ESG: What you need to know
ESG – Environmental, Social and Governance – is a rapidly evolving area, and businesses are facing stricter requirements for their ESG work, including sustainability. But what are the ESG requirements, and what does your organisation need to know about them? That is what we will cover in this article.
What is ESG?
ESG is an umbrella term for environmental, social and governance factors in a business. When talking about ESG, it is typically a thematic division of environmental, social and governance factors that each have different characteristics but often also share a number of common and partially overlapping characteristics.
The term ESG was mainly developed by international investors and organisations in the 2000s for the purpose of assessing the economic and societal impact of ESG factors on investments. Today, ESG has a much wider application and has been incorporated into Danish and EU legislation to a large extent. In recent years, formal reporting requirements have increased, particularly for the financial sector and listed companies. In the coming years, such reporting requirements will also be introduced for other large organisations and third-country establishments. Also harmonised EU requirements for ‘green claims’ will follow, as will requirements for mandatory due diligence for a large number of businesses active in the EU.
ESG advice
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ESG – the essentials
ESG encompasses a broad range of factors that cannot be exhaustively listed in any meaningful way and which are constantly evolving. The increased regulation does, however, serve to highlight a number of issues that will often be important to the organisations to which it applies. These issues relate to different branches of the ESG areas – environmental, social and governance – and cover, among other things:
- Environmental: Climate change mitigation and adaptation, water and marine resources, resource use and circular economy, pollution, biodiversity and ecosystems.
- Social: Equal treatment and diversity, labour conditions, respect for human rights.
- Governance: Governance in relation to sustainability, internal control and risk management systems, business ethics, anti-corruption and bribery, whistleblower protection and animal welfare, political influence, and matters relating to the business relationships of undertakings.
ESG plays an increasingly important role
The importance of ESG for organisations is on the rise, driven not only by compliance requirements but also by the desire for long-term value creation and the management of risks associated with ESG issues.
Example of the importance of ESG for businesses
Developments in recent years have shown some of the emerging consequences of climate change, ecosystems change, and the need to protect and regenerate biodiversity. As European legislation has evolved, the concept of a double materiality assessment has moved to the foreground. It is designed to assess the impact of an organisation's activities on people and the environment, but also the impact of sustainability issues on the organisation’s financial situation.
As these impacts often cut across multiple functions and divisions within any given organisation, ESG issues need to be tackled as an integral part of the organisation's business. This could be, for example, in relation to contracts, marketing, compliance, buying and selling of undertakings and properties, and dispute resolution. Also, the task of assessing, measuring and reporting ESG issues itself calls for cross-functional processes, controls and validation.
ESG and legislation
Not confined to any one law, ESG legislation, whether Danish or European, is increasingly in the form of regulation on specific areas such as reporting, due diligence, and marketing.
Often, though, the various requirements are interconnected. To properly conduct sustainability reporting, therefore, organisations need to ensure consistency between, for example, documentation of green claims and documentation of the impact of the organisation's activities.
2020 saw the adoption of the EU Green Deal, followed in 2021 by the EU’s first-ever climate law, reaching for EU-wide climate neutrality by the year 2050. As part of those efforts, a number of new legislative initiatives have since been introduced in the EU, and more are expected in the coming years.
Key EU legislative initiatives
ESG reporting
The current regulation on ESG reporting lays down what companies in reporting classes C (large enterprises) and D must include in their Corporate Social Responsibility reports. For listed companies, the rules also require a diversity policy as part of the management report in the company's annual report.
Going forward, the EU's Corporate Sustainability Reporting Directive (CSRD) will be the central regulation of sustainability reporting in Denmark and the EU. Amending the Non-Financial Reporting Directive (NFRD), the CSRD is expected to be incorporated into the Danish Financial Statements Act and other relevant special legislation (e.g. the Danish Financial Business Act). Covered ESG factors will be widened significantly compared to those currently stipulated in the Financial Statements Act. Requirements for the contents of the reporting will also expand substantially, both in terms of qualitative assessments and quantitative data to be included in the annual report and audited.
Sustainable due diligence
Another key area of ESG regulation is the European Commission's proposal for a Directive on corporate sustainability due diligence. The proposal aims to promote respect for human rights and protection of the environment through companies’ own actions and value chains and to create a level playing field for businesses across the EU. The proposal also comprises certain third-country businesses that are active on the EU market.
