In this blog, we get to grips with what ESG is and why it matters for our clients.
Few topics have gathered more momentum over the last decade than responsible investment and ESG. The rapid growth, accelerated by the proposed “green recovery” from the pandemic, shows no sign of letting up. Estimates suggest that global ESG assets are on track to top $53 trillion by 2025, over a third of all assets under management.
But what is ESG? In this blog, we get to grips with what ESG is and why it matters for our clients.
What does ESG stand for?
ESG stands for Environmental, Social and corporate Governance, and is generally used to describe a set of standards or principles for a company's operations that investors can use to screen potential investments and factor into active ownership.
- Environmental – focuses on a company's environmental impact, e.g., its energy use, waste and carbon emissions.
- Social – focuses on a company's business relationships, e.g., its relationships with suppliers, its employees and their working conditions.
- Corporate Governance – focuses on the decision-making and management of a company, e.g., its structure and purpose, transparency, board makeup and reporting.
ESG is sometimes referred to as ‘sustainable investment' or ‘corporate responsibility'.
Ok, I understand the acronym – but what does ESG actually mean for companies?
With so many factors at play, it is very difficult to calculate and track a company's environmental and social impact, and assess its governance over time. There are a number of ratings agencies, such as Standard&Poor's, Deloitte, MSCI, Sustainalytics and RepRisk, which attempt to do this by using set indices, offering companies ESG evaluations and ‘scores'. The methodologies, data and importance given to different factors can be different from one agency to another, meaning that their ESG evaluations and scores can vary quite significantly.
Who uses ESG information?
ESG information is mostly used by investors as either a screening tool when deciding whether a company should be included or excluded from a particular investment portfolio, or to encourage companies they have invested in to develop responsible business practices. Some companies also use this data themselves to guide decision-making and improve sustainability performance. A good ESG score can also be a powerful marketing tool, both for consumers and employee recruitment and retention.
How is the legal regime developing around ESG?
There is no single ‘law' regulating ESG, which is primarily driven by investment. However, we are seeing regulators in the EU, the UK, and further afield increasingly develop regulation on ESG. For example:
- In March 2021, the EU Regulation on sustainability-related disclosures in the financial services sector came into effect, requiring financial market participants to disclose details about their approach to sustainability-related issues on their website and in other disclosures.
- In April 2021, the European Commission proposed a ‘Corporate Sustainability Reporting Directive' which, if adopted, will amend existing non-financial reporting requirements. The proposal suggests extending the scope of reporting requirements to all large companies and companies listed on regulated markets. These companies will be required to (1) disclose more detailed information on sustainability, such as the company's plans to “ensure its business model and strategy are compatible with the transition to a sustainable economy”; (2) audit reported information; and (3) report the information in accordance with mandatory EU sustainability reporting standards.
We are also seeing ESG considerations increasingly form part of product regulation relevant for Cooley's clients active in products. For example:
- There is a focus on sustainability and the circular economy in almost all new products rules. The current EU flagship policy – the ‘Green Deal' – plans to create “longer lasting products that can be repaired, recycled and re-used”. As a result, considerations relevant to sustainability and the circular economy (e.g., right to repair) are central to large amounts of newly introduced EU products regulation. One example of this is the EU's Sustainable Products Initiative, which aims to revise current ecodesign rules and propose new laws to make products placed on the EU market more sustainable.
- New proposals updating existing products legislation increasingly include requirements for mandatory supply chain due diligence, such as in the current proposal for a new EU Batteries Regulation.
- New laws are also coming out to clarify the rules around ‘greenwashing' claims, which are relevant to businesses publishing ESG scores or making other claims about their environmental performance. We covered the new UK CMA Green Claims Code here. New EU guidance on green claims is expected later this year.
What do I need to do?
ESG is a rapidly developing area which shows no sign of slowing down. Our top tips are as follows:
- Keep on top of regulatory compliance. Assess which new ESG-related laws and reporting requirements may apply to your business and future proof as far as possible to ensure compliance.
- Understand the importance of ESG for your stakeholders, including investors, management, consumers and employees.
- Consider developing an ESG policy.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.