to achieve a better and more sustainable future for all”. The SDGs was set up in 2015 by the United Nations General Assembly and are intended to be achieved by 2030. Again, all nations track SDGs and responsible businesses also track SDG achievements to prove their contribution towards sustainability.
In a parallel timeline, India is perhaps the only country that has mandated Corporate Social Responsibility (CSR) for profitable large businesses since 2019. This has led to businesses setting aside a portion of their profit for social causes. Interestingly, 80 percent of the top 100 companies in India incorporate SDGs in their CSR actions. CSR being introduced to ensure profitable businesses to give back to the community, is also being used as a key indicator for meeting ESG goals of companies.
For example: A leading consumer brand achieved ‘Zero Waste to Landfill’ and ‘Water Positivity’ last financial year. It has further expanded its extended producer responsibility by taking back post-consumer plastic packaging waste, equivalent to plastic packaging it sends out. All these initiatives create an ecosystem of social entrepreneurs and drive circularity, which contributes to ESG goals set voluntarily by companies. Thus, we do see the line between SDGs, CSR and ESG being blurred, and it does make business sense, and businesses are increasingly hunting for uniform standards that can help them with integrated and uniform reporting for all commitments. While ESG is still voluntary, the CSR space in India provides an enabling mechanism to meet both.
Despite multiple drivers, the issues were not taken seriously enough as we always thought that it’s someone else’s job to take action while we continue to pollute and over-use (the planet). So, why have businesses suddenly woken up to ESG so actively? It’s the financial impact that businesses face in light of changing climate, driving ESG disclosures and actions.
Financial impact of climate change, key driver to responsible investments
A key angle in this space is the financial lever. Any business would invest in the needs of environment and society, provided it makes financial sense. Also, financial institutions and insurance companies need to weigh in the impacts of climate risks before insuring a property.
Imagine a condition, when a settlement insured by or financed by a financial institution is ravaged by unprecedented floods or storms. The risks are large and pay-outs huge, in addition to irreparable loss of human lives. Thus, there is a great need to anticipate and build resilience and factor in risk managements. Hence, all actions by businesses also go through the financial filters or the ‘financial materiality’ assessment before implementation. Thus, good governance, financial oversight, transparent accounting, health safety, etc. all come into consideration when we are reporting and implementing the trio ― ESG.
Have you noticed on airline portals that emissions for your travel are being disclosed? What if airlines start putting a carbon price to your travel? It will impact costs, and airlines need to be cost competitive by reducing carbon footprint. Thus, increasingly the financial impact of climate risks is being understood and addressed.
Decoding the alphabet soup: need for unified protocols and well-defined materiality
The ESG space is overwhelmed by the alphabet soup: scope of emissions, materiality, ESG indices, ESG frameworks, etc. We come across these terminologies and they are often confusing.
Materiality is a key concept that drives the scope of ESG reporting and actions by a company. It is the effectiveness and financial significance of a specific measure that is fundamental to long-term success of the company. Materiality aspects vary from company to company, and the scope also varies.
For example, a builder reporting ESG parameters will report emissions from its managed properties and entities only. Say, a builder constructs a residential building and a commercial building and is managing its commercial asset fully, but is managing only the common areas of the residential property. The builder will most likely report emissions and set targets for reduction from the commercial asset, while leaving out the emissions from the individual apartments occupied in the residential premises, as it is not within the builder’s scope to control or set targets. Thus, materiality and perception on materiality is a huge space to tackle and increasingly standards are more vigilant on this aspect.
Some key materiality aspects are carbon emissions, product carbon footprint, water stress, biodiversity and land use in the environment category; labour management, health safety, and chemical safety in the social category, and board diversity, business ethics, tax transparency, and accounting in governance. It is apparent that all issues do not apply to all businesses; so, the first task of ESG is to identify and lay out the materiality aspect.
There is a plethora of reporting frameworks that help set materiality or guidelines that support companies to report on ESG. Some also help set targets for companies to achieve, based on disclosures and long-term commitments, Frameworks by the Climate Disclosure Standard Board (CDSB), Science Based Targets (SBTI), Task Force on Climate-related Financial Disclosures (TCFD), Global Reporting Initiative (GRI), Integrated Reporting (IR), Sustainability Accounting Standards Board (SASB), and ISO 26000 are some commonly used ones.
A word of caution here ― these are not comparable standards; industries and businesses choose one or more selectively in part or whole to define materiality and reporting as per that standard. For example, a major consumer product conglomerate that has large dependence on water as a resource, uses SASB to define materiality in ‘water use’ and uses GRI reporting to report on these topics.
On the other hand, it uses ‘SBTi’ to set its carbon goals and uses Greenhouse Gases Protocol to report on emissions and targets. Cherry picking metrics and indicators is a common norm in the ESG space. Regulations are being introduced slowly in the area, and hence, we do see an inclination in companies towards certain indicators and frameworks, based on alignment with regulations. For example, many EU-based companies prefer TCFD, as it is recognised by governments in many EU countries. SEBI, in India introduced the BRSR (Business Responsibility and Sustainability Reporting) in May 2021, aligned with GRI/SASB/TCFD and IR and we shall see Indian businesses using these frameworks largely.
Drawing a parallel with green building programs
Drawing a parallel with green building-rating systems, such as Leadership in Energy and Environmental Design (LEED) that has changed the landscape of sustainable buildings globally, availability and application of ESG ratings is still evolving. Global Real Estate Sustainability Benchmark (GRESB), and Dow Jones Sustainability Index are some relatively popular ESG ratings. But these have a long way to go.
Companies are now increasingly looking at unified mechanisms for reporting and compliance and there is an urgent need to look at unified approaches that are well understood by industries. Peer to peer comparison is also necessary to drive innovations in a competitive landscape. The International Sustainability Standards Board (ISSB) has been set up to help unify the frameworks and standards in the ESG space. The intention of ISSB is to deliver a comprehensive global framework of sustainability-related disclosure standards that provide capital market participants with information about companies’ sustainability-related risks and opportunities to help them make informed decisions.
LEED, a market leader and transformation tool for green buildings, communities and cities, is now undertaking its next level of development. ESG alignment and providing a pathway for assets, buildings, and cities to disclose and take actions is part of the next development cycle for LEED. Stay tuned!