ESG explained | Article series examining ESG from the ground up | #1 What is ESG? (2024)

Background

On April 21, 2021, the European Commission adopted the sustainable finance package, which includes the proposed CSRD¹which reforms and significantly expands the scope of required reporting related to the NFRD²information requirements. The expansion of the size means that there will be almost 50,000 from 2023³companies in the EU must now report on ESG issues

The Hungarian Stock Exchange (BÉT) has recommended that all issuers develop a roadmap for ESG reporting by the end of the year. To help with this task, we have decided to publish a series of articles exploring the topic of ESG and how we can approach it.

What is ESG?

ESG stands for environmental, social and governance. These are called pillars in ESG frameworks and represent the three main topics that companies are expected to report on.The purpose of ESG is to capture all non-financial risks and opportunities associated with a company's daily operations.

Why is ESG here to stay?

Our world is facing a number of global challenges: climate change, transition from a linear economy to a circular economy, increasing inequality, balancing economic needs with social needs. Investors, regulators, as well as consumers and employees, are now increasingly demanding that companies are good stewards not only of their capital, but also of natural and social capital, and that they have the necessary governance frameworks in place to support this.More and more investors are incorporating ESG elements into their investment decision-making process, making ESG increasingly important in securing capital, both debt and equity.

What falls under the environmental pillar?

Emissions such as greenhouse gases and air, water and land pollution emissions. Resource use, such as whether a company uses new or recycled materials in its production processes and how a company ensures that the maximum material in its product is returned to the economy from cradle to grave rather than ending up in a landfill. Likewise, companies are expected to be good stewards of water resources. Land use concerns, such as deforestation and biodiversity disclosure, also fall under the environmental pillar. Companies also report on the positive sustainability impacts they can have, which can translate into long-term business benefits.From a reporting perspective, this is the most complex pillar.

What falls under the social pillar?

Under the social pillar, companies report on how they manage the development of their employees and their working methods. They report on product liability related to the safety and quality of their product. They also report on their labor and supply chain health and safety standards and on controversial procurement issues. Where relevant, companies are expected to report on how they provide access to their products and services to disadvantaged social groups.

What falls under the steering column?

The main topics reported under the governance pillar are shareholder rights, diversity on the board, the way directors are rewarded and how their remuneration is in line with the company's sustainability performance. It also includes questions about business conduct, such as anti-competitive practices and corruption.

How is all this relevant to your business?

Of course, not all sectors of the economy face the same ESG issues. For example, in banks, greenhouse gas emissions (more specifically scope 1 and 2) are not as important as with energy. These differences in what is important for a particular sector from an ESG perspective are called materiality. Companies report on topics that are important to them. Materiality is typically determined based on the ESG issue that is considered economically significant in a particular sector. Financially significant issues are matters that can affect a company's financial performance (for example: unexpected profit costs, fines, loss of brand value, loss of revenue as consumers choose more sustainable alternatives). Increasingly, dual materiality is being recognized as an important concept in the choice of what is considered material by a company. Double materiality means that in addition to economically material issues, socially material issues are also treated as material.

How do you report?

ESG is now widely considered a reporting framework, but originally it was a framework developed to evaluate public companies' sustainability-related disclosures to investors. As demand for ESG-related information increases, the ESG framework has become synonymous with reporting. There is no standard ESG framework (yet), only a broad consensus on the topics covered; there can be numerous differences at the data point level. For this reason,companies rely on sustainability reporting standards to determine how and what they report.

Reporting is typically done using one or more frameworks.The two most commonly used reporting frameworks are the Global Reporting Initiative (GRI) and the Sustainable Accounting Standards Board's Standards (SASB).. ESG reporting is typically done by publishing a sustainability report, although more and more companies are making data public through web pages that show the company's ESG performance alongside a more standard report.