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By Julian Harrell, Faegre Drinker Biddle & Reath LLP
Winds of change swirl often; however, certain “evolutionary gusts” seem particularly persistent right now. Between headlines oozing the doom and gloom flavor of the day, there is a spotlight on environmental, social and governance (aka ESG) and sustainability activity. Depending on the nature of the informational
echo chamber that we may occupy (intentionally or unwittingly), conceptualizations of ESG/sustainability diverge and convene along a complicated landscape.
That said, our goal in this piece is three-fold: (1.) provide a fundamental understanding of ESG/sustainability; (2.) explain in broad terms “why ESG and sustainability matter”; and (3.) highlight our upcoming CLE where we will share thoughts on proactive steps to help navigate ESG risks and opportunities.
What is ESG? Is it the same as ‘sustainability’?
ESG is the “fuel driving the transition to a low-to-no carbon economy.” But ESG’s origins are somewhat obscure. The term ESG itself was arguably first found in the International Finance Corporation’s 2004 report titled “Who Cares Wins.” Regardless, ESG has evaded definition and general consensus. Yet there are practical and broad ways to define ESG.
At a high level, “ESG” is a process to account for and respond to numerous, often competing, issues impacting an entity’s environmental, social and governance functions — ideally in a way that drives financial value over time. Clear as mud, right? If we look deeper, ESG also represents a “departure from business as usual” in response to demands from various stakeholders (e.g., investors, shareholders, regulators, community leaders, lenders, etc.) for increased transparency and sustainable practices. Thus, businesses are facing pressure to disclose information that reveals their environmental and societal impacts, and their resilience to change.
In making “ESG disclosures,” entities must articulate two distinct but related sets of information. First, how is a company’s financial position affected by specific risks (and opportunities)? Asked differently, how resilient is a company’s business model to the increased intensity/frequency of natural disasters, changing regulatory policies, increased accountability to shareholders, etc.? This first inquiry deals with “financial materiality” — external impacts on a company’s financials. Second, what impact does an entity’s operations have on the environment and society? This second inquiry addresses “impact materiality” — the entity’s outward impact stemming from its products, services and value chain. The combination of “financial materiality” and “impact materiality” is called “double materiality.”
Notably, the International Sustainability Standards Board (ISSB) has chosen “sustainability” over the unwieldy definition of ESG. ISSB defines “sustainability” as an imperative for companies to maintain access over time to critical resources and relationships (e.g., financial, human and natural). ISSB sees sustainability as a practice that will drive “preservation, development, and regeneration” for companies to realize their goals. Regardless of the label, however, outcomes matter.
On top of evolving definitions and related obligations, there has been a proliferation of policy, political and other issues that, rightly or wrongly, arise in the ESG context — perhaps under the “social” factor if forced to choose a precise fit definitionally. The main reason people view these issues through an ESG lens flows from constituencies’ strong expectations about organizational behavior and social change. The challenge, especially for businesses, is addressing competing demands simultaneously (e.g., with opposing views of governments and elected officials).
Why do ESG/sustainability matter?
The short answer for why ESG and sustainability matter is “because stakeholders say so.” The longer answer is that stakeholders are demanding transparency around “financial materiality” and/or “impact materiality” — and it is no longer an option for virtually any entity to do nothing. In other words, “inaction is still action.” Also, assessment and disclosure are only part of the equation. Stakeholders are demanding transparent, substantiated performance metrics. Said differently, entities have to “mean what they say — and back it up.” As noted above, actions intended to accomplish “positive goals” can nevertheless attract negative attention and reactions from an intersectional range of stakeholders.
What risks and opportunities permeate ESG and sustainability? How can we prepare?
ESG and sustainability are complex — and stakes are high. Plus, there is no magic “alignment” wand. While attainable, developing a resilient ESG/sustainability strategy requires careful and continuous assessment. We look forward to illuminating further during our CLE on April 6 at IndyBarHQ.•
Julian Harrell is a partner with Faegre Drinker Biddle & Reath LLP counseling clients on environmental law issues. He’s an IndyBar Bar Leader Series graduate and a member of the Indianapolis Bar Foundation Board of Directors.
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