CSR (corporate social responsibility) — a management strategy according to which enterprises voluntarily combine their operations with social interests, environmental aspects and relations with various groups of stakeholders, in particular with employees — could, hypothetically, have a child, it would certainly be ESG. CSR has been treated by many companies as a good marketing strategy to warm up the company’s image. Years later, it turned out to be of too little value, while ESG now plays an increasingly important role in making business decisions — investors and consumers often choose companies that meet their values.

The role of business in society has been discussed for over 50 years since Milton Friedman’s epochal essay, “The Social Responsibility Of Business Is to Increase Its Profits,” was published in 1970 in the New York Times Magazine. Since then, and picking up exponential speed in the last two years, there has been a shift towards a wider understanding of how corporate decisions affect all stakeholder groups and not just shareholders. There is even a now-widely discussed idea of conscious capitalism, that was coined by marketing professor Raj Sisodia.

EXPLAINING ESG

It is worth explaining what the three letters, the importance of which has grown in recent years, mean. ESG stands for challenges related to environmental, social and corporate governance issues. The growing demand for sustainable products and services is a response to the changing consumer behaviors. The increasing consumer interest in the issues of broadly understood environmental friendliness (e.g. choosing cosmetics containing natural ingredients, electric or hybrid cars, vegetarian or vegan food, energy-saving devices) may pose a risk to both sellers and buyers. You can clearly see the growing social awareness of non-financial aspects, which turns into a need for action and an overwhelming desire for knowledge. This is reflected in the plans of enterprises.

From 2024, all large companies and large capital groups as well as listed companies (employing over 250 people) will be subject to the obligation to report activities for sustainable development in the EU. SMEs will have three additional years to prepare because the obligation to report non-financial factors will apply to them from 2026. The work on EU legal edicts: firstly, regarding the disclosure of non-financial information (NFRD/CSRD), and secondly, the EU taxonomy, which will create a framework to facilitate sustainable investment is still ongoing, but the need for a shift to uniform European reporting standards in this regard is a pressing one. Among other things, the normalization of annual reports is ongoing as well. This could mean a revolution in terms of transparency.

EU TAXONOMY

The EU taxonomy requires large companies that are public interest entities, as defined in the NFRD, to disclose the percentage of turnover, investment (CAPEX) and expenditure (OPEX) in a given reporting year in relation to assets or processes contributing to the achievement of the objectives specified in the taxonomy. Businesses offering “green” or “sustainable” financial products and services within the EU will also need to disclose to what extent their activities contribute to the taxonomy objectives, similar to the percentage of investments (turnover, CAPEX and OPEX) that complies with its requirements.

Increasingly, key ESG issues are comprised in annual activity reports. ESG reporting requires choosing a reporting method. However, this type of information is usually limited to a few of the most important topics and indicators. Another frequently chosen method of reporting in companies around the world is a separate sustainability report. It enables gathering all information on environmental, social and corporate governance issues in one document. The choice of this reporting method gives companies greater freedom to present the undertaken ESG activities and their results in a way that best suits their needs. NFRD companies can publish a non-financial information report that covers only the topics required by the directive or a full-fledged sustainability report. It is good practice to include an explanatory table in the report, which would indicate where the information required by the directive has been given in the report so that users can find it quickly. According to the NFRD directive, companies have six months from the date of publication of annual reports to publish a sustainable development report. The integrated report comprises both the elements of the financial report and the sustainable development issues in one document. For this reason, this format is a preferred choice of more advanced companies with a well-developed approach to ESG. We can also compare reports from companies that disclose ESG information. It is possible when such reports are prepared in accordance with commonly accepted reporting standards and frameworks (GRI, IIRC, SASB).

A METHODICAL APPROACH

ESG reporting requires a methodical approach to the content of the report. After determining the purpose and recipients of the report, a materiality analysis should be conducted, which would indicate important areas for potential users of the report, including the company’s business model, ESG risks and opportunities arising from the business sector and stakeholder expectations management. The financial, environmental and social significance will work together. Then, it is necessary to assess how the organization’s activities are related to the minimum guarantees (e.g. UN, OECD guidelines) so that the economic activity is classified as sustainable. The report requires selecting appropriate indicators from several categories: environment, society, corporate governance (e.g. water consumption, diversity in supervisory bodies and the equal pay index, anti-corruption policy) and its preparation is based on the collected data, in accordance with the NFRD directive and the EU taxonomy. How does the implementation of ESG principles work in our favor? It allows companies to maintain constant and long-term cooperation with customers, showing respect for the adopted principles. It also responds to the expectations of employees and investors, as there is less and less interest in companies that do not take into account environmental issues. It increases the company’s value and prepares for future changes, including the announced European Green Deal. It facilitates access to capital — banks and financial institutions that make capital support dependent on the approach and activities of companies in the field of sustainable development. In the era of social media, which enables almost instant disclosure of various types of abuse and neglect, it will be easier for companies and governments of countries that care about ESG to manage a potential image crisis. It can be said that ESG protects against issues that are difficult to define and which can stand across the organization’s way. The new regulatory requirements are an opportunity to improve the quality of reported information and to better adapt it to investors’ expectations.

FIGHTING AGAINST GREENWASHING

It is also worth mentioning that ESG may contribute to the fight against greenwashing, which consists in making consumers think that a given product or the company producing it operates in accordance with the principles of sustainable development. If such information is in fact untrue or unverifiable, the consumer thus becomes a victim of unfair market practice, i.e. greenwashing. Environmental fiddle will become more difficult to hide, especially when irrespective of ESG standards, regulations on the production and certification of organic products come into force (in 2022) in Poland. Producers will have to reckon with penalties for the misuse of “bio” and “eco” labels, which can mislead consumers and falsely imply the organic origin of the products.

Ultimately, environmental protection is not costly and demanding but needs to be properly organized, in the form of well-thought-out incentives and not just various forms of coercion. After all, we would like to live in an ecological, nature-friendly environment. Creating a world where people are happy and wealthy, without a damaged natural environment is an important challenge for humanity.

Key Legal Documents

Directive 2014/95 / EU of the European Parliament and of the Council of October 22, 2014, on the NFRD (Non-Financial Reporting Directive).

Regulation 2019/2088 of November 27, 2019, on SFDR disclosure of information related to sustainable development in the financial services sector. SFDR Regulation is effective in Poland from March 10, 2021.

Regulation 2020/852 on the establishment of a framework to facilitate sustainable investment, amending Regulation 2019/2088, known as the EU Taxonomy, is a unified classification system for sustainable development activities intended to support investors in making investment decisions.

Regulation 2018/848, according to which, from January 1, 2022, the standards of ecological certification will be additionally tightened.

ESG Benefits

• ESG can help bolster the bottom line

• Running operations responsibly in the most carbon-efficient fashion

• Better positioning companies to proactively manage risks

• Building trust with stakeholders and shareholders, providing increased visibility into  planning, identification, and management of  operational risks

• Helping oil and gas companies make better informed business decisions

• Atracting talent

• Stimulating innovation

• Long-term value creation

• Mitigating risk of litigations

ESG Challenges

• Readiness of companies to integrate it into operations

• Identifying the right standards and metrics for consistent measurement

• Aligning ESG with other company priorities

• Cultrual business norms in host countries

• Upfront costs

• Resource cycles