The consequences of rising global emissions and the effects of climate change are becoming more pronounced and more severe. It is no longer business as usual.
This is known to both investors and customers alike, hence the growing emphasis on the ESG (Environmental, Social, Governance) criteria.
ESG is a set of criteria guiding a business's behaviour used by socially or environmentally conscious investors and companies to evaluate potential investments or purchases.
However, with the introduction of new mandatory ESG laws in the UK, there's a lot that companies still need to know.
Here's what UK companies need to know about ESG in 2022:
What is ESG?
ESG stands for environmental, social, and governance; a set of criteria for evaluating companies based on these factors.
These criteria are increasingly becoming important to both investors and customers alike. With the effects of climate change becoming more pronounced and visible, it is now standard practice for institutional investors to look at their investments' looming environmental and ecological risks.
As the name suggests, environmental criteria evaluate how a company protects the environment, specifically through its corporate policies, to address or mitigate the effects of climate change.
The social criteria in ESG evaluate how a company treats its employees, suppliers, consumers, communities, and other stakeholders.
Finally, the governance criteria focus on the company's corporate governance and leadership, especially regarding board composition, executive compensation, transparency, and shareholder rights.
More nuance goes into all three of these factors that we will cover below.
What are ESG criteria?
In recent years, ESG has become a cornerstone of investment decision-making for many of the largest institutional investors.
Following the 2007 Financial Crisis, traditional economic principles such as the Friedman Doctrine (which states that a firm's sole social responsibility is to maximise profits) have fallen out of favour. Now, customers and investors alike want the companies they do business with and invest in to account for and show responsibility for the environmental and social risks they are connected with.
The expansion of ESG shows no signs of slowing down. Total ESG assets are projected to grow to $50 trillion by 2025 from their current $35 trillion positions.
However, there is no common standard for ESG criteria. Typically, institutional investors will have their own particular set of factors to evaluate the ESG rating of companies.
Here we break down what you need to know.
Environmental
Environmental ESG criteria typically focus on a company's climate & environmental policies, its energy use, how much greenhouse gas it emits during its operations, its relationship with natural resources, and how it treats animals.
As you can imagine, environmental criteria help investors better understand the environmental or ecological risks that affect or influence a company. In addition, these criteria help ensure that companies are aware of these risks and have processes in place to manage or mitigate them.
The consensus on the existence of climate change, its linkage to human activity, and the potential consequences of not addressing it has never been more significant. As such, it has never been more critical to evaluate potential investments in terms of their impact on climate change.
So, for example, an institutional investor may only include companies with the following characteristics in their ESG portfolios:
- Regularly releases data regarding its carbon emissions
- Restricts the use of harmful pollutants or chemicals in its operations
- Reduces greenhouse gas emissions as much as possible
- Uses as many renewable sources of energy as possible
Social
The "social" part of ESG, as we mentioned, relates to how a company treats all its stakeholders. This means its employees, other companies it does business with, its customers, and the communities it operates in.
Investors are concerned with the social aspects of a company for several reasons. First and foremost, companies that do not act ethically towards their employees, customers, and communities are not necessarily sustainable, safe, or long-term investment options.
For example, suppose a business establishes a reputation for shady business practices or lacklustre workplace conditions. In that case, consumers will become increasingly sceptical of supporting it, and employee retention will be low.
Instead, investors and consumers increasingly want companies to treat employees well, support diversity and equality in their workplaces, and incorporate strong consumer protections into their business models.
So, for example, institutional investors may include the following social standards in their ESG criteria:
- Maintains an ethical supply chain that also complies with ESG standards
- Encourages diversity in the workplace and in its hiring practices
- Has procedures and processes in place to protect employees against sexual misconduct
- Employees are paid fair, competitive wages with worker protections
- Strong consumer protection
- Protects customer/user data & privacy
Governance
Finally, the final aspect of ESG is governance. Needless to say, governance in ESG criteria is focused on the firm's corporate governance.
This aspect of ESG is meant to assure a company's leadership acts with integrity, accountability, and transparency.
Investors could evaluate how a company discloses its finances and accounting methods, how much diversity is found in the composition of the board of directors, and how accountable the firm is to its shareholders.
It goes without saying that sustainable investors are interested in companies that do not have unethical or shady leadership.
ESG governance standards may require a lack of conflicts of interest, a limitation on political lobbying, and a track record clean of corruption, bribery, or other illegal conduct.
