This post is the last of three to be published in our attempt to summarize the impact of ESG regulations.
5. How will it affect corporates?
Eventually all companies will be required to report on adherence to ESG policies and to report on climate risk and environmental impact.
On the climate-risk reporting side, its impact will create a set of new business risks to consider. Besides the most obvious physical risks (e.g., the supply shortages caused by water scarcity), companies are exposed to transition risks which arise from society’s response to climate change, such as changes in technologies, markets and regulation that can increase business costs, undermine the viability of existing products or services, or affect asset values. Another climate-related risk for companies is the potential liability for emitting greenhouse gases (GHG), which we discuss further below.
On the environmental performance side, the inclusion of ESG criteria will soon require companies to invest in infrastructure to oversee this reporting. Banks are preparing questionnaires to understand the maturity level of their clients in meeting ESG requirements. For companies this will involve additional training or the appointment of an in-house ESG officer, or alternatively, the hiring of third-party appraisers to report and audit ESG compliance at least on an annual basis. At the top 30 global asset managers, ESG teams have grown on average by close to 230% between 2017 and 2020. As we have observed in the setting of ESG KPIs (cf. Our second post), industry practice on reporting is also variable and best practices are still developing. But the more advanced your ESG guidelines and practices are, the better qualitative criteria (policies, management, …) you will have and the better your ESG rating will be when it becomes a compulsory variable.
Nevertheless, it is advisable to start working on improving its ESG rating already today, by working on environmental or social parameters alike. Companies establishing ESG objectives must also follow a long-term approach, considering that short-term objectives drive towards a short-term thinking process which prevents growth and real change. Long-term objectives also promote innovation within companies. By originally incorporating responsible business practices, which respond to environmental, social and economic concerns, the future cost of implementing the measures required to achieve these objectives can be reduced.
Companies and stakeholders should consider assessing their decarbonization potential and opportunities. Companies can for example start screening their activities’ impact on their environmental footprint, in all three scope categories of the Greenhouse Gas Protocol, and ideally start developing strategies to significantly reduce them.
- Scope 1: All Direct Emissions from the activities of an organisation or under their control.
- Scope 2: Indirect Emissions from electricity purchased and used by the organisation.
- Scope 3: All Other Indirect Emissions from activities of the organisation, originating from sources that they do not own or control
Source: GHG Protocol
A major problem for corporates is the assessment of Scope 3 emissions – those that originate beyond corporate boundaries in their respective value chains. Yet, Scope 3 accounts for the vast majority of the emissions impact for European corporates as a whole. Moreover, an increasing number of FIs are taking action on their carbon footprint through the Global GHG Accounting and Reporting Standard (developed by PCAF), in which they assess their emissions on all three scopes. As the pressure and restrictions on FIs is growing, it will reverberate on companies which will be asked by their banks or other parties to report themselves on their emissions, hence the need to already prepare for it now.
ESG reporting might have been considered as a futuristic idea before the 2008 crisis. However, it now clearly is a central thematic every company must work on. While the whole ESG transitioning may be complex on many levels and the end view still be unclear, companies need to start working on it as soon as possible.
Only through a step-by-step process starting today will companies be better prepared for the challenges ahead. Preparational work on carbon emissions’ reporting should already be on most companies’ agenda, as it will soon enough become normative and mandatory to do so.
Delivering the change required is challenging in a large company – but failure brings risks. Green challengers are showing they can move fast and attract strong investor interest, incumbent companies will be challenged to show that they can keep up.