Environmental, Social, and Governance (ESG) has gained rapid adoption within the investment community and among firms as a framework that helps them understand how an organization can manage their sustainability risks and opportunities related within an industry. By adopting ESG practices and being ESG-compliant within their operations organizations can better measure, manage, and report their ESG performance. Being ESG compliant means adhering to and aligning with the principles of ESG reporting standards and frameworks such as the Global Reporting Initiative (GRI), International Sustainability Standards Board (ISSB), and Carbon Disclosure Project (CDP), among others. ESG compliance reflects a commitment to responsible and sustainable business practices that consider the company’s impact on the environment, its relationship with society, and the effectiveness of its governance structures. However, regulatory requirements globally have been evolving gradually making ESG compliance a challenge for many firms.
Why ESG compliance is important in the present scenario?
Over the last four years, ESG reporting provisions provided by governments have increased by at least 70% according to a survey by Carrot & Sticks and as of 2023 nearly 90% of public companies have ESG initiatives in their firms according to a survey by Navex Global. ESG frameworks provide a systematic approach for companies to integrate sustainability and responsible business practices into their operations, strategy, and reporting, helping them achieve and demonstrate ESG compliance. However, despite the increase in the disclosure of sustainability-related information, Chief Sustainability Officers (CSOs) across multiple firms have found it challenging to cope with multiple reporting frameworks due to the lack of understanding on sustainability definitions, the lack of knowledge on materiality approaches, and diverse calculation methodologies.
Being ESG compliant is not a one-time achievement but an ongoing commitment to integrate sustainable and responsible practices into the core of business operations. Companies that prioritize ESG compliance often aim to create long-term value, build trust with stakeholders, and contribute positively to the broader context in which they operate making ESG compliance critical for companies.
Investors and asset managers place greater emphasis on ESG factors while making investment decisions. 2022 research by Capital Group, an asset management firm shows that 90% of investors consider ESG issues within their investment approach while 31% of investors in Europe considering ESG as fundamental to their investment approach. Furthermore, only 13% of the investors consider ESG as a changing phenomenon that will go “out of fashion” over time. With investors keen on understanding the impact of their investments, companies demonstrating ESG compliance will attract and retain sustainable investments.
How being ESG-compliant can help firms in the Modern ESG Era
- ESG compliance helps companies identify and manage potential risks related to ESG factors, such as climate change, employee healthcare and safety, and data privacy. Compliance and risk leaders across the U.S. and Europe are more involved in governance and social management of ESG. In NAVEX Group’s recent survey of compliance leaders across the Europe and U.S. it was found that 90% of the compliance leaders already include ESG as a part of their compliance program and a further 70% strong or somewhat agree that ESG management should involve compliance. Proactive risk management in ESG areas prevents reputational damage, regulatory fines, and other financial liabilities for firms operating across all sectors.
- Moreover, ESG-compliant companies may have better access to capital and potentially lower costs of capital. The Economic Survey conducted in 2023 to assess the performance of top 1,000 firms in India concluded that being ESG-compliant through ESG disclosures, had helped build investor confidence on those firms and increased their access to capital at a lower cost. Investors increasingly recognize that companies with strong ESG performance are often more resilient and better positioned for long-term success.
- ESG compliance is increasingly important for attracting and retaining top talent, especially among the younger workforces. In Randstad’s 2022 global survey of 35,000 employees, almost 50% of millennials and Gen Z employees stated that they would not consider a job that does not align with environmental issues. Therefore, employees are more attracted to companies with a strong commitment to sustainability and social responsibility.
ESG Compliance and Reporting – The Importance of Mandatory and Voluntary Frameworks:
Although ESG compliance helps a business attract investors, retain talent, and manage risk, the discussion at the core is differentiated by the goals of an organization. This leads to the compliance approach in two main ways: mandatory compliance and voluntary compliance.
Under ESG mandatory compliance, various factors such as government and regulatory bodies mandate companies to disclose specific ESG-related information. Compliance with these regulations is compulsory, and companies are legally required to adhere to the specified reporting standards with public companies largely falling within this scope of compliance reporting. There are several mandatory requirements or regulations globally that are shaping corporate sustainability including the U.S. Securities and Exchange Commission’s proposed Climate-related disclosure, the Sustainable Finance Disclosure Regulation (SFDR), the Securities and Exchange Board of India (SEBI), and the Corporate Sustainability Reporting Directive (CSRD), among others.
In contrast, voluntary compliance allows companies to follow industry best practices and adopt ESG standards without being legally obligated to do so with both public and private firms falling within the scope of reporting. This is based on a commitment to responsible and sustainable business practices offering companies with a flexibility to choose from various frameworks based on their industry, business model, and stakeholder expectations. The CDP, GRI, and Sustainability Accounting Standards Board (SASB) are examples of frameworks demanding voluntary ESG disclosure.
In real time, many companies engage in both mandatory and voluntary ESG compliance. They comply with legal requirements while also voluntarily adopting additional ESG practices to align with stakeholder expectations and position themselves as responsible corporate citizens.
The discussion on ESG compliance creates an impact and brings in the perception of both public and corporate leaders, which is critical for shaping the company’s approach to sustainability and influencing stakeholder trust. When leaders prioritize and communicate the importance of ESG principles, it sends a clear signal to employees, customers, and investors that sustainability is a fundamental aspect of the company’s values and culture. In essence, ESG compliance is not only a regulatory requirement but a strategic imperative for companies aiming for long-term success and value creation, stakeholder trust, and positive societal and environmental impact.
