ESG – how can we measure how ‘good’ companies are?

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Robin Pomeroy, Podcast Editor, World Economic Forum

• ESG stands for ‘environmental, social and governance’ issues.
• Investors are increasingly putting money into companies that claim good ESG performance.
• But how do we measure that? An expert explains on this episode of the Radio Davos podcast.
• Subscribe to Radio Davos.

ESG is an acronym that’s on everyone’s lips in the business world. But just what do we mean by the ‘environmental, social and governance’ performance of a company, and how can we measure that in a meaningful way?

In this episode of Radio Davos, Nadja Picard, Global Reporting Leader, PwC, Germany, talks us through what ESG is and how close we are to having clear ways of measuring it around the world.

What is ESG?

Nadja Picard, Partner, Global Reporting Leader, PwC, Germany: ESG is a relatively new global term that focuses on environmental, social and governance matters, which do affect various stakeholders across society. But it’s also often distinguished from, and at the same time used as a synonym for, sustainability. So really, what we’re after here is sustainable outcomes of business behaviour, of societal behaviour, of what governments are tackling.

Robin Pomeroy: And the metrics then, is how we measure it. Because it’s all very well for a company to say on environment and social and governance issues, ‘We’re doing a great job,’ but we don’t believe it until we see it, do we? So can you tell us how you measure, or give us some history – where did it start and what’s happened so far?

Nadja Picard: I think, really, the pandemic has accelerated the focus on some of these issues for a number of reasons. We’ve seen that supply chains are vulnerable. We’ve seen that inclusion in our society is slowly falling apart. We are also seeing that economic growth and economic prosperity is not always enough for people and for our societies. So that really has helped focus in on sustainability matters and sustainability issues.

From that then the step into looking at companies, on how they are addressing these issues, is not very far. And climate change, as one of the issues, is also quite apparent these days. There is little scientific debate that remains on climate change being a fact of life and that society, governments, but also companies as a part of society, need to address these issues. So that is really why ESG or sustainability disclosures are on everybody’s mind.

And investors who are challenged with investing into companies sometimes for the long term are also challenged at making sure that the companies they invest in have a sustainable future, have a long future ahead of them. And they want to, on the one hand, make sure that the companies they invest in behave properly in terms of their environmental behaviour, in terms of how they look at their workforce, their employees and how they treat them, to make sure that their investment really holds up to scrutiny, but also is there for the long term and is not challenged by either physical risk or regulatory risk or other risks. So this is how it all really came about.

Users of information, of corporate reporting – whether investors, employees or governments – are realising that the whole environment needs to come together to settle on comparable, reliable, robust disclosures that are underpinned by standards that are easy to apply and really comparable across the globe.—Nadja Picard, Partner, Global Reporting Leader, PwC, Germany

All this somehow needs to be measured and where we were, maybe a year ago, we had a number of different standards and frameworks and protocols on how to measure this – because it is complex, right? Measuring climate change behaviour and impact is complex, measuring the value of diversity, equity and inclusion or what that even means, and measuring how companies behave to enhance the prosperity of the communities they live in – it’s all very complex issues. And that has led to a number of metrics, selective disclosures, selective metrics being used by companies, depending on what they’ve been asked to report on. People are realising, users of information, of corporate reporting – whether these are investors or these are employees that make a choice on where they want to be employed, whether these are governments – are now realising that the whole environment needs to come together to really settle on comparable, reliable, robust disclosures that are underpinned by standards that are easy to apply and comparable across the globe.

And I keep saying ‘disclosures’, which is more than ‘metrics’, because we think that a strong focus is on companies explaining not only where they are in terms of measuring metrics in the here and now or for the past period, but also on where they would like to go, what they would like to achieve, and how they would like to get there. So what are the strategies, what are the targets and what are the milestones and actions to really get to these targets?

Will there ever be global ESG standards?

Robin Pomeroy: Will there ever be a case where you can compare a company of one corner of the world to a company from the other corner of the world? They make a similar product or service, and you could say this one is 50% better when it comes to ESG. Is that ever going to be possible? Or is it just that there’s different jurisdictions and different requirements on companies as to what they report and make public?

