By Viktor Koleda, Analyst ‘s guide to ESG
Environmental, Social and Governance (ESG) factors have become an essential consideration for fund managers who take a long-term view of the investment process and seek to enable effective management of risks and opportunities across their portfolios. Similarly, business owners who want to highlight their companies’ positive impact, or to align their reports to the interests of potential investors, turn to the existing sustainability landscape for frameworks and guidance.
However, what they are likely to discover is a bewildering array of jargon and acronyms, compounded by the disorienting proliferation of reporting standards. Although various efforts to harmonise the ESG space are at play, the current state of affairs is commonly – and fairly – described as the “alphabet soup” of initiatives, frameworks and institutions.
The great confusion resulting from such potpourri hinders the ability of market participants to be on the same page and speak the same language. And so, while the standardisation of all the standards remains an ambition, how can you begin to take steps towards integrating ESG principles and practices into business operations?
Luckily, DRD have created a cheat sheet that will help you navigate the basics of ESG terminology, guiding you through the muddled world of sustainability reporting.
We are on-side with clients day to day, helping them understand the landscape and employ language that will cut through to the right audiences.
Using a strategic, stakeholder-driven approach to ESG helps us deliver information in a way that achieves the best outcomes for the client and ensures that their actions are perceived as significant, appropriate and credible.
Basics of ESG Investing Terminology
|Environmental factors||Issues related to how a business impacts (or is impacted by) climate change, what natural resources it produces or uses and whether it contributes to pollution or waste.|
|Social factors||Issues related to how the company affects customers, looks after its employees, deals with suppliers, and interacts with the communities in which it operates.|
|Governance factors||Factors that measure the quality and robustness of a company’s internal structure and practices, its consideration for shareholder rights, its accountability and wider transparency framework.|
|Investor materiality||Information can be considered ‘material’ when it could influence the economic decisions of investors and any other readers relying on the financial statements. For the VC asset class, such issues as concerns about the gig economy, the risk of artificial intelligence perpetuating discrimination and the responsible use of data are often material.|
|ESG Integration||Systematic and explicit inclusion of material ESG factors into investment analysis and investment decisions|
|Stewardship / Active Ownership||Entails engaging with companies and voting company shares on a variety of ESG issues to initiate changes in behaviour, policies or practices.|
|Exclusions (Negative / ethical screening)||An investment approach that incorporates an investor’s principles by excluding companies involved in certain activities or industries.|
|Positive screening||Investment approach which involves selecting targets that perform well on ESG dimensions. This could be done as “best-in-class” screening, in which an investor only selects companies that are leaders among their peer groups.|
|Sustainable and Responsible Investing (SRI)||SRI funds seek to build a portfolio with an above average ESG quality; in practice, this is often a combination of a positive and a negative screening.|
|Impact investing||Investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.|
|Greenwashing||Dishonest or deceitful marketing about the environmental impact of an entity, aiming to persuade the public that certain products, practices or policies are more environmentally friendly than they actually are.|
|UN SDGs||The United Nations Sustainable Development Goals is a collection of 17 goals adopted by the UN member states in 2015 to achieve the 2030 Agenda for Sustainable Development. The SDGs provide a blueprint for countries to achieve a more sustainable future, including ending poverty and hunger, improving health and education, combating climate change and protecting oceans and forests. While the SDGs were created for UN member states, the UN Global Compact and GRI have joined forces to help businesses report on the SDGs.|
|Green bonds||Any type of bond instrument where the proceeds will be exclusively applied to finance or re-finance climate or environmental projects.|
|Divestment||Sale of an asset for social/political/reputational reasons.|
|Integrated reporting||Company reporting that communicates the relationship between a company’s strategy and its financial, governance and sustainability performance.|
|Triple Bottom Line (TBL or 3BL)||An accounting framework that goes beyond traditional measures to incorporate three additional dimensions of performance: social, environmental (or ecological) and economic.|
|Carbon footprint||A measure of the total greenhouse gas emissions, expressed in tons of carbon dioxide.|
|Clean technology||A range of products, services and processes that reduce the reliance on natural resources, cut or eliminate emissions and waste.|
|Stranded assets||Assets that at some time prior to the end of their economic life are no longer able to earn an economic return as a result of changes associated with the transition to a low-carbon economy (lower than anticipated demand / prices).|
|Systemic Risk Management||Company’s management of risks resulting from large-scale weakening or collapse of systems upon which the economy and society depend, such as financial, natural resource, and technological systems.|
Reporting standards and principles
Reporting ESG performance in a formalised and systematic manner allows companies and funds to stand out among their peers.
