Insights

This is the second and final part of a two-part article. Part 1 was published last week and discussed ESG impacts on companies, including how such ESG Factors need to be integrated into a company’s purpose and strategy and the legal frameworks revolving around a board’s ESG responsibilities.

Reporting and Disclosure

Different companies have different disclosure policies and reporting requirements.  A common trend being seen amongst companies (mainly public companies) is increasing pressure from investors for disclosure of ESG-related information, which is to be produced in a clear, more efficient and comparable method. This notwithstanding, disclosure of ESG data is often not compulsory under typical reporting standards, which can lead to over-disclosure of non-material ESG information.

Not disclosing specific ESG data does not necessarily mean that ESG risks or opportunities are being managed poorly.  It might be the case that certain information may be assumed to be of limited importance to investors or otherwise commercially sensitive in nature.  Furthermore, disclosures also vary by geography, industry practices and company size.  However, a lack of disclosure can possibly be an indicator of poor management/results, a result of which certain disclosures would allow investors to make certain relevant judgements.

Investors (including the general public) understand that ESG activities can have both negative and positive financial consequences and thus they want to be in a position to anticipate and consider any operational, regulatory and reputational impact of ESG factors. Such disclosure allows investors to better understand and assess the risks and added value of ESG factors relating to a specific company and their potential on the company’s long-term value. In terms of topics investors are keen to hear about, these could vary from material environmental information such as carbon emissions and waste and pollution management, social matters such as employment equality and gender diversity, and also governance-related matters which can include information provided on compensation of employees and executives, board and company diversity and also tax strategy and accounting standards.

Directors should also evaluate and undertake an assessment as to whether the obligation to disclose any ESG related matters are to be included in the annual financial statements and any other corporate disclosures.

Given the pressures towards and the advantages of comparability, there is an intensifying regulatory focus on the emergence of global disclosure standards, which seek to emphasise on non-financial reporting. Furthermore, regulators are increasing their focus on the so-called “greenwashing”, whereby companies, knowingly or accidentally, misrepresent their ESG initiatives in their marketing programmes as a marketing stunt. Thus, regulators are also introducing marketing standards and guidelines to tackle such issues. Whilst the lack of industry standards impedes stakeholders from assessing any statements relating to ESG, it is the director’s responsibility to ensure and validate, that any ESG initiatives or products are marketed appropriately.

The EU has issued, and Malta has successfully adopted, the Sustainable Financial Disclosure Regulation which applies to specific market participants and which requires standardised disclosures in the documentation provided to investors and websites on issues relating to risks and impacts of any investment decisions on ESG matters. Furthermore, it requires disclosure on how such companies integrate ESG matters in their remuneration policy (as further discussed below). Similar requirements are in the pipeline with regard to listed companies and eventually, these may also apply to large private companies.

Recent EU initiatives will significantly contribute to reducing the risk of greenwashing. However, these initiatives are foremost disclosure regulations and do not and are not intended to provide substantive distinctions between financial products that only have a very basic integration of ESG factors into their investment process and products that have elaborate and strict ESG screenings in place.

As a result, sustainability labels can be tools that allow investors to distinguish among different shades of sustainability, without requiring them to undertake a detailed and often complicated analysis themselves. We have seen a number of sustainability labels being created by a number of jurisdictions, such as Luxembourg’s LuxFlag, Germany’s FNG Label and the Scandinavian Nordic Swan Ecolabel, amongst others, which provide further insight to investors into a particular product’s sustainability aspects.

Board of directors of companies that are seeking to go public are to be mindful and aware of any potential liability that the company, its officer or directors may face when disclosing information on ESG related matters, since these may constitute forward-looking statements for the purpose of securities law. Therefore, when issuing any statements relating to ESG matters, the necessary caution, disclosures and risk factors are to be included, furthermore, the board is to ensure that ESG claims are accurate, and the appropriate cautionary language is present.

Ultimately, it is in the company’s interest to provide robust ESG disclosure. Such disclosure will provide all relevant stakeholders with the information they can analyse and decide upon, should this not be readily available, they may formulate a wrong impression about the company or decide to invest/do business with other entities that are more forthcoming about their ESG initiatives. Apart from allowing a company to demonstrate its effort in relation to ESG initiatives, such disclosure will permit the company to benchmark its own practices and reporting. Most importantly, such disclosure will put the company’s management in control of the company’s ESG narrative, and stakeholders will receive such ESG data directly from the company as opposed to any other platforms which might not provide the latest or most accurate data and not depict the correct narrative the company is trying to set.

Risk Mitigation

Whilst ESG can provide a plethora of opportunities for companies operating in various industries, directors are to be aware that ESG factors can also result in the company facing various risks. Risks can vary from physical risk, transition risk and regulatory risk. From a reputation perspective, companies are also facing challenges as investors and consumers are giving importance to such factors when taking decisions in relation to a particular company.

To be able to identify and mitigate ESG risk-related matters, the board of directors should first be aware of the potential impacts, risks and opportunities posed by such ESG concerns. An ESG assessment should be undertaken for the board to be clearly informed on the most material risks faced by the company. Such an exercise and risk assessment should protrude beyond the company, with external stakeholders being engaged as necessary. A risk assessment should be comprehensive and cover various aspects of the company’s operational activities. Furthermore, the assessment should not only identify and rate the probability of such risk occurring, but should also consider such risks and their relation to the company at an enterprise level.

To ensure the appropriate risk mitigation measures are undertaken, the board (depending on the size and operations of the company) should also consider establishing specific ESG roles and responsibilities. This can be done through the appointment of a specific individual or by giving C-suite executives or specific directors ESG responsibilities. With correct roles being successfully integrated, a company will be able to better understand and manage data gathering, measurement and reporting mechanisms, which will ultimately permit the board to be in a better position to identify, set and implement short- and long-term goals. Furthermore, boards are to understand the benefits and also undertake the necessary steps to enhance the board’s diversity and also ensure that the directors have the necessary expertise on ESG matters.

Conclusion

Global events such as the COVID-19 pandemic, armed conflicts, the climate emergency, economic uncertainty, and social and racial justice are causing companies to accelerate changes to their ESG priorities, ensuring ever closer alignment between these issues and their long-term corporate strategies.  Such issues have resulted in companies being faced with further financial pressures from many stakeholders. Those companies that take this opportunity to better understand such pressing matters, whilst undertaking a broader view of their long-term strategy, including the company’s strategy in relation to ESG issues, will be better positioned to overcome such challenges.

Boards are to take responsibility for ESG and ensure that they have the right people to do so. By establishing the right policies and procedures, which will ultimately permit the company to integrate these ESG matters into the wider operational and strategic goals of the company, the board is ensuring that the company is responding to stakeholders’ requests and needs and the long-term viability of the company.

Ultimately, a company that ignores such environmental, social and governance challenges is doing so at its own risk.

This article was first published on Times of Malta.