ESG reporting – why accuracy is everything

Environmental, Social and Corporate Governance (ESG) reporting has become more important over recent years. Profit is no longer the sole criteria for investors; they are increasingly considering the social and environmental impact of companies, as well as the integrity of their management structure.

What is ESG reporting?

Environmental, Social and Corporate Governance (ESG) reporting is essentially comprehensive information about how a company deals with a range of ethical and compliance issues, some of which we will consider below.

Environment
What is the environmental impact of a company’s products and services? For manufacturing companies this may encompass both the pollution and waste from making products, as well as how these any manufactured goods may impact the environment (eg for an automobile manufacturer, the amount of C02 emissions). A professional services company will obviously have a far lower carbon footprint, but it will also need to consider how it uses energy – such as the heat insulation in an office and whether it recycles paper etc.

Human rights
There are different laws and declarations relating to human rights, including:

Human Rights Act – the Human Rights Act 1998 is the primary piece of legislation that protects human rights in the UK. It incorporates into UK law the rights contained in the European Convention on Human Rights.
European Convention on Human Rights (ECHR) – the European Convention on Human Rights is an international convention which aims to protect human rights and political freedoms in Europe.
Universal Declaration of Human Rights (UDHR) – the Universal Declaration of Human Rights is an international document adopted by the United Nations General Assembly that enshrines the rights and freedoms of people across the world.

Ensuring that human rights are upheld can be particularly difficult for companies with extensive supply chains, such as clothing retailers. Some businesses carry out regular audits on all their suppliers but this can often miss problems further down the supply chain. Compounding problems in this regard is the fact that different countries have different levels of human rights, particularly when it comes to issues such as working hours or conditions.

Health and safety
In some ways this can be considered an extension of human rights legislation. Health and safety generally applies to the relationship between employers (ie the company) and employees. The Health and Safety at Work etc Act 1974 is the main piece of legislation covering occupational health and safety in the UK. Some of the responsibilities a company has towards its employees include:

making sure that the workplace is properly ventilated, with clean and fresh air at all times
keeping temperatures at a comfortable level, with a minimum of 13 degrees celsius where the work involves physical activity or 16 degrees celsius for ‘sedentary’ places of work such as offices
ensuring premises are property lighted so that employees can work and move about safely
making sure that the workplace and equipment are kept clean
ensuring that workrooms are large enough to allow easy movement (with at least 11 cubic metres per person)
providing workstations which suit the employees and the work being carried out
the workplace and equipment should be kept in good working order
floors, walkways, stairs, roadways etc should be safe to use
protections should be in place which prevent people falling from height or into dangerous substances
things should be stored so they are unlikely to fall and cause injuries
providing somewhere for employees to get changed and to store their own clothes (if necessary)
areas should be set aside for rest breaks and to eat meals, including suitable facilities for pregnant women and nursing mothers
employees should be allowed to take appropriate rest breaks and their correct holiday entitlement
ensuring that employees who work alone, or off-site, can do so safely

As with human rights legislation, it can be particularly difficult for companies with extensive supply chains to ensure that all workers involved with manufacturing goods are afforded the correct level of health and safety protections. Since health and safety laws can be substantially different depending on the relevant jurisdiction, international supply chains are the most tricky to audit.

Bribery and corruption
It is illegal for companies to offer, promise, give, request, agree, receive or accept bribes. Companies should consider implementing an anti-bribery policy if there is a risk that someone who works for the company is at risk of being exposed to bribery. Any such policy should be tailored so that it is appropriate to the level of risk faced by a particular business, and it should include:

the company’s approach to reducing and controlling the risks of bribery
rules for staff about accepting gifts, hospitality or donations
guidance on how to conduct business – such as on the best ways of negotiating contracts – to avoid any risks of bribery arising
rules on avoiding or preventing any potential conflicts of interest

The anti-bribery policy should be regularly reviewed and communicated to all members of staff. Efforts should also be made to ensure that employees fully understand all aspects of such a policy.

