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Author: Jason Nachamie
In May of 2021, President Biden released an executive order calling for Financial Regulators to standardize the assessment and planning process for addressing climate-related financial risks. These policies focus on the financing needs of achieving a net-zero U.S. economy by 2050. In June, Congress also released the Corporate Governance Improvement and Investor Protection Act. This act would appeal the Securities Exchange Act of 1934 to establish new disclosure requirements of public companies by increasing the reach of regulators, specifically the Securities and Exchange Commission (SEC). These new regulations focus on increased accountability, transparency, and specificity in the hopes of creating a more standardized set of requirements for Environmental, Social, and Governance (ESG) activity.
In response, the SEC has already begun to work on establishing the guidelines for these new disclosure standards. Their 2021 Examination Priorities seek to align voting and investment policies with business’ continuity plans to evolve the agency’s regulatory framework around the need for businesses to address escalating climate-related risks. The SEC has also established a Climate and ESG Task Force in the Division of Enforcement to identify and mitigate material gaps or misrepresentation in key ESG data.
The bottom line is that change is happening fast. We have already seen this play out in Europe, with the Sustainable Finance Disclosure Regulation (SFDR) having gone into effect in March of 2021. The SFDR set a high bar for disclosure and regulation, which will only increase the momentum here in the U.S., meaning that U.S. Businesses should begin planning their ESG strategies now. Those who wait until these regulations are put in place locally will already be too far behind the trend, risking sanctions, fines, and a serious loss of market share.
More importantly, businesses should embrace ESG as an effective long-term strategy. Strong ESG performance directly links to better top-line growth through favorable customer value-props. Proven performance provides better access to resources and partnerships, reduced energy consumption to lower costs, increased employee motivation and job satisfaction, and enhanced investment returns by shifting capital to long-term assets. Investors are looking for this kind of activity, as BlackRock predicts that Exchange-Traded Funds (ETFs) with a sustainable focus will rise to $400 billion over the next decade. This prediction is not unfounded, as 19 out of 26 ESG ETFs outperformed the S&P 500 during the pandemic. ESG is here to stay; investors want it, consumers want it, public policy increasingly requires it, and the long-term success it can provide for your business is proven.
The real question we all need to ask ourselves is “what should my business be doing to design and implement an efficacious ESG program?” Creating an effective ESG Program is tricky, as consumers have a knack for flushing out greenwashing. Just take Sweden’s Oatley, who’s share price hit an all-time low, and rallied groups of short-sellers after allegations of shady accounting practices and misleading sustainability claims. McKinsey points out that weak ESG propositions, either too vague or missing the mark on the most material issues, can lead to double-digit declines in market capitalization once the public catches wind. For that reason, if your company truly wants to do it right, you’ll need to master these key processes first.
Effective ESG initiatives are ones that address duties or obligations owed to stakeholders, who’s well-being depends on, at least in part, the actions of the firm. The International Integrated Reporting Framework defines a stakeholder as “those groups or individuals that can reasonably be expected to be significantly affected by an organization’s business activities, outputs or outcomes, or whose actions can reasonably be expected to significantly affect the ability of the organization to create value over time.”
Relevant stakeholder groups include, but are not limited to, shareholders, owners, employees, customers, trading partners or suppliers, NGOs, legislators, and local communities. Pinpointing the relevant stakeholder groups early on helps you identify key issues based on who is being affected and what initiatives you need to design to address these issues.
Brainstorming is the best place to start for stakeholder identification. Gather an internal team of employees, consult with the board, or even a friend who works in a similar space. Leave no stone unturned and list out every possible stakeholder by asking yourself, “Is the well-being of this individual or group impacted by our business?” If the answer is, in any capacity, a yes, then put them down on the list. Once you have this master list you can then begin to narrow it down by categorizing them into three groups; Primary Stakeholders, Secondary Stakeholders and Key Stakeholders. It’s best to start by focusing on primary stakeholders, those that are directly impacted (either negatively or positively) by the firm’s actions. A power/interest grid helps to prioritize those primary stakeholders.
A material sustainability issue is an economic, environmental, or social issue in which a company has an impact on or may be impacted by. It may also be one that significantly influences the assessments and decisions of stakeholders, which is why it is so important to identify all relevant stakeholders. The materiality assessment process inventories and quantitatively analyzes stakeholder perspectives on the company’s pro-social performance, helping to plan and prioritize specific initiatives.
To identify which specific initiatives you need to prioritize, engage in a series of surveys and interviews with primary stakeholders. Ask them which issues they see as most impactful to the business and try to delineate which issues are “impact inwards” vs “impact outwards.” This double-materiality allows a company to identify and assess external sustainability issues that can affect enterprise value and internal aspects of the business that affect the economy, the environment and society. In addition to double-materiality, more authentic forms of sustainability accounting call for context-based materiality. This approach interprets performance in terms of what an organization’s impacts on vital capitals are relative to norms, standards or thresholds for what they would have to be in order to be truly sustainable.
