GARY RYNHART: Watchdogs set to tighten their grip on ESG efforts

A common complaint from sustainability practitioners has been the plethora of reporting frameworks that firms use to report on sustainability and environmental, social & governance (ESG) efforts. There has been significant progress on this front in the last few months.

The International Sustainability Standards Board (ISSB) established in 2022, which had previously consolidated other reporting frameworks such as the Climate Disclosure Standards Board and the Sustainability Accounting Standards Board industry standards, is partnering with the Global Reporting Initiative to create a global baseline of sustainability reporting. This is a game-changer.

This reporting convergence brings the potential for greater collaboration between a company’s sustainability team and its finance department. The significance of the International Financial Reporting Standards Foundation setting up the ISSB is that the main body governing financial reporting standards is now overseeing sustainability reporting too.

While the alphabet soup of reporting acronyms is finally shrinking in size, don’t bet on it going away completely. Emerging from the Task Force on Climate-related Financial Disclosures, the Task Force for Nature-related Financial Risk is due to be launched later in 2023. Its goal is to provide financial institutions and companies with a complete picture of their environmental risks using metrics covering resources such as water, phosphates and ocean use.

Other significant changes relate to how firms report their ESG efforts. Most firms do not report their Scope III emissions (emissions from third parties and suppliers). The ISSB will now require their inclusion. There have been several high-profile cases of firms being caught highlighting Scope I and II emissions (the ones they control) while their Scope III emissions remain very high.

On average Scope III emissions are more than 10 times Scope I and II combined. This ties in with regulatory initiatives targeting “greenwashing” and “green-hushing” (companies avoiding greenwashing claims by not reporting at all or minimising reporting). Expect far more focus on this area.

Ratings agencies

Allied to this is the increased use of more dynamic reporting defined as data that might seem financially immaterial now, but could become material in future. Attention should therefore be paid to how business models could trigger certain effects and how they aggregate over time.

A related issue is data gaps. Firms that say they lack the information now on a given issue suggest they do not think it important. Yet it could be. Data gaps in themselves can be quite revealing for a firm.

Also expect a stronger spotlight (also from regulators) on the global ratings agencies that assess and compare companies on their ESG performance. Legislative interventions to improve transparency on ESG rating providers’ methodology and the reliability and comparability of ratings can be expected. It is overdue. A recent study commissioned by the International Labour Organization (ILO) on how global ratings agencies assess “decent work” issues, shows how fragmented reporting is.

Decent work-related items represent about 20%-35% of overall ESG scores but can be found across categories such as human rights, human resources, business relationships or supply chains. ESG ratings agencies do not measure companies’ ESG performance through the lens of global supply chains, which are often treated separately from other items, such as carbon emissions, climate change effects, pollutants and human rights. This means all those items, if not captured in the ambiguous “supply chain” metric, reflect each company’s own actions but not those of their supply chain partners. Much like the inclusion of Scope III emissions on the “E” side, expect sharper focus on supplier behaviour on the “S” side.

The direction of travel of the social component of ESG is best reflected in several current international initiatives. The 2019 World Development Report (World Bank) proposed a global “New Deal” to achieve equality of opportunity and social wellbeing.  UN secretary-general Antonio Guterres proposed in his Our Common Agenda Report (2020) a new social contract. ILO director-general Gilbert Houngbo has called for a new social contract to promote social justice (2022). The concept has also been developed by the World Economic Forum at Davos 2022. All of these initiatives represent a new quest for increased social scaffolding to support free market and capitalism architecture.

The drivers behind these initiatives are ever increasing inequality, technology disruption and artificial intelligence, the urgency of the climate crisis, the social exposure caused by Covid-19 and, chiefly, an increasing sense of unfairness. These discussions and what they mean in concrete terms will most likely come to fruition and some conclusions at the 2025 UN Social Summit. The ESG debate will be shaped by it.

• Rynhart is senior specialist in employers’ activities with the ILO, based in SA.