What is ESG Compliance?

What Is ESG Compliance?

ESG compliance is a company's commitment to environmental, social, and governance standards and best practices–in other words, the environment, the way they treat people, and how the company is managed. It’s essentially asking yourself the question “Is this company doing the right thing?” across three different categories. ESG compliance has become quite the corporate buzzword in recent years and has even sparked controversy in Congress. However, regardless of personal opinions, ESG compliance is bound to affect your business either way–so you might as well brush up on your knowledge of the topic.

Environmental Compliance

The "E" in ESG stands for "Environmental" compliance, which looks at a company's sustainability standards and practices. This includes a company’s efforts to reduce carbon emissions, conserve energy and water, manage waste responsibly, and protect ecosystems, just to name a few. While some of these practices are optional, there are environmental regulations that companies must comply with, regardless of their personal preference–but we’ll get into that later.

Overall, environmental compliance has several benefits to your company’s bottom line, such as reducing operational costs and attracting eco-friendly consumers. A 2021 survey found that two-thirds of Americans are willing to pay more if it means purchasing a sustainable product, and 78% are more likely to buy a product labeled as environmentally friendly. (Equally telling, perhaps, is that over three-quarters of consumers said they would discontinue their relationship with a business that neglected ESG principles.)

Additionally, investors pay close attention to a company's environmental compliance because it directly impacts its long-term viability and reputation, as well as the global economy. Recent studies show that rising temperatures could decrease global GDP by as much as 25%, posing a direct threat to the economy. Investors realize that environmentally compliant companies are not only better positioned to navigate the challenges posed by climate change but also contribute to a healthy, growing economy.

Social Compliance

The "S" in ESG stands for "Social" compliance, which is a company's commitment to the ethical treatment of their employees, customers, suppliers, and communities–or really any person that touches their business. This includes following regulations and principles in relation to fair labor practices and human rights, along with diversity, equity, and inclusion (DEI) practices. 

Social compliance is more important than ever in 2023, with both consumers and employees prioritizing a company’s corporate social responsibility (CSR) efforts. According to recent surveys, 83% of employees would consider leaving their job if the company displayed irresponsible CSR practices, with 54% of global consumers considering a company’s CSR practices when making purchasing decisions. Additionally, social non-compliance can lead to boycotts, legal troubles, and a diminished brand reputation.

On the investor end of things, social compliance also impacts a company's long-term success and viability, with 78% of investors ranking CSR reports as “important” when evaluating a company. By doing the right thing by your communities, customers, and employees, companies can secure stronger stakeholder support, ensure profitability, and see sustainable growth.

Corporate Governance

The "G" in ESG stands for "Governance," referring to a company's structure for ensuring that all decisions are made ethically, and are in the best interest of the business. This includes elements of a company like executive leadership and compensation, board composition, shareholder rights, anti-corruption measures, and more. 

Strong governance is essential to a company’s reputation and shareholder value in a few ways. First, it aligns the interests of employees, executives, board members and shareholders so the company can make better business decisions that benefit everyone. Second, it ensures the company has sound strategy, direction, and goals that it can easily communicate, increasing investor and stakeholder confidence. Third, it shows investors that a company has the structure to remain resilient in the face of challenges. And lastly, it establishes transparency with both business stakeholders and the public, a trait that 60% of consumers believe is most important when looking at brands. 

ESG Reporting, Scoring, Frameworks, & Regulations

What Is ESG Reporting?

Remember when you used to get report cards back in elementary school? ESG reporting is like the corporate version of that, sharing how well companies are doing with their commitments to the environment, their people, and their leadership structure. 

Companies gather data on their actions in each of the three areas we mentioned earlier, allowing them to tangibly track progress to share with investors, customers, and the general public. ESG reporting is just as important as the action of compliance itself, as it holds companies accountable, promotes transparency, and encourages them to improve operations. It also aids investors in making informed decisions about where to invest their money, which in turn helps companies raise more funds. 

What Is ESG Scoring?

ESG scoring is how companies communicate their efforts towards ESG compliance. While it can be easy for a company to look ESG compliant with bold press releases, strongly-worded marketing campaigns, and other surface-level efforts, these actions don’t always translate to real change. ESG scoring works to address that by only rewarding companies for real actions taken. 

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While there is no one official body that determines ESG scores, scores are typically provided by investment firms, consulting firms, NGOs, or other agencies after a thorough review of information publicly available about ESG compliance efforts.

It is becoming more commonplace for companies to provide an ESG disclosure alongside their quarterly or annual reporting to showcase their commitment to ESG compliance objectives. 

