By now, our readers likely have working knowledge of what ESG is but may find themselves struggling to understand the acronym-heavy alphabet soup. Not only is ESG a complex subject, covering multiple business units and functions, but it is also in flux as disclosures are gaining public, investor and regulatory attention amidst an unconsolidated landscape.
There are hundreds of terms to understand in the realm of ESG – some are technical terms related to greenhouse gas emissions and others are the various players in the disclosure framework arena. In fact, understanding the full scope of ESG terminology is more like a graduate level course than a 101 course! This post is dedicated to outlining some of the basic key terminology you need to know to be able to “speak ESG”.
First: What is ESG and What Does it Measure?
Let’s start at the beginning with the basics: what is ESG? ESG is means environmental, social and governance, the factors measured in each of these areas is defined below:
Environmental factors include, but are not limited to:
- Greenhouse gas emissions
- Water and wastewater management
- Air quality impact
- Other waste production and disposal
Social factors are focused on the people parts of the business. Even organizations lacking a formal ESG program likely measure and report on some or all of these factors. Some of the most common social measures include:
- Employee engagement
- Diversity, equity and inclusion (DEI)
- Personal data security
- Human rights
- Community impact
- Employee health and safety
Governance factors are those more directly related to how the company is managed and conducts business. As with social, many of these metrics and business areas are already being measured – and many of them fall under the compliance function already. Good governance is critical to an organization’s culture; when approached through an ESG lens, the argument can be made that governance is the foundation of ESG. This may seem counter intuitive given the amount of focus on the environmental sector of ESG, but the critical governance factors are fundamental to an organization’s health. They include:
- Business ethics
- Competitive behavior
- Board diversity and structure
- Executive remuneration
- Internal incident risk management
- Systemic risk management
Second: Disclosure Frameworks, Defined
The purpose of measuring ESG metrics is to establish a baseline, set goals and make progress. Because the disclosure landscape continues to evolve and consolidate, choosing which framework to align to can be difficult and confusing. The recent SEC disclosure proposal seeks to establish formal regulations for disclosure, so it is likely that there will be some solidified direction for what organizations need to measure and disclose. Below are the leading disclosure frameworks – both voluntary, and for those that are currently regulated, mandatory.
Voluntary Disclosures and Frameworks
Voluntary disclosures and frameworks provide strategic and specific line-item disclosure guidance to help companies determine what to measure and report on. As ESG becomes a more well-known, mature and regulated space, consolidation of the various frameworks is expected. Below are a few of the leading voluntary frameworks.
The Carbon Disclosure Project (CDP) was created 20 years ago and is, “a not-for-profit charity that runs the global disclosure system for investors, companies, cities, states and regions to manage their environmental impacts.”
The Global Reporting Initiative (GRI) is headquartered in Amsterdam, the Netherlands, with a network of seven regional offices to support organizations worldwide. The GRI is, “the independent, international organization that helps businesses and other organizations take responsibility for their impacts, by providing them with the global common language to communicate those impacts.”
Greenhouse Gas Protocol, “establishes comprehensive global standardized frameworks to measure and manage greenhouse gas (GHG) emissions from private and public sector operations, value chains and mitigation actions.” The GHG Protocol is the world’s most widely used greenhouse gas accounting standards.
The International Financial Reporting Standards Foundation (IFRS) is, “a not-for-profit, public interest organisation established to develop a single set of high-quality, understandable, enforceable and globally accepted accounting and sustainability disclosure standards—IFRS Standards—and to promote and facilitate adoption of the standards. The IFRS is currently being formed through the consolidation of the Value Reporting Foundation (VRF) and the Climate Disclosure Standards Board (CDSB), this work is expected to be completed by the end of 2022.
The International Sustainability Standards Board (ISSB) was created on early November 2021 by the IFRS as a standards setting board to help meet the demand from investors for high-quality, transparent, reliable and comparable reporting by companies on climate and other ESG matters. The ISSB is currently finalizing the inclusion of the VRF and as a result the SASB Standards. SASB Standards provide line-item disclosure guidance for, “financially material sustainability information by companies to their investors. Available for 77 industries, the Standards identify the subset of environmental, social, and governance (ESG) issues most relevant to financial performance in each industry.”
