ESG standards are reverberating throughout the corporate world. It is now a standard practice for corporations to have an ESG rating or a sustainability rating in a public company’s annual report. But, what is ESG? And why is it important for corporate counsel to pay attention to these standards?
ESG stands for “environmental, social and governance” standards. Generally speaking, environmental criteria evaluate a company’s quality of environmental practices such as pollution abatement and reducing the company’s carbon footprint. Other examples include energy consumption, energy efficiencies, and sustainability of the raw materials the company uses. It also includes waste disposal and water quality. Social criteria evaluates a company based upon human rights policies and its relationships with employees, customers, suppliers and communities. A big chunk of the social element revolves around the support and approval of its employees, and helping the community in which the company serves. Governance criteria deals with a company’s internal controls, how a company handles its leadership, audits, executive pay and shareholder rights. Traditionally, corporate executive pay has always been linked to financial performance. Linking executive pay to ESG matters is revolutionary, but more and more companies are integrating ESG metrics into its executive compensation, e.g. Clorox, Royal Dutch Shell.
These ESG standards are driving a company’s operations that investors are increasingly using to determine if a company operates in accordance with these standards. Brokerage firms have responded and have started to categorize corporations in accordance with their ESG standards. The surge in demand from consumers for ESG practices is only increasing. According to Morningstar Direct, investment on environmental, social, and corporate governance (ESG) increased to $3.9 trillion in September 2021, up from $1.65 trillion at the end of 2020 and $1.28 trillion at the end of 2019. New investors are actively refraining from investing in companies, industries, and sectors that may negatively affect the planet or society, such as those tied to fossil fuels or tobacco. Likewise, investors are also actively seeking companies that are proactively improving their ESG practices. According to the Forum for Sustainable and Responsible Investment, as of 2020 one-third, or $17 trillion, of all U.S. assets under management were invested following sustainable principles.
In a nutshell, there is a measurable shift from traditional investment norms to more sustainable, and responsible investments. The trend shows that ESG investment will continue to be a fact for the foreseeable future. By improving employment practices, and reducing their carbon footprint, companies worldwide are following trends in ESG investing to stay relevant.
Corporations and their counsel who fail to recognize this shift in the investor dynamic risk getting left behind. If you are corporate counsel, now is the time to acclimate yourself to ESG principles and talk to your leadership about implementation. ESG scores are created by adding all of a company’s environmental, social, and governance scores. Corporate counsel can lead the way in developing a healthy ESG standard for their client.
Conducting an assessment first to determine whether your organization is embedding ESG standards in their policies and management of the company would be a good place to start. Once the assessment is concluded, counsel and leadership can target key areas to develop an ESG program and integrate ESG into corporate policies and decisions.
Below are just a few examples of many that you may want to consider discussing with your leadership and directors to discuss paths for improvement in your client’s ESG scores:
Use suppliers throughout the supply chain that are certified as sustainable and incorporate this requirement in your transactional documents. This will reverse negative impacts on the environment. Example: use paper suppliers who have a certification of net zero deforestation.
Help break the causation between consumption and waste. Implement an aggressive recycling program. Set a goal to achieve zero waste in your own operations. Utilize less packaging and improve waste reduction systems.
Maximizing governmental incentives relating to carbon emissions and renewable energy. There are numerous federal and state grants available to transform business utility use from fossil fuels to renewable or green energy sources.
Focus on retention and engagement strategies for employees, including flexible scheduling, learning opportunities, better benefits, and comp time. Stop the Great Resignation in its tracks by thinking out of the box and offering other non-traditional benefits. Checkout companies like Fringe which offers companies a personalized marketplace of perks for employees (Netflix subscription, DoorDash credits, etc.). Other examples: child care, educational opportunities, snacks, wellness programs.
Strategically implement a supply program that places small businesses owned by minorities on an equal footing to compete. Successfully implemented your company will be able to source goods and services from multiple and various diverse suppliers creating economic opportunities for many.
Ensure that your employees reflect the community you serve, including the board of directors and executive team, e.g. diverse in terms of gender, race, religious and political views, culture, socioeconomic background. Your company can be the leader in equity and inclusion in your business.
Community engagement – offering scholarships and sponsorships to local sports teams, academic achievement or community partnerships with local public projects. Think out of the box by developing a grant program to benefit small diverse businesses in the local community (social factor).
Draft a sustainability mandate (environmental factor) by prospectus and allow stockholders to vote on important issues such as executive pay.
Consult with risk managers and other experts to evaluate and mitigate litigation risks associated with environmental, social and government factors. Counsel can help the company assess and manage this risk in a variety of ways including developing a crisis management plan specific to ESG and a robust internal control system with checks and balances.
All of the ESG standards have a legal element to their assessment, development, and implementation. Leadership will want answers and a recommended path to move forward with enforcement of these principles in the corporate world. Corporate counsel should familiarize yourself with these ESG principles and be ready to take the lead.