What Is ESG and Why Is It Important?

When used together, they describe the nonfinancial considerations a business makes in its operations. Environmental, social and governance (ESG) may be a familiar term in investment scenarios, but today’s media and culture have elevated the concepts of environs, sustainability, biases and oversight to a higher level of social consciousness. They have become critical business factors to stakeholders — including employees — and impact how organizations are managing operations.

According to a survey released in November 2021 by Kiplinger’s Personal Finance magazine in partnership with Domini Impact Investments, ESG investing is defined as “considering a company’s record on environmental practices, social issues and governance policies before investing.” It furthers states that 91% of Millennial investors say they are likely to add these investments to their portfolios soon, compared with 80% of Gen X investors and 68% of Baby Boomer investors. The survey also reported that overall, more than 70% of respondents say a company’s environmental practices, social issues management and governance policies are very or somewhat important to them when choosing investments.

WHO’S MONITORING ESG COMPLIANCE?

Currently there is no regulating entity for ESG compliance. There is no legislation or single process or program for disclosure and reporting.

The U.S. Securities and Exchange Commission (SEC), as of this writing, does not require reporting on ESG matters. Reporting through 2021 has been on a voluntary basis — with the exception of an SEC disclosure requirement for certain organizations, and in specific classifications, to report on issues relating to climate change.

In early 2021, the SEC announced a Climate and ESG Task Force that will initially focus on identifying any “material gaps or misstatements in issuers’ disclosure of climate risks under existing rules.” The SEC also proposed ESG reporting on human capital, which has not moved forward as of this writing. Separately, the Financial Accounting Standards Board (FASB) is looking at revisions to its human capital reporting. Should the FASB approve revisions to its human capital reporting process, new metrics such as diversity, culture and turnover will be required data along with existing technical reporting.

“ESG is not a problem that can be addressed by any one group in an organization,” says Mark Thomas, CGEIT, CRISC, CDPSE, President of Escoute Consulting. “To accomplish a broad ESG agenda, multiple entities will need to work in collaboration with legal and regulatory teams to establish an accountable and transparent system and supply chain for ESG.”

ESG impact is seen on a global scale, but currently there is not a single international authority in the ESG reporting and disclosure domain.

LAW FIRMS CANNOT AFFORD TO DISMISS ESG

The impact on law firms and firm clients will grow as media and stakeholders demand more from organizations. ESG is now becoming a critical business model. Frameworks will be developed and reporting requirements implemented and enforced.

“Because of the growing interest in ESG investing, clients will look to their legal counsel for guidance,” says Caren Shiozaki, CGEIT, CDPSE, CEDS, the Executive Vice President and Chief Information Officer for TMST, Inc. “This will include understanding evolving regulations, advice on how to structure new products, and how clients responsibly invest their own funds.”

“Law firms will face the same stakeholder scrutiny as any other company for how they address ESG.” 

Investment portfolios offered to law firm employees will also be analyzed, as employees want a voice in portfolio selection and more information and transparency about portfolios offered before they invest their own funds.

“Law firms will face the same stakeholder scrutiny as any other company for how they address ESG,” says Shiozaki. “The type of clients with which they work, the diversity of firm partners, the social impact the firm has in communities — [these] are a few examples of how law firms will be viewed from an ESG lens.”

There is no turning back as stakeholders demand more from the organizations with which they conduct business and invest. Stakeholders are seeking greater sustainability and a long-term commitment to better governance.

Strategically, it will benefit organizations to begin considering how ESG will impact their business. Waiting for regulations and oversight directives means firms and firm clients will be reactive.

“Many organizations are launching their own internal ESG initiatives in response to internal and external pressures, and they do this without legal, regulatory or consumer mandates,” says Thomas. “This is a significant opportunity in the legal domain to be proactive in helping clients understand their options with respect to being an ESG-friendly organization.”

The SEC publishes all proposals for comment. If you or your firm is interested in having a voice in the process, offering metrics for consideration, sharing proactive steps your organization has already taken in this area, or learning about future proposals, visit sec.gov/rules/proposed.shtml.