ESG Compliance: An Introduction to Building a Reputation for Ethical Investing

With the current regulatory landscape placing emphasis on sustainable investing, it is important for companies and investors to assess whether they wish to have a focus on Environmental, Social, and Governance (ESG) criteria. If the answer is yes, a company should determine its expectations and goals when it comes to factors like sustainability, diversity, and transparency, whereas an investor should build a portfolio of companies that are working to meet certain criteria. Given the impacts of climate change and social change, exemplified by advancements in corporate culture, lenders see ESG compliance as a form of risk management, something that will work in companies’ and investors’ favor when it comes to obtaining funding.

Disclosures of ESG measures continue to be emphasized in the regulatory sphere. On May 24, 2022, the U.S. Securities and Exchange Commission proposed that funds that contain any ESG language must invest 80% of their assets in holdings that demonstrate working conditions aligned with that language and that ESG funds are required to report ESG compliance in “structured data language” – in other words, standardized language that allows for comparability across funds. Considering this development as well as global signals of ESG’s significance, it is essential that companies and their investors understand how to measure ESG compliance.

To do this, companies are using Key Performance Indicators (KPIs): trackable, quantifiable figures. Examples of these indicators are greenhouse gas emissions, employee working conditions (which could be measured by tracking anything from workplace injuries to compliance with company values and protocols), and workplace and leadership diversity. Companies should also consider how these metrics apply to their supply chain and corporate partners. Tracking KPIs can be used to prove to lenders that the company is taking steps to foster an ethical workplace, one that is likely to be adaptable to corporate, natural, and societal developments.

It is important to note that there has been much headway regarding KPI reporting and ESG compliance in Europe. As of 2022, per the Sustainable Finance Disclosure Regulation (SFDR), companies are required to report on KPIs for asset management, insurance, and financial advice. In 2024, public-interest companies will have to report KPIs for all six environmental objectives outlined by the European Union (EU) Taxonomy.

As companies prepare to adopt ESG initiatives, it is useful to review two other industry terms: Socially Responsible Investing (SRI) and Impact Investing. While these three terms are often used interchangeably, there are important differences. While ESG evaluation mainly serves as a risk and opportunity indicator for a company, SRI takes it a step further in that it might eliminate investment opportunities that don’t align with certain ethical considerations. Finally, Impact Investing is focused on making investments that maximize tangible social good, whereas the primary purpose of ESG investing remains financial returns. Keeping these three terms in mind will help companies navigate their priorities, in the financial and ethical sense.

For further information about what ESG is, its importance, and what improved ESG performance could mean for you, please contact your Anchin Relationship Partner.