The ESG Labyrinth

Finding Your Way Through Conflicting Standards

This is a summary of the lecture by Edson Paula de Souza, IP Director at Bayer about challenges due to the variety of ESG standards from the joint CEIPI European Patent👉 A legal right granting exclusive control over an invention for a limited time. Office Diplom Universitaire IP Business Administration

In a world increasingly focused on corporate sustainability, Environmental, Social, and Governance (ESG) factors have become critical for businesses. However, the proliferation of ESG standards and frameworks presents a significant challenge. Edson Souza, Director of Intellectual Property👉 Creations of the mind protected by legal rights. at Bayer in Brazil, sheds light on this issue in his lecture, “Challenges Due to the Variety of ESG Standards.” This summary, based on the lecture transcript and accompanying manuscript, delves into the complexities of the ESG landscape, examining the key standards and frameworks, the challenges they pose, and potential paths toward clarity and coherence.

ESG Standards vs. Frameworks: Defining the Landscape

Souza begins by differentiating between ESG standards and frameworks. Standards provide specific, detailed criteria and metrics for reporting on ESG-related topics. They are characterized by a public interest focus, independence, due process, and public consultation. In contrast, frameworks offer a broader, more flexible approach, providing principles and guidance without prescribing detailed metrics. Both standards and frameworks can originate from various sources, including governmental bodies, independent organizations, and expert associations.

The sheer number of available options can be overwhelming for companies seeking to refine their ESG strategy. Souza focuses on six key initiatives that address a wide range of sustainability issues: CDP (Carbon Disclosure Project), SASB (Sustainability Accounting Standards Board), TCFD (Task Force on Climate-related Financial Disclosures), GRI (Global Reporting Initiative), CDSB (Climate Disclosure Standards Board), and IIRC (International Integrated Reporting Council).

• SASB (Sustainability Accounting Standards Board): SASB develops sustainability accounting standards primarily for investors. It recommends topics and metrics for 77 industries across the three ESG pillars. While SASB provides standards, it does not rate company performance; this role is assigned to licensees who use SASB standards for ESG scoring and analysis. SASB identifies sustainability issues that may impact a company’s financial or operational performance, categorized into five dimensions.
• TCFD (Task Force on Climate-Related Financial Disclosures): TCFD focuses on climate-related financial disclosures, addressing climate-related risks and opportunities. Its recommendations cover governance, strategy, risk management👉 Process of identifying, assessing, and controlling threats to assets and objectives., and metrics and targets. TCFD disclosures are relied upon by various stakeholders to understand how organizations are addressing climate-related issues.
• GRI (Global Reporting Initiative): GRI provides robust disclosure standards for environmental issues, human rights, and governance. GRI standards address disclosures of socially material topics affecting a company’s stakeholders. These standards are designed for voluntary use by organizations to report their impacts on the economy, environment, and society. GRI standards are categorized into universal, sector-specific, and topic-specific standards.
• CDSB (Climate Disclosure Standards Board): CDSB promotes a framework for integrated reporting of environmental and social information, linking natural, human, and social capital to a company’s strategy and performance. In January 2022, CDSB was consolidated into the IFRS Foundation and supports the International Sustainability Standards Board (ISSB). The CDSB framework provides principles that leverage the application of TCFD and SASB recommendations.
• IIRC (International Integrated Reporting Council): IIRC is a global think tank focused on refining capital allocation. It offers an umbrella principle of transparency in corporate reporting, linking non-financial reporting with business aspects to understand value creation. IIRC considers six types of capital: financial, industrial, intellectual, human, social, and relational, all of which contribute to a company’s business model👉 A business model outlines how a company creates, delivers, and captures value. and value creation.

Challenges Arising from the Variety of Standards

The abundance of ESG standards and frameworks presents several challenges:

• Confusion and Overwhelm: With so many options available, companies may struggle to determine which standards are most relevant and important. The sheer volume of ESG frameworks can lead to analysis paralysis, preventing organizations from taking meaningful action. Identifying the best fit requires significant resources and expertise to navigate the intricate details of each standard. This confusion can result in delayed implementation or the selection of inappropriate standards, ultimately hindering the effectiveness of ESG efforts and stalling any ESG improvements.
• Lack of Consistency: The lack of consistency among standards can confuse investors and stakeholders, hindering a company’s efforts to streamline its ESG narrative. Differing metrics and reporting requirements make it difficult to compare performance across companies and industries, undermining investor confidence. This inconsistency makes it challenging for companies to create a clear and coherent message about their sustainability efforts. A fragmented reporting landscape can also lead to greenwashing, as companies selectively highlight data that portrays them in a favorable light.
• Implementation Obstacles: Implementing an effective ESG strategy becomes more difficult due to the complexity and variety of standards. Companies may face challenges in gathering and analyzing the data required to meet the diverse reporting requirements. The need for specialized expertise and resources can create significant barriers, especially for smaller organizations with limited capacity. Successfully navigating this complexity requires a dedicated commitment and a strategic approach to data collection, analysis, and reporting.
• Materiality Differences: A key point of contention is materiality. While IIRC, SASB, and TCFD focus on financial materiality (how ESG issues impact a company’s financial performance), GRI takes a broader perspective, including social and environmental implications, known as “double materiality.” This divergence in materiality concepts creates confusion about which ESG issues are most relevant to report. Companies must carefully consider their target audience when deciding which materiality approach to adopt, understanding what is important to investors versus other stakeholders. Choosing the wrong approach can result in overlooking critical ESG factors or failing to meet the expectations of key stakeholders, which may stall ESG improvements.
• Data comparability: Due to the variety of standards, it is difficult to compare companies ESG performance. Investors and stakeholders often struggle to assess and benchmark companies accurately. The variety of methodologies makes it challenging to create standardized ESG ratings and rankings, potentially leading to misinterpretations and misinformed investment decisions. It can also make it difficult to track progress over time, undermining efforts to promote accountability and drive meaningful improvements in corporate sustainability.

Materiality: A Critical Consideration

Choosing the correct concept of materiality is crucial. Enterprise materiality is relevant to financial evaluations, while double materiality engages NGOs and activist stakeholders. Companies should carefully consider their target audience and objectives when selecting a materiality approach. If a company wants to improve its ESG strategy, double materiality may provide clues regarding areas of improvements.

Ways Forward: A Call to Action

Souza concludes by emphasizing that while ESG disclosures are common, there needs to be more standardization. The numerous standards and frameworks have made it challenging to provide stakeholders with consistent and comparable information. Companies and industry associations should be bolder in their actions, engaging with stakeholders and advocating for changes to create a clear and reasonable baseline for ESG reporting.

In essence, navigating the ESG landscape requires a thoughtful approach, considering the various standards and frameworks, their unique characteristics, and the importance of materiality. By embracing collaboration and seeking coherence, companies can overcome the challenges posed by the variety of ESG standards and contribute to a more sustainable future.