Investors may include the following governance standards in their ESG criteria:
- A diverse set of Board of Directors,
- Transparent about corporate practices and leadership,
- No bribery, corruption, or criminal conduct,
- Lower executive compensation to employee pay ratios,
- A limitation on political lobbying
Why is ESG important for UK companies? What you need to know.
ESG reporting will be mandatory for UK businesses in 2022
The most important thing to note about ESG for UK companies is that it could become a requirement for doing business in the UK. This is because the UK passed two different laws that make environmental reporting mandatory for many (but not all) UK businesses.
UK companies with more than 500 employees or £500 million in annual revenue are subject to the ESG criteria laid out by the Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022 and the Limited Liability Partnerships (Climate-related Financial Disclosure) Regulations 2022.
Luckily, the Task Force on Climate-Related Financial Disclosures (TCFD) has created a framework to help companies and other organisations disclose this required environmental information.
ESG standards are becoming increasingly important for investors in the UK or otherwise
Many investors are increasingly unwilling to finance companies that do not uphold specific ESG standards, especially following the COVID-19 pandemic.
In fact, one of the biggest asset management companies, BlackRock, is famous for pushing ESG criteria. For example, Larry Fink, the firm's CEO, published a letter that suggested that those investments that show responsibility towards their stakeholders and uphold ESG standards will be those that thrive in the future.
Companies that shirk ESG are looking more and more like high-risk or unsustainable investments.
The key takeaway for UK companies is that they should implement ESG standards in their businesses (even if they aren't required to by law) if they have not done so already.
The governance of your company influences public trust
56% of UK adults say they are more loyal to companies whose ethical values align with theirs. Not only that, nearly 43% stopped supporting or buying products from unethical companies.
Suppose your company's ESG standards include transparent governance. In that case, your company will enjoy a greater level of trust, respect, and confidence from customers.
In the wake of the COVID-19 pandemic, the need for ESG or sustainable investing has become significantly more apparent to many investors. A significant effect of the pandemic was on supply chains. Disruptions lead to shortages of many goods all over the world.
So, for instance, transparency by a company regarding supply chain issues and what these issues mean for their customers would be a great example of how ethical leadership would influence public trust.
At the end of the day, a lack of ethics within a company's leadership will harm its reputation with consumers and employees alike.
ESG will influence your company's competitiveness
If a company does not focus enough on its ESG strategy, its competitive edge will be undermined.
With the threat of climate change weighing heavily on more and more people's minds, consumers are more climate-conscious than ever regarding their buying habits.
The sustainability of products is nearly as important as the product itself. They consider the sustainability of products before making a purchase. Consumers are willing to pay higher prices if it means more climate-friendly or ethical goods.
As we mentioned earlier, not every UK company is required to participate in environmental reporting. Yet, this doesn't mean that you shouldn't uphold ESG standards. Because if your company isn't paying attention to ESG, chances are your competition is, and this discrepancy will undermine your competitive edge with climate-conscious consumers.
What is mandated by 2022 UK ESG legislation?
It is important to note that ESG standards are no longer optional for many UK companies. From 2022 and on, all UK businesses that either have more than 500 employees or £500 million in annual revenue must comply with the ESG criteria laid out by the Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022 and the Limited Liability Partnerships (Climate-related Financial Disclosure) Regulations 2022.
This legislation mandates that these companies produce sustainability reports on climate-related disclosures every year.
These laws are commonly called ESG laws. However, these mandated disclosures are only applicable to the environmental risks faced by companies, excluding the social and governance factors in ESG.
The sustainability information statement requires UK businesses to declare the following:
- Must report all the environmental risks that impact the companies operations,
- How the company's governance will assess and manage environmental risks and outline various ecological outcomes,
- Must list and report environmental goals and key performance indicators (KPIs) used to measure environmental risk performance.
- Must describe the process used to identify, assess, and manage environmental risks,
- Describe how the company will integrate environmental risk into the greater enterprise risk management strategy.
Final words
As you implement these ESG standards in your firm, it is also vital to enlist the help of a credible carbon accounting partner.
Consequence.world offers the world's most intelligent carbon accounting platform for Net-Zero. All your carbon footprint data collection, calculation, and reporting workflows necessary for ESG criteria can be automated using the Consequence platform. This streamlining will give you time to focus on the highest value efforts, like growing your company and accelerating your journey to net zero.
Start intelligent tracking, reductions, and reporting of your carbon footprint.
Visit www.consequence.world to get started.
