ESG faces a make-or-break moment as the industry comes of age

Environmental, social, and governance (ESG) investing and reporting is facing existential questions associated with a lack of standardization, regulation, and common purpose, according to The emerging sustainability information ecosystem, a new report published today by the EY organization and Oxford Analytica. Rising inflation and the war in Ukraine are compounding these challenges.

According to the report, growing allegations of greenwashing have become one of the major challenges to ESG’s credibility and success. Addressing these challenges and building trust in the system is the responsibility of the many players who shape the sustainability ecosystem if ESG is to be seen by stakeholders as on a par with the more established ecosystem of financial reporting.

The report argues that there has been a lack of agreement on what ESG should include, how to apply agreed metrics and how best to use available data. To build greater trust in ESG, The emerging sustainability information ecosystem outlines five core areas that must be addressed:

1. Increased transparency over ESG ratings.
2. Increased understanding of the varying uses of sustainability information
3. Independent assurance alongside enhanced reporting standards and rigor, similar to financial reporting.
4. The development of agreed sustainable finance taxonomies to help eliminate confusion on what is considered sustainable and what is not.

5. Lower barriers to entry for those from emerging econ

Massimo Bettanin, Partner Climate Change and Sustainability, EY România: “The report provides a few useful recommendations addressing issues such as materiality, transparency, rating methodology, data reliability, etc. which may undermine the credibility of the sustainability information system. Interestingly, it also highlights the need for broadening the scope of non-financial reporting in order to provide relevant information about the sustainability-related impacts which the organization’s activities, services, and products have, or can have, on the environment and the society at large, in addition to the more consolidated ESG-related risks affecting the business.”

As mentioned in the report, these two primary uses of sustainability-related information ‘are not mutually exclusive but are often confused, with the latter primarily intended to support the financial stakeholders in taking ‘informed’ investment decisions, while the former is more important for a wider range of stakeholders such as the local communities, customers, employees, regulators, etc.

Massimo Bettanin added: „However, a growing body of evidence indicates that significant negative or positive impacts on the environment and society often affect, negatively or positively respectively, the financial performance of an organization in terms of costs (e.g. increased costs due to clean-up expenses, fines, compensations, permitting delays vs reduced costs resulting from energy and resource efficiency programs, waste avoidance and minimization processes, etc.), revenues (e.g. fewer revenues due to operation shut-down, loss of license to operate, customers boycotting products, vs increased revenues resulting from taping new markets and/or expanding existing ones or driving consumer preferences, etc.) and capital allocation (e.g. risk of stranded assets that may not generate long term returns due to medium-long term environmental or social issues) confirming the link between these two, apparently different, perspectives.

This concept has been captured by both the 2021 GRI ‘Material Topic’ standard and the new EU Corporate Sustainability Reporting Directive (CSRD) through the ‘double materiality’ concept and I am confident that a more comprehensive and transparent disclosure of the organizations’ impacts, both positive and negative, will help to improve the credibility and trust in the non-financial reporting system by both financial and non-financial stakeholders.”

The report highlights the need for a greater understanding of ESG ratings, materiality – including the varying uses of sustainability information, and the conditions needed to enable assurance. While there are increasing connections between ESG and financial reporting, the report
identifies the additional voices and perspectives that shape the ESG ecosystem, including civil society and people in employment. It calls for greater engagement among these groups to
develop reporting and disclosure standards, sustainable finance taxonomies, and ESG ratings that serve investors including those focused on financial risk and social impact.