ESG and Compliance – Monitoring

Thomas Fox - Compliance Evangelist

Compliance Evangelist

We next consider monitoring. You would not be wrong to begin with the adage: “You can’t manage what you don’t measure.” Its central tenet should be a key part of your ESG management and reporting. ESG stakeholders, from investors to employees to the regulators to the general public, are all looking to confirm that appropriate ESG data management plans have been put in place, built around key performance indicators (KPIs) and related targets. To monitor the achievement of ESG objectives, companies usually define uniform KPIs. These KPIs are consolidated regularly throughout the company and should be reported, at least on an annual basis, to the central ESG management committee.Monitoring the ESG performance is critical for an organization with a serious commitment to ESG. But it can be much more difficult than monitoring financial performance. The key is a standardized approach to ESG data collection and monitoring. This is because without such standardization, leading to consistent reporting practices across an organization, it can be challenging to understand and compare performance and progress toward targets. However, even with an outstanding ESG framework, you can only go so far as you must track qualitative and quantitative ESG metrics across a portfolio.

Obviously ESG is much broader than third parties but that is but one example every compliance professional will understand. Helee Lev, writing in a Goby blog entitled Identifying ESG Metrics That Matter, noted that as you begin to define the metrics you will use for ongoing monitoring, it is incumbent to focus on the three main categories of ESG. While disparate industries and companies will have different metrics that are material to their business, she believes that commonly metrics tracked include:

  • Environmental metrics including reductions in electricity usage, changes in fuel consumption for company vehicles, carbon emissions reductions, gallons of water saved, and increased waste diversion
  • Social metrics focused on employees and occupants, health & wellbeing, diversity & inclusion, and supply chain management
  • Governance metrics that are determined by the existence of policies on a wide range of issues such as company values and business resilience plans

Lev stated, “These metrics aid in predicting a company’s future financial performance and give corporations and asset managers a way to communicate with stakeholders, demonstrate commitment to fundamental principles, and assess environmental and ethical impact.”

The World Economic Forum has worked to develop a core set of common metrics and disclosures on non-financial factors for their investors and other stakeholders. The core and expanded set of “Stakeholder Capitalism Metrics” and disclosures can be used by companies to align their mainstream reporting on performance against ESG indicators and track their contributions on a consistent basis. The metrics are deliberately based on existing standards, with the near-term objectives of accelerating convergence among the leading private standard-setters and bringing greater comparability and consistency to the reporting of ESG disclosures.

The metrics are centered on four pillars:

  1. Principles of governance: This reflects a company’s purpose, strategy, and accountability and includes criteria that measure risk and ethical behavior.
  2. Planet: This reflects a company’s dependencies and impacts on the natural environment and includes metrics such as greenhouse gas emissions, land protection, and water use.
  3. People: This represents a company’s equity and its treatment of employees and includes metrics centered around diversity reporting, wage gaps, and health and safety.
  4. Prosperity: This represents how a company affects the financial wellbeing of its community and measures metrics such as employment and wealth generation, taxes paid, and research and development expenses.

If an organization has consistent reporting and monitoring across their portfolio, they can begin to explore key topics, like the relationship between financial and ESG performance. Some areas will be very familiar to the compliance professional. For instance, consider ongoing due diligence around third parties in a variety of areas. As every compliance professional knows, ongoing due diligence and continued assessment is not a one-time activity, but a continuous, ongoing process. This involves regular consistent third-party database checks as well as periodic assessments through questionnaires and inspections. Database checks of third parties against lists can be done on a daily continuous basis, while periodic assessments surveys are typically done on an annual basis. However, when key risk indicators are triggered, such as an issue found in one supplier, it may kick off an assessment outside the periodic assessments.

Another approach is to consider what investors are interested in as a base starting point for your creation of ESG metrics. Lev identified 10 common ESG standards and metrics that are considered by private equity investors during the due diligence and investment oversight processes, which could form the basis of your metrics. These included:

  • The distribution of responsibility related to ESG integration across the organization.
  • Environmental, social, and ethical regulatory investigations or litigation.
  • Diversity among employees, board members, and management.
  • The employee composition, including the ratios of part-time and contract workers.
  • A formal environmental policy.
  • Your company’s direct and indirect greenhouse gas emissions.
  • Data breaches and cybersecurity incidents.
  • Health and safety events.

The bottom line is that companies who better manage risk, produce value, and differentiate performance by collecting and tracking key metrics throughout their lifecycle are not only better run companies but they are more attractive to a wide variety of stakeholders interested in ESG. But the entire process comes back to having a defensible ESG monitoring system. Your organization needs to be able to provide a clear picture into ESG across their entire series of stakeholders and business relationships and have this role up into the broader organizational ESG reporting and disclosure processes.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Thomas Fox - Compliance Evangelist

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