Understanding ESG metrics for the Finance Sector

Libby Cross, Senior Marketing Executive

Financial firms are including more environmental, social and governance (ESG) metrics in their annual reports. But what exactly are the requirements for ESG reporting and why does it matter?

What is ESG?

ESG covers a broad range of environmental, social and governance issues. These include climate change, sustainability, human rights, slave labour, diversity, employee relations and pay, data security, and anti-corruption measures. The pandemic has brought many of these issues, especially the social ones, into the spotlight.

ESG is now big business. A Thomson Reuters report estimated that sustainable investments in 2020 reached $35.3 trillion, more than one-third of all assets under management, in five of the world’s largest markets. Financial services firms are particularly affected as they are not only capital providers to industry and channels for investing individual wealth, but are also heavily involved in managing the transition from a fossil-fuel economy to one driven by renewable energy.

Firms are being assessed by stakeholders and investors alike on the way they run and position their businesses in relation to key ESG issues. They’re judged on their commitment to publishing ESG metrics and disclosing what steps they are taking to address them. These metrics have become key indicators for the health and sustainability of investment and business performance.

What are the environmental, social and governance standards?

Unlike the measurement of financial performance, there is no set standard (or agreed set of standards) for measuring and disclosing ESG data. In fact, it’s been estimated that there are currently more than 600 frameworks for ESG and thousands of metrics.

But while there’s no set standard, we are seeing the beginning of a convergence among different jurisdictions and a sense that a common, global approach to ESG is required. A good example of this is the UK’s new ESG regulation in Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022 and the Limited Liability Partnerships (Climate-related Financial Disclosure) Regulations 2022. In the US, meanwhile, the SEC is moving to standardize ESG reporting and regulation with initiatives like the climate disclosure rule proposal (March 2022). The EU’s Green Deal drive contains regulations for sustainable finance.

The WEF’s ESG initiative

So far, the biggest contribution towards the standardization of ESG metrics comes from the World Economic Forum in partnership with Deloitte, EY, KPMG, and PWC. Their proposals for a more consistent approach to ESG reporting are contained in a white paper entitled ‘Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation’. The WEF paper identifies 21 core metrics and 34 expanded metrics designed to help companies measure and disclose their ESG contributions and impact.

Examples of the WEF core metrics include:

Environmental: greenhouse gas emissions; land use; water consumption
Social: diversity and inclusion; pay equality; health and safety
Governance: anti-corruption; ethics advice; setting firms’ purpose to address ESG issues

In May 2020 the Forum announced that 70 companies have already included the Stakeholder Capitalism Metrics in their reporting documentation, including annual reports and sustainability reports.

How should financial firms respond?

It seems clear that there is going to be greater convergence towards a fixed set of ESG standards backed by more legislation. It makes sense then to prepare your firm for that eventuality. But it also makes good day-to-day business sense to advertise what you are doing in areas of sustainability, climate change, workplace relations and transparent corporate governance as these are areas of concern that drive your employees, management, investors, and shareholders.

Firms can prepare the ground for a greater commitment to ESG reporting by addressing key questions like:

Have we adopted a comprehensive approach to these issues?

Can we add new risks within our existing enterprise risk frameworks?
What are the roles and responsibilities of our compliance, human resources, and risk management professionals?
Do we have the right talent in place to cover our ESG commitments?
Can we identify those customers and employees and other stakeholders who have the greatest exposure to ESG issues?
How do we work with them to mitigate ESG risks?

When it comes to collecting and reporting ESG metrics you need to have robust processes in place. Key action items include:

Agreeing on what data is to be reported
Ensuring data is reliable and robust
Taking time to get it right
Measuring yourself against other firms in the sector and in your geography
Assessing and adopting best practice
Being aware of existing and upcoming legislation and government policy initiatives
Being proactive rather than reactive
Adopting a holistic approach (i.e. including all accessible environment, social and governance data)
Avoiding exaggerating the data, a practice known as ‘greenwashing’

The benefits of ESG

ESG reporting is no longer something that’s ‘nice to have’. It’s a necessity – and not just because of increasing legislation. Measuring the impact companies have on the environment and society is essential to meeting climate change targets and sustainability.

ESG accountability leads to benefits for business sectors and firms. Recent research suggests that firms with the greatest commitment to ESG outperform those with fewer ESG credentials. Adopting ESG policies and tracking the data has benefits for individual firms, most notably creating a better working environment and delivering efficiencies. coring well on ESG metrics makes businesses more attractive to investors and consumers who are increasingly looking to make ethical, socially and environmentally conscious choices.

Support for sustainable development, good governance, and the ethical treatment of people improves your business’s performance.

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