What is ESG in Financial Reporting, and What Are the Requirements?

More and more often, investors want their investments to be sustainable and socially responsible. As a result, many investment managers are incorporating ESG criteria into investment decisions.

ESG factors help these investors determine the potential social and environmental impacts on their investments. Using these factors can help individuals determine how ethical or sustainable an organization, loan or investment portfolio is.

What Is ESG?

Environmental, social and governance (or, ESG) factors are non-financial factors that impact a business’s overall ethical and environmental impact. ESG reporting typically refers to the disclosure of data related to ESG — like a business’s carbon emissions or investments in human capital development.

For investors, ESG provides a snapshot of a business’s environmental and social commitments, providing additional information on the non-financial impacts that their investment may have.

ESG Reporting Regulations and Requirements

ESG is more of a movement or investment philosophy than a formal set of standards — though a growing number of businesses are developing standards and tools for measuring business ESG.

There is no certifying organization that determines which factors count as ESG factors or publishes a calculator that determines an ESG score. However, there are ESG agencies that perform their own analysis and measurement of business ESG performance.

These agencies use a combination of qualitative and quantitative measures — sometimes in combination with technology like AI — to calculate ESG ratings for businesses. These measures may include metrics like a business’s carbon footprint, its water usage, its cybersecurity practices and board diversity statistics.

These agencies provide the closest thing to an “official” ESG score that exists. Many asset managers and financial institutions that want to use ESG in asset management or investment strategizing will work with these agencies to determine the likely environmental or social impact of an investment.

While ESG reporting is mostly an informal process, it will soon become more heavily regulated. Beginning in 2023 in the EU, for example, the SFDR will require asset managers, pension funds and insurers to disclose how they consider ESG in investment decisions.

These businesses will also be required to include information on their websites and in their fund documentation about ESG risks in their investment portfolios.

In the U.S., no similar regulation is in place or on the horizon — but SEC reporting guidelines require public companies to disclose all information that may be material to investors, which could include ESG assessments.

An investment advisor who holds back pertinent information from clients, like ESG reporting, could also be at risk of breaching their fiduciary obligations, which could have serious consequences depending on the financial advisors and their client relationship.

How Can Businesses Use ESG?

Investors can use information and ratings from ESG rating agencies to more effectively understand the non-financial impacts and risks associated with investments or portfolios.

For investment firms and asset managers, providing ESG agency data directly to clients may be an additional way to provide some extra value and better data on investments or portfolios.

For businesses that want to improve their ESG scores or adopt more environmentally and socially responsible policies, working with these agencies may also help.

A partnership with an ESG agency or similar organization can help the business to develop ESG reporting practices and internal processes that will improve the business’s ESG score.

Transparency in ESG reporting can also help a business seem like a better investment. Research from major analysts like McKinsey has suggested that there may be serious financial benefits for businesses that track and report. ESG information.

Investors are increasingly looking for businesses that make strong environmental and social commitments. ESG reporting could help tip the scale in a business’s favor.

The Importance of ESG Reporting for Businesses and Investors

Environmental, social and governance factors can provide investors with information that other financial metrics may not communicate. These ESG factors are becoming important as more investors prioritize non-financial measures of business practices and as government regulations make ESG reporting necessary.

Add Comment