Nadja Picard: What we are seeing happening right now is that comparable globally aligned standards are emerging. We have the ISSB, the International Sustainability Standards Board that has been announced at the climate conference in Glasgow, COP26. It is a standard setting board, much like financial reporting, that is driving towards global adoption, and is really setting out to provide globally aligned, globally comparable standards on how to report on, let’s say, climate, gender pay gap, diversity, equity inclusion metrics.

And we really need that to happen, as our global chairman says, at an ‘Apollo pace’, because societies really want that.

[Even] if the rules on what is ‘good’ are different, you would still have very comparable factual reporting that could lead to comparisons between, let’s say, a German company and an Argentinian company.—Nadja Picard, Partner, Global Reporting Leader, PwC, Germany

On the other hand, can we really determine which company is better than the other company? Now those rules on what a desirable behaviour is, is in the hand, on the one hand, of investors, because they will form a judgement on company performance over and above financial performance. But this is also in the hand of governments who will then determine what is acceptable behaviour and what is not acceptable behaviour, and that might very well differ in various corners of the world, very much also driven by the various different societies in the various corners of this world, the various cultural backgrounds and the differing needs of these economies and societies. But again, if the rules on what is ‘good’ are different, you would still have very comparable factual reporting that could then also lead to comparisons between, let’s say, a German company and an Argentinian company.

Robin Pomeroy: How are companies reacting to this? Are they are they embracing this in general? Are they resistant to it?

Nadja Picard: It really depends on where you sit in the world. Europe has been on the quest of demanding sustainability disclosures from its companies for a while. The discussions around tightening those rules have been very transparent over the last years, culminating in the Corporate Sustainability Reporting Directive being issued last year in April. And now we see reporting standards requirements being issued under this reporting directive, so you could argue that in Europe, companies really have seen it coming and have started to prepare probably a lot earlier than in other corners of this world.

Will ESG disclosures be mandatory?

Robin Pomeroy: When you say they’ve seen it coming, they’ve seen mandatory requirements to report on some of these metrics.

Companies really should make sure that the quality of this reporting is equal to the quality and robustness and tightness [as] for financial reporting, because it does have equal importance.—Nadja Picard, Partner, Global Reporting Leader, PwC, Germany

Nadja Picard: That’s right. So it will be mandatorily required to report under this directive. There’s a little bit of debate on when that will be. The first draft said that this reporting should be already implemented in 2023. There are signs that that might be delayed by a year to give companies a bit more time to prepare for these disclosure requirements because it is quite complex to gather the data in a very robust manner, in a very controlled manner. And companies really should make sure that the quality of this reporting is equal to the quality and robustness and tightness in governance around it like it is for financial reporting because it does have equal importance.

Robin Pomeroy: So is the rest of the world following suit?

It’s not only regulators who are demanding these disclosures, it’s very clearly investors who are very interested in this … More than 70% of investors want globally aligned robust standards that underpin global reporting on ESG matters.—Nadja Picard, Partner, Global Reporting Leader, PwC, Germany

Nadja Picard: If you look at the U.S., for example, the U.S. has a strong focus on diversity, equity and inclusion data, with the SEC having also already mandated human capital disclosures. The U.S. is currently considering – the Securities Exchange Commission, the SEC – is currently considering mandating climate disclosures.

We are already working with a lot of companies that are acting on a global scale and helping them prepare for these disclosure requirements. But really it you take a step back again, it’s not only regulators who are demanding these disclosures, it’s very clearly investors who are very interested in this. We’ve recently conducted a survey of 325 investors, around 43 territories, backed up by over 40 interviews in another 11 territories, to understand what investors really want in terms of sustainability disclosures. There are some regional differences. In Europe, investors really are focussing on climate related disclosures. In the US, workers’ health and safety disclosures and diversity, equity and inclusion disclosures are much higher ranked in terms of the importance of disclosures that investors want. Overall, it’s very clear. More than 70% of investors want globally aligned robust standards that underpin global reporting on ESG matters.

ESG: why do investors care?

Robin Pomeroy: Why do you think that is, why do investors care about this? If you’re investing money, you’re a pension fund or a hedge fund, you’ve got billions of dollars to invest, surely all you care about is the percentage return on your investment every year. Why would anyone be interested in this?