EU Taxonomy Regulation to promote sustainable investment
Formally, the EU Taxonomy Regulation to facilitate sustainable investment only imposes requirements on certain financial market players, listed companies, and issuers of green financial products, requiring them to publish information on whether and to what extent their activities or assets are environmentally sustainable within the meaning of the Regulation.
However, the Regulation's technical methodology for measuring the degree of environmental sustainability of, say, construction of buildings, energy or low-carbon technologies has already had an impact on organisations not directly subject to the Regulation, prompting many of them to adjust the way in which they arrange their products and services so as to qualify as environmentally sustainable within the meaning of the Taxonomy Regulation and thereby be eligible for investments from pension providers, for example.
Sustainability-related disclosures in the financial sector
The Sustainable Finance Disclosure Regulation (SFDR) is the EU’s regulation on sustainability-related disclosures in the financial sector. It lays down the manner in which players on the financial market must disclose sustainability information about the financial products they are offering.
Although the SFDR does not require financial market participants such as banks, pension funds or private equity funds to be sustainable, it has nevertheless already had some degree of impact on the design of certain financial products by ensuring that products are being offered in accordance with the principles and requirements of the Regulation.
Supplementing the above examples of ESG-related legislation are a host of requirements laid down in both Danish national law and EU law. The requirements relate to certain physical or financial products, construction, marketing of green claims, and green procurement and have been adopted or are expected to be adopted or revised in the near future.
The legislation is based on UN principles
In Denmark and the EU, ESG legislation is based on the implementation of, inter alia, the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises on Responsible Business Conduct. What used to be ‘soft law’ will now become ‘hard law’. This inevitably raises a number of questions about what impact the elevation of these principles into statute will have on companies that themselves become subject to regulation in the ESG area or share value chains with companies that do.
Our ESG experts monitor the development closely and can help you and your organisation with any question or problem you may have in terms of implementing the legal requirements. Please do not hesitate to reach out to us for any ESG-related concerns you might have.
What is the difference between ESG, CSR, and sustainability?
ESG, CSR, and sustainability. These terms are often used interchangeably, but what is the difference between them?
What is ESG?
In a regulatory context, the term covers the regulation of environmental, social and governance issues. They are often supplemented by standards, guides and practices.
When businesses or investors speak of ESG, they will typically have one or more specific ESG issues or objectives in mind. For example, it might be in the context of a company’s performance on ESG issues, reporting of ESG issues, or qualifying the impact of certain ESG issues on the company. The assessment and management of ESG issues is often linked to a company or investor's societal or ethical ambitions, values and beliefs.
This may affect the way in which an organisation reacts in situations where there are environmental, human and financial consequences to consider. It can also affect whether investors feel assured or not that any given ESG-related risk has been adequately dealt with. With the increasing focus of EU legislation on the impact of companies' activities on people and the environment, all businesses will need to be more explicit about their position on corporate social responsibility.
What is CSR?
Originally, the concept of corporate social responsibility was used in a broader sense, denoting the corporate sector’s responsibility for its impacts on society. And indeed, much of Danish as well as EU legislation on the subject aims at formulating requirements for how businesses should live up to that responsibility.
Often, though, CSR is also used in the context of the voluntary acts and initiatives made by an organisation to create a positive environmental or social impact above and beyond the minimum requirements of statute. Examples include philanthropic projects, charitable donations, volunteer work and other activities on which the company does not expect to gain a financial profit.
What is sustainability?
In recent years, the term ‘sustainability’ has gained momentum as a broad term, often used to describe the positive and more sustainable development of certain ESG factors. This could be in the form of, for example, more 'sustainable' products.
Given this broadness of the term, it can be difficult to document wherein the sustainability of any given thing resides, which, of course, renders the concept at risk of becoming vague or even misleading.
The Consumer Ombudsman has offered the following definition of sustainability:
“A sustainable development is one that meets the needs of present generations without compromising the ability of future generations to meet theirs”.
To help illustrate what claims about sustainability businesses can and cannot make in their marketing, the European Commission has taken steps to regulate the use of environmental claims. The EU Taxonomy Regulation for Sustainable Investment also lays down technical criteria for environmentally sustainable activities within the meaning of the Regulation.
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