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Everything you need to know about ESG in ten minutes

By 08/05/2022November 8th, 2022No Comments

The ESG presentations are bursting at the seams, so if you want to keep up to date we’ve put together a quick summary of the most important ESG topics.

What is ESG? How complicated is it to prepare an ESG report for a medium or small company and how much does it cost?

ESG stands for Environment, Social and Governance. You may be familiar with the acronym CSR from the past, Corporate Social Responsibility – ESG is a bit of a successor.

The acronym ESG itself first appeared in 2005. The three pillars of ESG are not chosen at random, as they correspond to the three pillars of sustainable development as promoted by the United Nations, for example.

Sustainable development is also built on environment, society and economy, with some authors introducing a fourth pillar, culture. At its core, ESG is a tool for identifying non-financial risks and opportunities, and is intended to serve as a basis for long-term decision-making, but also, for example, as a basis for marketing.

Although it is a non-financial reporting tool, for ESG to be meaningful it must be closely linked to the company’s economic indicators. It is not just a report for the sake of a report, it is a very effective management tool. It has been our experience at EnviTrail that many companies create an ESG report voluntarily and really see it as a great market opportunity.

ESG is not yet very common in the Czech Republic, but it is in the world. In the UK, for example, a regulation has been in place since September 2021 that obliges companies bidding for certain public contracts to produce non-financial reports. In Germany, there is a similar law that has universal application, not just to public procurement. But let’s not be fooled into thinking that ESG only affects large companies – through supply chains, and especially through banks, ESG will affect the vast majority of companies.

Take the construction industry as an example. Various standards have been commonplace in the construction industry for many decades, such as the US LEED or the UK BREEAM, which assess a building in terms of its impact on the environment, occupant comfort and so on.

LEED, BREEAM and, more recently, the WELL standard are now practically standard for every construction project. If you are a construction company, even a small one, and you want to deliver on such a building, you have to report on a whole range of indicators – you are actually doing an ESG report. And it doesn’t matter if you’re a multinational cement supplier or a small manufacturer of art fixtures. Everyone in the supply chain has to report.

More fundamentally, banks will be required to report on the ESG of their portfolio, which of course will be passed on to the bank’s customers. There are already products on the banking market that favour green projects. I am sure you have all heard of green mortgages or green investing.

In order for ESG reporting to be of any use to a company, we need to be able to compare ESG reports from one company to another. This is done by standardisation, which is still low.

ESG is a relatively young thing, so its form is not yet established. The consulting firm Ernst and Young calculated that in 2020 there were over 600 different reporting methodologies in the world. Some of these are relatively well established – for example, the construction industry uses the GRESB methodology and European banks are based on the PCAF methodology.

The situation in carbon footprint reporting is clearer, where there are now only two very similar standards in practice – the GHG Protocol and the ISO 14,000 series. But even in terms of general ESG, the range of methodologies used is already beginning to narrow, with a preference for approaches that naturally link non-financial indicators to financial reporting.

This is mainly based on IFRS, which define, for example, the rules for audits. The TCFD methodology developed by the team led by Michael Bloomberg, which focuses mainly on assessing risks and opportunities, is also based on these. The GRI methodology, on the other hand, is typically an accounting methodology, to the extent that it has prescriptive dials, the same as the chart of accounts.

These three methodologies – IFRS accounting, TCFD analytical and GRI structured – can be used together. This is a very comprehensive approach, which is particularly prevalent in multinational corporations. But even for carbon footprinting, they promote practices that are close to accounting and are actually audits. This has two main advantages.

First, companies are not doing a completely new thing, but they can use their experience and practices from financial management.

Second, the result is reviewable, sometimes even certifiable, and greenwashing is avoided. If you calculate your carbon footprint in a web calculator, it’s a good tool to try, but for serious consideration you really need an audit.

Faced with the challenge of unifying reporting methodologies for ESG, the European Union has gone its own way, and for the last decade or so we have been working towards a legislative framework for ESG in Europe. In particular, there is an effort to assess environmental impact with a tool called the EU Taxonomy, and a directive known as the CSRD is being developed for ESG reporting. This will apply to all large companies active in the European Union.

