Deep Dive into ESG Metrics
Businesses are increasingly incentivised to maximise their sustainability to boost their attractivity to socially conscious investors, customers and employees, many of whom are now deeply concerned with the impact that their practices have on the natural environment and human societies. In this context, Environmental, Social and Governance (ESG) metrics have become crucial for companies to demonstrate their commitment on these fronts.
Although the weight of these indices in sustainable finance has only grown in recent years, there remain a lot of questions so to remove any ongoing confusion. What are ESG metrics and what do they measure? What are the main frameworks that companies can follow to report their ESG performances? In what ways do these metrics challenge businesses? This article aims to answer those questions and provide a basic understanding of ESG metrics as well as the debates surrounding them.
Businesses exhaustively use metrics to assess their progress and performance in key areas that influence their success and viability, which include among others their revenue, productivity and employees. Accordingly, ESG metrics are simply indicators that measure a company’s performance on ESG issues. These performance measures can be either quantitative or qualitative, and are generally set by frameworks or regulations that demand very specific information on a well-defined topic.
There is a plethora of such ESG frameworks to guide companies’ reporting practices. For instance, the Global Reporting Initiative (GRI), which is an independent international organisation founded in 1997, has published sustainability reporting standards called the “GRI standards” since 2010. They are allegedly the most widely used ESG standards in the world. In this framework, ESG metrics are divided in three categories: universal standards, sector standards and topic standards, the latter applying to companies depending on their material impacts.
Another popular framework is published by the Sustainability and Accounting Standard Board (SASB), an independent not-for-profit organisation founded in 2011 that is now part of the International Financial Reporting Standards (IFRS) Foundation. Its purpose is to “guide the disclosure of financially material sustainability information by companies to their investors”. SASB Standards identify the ESG issues “most relevant to financial performance” in 77 industries. The International Sustainability Standards Board (ISSB) is currently leveraging the SASB’s methodology and industry-specific standards to establish a new universal set of baseline corporate sustainability standards.
In the same spirit, the World Economic Forum (WEF) identified a new set of global ESG performance metrics, called the Stakeholder Capitalism Metrics, which aim to promote alignment among ESG frameworks. Created in collaboration with the Big Four consulting firms – i.e., Deloitte, EY, KPMG and PwC – the Stakeholders Capitalism Metrics are based on existing standards and set metrics that can be used to compare companies regardless of their industry or region. The metrics are divided into four pillars: Principles of Governance (assesses the company’s purpose, strategy and accountability), Planet (concerns the company’s impact on the natural environment), People (evaluates the company’s treatment of its employees) and Prosperity (reflects how the company influence the financial well-being of its community).
As one can begin to observe with these examples, the numerous ESG frameworks differ in their taxonomy of topics and standards. This plethora of rating bodies and frameworks with different acronyms and measurement methodologies is known as ESG’s “alphabet soup”. This oversupply of tools and frameworks generates a lot of confusion and substantially complicates the task of companies willing to report their sustainability performance. It is also one of the main problems facing ESG investors. Drown in the ESG alphabet soup, they often struggle to determine which ESG metrics should bear more weight in their cost-benefit analyses. Although the trend is now toward convergence of ESG metrics, a lot of efforts are still to be made to increase the coherence and comprehensibility of the ESG space.
Another issue with ESG metrics is simply that their usefulness is limited for impact-focused investors wishing to compare distinct social impact projects. The complexity of the socio-economic issues at stake and the sheer variability of local market conditions between different projects means that it can be challenging to compare them using the same metrics. Not to mention that it is sometimes impossible to use the same measurement methodology for all proposed projects.
It therefore seems that although the development and use of ESG metrics have spiked as a result of regulation and private actors’ self-consciousness, more work needs to be done to facilitate their use and determine the weight they should be given in investment decisions.