Early-stage businesses in particular benefit from adjusting to reporting practices with a view of future growth, as the ESG expectations grow with scale. Using reporting standards can align the data published by a company with expectations of potential investors and facilitate greatest market access, which is especially important in the tech sector.
Principle-based frameworks, such as UN PRI, usually set general guidance, while reporting standards allow its practical translation into company’s operations.
|UN PRI||In 2006 the United Nations launched the Principles for Responsible Investment to help investors incorporate ESG factors into their investment and ownership decisions. The international network of investor signatories has grown from 100 to over 2,300, representing over $80 trillion in assets under management. The six principles are a set of voluntary investment principles, supported by 35 possible actions, that investors can use to integrate ESG into investment practice. The PRI has specifically aligned its work with the UN SDGs and has also made TCFD-based reporting mandatory for its signatories in 2020.|
|UN Global Compact (UNGC)||The Global Compact requires companies to commit to a set of ten universal principles concerning human rights, labour, environment and anti-corruption.|
|Organization for Economic Co-operation and Development (OECD) Principles of Corporate Governance||A regularly reviewed set of principles that set down the guidelines on how to create a sound corporate governance system. Principles include transparency, accountability, board oversight, and respect for the rights of shareholders and the role of key stakeholders.|
|GRI||The Global Reporting Initiative, formed in 1997, developed the first and most widely adopted global standards for sustainability reporting. The GRI Standards are broader in scope than some of the other frameworks, aiming to meet the information needs of all stakeholders. GRI’s modular structure supports both comprehensive reports and selected disclosures.|
|SASB||The Sustainability Accounting Standards Board in 2018 published a set of standards for 77 different industries, which identify the minimal set of financially material sustainability topics and their associated metrics for a typical company in a given industry. SASB is more granular in scope than some of the other frameworks. SASB and IIRC announced plans to merge in November 2020.|
|TCFD||The Task Force on Climate-related Financial Disclosures, chaired by Michael Bloomberg, was set up in 2015 by the Financial Stability Board (FSB) of the G20 to develop voluntary guidelines for companies, banks and investors to use when disclosing climate-related financial risks and opportunities to their stakeholders. The recommendations, issued in 2017, aim to help financial markets, including lenders, insurers and investors, better assess and price those risks and opportunities. In 2020 UK Chancellor announced the intention to make TCFD aligned disclosures fully mandatory across the economy by 2025. In 2019 it was also announced that TCFD-based reporting would become mandatory for all asset owners and managers signed on to the UN Principles for Responsible Investment.|
|CDP||Formerly the Carbon Disclosure Project, CDP is a UK-based non-profit that runs a global disclosure system for investors, companies, cities, states and regions. CDP collects standardised information from companies on climate change and the use of natural resources such as water and soft commodities. Over 8,400 companies, 800 cities and 120 states and regions have reported through CDP. Each year, CDP takes the information obtained through its annual reporting process and scores companies and cities on their environmental performance.|
|IIRC||International Integrated Reporting Council (IIRC) is a global coalition of regulators, investors, companies, standard-setters, accountants and NGOs that helps businesses and investors adopt integrated reporting. SASB and IIRC announced plans to merge in November 2020.|
|CDSB||International consortium of business and environmental NGOs that has set forth a framework for companies to report environmental and climate change-related information in their corporate financial reporting, such as the annual report. The organisation aims to enable companies to report environmental information with the same rigour as financial information in order to provide investors with decision-useful information to ensure resilient capital markets.|
|Integrated reporting||The Integrated Reporting Framework helps companies produce a concise, investor-focused report that looks at an issuer’s performance and prospects through the lens of six ‘capitals’ (financial, manufactured, human, natural, intellectual, social and relationship).|
|Better Alignment Project||The Corporate Reporting Dialogue, for example, has launched the Better Alignment Project, a two-year collaboration between CDP, CDSB, GRI, the International Integrated Reporting Council (IIRC) and SASB, to help synchronise the different reporting frameworks.|
Other relevant groups and organisations
|European Sustainable Investment Forum (EuroSIF)||The leading European sustainable and responsible investment organization whose mission is to promote sustainability through European financial markets. Different regions have their own local SIF, e.g. US SIF, UKSIF, SWESIF.|
|International Corporate Governance Network (ICGN)||An investor-led organization of governance professionals, ICGN’s mission is to inspire and promote effective standards of corporate governance to advance efficient markets and economies worldwide.|
|UK Sustainable Investment and Finance Association (UKSIF)||The membership network for sustainable and responsible financial services in the UK.|
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