What is ESG?
ESG stands for Environment, Social and Governance.
In business, environmental factors consider the extent to which companies are environmentally engaged, contemplate sustainability issues in modern society when devising operating strategies and can be considered environmentally sustainable.
The social pillar of ESG focuses on a company or industry’s policies and practices regarding labour and supply chains to assess the extent to which businesses are socially engaged.
Governance refers to how an organisation’s objectives are set and achieved, how risk is monitored and addressed and how performance is optimised. Key factors to consider when assessing the governance factor of a company’s operations include regulatory complexity and involvement in controversy.
Investors and key business stakeholders are increasingly applying ESG factors as part of their analysis and risk management processes in order to identify and address both material risks and growth opportunities.
Why is ESG important to UK industries?
In November 2020, the UK government announced its intention to make financial disclosures aligned with recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) mandatory across the economy by 2025. This will take the UK beyond the ‘comply or explain’ approach adopted under the EU’s Sustainable Finance Disclosure Regulation, which came into effect on 10 March 2021, and build on principles set out in the government’s Green Finance Strategy (GFS).
Alongside this, the UK government published an interim report and roadmap towards mandatory TCFD-aligned disclosures, setting out a timeline of planned and potential regulatory actions or legislative measures.
At present, UK regulators, government departments and TCFD member organisations are progressing strategies in the roadmap, in particular monitoring the progress of a cross-sectoral implementation strategy to ensure a coordinated approach is maintained. They are also accelerating consultations seeking views on proposals to mandate climate-related financial disclosures.
With the government set to provide an update on progress in the 2022 refresh of the GFS, now is the time for business managers and stakeholders to scrutinise and further consider climate-related and other sustainability disclosures and practices in order to ensure full compliance with impending legislation.
Contextualising these factors, which form part of the broader ESG theme, is vital in understanding a businesses’ and markets’ vulnerability to possible compliance issues. Further, it provides an indication of businesses’ and markets’ future performance and ESG best practice as the focus on sustainability becomes ever stronger in light of the UK’s transition towards net-zero.
How can businesses benefit from assessing ESG risk?
Assessing ESG risk is important in every industry due to emissions reduction targets, growing regulatory and reporting requirements and rising attention on ESG issues from consumers, among other factors. Companies must ensure they properly address ESG factors in every area of their operations in order to maintain compliance with legislation and attract demand from customers seeking ethical and environmentally friendly companies.
Below, we’ve highlighted the ways in which three industries can benefit from placing greater attention on ESG.
Accounting and auditing
A growing requirement for companies to disclose ESG-related information in their financial accounts is affecting operations in the Accounting and Auditing industry. While the companies themselves must ensure their accounts contain all the required information, it is also important for auditing businesses to put processes in place to help them assess these areas of a company’s accounts, particularly as ESG reporting requirements are expected to increase in the near future.
In particular, the Financial Reporting Council has expressed concerns that disclosures on energy use, costs and emissions are not always clear enough, meaning that users can struggle to understand them or find them relevant. Auditors that are able to conduct a proper assessment of a company’s ESG disclosures will be better able to help companies determine the level of financial risk their operations may be facing, which could be key to attracting clients.
Banking
At the same time, businesses such as financial institutions can benefit from drawing ESG risk into business strategies in order to protect cash flow and ensure compliance with both current and future regulation. With regulations relating to the environment growing and ethical issues such as labour standards remaining key, it is important to consider the impact of ESG factors on financial risks and reputational risks.
For example, ESG factors must be taken into account in the lending process to help banks assess which companies are more likely to default on loans, as companies operating in industries with a high level of ESG risk are likely to be riskier investments. Additionally, they can help lenders judge whether or not a client’s operations can be considered sustainable and ethical, which can help protect the bank’s reputation.
Clothing retailers
In addition to helping ensure that companies are meeting increasingly stringent regulations, companies’ attitudes towards ESG factors can be influential in attracting demand. Growing environmental and ethical concerns among the general public are driving the ethical consumerism trend and businesses that fall short of consumers’ expectations risk being left behind. Conversely, companies that emphasise their environmental and ethical credentials are likely to fare better.
This trend has been increasingly evident in the Clothing Retailing industry, with fast-fashion firms facing scrutiny for promoting wastage and exploiting workers through low wages. In response, many companies have focused on making their operations more sustainable, such as by using recycled materials to manufacture clothing and introducing clothing recycling schemes in stores.
Conclusion
The growing importance of ESG to both businesses and consumers means assessing ESG risk is becoming ever more important to UK industries. Rising regulations relating to reporting standards and climate change, as well as an increasing consumer focus on ESG issues, mean that companies must ensure their operations meet ESG expectations in order to avoid legislative issues and maintain demand.
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