The Real Economy, Canada

How companies can put ESG goals into practice

Plus a Q and A: Improving ESG reporting standards

May 17, 2022
Economics ESG The Real Economy

Environmental, social and governance practices, or ESG, have taken centre stage among middle market businesses as firm managers increasingly must demonstrate to investors, employees and other stakeholders that they are committed to the practices.

Over the past number of years, organizations like the Sustainable Accounting Standards Board, the International Sustainability Standards Board and other similar organizations have made significant progress toward developing a common reporting framework.

Yet the practice of how firms integrate ESG at an operational level, including into the investment decision-making process, is still in its infancy. So how can companies implement ESG guidelines into their operations? Here are three examples:

Shadow pricing: This is a technique used to more directly account for externalities that a company generates as a result of the products and services it sells. Recognizing that carbon taxes will increase dramatically over the next several years around the world, companies in carbon-intensive industries are increasingly using a pricing method known as shadow pricing to account for carbon in their investment models. Using a shadow price that reflects the social cost of an added ton of carbon dioxide, which can be several multiples higher than a carbon tax, would better align the company to society’s long-term objectives. It would also extend this practice to other socioeconomic and environmental impact categories including water usage, health and safety.

ESG due diligence: This is another sustainability integration technique that organizations can use in a merger and acquisition context. Due diligence, in combination with shadow pricing, can help assess the alignment of a company and its stakeholders. Many asset managers already account for some of these factors in their own due diligence, but that may not fully account for all stakeholder groups or all ESG-related risks. Organizations like the CFA Institute provide some examples detailing how a range of asset managers integrate ESG considerations into the investment decision-making process. As ESG proliferates, the art and science of ESG due diligence will need to develop and expand. But even now ESG due diligence can be quite powerful at helping organizations more fully integrate sustainability considerations into their strategies and operations.

Pricing in risk: Some industries are advanced at accounting for ESG-related risks. The insurance industry, and property and casualty insurers in particular, have developed sophisticated models to assess climate change risk. Charging higher premiums to insure properties in areas more affected by climate change - think of vacation homes on coastlines - can lead to development funnelling away from those regions. Doing so could also lead to lower premiums across the board and benefit all consumers. Other industries can use these methodologies to more directly account for the impact of climate change on their business.

The takeaway

If the objective of corporate sustainability is to better align an organization's success with the long-term objectives of society, then companies need to understand at a quantitative level how they embed sustainability into their operations and how they have aligned their success to their stakeholders' success.

Q and A: Improving ESG reporting standards

Alex Kotsopoulos, a partner in RSM Canada’s environmental, social and governance advisory practice, discussed the importance of taking a structured approach to ESG reporting and integration. What follows is a conversation that has been edited for brevity and clarity.

Q: How has the conversation surrounding ESG changed recently?

A: Companies of all shapes and sizes have been thinking about sustainability for a long time now. It is not a new topic. Companies fundamentally understand that they need to think about their stakeholders and the communities where they operate. What’s changed are the expectations of these companies and that they are being held accountable. That’s where rigorous ESG reporting comes in. Stakeholders are demanding that companies report on these factors in a much more structured way and think about ESG at an operational level across the organization.

Q: How can a company improve its ESG reporting?

A: It’s important to take a structured approach. To begin with, companies have to be thoughtful about materiality, which is another way of saying how a company’s operations are affecting their community in a material way. It can vary widely from company to company and industry to industry. So figuring out what is material to a specific company and what comprises a risk is a substantial hurdle to clear. The good news is that organizations like the Sustainable Accounting Standards Board provide some guidance on what is relevant to companies within specific industries.

A lot of companies think they are starting from scratch when it comes to an ESG program. But often, they are not. They have been thinking about it already.
Alex Kotsopoulos, partner in RSM Canada's environment, social and governance advisory practice

Q: So that’s a start. Where do companies go from there?

A: First, companies need to build on top of what they are already doing. A lot of companies think they are starting from scratch when it comes to an ESG program. But often, they are not. They have been thinking about it already. A mining company, for example, already tracks the health and safety of its workers. So they can build on that and expand the scope of how they are reporting on other ways they are having an impact on their workers and communities.

The second piece lies in technology. Companies need to start thinking about this early in the process. Capturing ESG data doesn’t have to be a significant burden—if the right technology is in place. The right systems can collect lots of data from various sources, all of which can be automated. While putting these systems in place takes resources and effort, it’s important not to lose sight of the goal: to collect data that helps a company make better decisions.

Q: What do you say to a smaller firm that says it will cost too much?

A: ESG is a marathon, not a sprint. People realize this will take time. The expectations of smaller companies in terms of disclosure are a lot lower than they would be for a larger company. But it’s important to start somewhere. There are ways to design a program that fits the goals of companies of any size. It is all very possible.

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