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Increasing focus for ESG

A look at ESG and how increasing momentum in this area is likely to affect businesses going forward.

“ESG” is the now well-known acronym for “environmental, social and governance” issues as they relate to a company’s activities. ESG can be thought of as a part of corporate social responsibility, although the acronym came into wide usage after its adoption by investors looking to grade progressiveness on these issues in the companies they are looking to invest in. Increasingly ESG is being used as the label for new standards governing a company’s behaviour in these areas.

The ESG movement was started by socially conscious investors seeking to invest only in companies which act responsibly on the ESG issues. And until recently ESG has related primarily to metrics for distinguishing the relative performance on ESG issues between private sector actors, as measured by and for investors, brokerage firms, and mutual funds pursuing ESG investing strategies. However, what started as a movement to foster and encourage change will increasingly be used as a tool to force higher standards by all private sector actors.

The Environmental aspect of ESG is primarily concerned with the energy and other resources a company consumes, together with the waste it discharges, and the consequences of these actions. Every company is expected to be affected by ESG standards in some way according to what energy and other resources it consumes and the consequent carbon and other emissions and related contributions to climate change or other environmental damage.

The UK intends to force higher environmental standards using the Task Force on Climate-related Financial Disclosures (TCFDs) and Sustainability Disclosure Requirements (SDRs). TCFDs are set out by the Financial Stability Board and have become the main framework for climate reporting across many jurisdictions. They aim to provide a uniform approach to reporting financial information related to the climate by requiring premium listed companies and standard listed companies to include a statement in their annual report which is consistent with the TCFD recommendations. This approach will include companies having to explain any non-compliance with the guidelines and identifying where any additional disclosures are, should they not be in the annual statement. The guidelines themselves are focused on governance, strategy, risk management and metrics and targets and it is expected that the government might review whether to expand the scope of TCFD disclosures for UK registered companies later this year.

Alongside this, the plans surrounding SDRs were last updated in March 2023 when the consultation period ended. SDRs aim to stop firms from being able to make exaggerated sustainability related claims. Once approved, the Financial Conduct Authority (FCA) will introduce a requirement for businesses to label products to helps consumers find sustainable products, but in order to be able to label a product as sustainable, the product will have to meet the qualifying criteria of one of the proposed categories. The FCA intends to publish a policy statement later this year with the proposed effective dates in which businesses will have to comply with the restrictions surrounding labelling products as being environmentally safe.

The EU and US are also in the process of introducing strategies that will help monitor companies’ contributions to the environment. The EU has adopted reporting standards which will require companies coming within the scope of the Corporate Sustainability Reporting Directive to report extensively on sustainability matters from 2024 and the US, while moving a little slower than the EU, is also looking to expand ESG reporting obligations.

ESG aims to not only control the physical contributions to environmental issues but to also limit businesses from “greenwashing.” Recently, we have seen an increase of companies being accused of greenwashing by making claims about their products or services which are not strictly true and do not allow a consumer to make an educated decision. Likewise, the EU have created a set of standards which aim to fight the issue of “greenwashing.” Under their new rules, 85% of the funds raised by issuance must be allocated to activities that define sustainable investments and disclose how such activities will help with the transition to the larger ESG goals in order to be considered a green company. You can read about how companies have been investigated for greenwashing in the UK here.

While the reporting requirements impact larger companies in the first instance it is likely that smaller companies will be affected as ESG gains further momentum. In particular, larger companies may raise their ESG expectations of the smaller organisations in their supply chains.

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