What Is an ESG Framework?

ESG frameworks are voluntary guidelines created by various organizations that help businesses plan out their ESG compliance efforts. Additionally, they provide guidance on ESG opportunities, risks, and the manner in which businesses should be reporting their ESG efforts. In simple terms, if an ESG report is a report card, then an ESG framework is a roadmap telling them how to achieve those results. While a wide range of ESG reporting frameworks have been created for companies to follow, there are a few key ones you need to know about.

Major ESG Frameworks

Global Reporting Initiative (GRI)

The Global Reporting Initiative (GRI) is the independent, international organization that helps businesses and other organizations take responsibility for their ESG impacts, by providing them with global guidelines to communicate those impacts. They are a widely known and used set of guidelines that were originally established in 1997, shortly after the Exxon Valdez oil spill. While originally aiming to hold companies accountable for their sustainability efforts, the guidelines have evolved to measure social and governance topics as well. 

GRI standards are divided into three different sections: Universal Standards, Sector Standards, and Topic Standards. The Universal Standards are reporting guidelines that should be followed by all companies, while Sector and Topic Standards should be applied to reporting for specific sectors and industries, such as oil, agriculture, textiles and more. In total, GRI plans to develop sector guidelines for 40 different sectors, allowing a wide range of companies to participate in more detailed ESG reporting.

Sustainability Accounting Standards Board (SASB)

The Sustainability Accounting Standards Board (SASB) is a nonprofit organization helping companies across 77 different industries disclose relevant ESG information to their investors. The organization was founded in 2011 to help businesses and investors develop a common language about the financial impacts of business sustainability, and is split into five different dimensions today: The environment, human capital, social capital, business model and innovation, and leadership and governance. 

Additionally, as of 2022, SASB was consolidated into the International Sustainability Standards Board (ISSB–yes, another acronym), to build upon and combine the work of various global reporting initiatives, including the Task Force for Climate-related Financial Disclosures (TCFD).

Task Force for Climate-related Financial Disclosures (TCFD)

The Task Force for Climate-related Financial Disclosures (TCFD) was created in 2015 to develop recommendations on the types of ESG information that companies should disclose to support investors, lenders, and insurance underwriters in appropriately assessing and pricing risks related to climate change. In 2017, the task force released their set of recommendations to help companies make more informed decisions when it comes to capital allocation. These recommendations are structured into four pillars –governance, strategy, risk management, and metrics and targets–with a goal of giving companies and investors a deeper understanding of climate-related business risks. 

What Is an ESG Regulation?

Now that you have a sense for ESG reporting and frameworks, one of the last components to learn about ESG regulations. This refers to government rules that require companies to disclose their environmental, social, and governance practices. So what exactly does this mean?

Well, unlike ESG frameworks, which are voluntary, ESG regulations are mandatory. While frameworks provide a flexible structure for reporting and improving ESG efforts, regulations carry legal implications, forcing companies to meet specific rules and criteria. Failure to comply with these regulations can lead to significant consequences, including fines, legal action, or damage to your brand reputation. We can learn from banking giant Wells Fargo, for example, which is set to pay an estimated $97.8 million in fines for inadequate oversight of its compliance risks. This level of non-compliance can alienate investors, hinder access to capital, and lead to customer backlash, which is why strictly adhering to ESG regulations is essential to any business. 

ESG Regulations You Need to Know

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Proposed SEC Climate-Related Disclosure Rules

In early 2022, the U.S. Securities and Exchange Commission (SEC) proposed rule changes that would require businesses to include certain climate-related disclosures in their registration statements and ESG reports. This would include information about climate-related risks that are likely to impact their business, in addition to a disclosure of a company’s greenhouse gas emissions, which have become a commonly used metric to assess the potential impact of these risks. 

The SEC’s climate-related disclosure rules were officially adopted in March 2024, and were set to take effect two months later, at the end of May. But after a raft of lawsuits were filed, including by environmental NGOs like the Sierra Club arguing that the law did not impose sufficient accountability on corporations, the SEC put a pause on the disclosure requirements. The federal agency plans to fight the lawsuits and defend its proposed ESG regulation in court before taking any further steps toward implementation. 

Corporate Sustainability Reporting Directive

Starting in January 2024, nearly 50,000 companies became responsible for carrying out mandatory ESG reporting–including non-EU companies which have subsidiaries operating within the EU or are listed on EU regulated markets–due to the European Union’s Corporate Sustainability Reporting Directive (CSRD). According to KPMG, the CSRD is much more rigorous in scope and depth than its predecessor, the Non-Financial Reporting Directive (NFRD), with affected companies needing to disclose hundreds of metrics and targets. Reporting for the tens of thousands of in-scope companies will be due in 2025. 