Nadja Picard: There is a strong interconnectivity between sustainability matters and financial performance of companies. On the one hand, obviously, climate change presents a risk to companies. There’s physical risks – risk of flooding, risks of severe weather conditions – that put companies at risk. But there’s also risk of regulatory action, carbon pricing that investors would like to factor into their decision making.

Pension funds are looking after the money of workers of a particular industry, and those people are also interested in a sustainable future. —Nadja Picard, Partner, Global Reporting Leader, PwC, Germany

And frankly, investors are typically administering or investing money that is given to them by society, by people. Pension funds are looking after the money of workers of a particular industry, and those people are also interested in a sustainable future. So investors are, in my mind, always a bit a mirror of society, and society is closing in on these issues. Frankly, some of them are still really looking at ensuring that their investment is not at risk, so it does come back to financial performance. But it really does go beyond only financial performance.

Robin Pomeroy: Now there are sceptics out there who will say companies are keen to shine-up their image, to greenwash, and perhaps this is part of that. They will say, you could put out a glossy brochure showing we’ve scored so well on environmental or social or governance issues, they’ve managed the figures to make themselves look better, but actually, if you look under the surface, maybe they won’t be doing anything. What would you say to a sceptic who would say that about this whole endeavour?

Nadja Picard: We all live in an environment where we see that trust is paramount for companies. Companies need to be trusted by their customers. Companies need to be trusted by their employees. And companies need to be trusted by their investors for various reasons. They want to hire the best talent. They want to sell their product, possibly in the value chain, and they want to attract the best investors to to help them with their growth ambitions and business performance. So companies really can’t afford cheating, They’re very well advised to take a very wholesome view at these sustainability issues, not cherry-picking, and really looking at what all these stakeholders are looking for in terms of issues that should be addressed by companies.

The World Economic Forum has put together a paper that identifies 21 metrics as a good start for companies to look at.—Nadja Picard, Partner, Global Reporting Leader, PwC, Germany

That is quite difficult because it’s not defined, and that puts a company really at risk of unintended omissions or unintended disclosures that might not be as robust as financial disclosures, which again, is why I think the whole ecosystem – investors, customers, employees, companies – while preparing the information, would really benefit from clear standards that tell them, give them a bit of a framework on how to think about materiality, the significant issues they should be tackling and how to think about it, but also on the definition of the metrics. Which metrics must be prepared? Which metrics can they choose to prepare depending on the significance of their particular industry or business model? And if that framework is available, just like it is available for financial reporting these days, that will help shape honest, fulsome disclosures around sustainability issues as well.

Robin Pomeroy: Where should people go if they want to learn more about ESG and ESG metrics? Will there be things coming up that will be milestones in this march towards ESG metrics and standardised global ways of measuring these things?

Nadja Picard: Let me start with the World Economic Forum.

Because it is such a complicated area with undefined standards as of now, the World Economic Forum has put together a paper that identifies 21 metrics as a good start for companies to look at. Those 21 metrics cover areas like governance, prosperity, people and environment, and are a very good start for a company to look into sustainability issues and start preparing for disclosures.

There are two major developments globally of those standards being prepared, and that is what companies really need to look out for. On the one hand, we have the European Union who is about to conclude on its Corporate Sustainability Reporting Directive and the underlying standards. The pre-drafts are already available on their websites so companies can take a look at the requirements that are out there. And these requirements also extend beyond the European Union. The way the legislation is drafted, they extend to businesses in Europe which may be held by corporations outside Europe, so they might be forced to look into these disclosures as well, even if they don’t sit in the European Union.

And then there is the International Sustainability Standards Board, which sits under the International Financial Reporting Standards Foundation, really setting out to prepare sustainability ESG reporting standards, with the hope that they are globally adopted by the stock exchanges, by those demanding corporate reporting. They start with climate as the first issue and a general disclosure standard, which are already available, again as working papers informing companies about the direction of travel on what these disclosures will be looking like. But we also are pushing this board, the International Sustainability Standards Board, to address issues beyond climate, other environmental issues and also social issues, diversity, equity and inclusion issues, at pace to really provide that basis for a full set of disclosure standards.