Surveys should also be sent to other identified stakeholder groups, such as suppliers, customers, or communities located near manufacturing facilities. Ask these stakeholders to list and rank the issues they deem essential for the business to address. You can then superimpose this list on a materiality matrix. Using a materiality map creates a great visual, ensuring you only focus on issues placed in the top right of the map. Check out Mark McElroy’s UNRISD Working Paper on Making Materiality Determinations for further instruction on how to determine materiality.
Creating and Engaging Your B-Team
Establishing an internal team is essential for managing all the different processes that are required to organize, measure, and report on your ESG initiatives. A strong ESG program encourages collaboration to gather a wide variety of insights, so leaving it up to one sustainability officer isn’t practical or efficient. Studies show that a strong ESG performance links to increased job satisfaction and the firm’s ability to attract and retain talent in the increasingly skeptical Millennial and Gen Z workforce. For this reason, we want employees to engage with initiatives they are passionate about.
It’s important to note that because these projects will be adding to the employee’s normal responsibilities, participation in the B-Team should be completely voluntary. Ask employees if they want to work on projects related to an issue they listed during the materiality determination phase. Managers need to ensure that these additional undertakings are well-balanced with the employee’s day-to-day tasks.
Getting the Most Out of a Third-Party Standard
With the acceleration of ESG reporting, the amount of Third-Party standards has skyrocketed, making it increasingly difficult to wrap our heads around the ins and outs of each one. Currently, these 12 ESG Reporting Frameworks are the most widely used, with another dozen smaller frameworks recently developed. Each with its own set of guidelines and scoring methodologies, it’s a cumbersome task just figuring out which one your organization should be using. However, it’s essential to choose one that is appropriate for your business model and the size of your organization.
Companies that don’t provide a third-party verification of their ESG efforts can be overlooked by investors because of unknown risk and can also face significant sanctions once the SEC institutes new disclosure regulations. That is why 90% of the S&P 500 has already standardized the process of producing and publishing their annual sustainability reports.
Proper reporting enhances your efforts both internally and externally. Externally, not only will you comply with the new ESG regulations, but you also give investors and stakeholders a proper representation of your efforts measured against an independent third-party. This information is verifiable and audited, which is important considering 43% of investors are more likely to trust an ESG performance when reported through numbers and data rather than qualitative descriptions.
Internally, these reports should inform your strategy decisions and ensure that your efforts are focused in the right areas. Using these standards to develop a baseline for your current impact allows you to highlight the areas you are performing well in, as well as those where you need to improve on. This makes the third-party standard an extremely valuable tool for aligning the company’s efforts and resource allocation.
Integrating ESG With Your Brand
Transparency is the bread and butter of marketing your company’s ESG efforts. This can be a huge value-add in the eyes of consumers and investors, but only if done correctly. When setting and announcing ESG goals, be sure to provide insight on how you plan on reaching that goal. List processes put in place, partnerships established, and your current progress toward achieving that goal.
When creating your Annual Sustainability Report and sharing this information with the public, focus on the critical steps taken to reach that goal. More importantly, if you failed to reach that goal, explain why and outline how you will reach it next time. Honesty is essential here, because while we are trying to ‘wow’ the stakeholders, we are trying to paint a clear picture of your company’s efforts on this long and tedious journey. Consumers are much more likely to shun you for announcing audacious goals with no context than they are for explaining the challenges that inhibited progress, as long as you include the insights that explain how you’re going to do better in the future.
The disclosure requirements are a good push for the ESG movement, encouraging alignment and compliance. Still, as evident by the need for more information like what is listed here, businesses would truly benefit from instruction and guidance for implementation. These processes are tricky and vary between industries — even between companies in the same industry. Regulators can reduce this barrier by including resources on effectively creating, measuring, and managing an ESG program along with the new set of regulations. A few forms already attempt to do this, like the Public Benefit Corporation, an alternative corporate structure enabling systematic change in how businesses operate. Emerging structures like this have been making waves. Still, without the necessary information businesses need to execute these new strategies, progress is slow and sporadic, just like our legislative process.
You can check out my work on Improving the Public Benefit Corp Structure, which includes more in-depth information on how your business can master the processes listed above. By spreading this information, and by continuously improving the ways we approach ESG, our programs will become more innovative and our impact will only continue to grow, proving businesses’ ability to use their capital resources for good.
Jason Nachamie (he/him) received his MBA in Sustainable Innovation from the University of Vermont where his passion for making the business case for sustainability led him to dive into the ESG space. He now finds himself working with Rho Impact, which combines professional advisory with advanced data analytics and software tools. Jason helps businesses get up to speed with the ESG movement and seize the opportunity to drive change through impactful pro-social business strategies. While Jason admittedly spends a lot of his time researching market trends and ESG development, he prefers to unplug by exploring the mountains of Vermont on his bike or snowboard.