Fraud and money laundering
All companies should be alert to any kind of fraudulent activity perpetrated by members of staff, suppliers, customers or any other third parties which deal with the company. Regular auditing of senior executives can help to ensure everything is in order at higher levels (which are often most prone to internal fraud).

Furthermore, the Money Laundering Regulations compel companies to register with a supervisory authority, to help prevent money laundering, if they operate in certain sectors, eg:

financial and credit businesses
independent legal professionals
accountants, tax advisers, auditors and insolvency practitioners
trust and company service providers
estate agents
casinos

Whistleblowing
The official name for whistleblowing is ‘making a disclosure in the public interest’, but it is more commonly called ‘blowing the whistle’ or ‘whistleblowing’. If an employee believes there is wrongdoing in their workplace (eg bribery or fraudulent activity) they can report this by following certain processes, and they will be protected from being dismissed or discriminated against on the basis of whistleblowing.

Employees who decide to blow the whistle on an organisation are protected by employment law and their employer cannot victimise them in any way. Whistleblowers are provided with this protection for the public interest, to encourage people to speak out if they find malpractice in an organisation or workplace.

Gender and race equality
Many companies are trying to ensure there is more of a balance on their boards in relation to protected characteristics under the Equalities Act 2010. Gender pay gap reporting regulations have also helped to ensure there is more parity in terms of pay.

How do investors use ESG information?

Environmental, social, and governance (ESG) information is increasingly used by investors to assess the management of a company and identify any potential business risks. ESG reports are not only important to socially conscious investors; anyone looking for a return on investment will want to ensure that they are not exposing themselves to any unnecessary risks.

Why is the accuracy of ESG reporting so important?

Some companies approach ESG reporting as more of an afterthought; a tick box exercise which ensures they receive necessary investment. But spending time on ensuring the accuracy of ESG information is crucial for several reasons:

Many investors will use ESG reports to evaluate a company and this can be a key factor for deciding whether to invest.
If information provided is inaccurate this can damage any sense of trust, harming the business relationship and potentially resulting in investment funding being pulled.
If investments are provided on the basis of an ESG report, a company which fails to provide accurate data could potentially be in breach of contracts pertaining to funding, leading to heavy fines.
Investors will often rely on ESG reporting to avoid making potentially risky investments – for example in companies which are more likely to be subject to hefty fines by Environment Agency etc.
Some investors make decisions partially based on advice from ratings agencies (or automated software) which use a set of ESG criteria to assess a company for suitability of investment.
For some companies, ESG reporting is a legal obligation (see below) and therefore the accuracy of information is vital to avoid penalties.

Is ESG reporting mandatory?

Currently ESG reporting is only mandatory – to a certain extent – for some large or listed companies. For example, part 7 of The Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013 requires quoted companies to submit a report which includes some very specific figures relating to C02 emissions:

“(2) The report must state the annual quantity of emissions in tonnes of carbon dioxide equivalent from activities for which that company is responsible including—
(a)the combustion of fuel; and
(b)the operation of any facility.
(3) The report must state the annual quantity of emissions in tonnes of carbon dioxide equivalent resulting from the purchase of electricity, heat, steam or cooling by the company for its own use.
(4) Sub-paragraphs (2) and (3) apply only to the extent that it is practical for the company to obtain the information in question; but where it is not practical for the company to obtain some or all of that information, the report must state what information is not included and why.

1. The directors’ report must state the methodologies used to calculate the information disclosed under paragraph 15(2) and (3).
2. The directors’ report must state at least one ratio which expresses the quoted company’s annual emissions in relation to a quantifiable factor associated with the company’s activities.”

Further information is required under s 414C about:

(ii) the company’s employees, and
(iii) social, community and human rights issues,including information about any policies of the company in relation to those matters and the effectiveness of those policies.

Other requirements pertain to the Energy Savings Opportunity Scheme and the Streamlined Energy and Carbon Reporting (SECR).