ESG: Importance, Impacts, & Reporting Implications
You might be noticing more discussions about Environmental, Social, and Governance (ESG) initiatives and wondering if they impact you…especially if your company is privately held. ESG reporting can provide stakeholders with transparency regarding the risks and opportunities your company faces related to environmental, social and governance issues. Learn why ESG is growing in importance and what this means for your business.
What is ESG?
This element of ESG relates to your company’s performance in caring for the environment, and includes things like climate change, energy management and greenhouse gas emissions. Another item that falls into the environmental category is litigation risk related to environmental contamination, raw material sourcing, sustainable products and packaging and water and waste management.
A few questions to consider:
- How does your company use natural resources?
- What impact does your supply chain have on the environment?
- What is your company’s carbon footprint?
The social element is arguably the broadest of the three elements. It includes the relationships your company has with the people it does business with and the communities where business is performed. The “S” can include things like community relations, diversity, equity and inclusion, workplace health and safety, human capital development and labor management. It also addresses privacy and data security, customer and quality issues, supply chain standards, product safety and issues related to corporate culture.
The governance aspect in ESG relates to your company’s internal processes and oversight. It includes things such as how upper management and the board of directors (if applicable) assess risks and opportunities, gather information, make decisions and communicate with internal and external stakeholders. The “G” considers polices related to executive compensation, diversity of leadership, ownership structure, tax transparency, corporate resiliency, business ethics and codes of conduct, anti-corruption and anti-bribery, and lobbying and political contributions.
Why is ESG important?
The elements of ESG are present in nearly every aspect of your business and often overlap. For example, strong leadership and governance that places importance on giving back to the community involves Social and Governance. Strong efforts to comply with environmental laws may overlap with broader social concerns about sustainability. ESG information provides insight into your company’s values, and how committed you are to those values. Where your company stands on the elements of ESG is growing in importance to a broad range of stakeholders including customers, suppliers, employees, credit rating agencies, regulators, policy makers, shareholders or investors and communities.
Is ESG reporting required?
Since ESG issues cover such a wide range of topics, there are different organizations involved in establishing frameworks and recommendations for ESG reporting. In the U.S., ESG reporting is largely voluntary. The SEC requires certain information in a company’s periodic filings such as Management Discussion and Analysis and Risk Factors where elements of ESG might be discussed. Specifically, the SEC requires disclosures related to climate change. This information is provided outside of the financial statements but as part of the SEC filing requirements.
Although there are no requirements at this time for privately held companies, you may wish to voluntarily provide this type of insight as information on ESG matters grows in importance to some stakeholders. The SASB is a good place to start for understanding what is possible and what may become required in the future. The Sustainability Accounting Standards Board (SASB) is a non-profit organization founded in 2011 to develop sustainability accounting standards.
The Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), United Nations Sustainable Development Goals (UN SDGs), United Nations Global Compact (UNGC), CDP, Task Force on Climate-related Financial Disclosures (TCFD) or the World Economic Forum’s International Business Council (IBC) metrics are all frameworks that will help companies benchmark priority issues.
Financial statement users regularly seek information beyond the general purpose financial reporting to gain a deeper understanding of a company. Some common sources of information are non-financial measures, evaluations of trends, industry comparisons and press releases. It is likely that ESG reporting will become a source of non-financial reporting that will provide critical information about your company to help stakeholders make decisions.
Do ESG matters have any impact on Financial Reporting?
Currently, when management applies the financial accounting standards, they are required to consider changes in the business or operating environment that may have an effect on the financial statements. ESG matters are an element of the business or operating environment and may directly or indirectly impact financial statements. For example, there may be a recorded expense directly related to an employment or environmental issue, a favorable or unfavorable impact on sales related to a corporate image event, or information about ESG developments that impact expectations about future profitability that will be considered in an impairment or going concern analysis. In these examples, current accounting standards would be applied to the ESG information similar to how existing financial accounting standards would be applied to other changes in a company’s business and operating environment.
The importance of ESG information is expected to increase in the future. An ESG report can be an important tool to provide transparency to various stakeholders about the risks and opportunities your company faces related to environmental, social and governance issues. Contact us today to learn more about ESG and other financial reporting matters.