From the E, to the S, to the G: unpacking ESG for businesses

Components of ESG

ESG is closely linked to the principle of corporate social responsibility (CSR) and describes the monitoring and measuring of a business’ CSR efforts, which can sometimes be in the form of an ESG score.

The various, often interrelated, factors that may be considered in assessing a business’ ESG includes:

Whilst many of these topics appear to be subjective, businesses are increasingly finding methods of objective reporting, making their ESG reports easier to track and more transparent.

Balancing of interests – profit vs CSR and ESG

The primary purpose of companies has historically been to make profits for its shareholders, raising the question of why a company should consider CSR and ESG matters, and whether it can legally devote time and resources to improving its ESG, especially where this may detract resources from the businesses primary operations.

This is a largely philosophical question, but there is significant evidence indicating the scales have shifted towards CSR rather than a sole profit making purpose. This, and many legal and non-legal factors mean businesses are being encouraged to pursue ESG matters, or else risk a range of consequences.

Legal ESG requirements

There is an increasing number of legislative requirements placed on businesses, which require compliance with a minimum standard in respect of aspects of ESG. For example:

• directors duties which require directors to act in the best interests of the company are now frequently understood to require some consideration of environmental risks, although case authorities are yet to confirm this position. Social and governance risks arguably also ought to be considered;
• specific disclosure requirements in respect of the Corporations Act 2001 (Cth), some expressly relating to discrete ESG matters (i.e., confirming compliance with environmental regulation) and other more general disclosure requirements which could be interpreted as capturing ESG matters;
• the ASX Listing Rules require listed companies to disclose the extent to which they have complied with the ASX Corporate Governance Principles and Recommendations. The Principles provide that a listed entity should disclose whether it has any material exposure to environmental or social risks, and if it does, how it manages or intends to manage those risks;
• specific legislation which creates minimum standards in relation to topics such as modern slavery, whistleblowing, anti-bribery and corruption, workers’ entitlements and WHS, carbon emissions, native title, and anti-discrimination.

Companies must take care to ensure any disclosures made about ESG targets or commitments are accurate and that there is a reasonable basis for the target or commitment announced, or else risk a claim against it for misleading or deceptive conduct.

Importantly, these legislative requirements simply set a minimum standard in respect of some aspects of ESG. There is no requirement to incorporate ESG into a business, it is a voluntary decision.

Non-legal ESG motivations

Given the uncertainty surrounding ESG, and what the primary purpose of a business should be, the key drivers of ESG are not the legal requirements, but rather factors such as risk management, and it presenting an opportunity to increase profits by doing better business, improve the business’ reputation, and therefore support or solidify its social licence to operate. Further, companies might employ ESG to improve relationships with shareholders and stakeholders, and avoid the risk of litigation or shareholder activism from disgruntled parties who consider the company is not satisfying their ESG obligations. ESG is also increasingly becoming a metric relied on by investors of all sizes when deciding where to invest.

Takeaways

ESG can be a confusing space for businesses, especially given the lack of formal regulation and legislation.

ESG will look different for each business, depending on factors such as what its social licence to operate is built on, the industry it operates in, and the size of the company. Regardless of these factors, to incorporate ESG, businesses should:

• consider who its stakeholders are, and what their expectations and requirements are;
• investigate and understand the risks to the business, beyond those traditionally considered;
• ensure strong internal processes are implemented around recording and reporting on ESG matters;
• exercise care around the ESG disclosures it makes;
• actively connect ESG with the broader corporate purpose and operations; and
• remain flexible to respond to the quickly changing and evolving societal and legislative requirements.

This article provides general commentary only. It is not legal advice. Before acting on the basis of any material contained in this article, seek professional advice.