The ABCs of ESG

Sri Lanka has prioritised sustainability and ESG (environmental, social, and corporate governance) problems in the last five years and is actively working on solutions. Numerous strategic initiatives proposed by the country’s leadership to re-establish the Government’s focus on supporting and promoting the United Nations Sustainable Development Goals (SDGs) to achieve transformation towards a sustainable and resilient society, including a commitment to carbon neutrality by 2050, half nitrogen waste by 2030 through the Colombo Declaration on Sustainable Nitrogen Management, and limiting the overuse of artificial fertilisers – to help address the issue of climate change. These goals are attainable with the support of technology, talent development, investment, and money.

The growing emphasis on an ESG framework assists firms in being more attentive to positive climate action, developing a more sustainable, resilient future based on these nonfinancial aspects that are typically not included by obligatory reporting. Environmental factors, in general, cover issues or themes such as waste management, the impact of emissions, energy efficiency, air and water pollution, environmental protection, and biodiversity loss and restoration. 

Human rights, labour rights, working conditions, health and safety, employee relations, employment fairness, gender diversity and pay imbalance, anti-corruption, and the influence on local communities are all considered social aspects. Ownership and structural openness, shareholder rights, board of director independence and supervision, diversity, data transparency, corporate ethics, and CEO remuneration fairness are all governance elements.

To summarise, an ESG framework provides an alternative method of evaluating a firm that looks beyond its profitability and balance sheet and considers how its performance affects society as a whole. Simply, an ESG framework assists stakeholders, especially potential investors, to judge if the organisation is a “decent corporate citizen” and a “worthy investment”. 

According to a 2020 Climate Change and Sustainability Services poll, investors are upping their game when analysing a company’s success using non-financial considerations. Overall, 98 % of investors polled examine non-financial performance using company disclosures, with 72% using a systematic, rigorous approach. This is a significant improvement above the 32 % who claimed they utilised an organised approach in 2018.

Organisations now employ a variety of ESG frameworks. The Global Reporting Initiative is the most extensively utilised in Sri Lanka (GRI). This framework is regarded as one of the most comprehensive techniques available for determining how an organisation’s existence and operations influence the world. 

Other frameworks used by organisations throughout the world include the United Nations Sustainable Development Goals (SDGs) and the Sustainability Accounting Standards Board (SASB). Regardless of the methodology employed, the quality of ESG reporting is only as good as the policy implementation, data collection, and governance around monitoring and reporting.

In the current scenario, investors should evaluate data based on the industry in which the reporting organisation operates. For example, the tire manufacturing business should ideally disclose more data on the environmental pillar than an IT service corporation. 

However, this does not imply that they should take a sluggish approach to reporting on the other two pillars. A tire manufacturing firm is likely to be more vulnerable to waste disposal and energy utilisation difficulties than an IT company. As a result, environmental considerations would be more dominant than social and governance ones. ESG data will provide insights into an organisation’s qualitative elements. Insights such as how a firm manages its waste resources, how it treats customers if it stays out of problems with authorities, and whether it has a good management structure that supports responsibility. Investors will assign reduced risk premiums to firms with excellent risk management systems, resulting in greater capital market values. 

Given the foregoing, these organisations will be able to acquire comparably less expensive funding than those that do not have such structures in place. Investors will invariably avoid organisations that are poorly handled and may end up with severe problems in the news that can hurt their reputation and company image.