The Task Force on Climate-related Financial Disclosures (TCFD), “was created in 2015 by the Financial Stability Board (FSB) to develop consistent climate-related financial risk disclosures for use by companies, banks, and investors in providing information to stakeholders. Increasing the amount of reliable information on financial institutions’ exposure to climate-related risks and opportunities will strengthen the stability of the financial system, contribute to greater understanding of climate risks and facilitate financing the transition to a more stable and sustainable economy.”
Depending on the organization’s location disclosures are mandatory. Global regulations continue to evolve to balance comparability with efficient ESG data collections. Below are some of the mandatory disclosures to be aware of.
The Equal Employment Opportunity Commission (EEOC) is, “responsible for enforcing federal laws that make it illegal to discriminate against a job applicant or an employee because of the person's race, color, religion, sex (including pregnancy, transgender status, and sexual orientation), national origin, age (40 or older), disability or genetic information. These federal laws affect the practices
The Non-Financial Reporting Directive (NFRD, applicable in the EU), “sets the rules on disclosure of non-financial and diversity information relating to the ESG areas (environmental protection, social responsibility and treatment of employees, respect for human rights, anti-corruption and bribery, and diversity on company boards) by certain large EU public-interest companies in their annual reports.”
The Sustainable Finance Disclosure Regulation (SFDR, applicable in the EU), “is a European regulation introduced to improve transparency in the market for sustainable investment products, to prevent greenwashing and to increase transparency around sustainability claims made by financial market participants.” Essentially, the SFDR imposes comprehensive sustainability disclosure requirements for organizations operating within the EU.
Third: Environmentally Specific Terms to Know
A greenhouse gas, commonly shortened to GHG, is a gas that absorbs and emits radiant energy in the thermal infrared range, which causes the greenhouse effect. The four major greenhouse gasses are carbon dioxide, methane, nitrous oxide, and fluorinated gases. While some GHGs are unavoidable, many are the direct result of burning fossil fuels for electricity, heat and transportation.
Greenwashing is a term to describe the practice of exaggerating a company’s sustainability or environmentally conscious capabilities. Essentially, it is a marketing or public relations spin, used to mislead the public that the organization’s products, goals and policies are environmentally friendly. For the untrained eye, this can be difficult to spot – but growing attention to ESG means that it is of huge importance to instill trust in the ESG data that a company discloses.
Direct emissions are emissions from sources that are owned or controlled by the reporting company.
Indirect emissions are emissions that are a consequence of the activities of the reporting company but occur at sources owned or controlled by another company.
A materiality assessment is meant to help identify and understand ESG and sustainability impacts to a specific organization. While the verbiage of a materiality assessment may be unfamiliar to some, this is essentially a risk assessment, tailored to the ESG risks a business faces.
Scope 1 measures “direct emissions” from resources owned and controlled by the company. This includes emissions from the company’s own facilities and vehicle fleet.
Scope 2 refers to “indirect emissions” which are generated from purchased energy, or utilities. These encompass all GHG emissions stemming from the consumption of purchased electricity, heat, cooling, etc.
Scope 3 emissions encompass all emissions generated throughout the corporate value chain, including all aspects of the business beyond physical assets and people operations (which are defined as Scope 1 and 2 risks). All ESG risks – including climate-related, social capital, human rights, and governance risks –apply to third parties as Scope 3 risks.
The Scopes are a complex part of the ESG story, for a deeper dive into the scopes, check out this blog post.
Getting Started With ESG
Though starting an ESG program is a complex endeavor, there are a wealth of resources available to help organizations at any stage of ESG program maturity. At NAVEX, we frequently post informative ESG content to this blog, as well as webinars and other helpful materials.
For a deeper dive into the value of an ESG program and useful resources to get started