Driving Forces Behind ESGGRC | 4 Min Read |16 November 21|by Shaun Wong
The Driving Forces of ESG
ESG – these are the most frequently spoken letters in boardrooms across the globe. From sustainable investing to emerging regulations, it is a burning topic for board directors, c-suite executives, and finance professional. Some see ESG as an evolutionary journey to become a better corporate citizen. Others see it as the brave new world of sustainable investing. This article will discuss some of the key challenges faced by risk and compliance leaders embracing the task of building corporate ESG programs. The road ahead for these pioneers is both exciting and murky. Building an ESG program is not a quick fix. It is tempting to sweep ESG under sustainability or environmental management. Others might simply categorize it as part of GRC. While both are correct, ESG is a delicate topic and requires more than just a one-size-fit-all solution. To understand ESG from the risk and compliance perspective, it is worth digging a level down to understand what the key driving forces are.
In just less than two years, the world witnessed major catalysts fueling the unprecedented acceleration of ESG. Growing concerns about lasting environmental effects. Widespread socioeconomic and human rights issues. Demand for greater corporate transparency. ESG carries material impacts and possesses the ability to influence the future of an organization. In 2020 alone, the US ESG ETF market saw a 318% year-over-year increase. Prior to 2019 or global COVID-19 pandemic, ESG investing was just merely a niche market, experiencing relatively insignificant growth. It is reasonable to assume that a significant portion of global capital is now being relocated from “weak ESG” companies to “strong ESG” companies at an exponential rate never seen before.
So what does “strong ESG” mean?
The growth of ESG investing has given rise to yet another problem - Greenwashing. Companies making inaccurate claims about their environmental and social responsibility efforts. This is not necessarily intentional or a toxic corporate behavior. ESG disclosure is inherently a tricky exercise. It involves a great deal of effort, time, and money. On top of that, there are very few guidance on which disclosure frameworks to use and how to use them. To further complicate the matter, regulators around the globe are starting to zero in on greenwashing. For instance, the European Union regulators launched a new set of ESG regulations in early 2021. The Sustainable Finance Disclosure Regulation (SFDR) sets mandatory disclosure requirements for financial market participants and financial advisers operating in the EU. These organizations will be required to follow specific mandates on how and what to disclosure on an annual basis. Compliance reporting has never been straight forward. From Sarbanes Oxley to GDPR, compliance leader around the world have seen their fair share of ups and downs navigating these turbulent seas.
There is yet another angle to consider. From institutional to retail investors, ESG index score has become a popular metric when it comes to investment decisions. An ESG index score is essentially the grade point average or credit rating of a company’s ESG performance. These figures don’t lie and are quite accurate. For instance, MSCI is a one of the leading investment research firms offering an ESG index score on over 2,800 companies. These companies are being assessed on thousands of ESG related data points and ranked against their peers. Investors leverage this research to understand the current state and potential long-term risk implications of companies. Index scores from different firms are typically used in conjunction for a broader perspective. This is an important consideration for the risk and compliance leaders managing ESG. Understanding the metrics and frameworks behind these index scores can not only help a company’s ESG ranking, but more importantly, keep risks under control and become a more sustainable company overall. These index scores should not be looked at as cheat-sheets for better ESG ranking. But rather guidelines to better corporate citizenship.
Global ESG assets are projected to exceed $53 trillion by 2025, more than a third of the projected total assets under management worldwide. ESG is expanding and by no means plateauing. These investment trends and regulatory changes are just the early stages. ESG investment products will continue to become more complex. Regulators will increase their focus on this matter. From the 2007-08 financial crisis to the COVID-19 global pandemic, and many challenges before; the answer is not a simple one-size-fit all solution. But a constant battle of wits and strength.
Watch the video to gain a deeper insight into how MetricStream’s ESGRC product can help your organization take the next step in your ESG journey.