As we described in our last article ESG: a look from the present to the future, the legal and regulatory frameworks addressing ESG (Environmental, Social and Governance) have grown considerably during the last decade. As a result, companies and investors are looking at ESG considerations in order to align their efforts with market requirements that have changed due to societal and market forces.
In the midst of corporate governance and socio-environmental efforts and initiatives, a number of companies and institutions have sought to address concerns without making any concrete efforts to promote such initiatives. These companies adopted what could be characterized as false, unsubstantiated or misleading practices under the guise of public relations and brand promotion, while not making any changes to their corporate values.
There are many examples of “ESG-Washing”. By way of example, companies may practice greenwashing when, while claiming to engage in sustainable practices, they continue to use fossil fuels in their business. An example of “socialwashing” would be a company that purports to donate to various charitable causes that promote various social causes, while at the same time subjecting their factory workers to an unsafe or unhealthy workplace. An example of “rainbowashing” is when, despite using LGBTQIA+ symbols in its advertising campaigns, a company is nevertheless politically and/or commercially involved with countries that suppress rights associated with LGBTQIA+ equality. These examples reflect measures adopted by companies solely to promote such institution’s brand and/or reputation, despite an absence of real ESG initiatives and policies in its core business. Whether by misleading, omitting or presenting generic data or socio-environmental measures, a company may be subject to “corporate makeup” practices.
At the individual level, the average consumer and investor may not be able to easily recognize empty ESG practices undertaken by companies or institutions. While the speed of information can contribute to the publication and disclosure of information without appropriate fact checking, the ever growing presence of digital media can counterbalance those challenges by providing a platform for public outrage and pressure when misleading business practices are identified. A highly competitive market has led to very little tolerance among consumers and investors for deceptive practices with respect to ESG.
Companies concerned with aligning their businesses with sustainable and equitable practices, as well as with reputational harm that comes from misleading consumers and investors with respect to their ESG practices, should follow certain principles on how to build and communicate their ESG initiatives:
- C-level buy-in: Receiving buy-in from top level management is critical to a company’s ability to successfully implement ESG practices, as such buy-in can permeate through an organization and affect the availability of resources allocated to such initiatives.
- Materiality: A company should focus on ESG initiatives that are directly linked to the company’s business model, rather than pursuing initiatives solely as a result of what it deems to be “trending”. A company’s decision makers should ask themselves: to what extent would a particular ESG initiative affect the company's financial situation or operating performance? ESG activities that are irrelevant or insignificant to a company’s business and the interests of its stakeholders should not be prioritized at the expense of other ESG initiatives which may have a greater effect.
- Strategic Planning: ESG initiatives should be undertaken as part of its business strategy rather than solely as a marketing opportunity. In developing its ESG strategic planning framework, a company should take into account the following steps: 1. Defining the company's goals, such as to what extent the company would like to get involved in ESG initiatives; 2. Analyzing external ESG factors (such as climate and environmental aspects) and ESG factors having an internal impact (such as corporate structure and governance structure); 3. Selecting goals and objectives aimed by the ESG initiative; 4. Creating an action plan; and 5. Measuring and evaluating results. The external communication of practices should only take place after some tangible results can be demonstrated.
- Consistency: Maintain consistent and realistic methodologies, rather than engaging in one-off actions of a grandiose nature. Consistency allows for a company to track its progress and efforts on a year to year basis. Steps that are keyed to a company's reality should be prioritized over others.
- Monitoring: A company should periodically monitor its progress in implementing its goals and performance by using key performance indicators (KPIs). It is also up to the company to communicate with other stakeholders, such as employees and contractors, to enable them to implement the practices and goals in question.
With these principles in mind, a company should be careful when communicating its ESG initiatives. One way to ensure transparency is by publishing annual ESG or sustainability reports. These reports should be developed to add value to companies, while communicating directly to stakeholders what the company’s contribution has been to sustainable business, as well as the direction and progress of the business with respect to such sustainability issues.
As discussed in the article ESG: a look from the present to the future, guides on how to disclose ESG and sustainability reports have been created by regulators, such as the Non-Financial Reporting Directive (NFRD) and the ESG reporting guide published by the Nasdaq Stock Market (Nasdaq).
The fact is that companies have a lot of freedom when it comes to how and what they disclose about their ESG initiatives and compliance. They are often free to present ESG information in the manner they deem best and more advantageous. However, alongside this freedom are best practices based on recognized market frameworks, such as the Global Reporting Initiative (GRI) Standards, the UN's 17 Sustainable Development Goals, the Sustainability Accounting Standards Board (SASB), and the Task Force on Climate-related Financial Disclosure (TCFD).
In addition to these parameters, companies may rely on the application of ESG ratings prepared by rating agencies and independent ESG rating indices. Although the relevance of the various criteria is not yet universally accepted, companies should nonetheless take such criteria into account given the importance that may be attributed to such criteria by the financial markets and consumers.
In Brazil, the B3 stock exchange maintains the following ESG-related evaluation indexes: the Carbon Efficient Index (ICO2), the Trade Corporate Governance Index (IGCT) and the Corporate Sustainability Index (ISE). Although the source of some criticism, recent changes to the methodology of the B3 Corporate Sustainability Index signal an increase in transparency and criteria used for the selection of companies to include in the ISE portfolio of companies perceived as being committed to corporate sustainability. In the new methodology of evaluation, unlike rating agencies’ questionnaires, the inquiries are keyed according to the company's specific industry sector. Further, in addition to achieving certain scores on questionnaires, companies that seek to join the portfolio are also subject to the evaluation of the RepRisk Index (Peak RRI) and the CDP-Climate Change Score. In addition, all scores of evaluated companies are made public, even for those companies that are not selected for inclusion in the index. Together, they are signs that the Brazilian financial market is gradually adopting zero tolerance for false, unsubstantiated or misleading practices.
As responsible corporate governance gains increasing levels of importance, ESG measures can only be shared if they follow what has been observed in reports based on identifiable ESG principles. Thus, if a company's communication to the market contains generic, inaccurate, or otherwise missing and misleading information, it may also be an indicator that the company is not living up to its stated values.
What a company discloses to the market with respect to its ESG practices and initiatives is generally shared on a voluntary and unaudited basis. However, as ESG considerations become bigger drivers in decisions made by investors and consumers, there is an increased business risk for a company that is identified as having been false or misleading with respect to disclosing information about its ESG practices. Given the inevitable growth of social and environmental concerns around consumers and investors, sustainable businesses are increasingly becoming the rule, not the exception. A study conducted by the NYU Stern Center for Sustainable Business published on 2021 concluded that ESG disclosure on its own does not drive financial performance and that improved financial performance due to ESG becomes more noticeable over longer time horizons. That is, a company may not immediately benefit from large increases in revenues arising from investments with respect sustainable initiatives. Many companies which are more skeptical about the financial benefits of implementing effective ESG initiatives have been taking a wait and see approach regarding the financial benefits of ESG practices before taking the lead to build and communicate strong ESG initiatives. However, companies that are active in implementing ESG initiatives in advance may be better positioned to adapt to new challenges and see the financial benefits of investments in sustainability and corporate governance.
Following the Brazilian elections and the return of former President Luiz Inácio Lula da Silva to power, the next article in our series: “Post-election ESG scenario in Brazil: international expectations and standards”, will discuss anticipated ESG related trends expected in the coming years given the new administration and its legislative and economic priorities.
Authored by Isabel Costa Carvalho, David Tyler, Ana Laura Pongeluppi, Cintia Rosa, Mariana Matos and Lizandra Baptista.