The CSRD is based on established financial reporting standards and combines IFRS accounting, the analytical TCFD and the structured GRI that we have already mentioned.

For the calculation of the carbon footprint it foresees the use of both the GHG Protocol and ISO standards. It has to be admitted that neither the EU Taxonomy nor the CSRD are at all popular among European companies. Unfortunately, the fact that they are very complex in terms of their formal description does not add to their popularity at all.

This is quite a pity. Both the EU Taxonomy and the CSRD are based on very simple and intuitive principles. If we get rid of the bureaucratic and legislative ballast, both the EU Taxonomy and the CSRD are good tools for the strategic management of a company. And although the final version of the CSRD is not yet known, its principles are already clear, which is why we at EnviTrail already make ESG reports CSRD-compliant.

So there is no need to panic. We all feel that when we say the European Union, directives, legislation, everyone imagines a very complex process. But how complex is ESG really? There is no simple answer to that. We said that large companies report under the established, most widely used standards – accounting IFRS, analytical TCFD and structured GRI. Such reporting is, of course, very comprehensive and suits multinational corporations.

They issue ESG reports either separately or as part of their annual report, combining financial and non-financial reporting as corporations are used to. They then present the summary report to their shareholders, boards and other bodies so that they have a good overview of the state of the company, its strategy and can make informed decisions about the future direction of the company.

At EnviTrail, we also frequently encounter cases where the Czech branch of a multinational corporation is faced with the task of providing structured information for its parent. And as it happens in a corporate environment, the instructions are often either very vague or so detailed that they are not understood. Then along comes an expert who understands ESG and can translate the mother’s requirements as if between the lines.

At the same time, he or she can help with reporting effectively. So this is the corporate world where ESG reporting is slowly taking root. However, what continues to surprise us is the surprisingly high interest in ESG among small and medium-sized companies. It is interesting how many smaller companies consider ESG to be important. Perhaps this is because ESG is really a very natural management tool. Smaller companies don’t need a complicated system, they don’t care if you follow GRI, TCFD, IFRS, SDG, CDP or BSR.

Under experienced guidance, they are able to identify and write up their ESG in one or two half-day workshops. ESG is very intuitive in principle.

So what does such an ESG look like in practice? It is a structured report in the categories E – environment, S – society and G – corporate governance.

The simplest approach is to take a draft of the categories in the form of a Chinese restaurant menu and choose which categories apply to my company and which do not. Here on the slide we see as a concrete example the categories used by the US technology exchange NASDAQ. NASDAQ’s methodology is very clear and simple and is suitable even for small companies, but if you want to get inspired, there are many such tutorial tables on the internet. So I choose from these or similar ESG categories.

Being a small company, board diversity probably won’t be relevant to me, simply because I don’t have a board, but energy consumption will definitely be relevant. Conversely, for example, for a large property development company, the climate investment category will be very relevant, but child and forced labour in the European space will – hopefully – not be relevant.

It must always be remembered that ESG is a tool for strategic decision-making and for marketing. Therefore, it is necessary to elaborate on the identified topics, give them target values or target states and determine the importance of each topic. To determine the importance, a division into three levels – “very important”, “would like to do” and “nice to have” – has been adopted.

For example, the category “Greenhouse gases” might turn into a commitment to reduce carbon footprint by 30% by 2030 in the case of a particular company, while employee diversity will lead to setting up a company nursery to encourage women to return from maternity leave.

And for example, publishing ESG reporting on a company’s website is now standard, some methodologies even strictly require it. (This could be Lucy with the pram :-)) ESG reports of large corporations are supposed to be dozens of pages long, but an ESG report of a smaller company or an executive summary of a complex ESG can fit on five pages.

On the first page you introduce your company, on the second page you briefly describe your ESG methodology and introduce specific topics, similar to what you see here in this table. Then you dedicate one page to the environment, one to the company and one to corporate governance.

At the same time, ESG is not yet very common, so if you want to get ahead of your competition, now is the ideal time to start ESG.