Corporate Sustainability Due Diligence Directive (CSDDD)

Another landmark ESG regulation introduced by the EU, the Corporate Sustainability Due Diligence Directive wound its way through a tumultuous approval process before finally being passed by European Parliament in April 2024. The CSDDD requires in-scope businesses—including both EU firms and non-EU businesses operating in the economic bloc—to carry out a number of mitigation measures to combat and rectify adverse human rights and environmental impacts along their supply chains. 

The directive utilizes a number of due diligence steps published in the Organisation for Economic Co-operation and Development’s (OECD) Due Diligence Guidance for Responsible Business Conduct. These include, among other measures, Identifying and assessing adverse impacts both within an organization’s own operations and across its sourcing partners; implementing targeted mitigation measures; and continuously monitoring these measures and tracking their effectiveness over time. Businesses likely won’t have to start adhering to the CSDDD’s requirements for a few years, though: EU member states have two years from when the law entered into force, in May 2024, to codify the directive into national law. 

The Sustainable Finance Disclosure Regulation (SFDR)

The Sustainable Finance Disclosure Regulation (SFDR) is a European Union regulation aimed at promoting transparency and sustainability in the financial industry. Introduced in March 2021 and adopted in February 2023, SFDR mandates financial market participants to provide clear and standardized ESG information, with a goal of reducing greenwashing and increasing investment in environmentally sustainable actions. 

The Benefits of ESG Compliance

While gathering and sharing compliance data can feel like a tedious and daunting task, it’s well worth it in the long run for your business. Beyond being mandatory and the morally right thing to do, ESG compliance comes with a number of bottom-line benefits, including:

Customer & Employee Loyalty 

Committing to responsible and ethical business practices can elevate your company's reputation and brand, leading to increased loyalty for both customers and employees. Surveys show that 77% of consumers are motivated to purchase from companies committed to making the world better. Additionally, looking at talent attraction, 83% of employees would be more loyal to a company that enables them to contribute to solving social and environmental problems.

Improved Financial Performance 

Over time, businesses typically see a slew of cost savings from their ESG efforts. From streamline processes to reducing resource consumption and costs, to identifying ESG-related risks to mitigate potential financial shocks, there are a number of ways that ESG compliant companies achieve improved financial performance. 

Attracting Investors 

In addition to improved financial performance, ESG compliance attracts socially responsible investors, leading to increased funding and better access to capital. Additionally, even if the investor doesn’t consider themselves “socially responsible”, most investors are impressed by the long-term effects ESG compliance has on a company, making it more viable.

Risk Management

Through ESG reporting, companies stay up to date on any ESG vulnerabilities or risks. In turn, this reduces their odds of encountering regulatory fines or legal liabilities. Additionally, ESG compliance allows businesses to be proactive, establishing a readiness to handle supply chain disruptions, workforce issues, shifts in consumer preferences, or anything else unexpected. 

Innovation

ESG compliance ultimately encourages the development of sustainable products, technologies, and operational practices. As a result, companies can explore new markets, differentiate themselves from the competition, and enhance their long-term viability.

Simple Steps to Create Your Own ESG Strategy

Ready to embark on your own ESG journey? Here are a few simple steps and guidelines to get you started – our very own framework, if you will. 

1. ESG Analysis

Identify ESG opportunities and risks relevant to your industry, then prioritize these factors based on their potential impact on your business and society.

2. Stakeholder Communication & Commitment

Gather opinions and support from leadership and your board to ensure everyone is in alignment on the most critical ESG issues before proceeding on your path forward.

3. Define ESG Goals & Objectives

Define specific, measurable ESG goals aligned with your business values and aspirations. You can break these down into time-based milestones to make your goals more digestible.

4. Choose Your Reporting Framework

As mentioned, your reporting framework will be essential to your ESG strategy, serving as your roadmap. Further explore one of the widely used frameworks mentioned earlier in this article to see which reporting structure is best for your business. 

5. Implementing Your Framework

Allocate human and financial resources to implement your ESG initiatives effectively. You’ll also need to inform employees, suppliers, and stakeholders about ESG principles and their role in achieving company objectives.

6. Collect Metrics & Data

Once you establish your framework, you’ll need to develop a system to track your progress, collecting and analyzing your ESG data to report on. 

7. Review & Improve 

Regularly review and assess your ESG strategy, refining your process and goals based on lessons learned, along with new regulations and trends. This is also your chance to invest in research and innovation to identify new opportunities aligned with your ESG goals.