Unveiling ESG [A Comprehensive Guide to Environmental, Social, and Governance Standards] and Climate Change Mitigation 

Introduction

Sustainability is a manner that preserves the Earth’s resources whilst still meeting the present needs of society. When it comes to economy and commercial sectors, it becomes corporate sustainability which is important for both the planet and businesses. Simply, it is an alternative to the traditional growth and profit-maximization model that requires the corporation to pursue societal goals, specifically those relating to using natural resources responsibly, investing in the long-term well-being of the planet, and ensuring that all people involved are treated fairly while supporting its economic growth.

In the dynamic landscape of modern investing, a new paradigm has emerged—ESG, standing for Environmental, Social, and Governance. This set of standards has become a compass for socially conscious investors seeking not just financial returns, but also a positive impact on the world. ESG encapsulates a framework that socially conscious investors utilize to sift through potential investments. It lays out the criteria by which Environmental, Social, and Governance factors are carefully weighed alongside traditional financial metrics. This multi-dimensional approach enables investors to make more informed and ethical choices in aligning their portfolios with their values.

The Pillars of ESG

Understanding ESG involves delving into its three fundamental pillars including, 

1. Environmental Factors such as Climate Change, Natural Resources, Pollution and Waste, Environmental Opportunities
2. Social Factors such as Human Capital, Product Liability, Stakeholder Opposition, Social Opportunities
3. Governance Factors such as Corporate Governance, Corporate Behavior

As investors increasingly recognize the value of ESG in their decision-making, the relevance of sustainability reporting and adherence to global goals becomes paramount.

This article aims to unravel the intricacies of ESG, shedding light on its importance in climate change mitigation. 

Global Initiatives Driving ESG

Internationally, the United Nations Sustainable Stock Exchanges (SSE) initiative stands as a catalyst for change. By encouraging stock exchanges to guide issuers on ESG reporting, the SSE acts as a bridge between issuers, investors, regulators, and other capital market stakeholders. This initiative not only supports the transition to greater ESG disclosure but also attracts investment flows with a sustainability focus.

How does Climate change affect businesses?

Climate change has wide-ranging implications for businesses across various sectors. Here are some of the ways in which climate change affects businesses. 

1. Physical Risk and Supply Chain Disruptions – The most direct impact of climate change on businesses comes from the physical risks associated with extreme weather events. Changes in weather patterns, such as more frequent and severe storms or droughts, can disrupt supply chains. This includes damage to infrastructure and increased operational costs due to the need for adaptation measures.

2. Regulatory Changes – Governments worldwide are implementing regulations to mitigate and adapt to climate change. Companies may face increased compliance requirements, emission reduction targets, or taxes on carbon emissions. Businesses that are unprepared for these changes may face financial penalties or reputational damage.

3. Market Shifts – Changing consumer preferences and concerns about climate change are influencing market dynamics. Consumers are increasingly favoring sustainable and environmentally friendly products and services. Businesses that fail to align with these preferences may face declining market share.

4. Financial Risks/ Insurance Costs – Climate change poses financial risks to businesses, particularly those heavily invested in industries that are carbon-intensive. As global efforts to transition to a low-carbon economy increase, companies reliant on fossil fuels may see a decline in asset values and face stranded asset risks. Some insurers are already factoring climate-related risks into their pricing models, and businesses may find it more expensive to obtain adequate coverage.

5. Reputation Management – Consumers, investors, and the general public are becoming more environmentally conscious. Businesses perceived as contributing to climate change or failing to adopt sustainable practices may face reputational damage, affecting brand value and customer loyalty. While climate change poses risks, it also presents opportunities for innovation and growth.

In summary, climate change introduces a multitude of risks and opportunities for businesses. Those who proactively assess and address these challenges can enhance their resilience, reduce risks, and position themselves for long-term success in a changing climate.

Importance of sustainable ESG reporting 

Sustainable Environmental, Social, and Governance (ESG) reporting holds significant importance for companies, investors, and stakeholders. Here are key reasons highlighting the importance of sustainable ESG reporting:

1. Enhanced Transparency and Accountability for companies and investors

ESG reporting provides a platform for companies to disclose their environmental, social, and governance practices transparently. This transparency fosters trust among stakeholders and allows them to assess a company’s commitment to sustainability. It holds companies accountable for their impact on the environment, society, and governance practices.

2. Risk Management

Identifying and reporting on ESG factors helps companies understand and manage risks associated with environmental degradation, social issues, and governance lapses. ESG reporting allows investors to assess the risks in their investment portfolios related to climate change, regulatory changes, labor practices, and more. 

3. Stakeholder Engagement

ESG reporting facilitates engagement with various stakeholders, including customers, employees, suppliers, and local communities. It demonstrates a company’s commitment to responsible business practices and invites feedback from stakeholders. Investors increasingly consider ESG factors to align their investments with their values. 

4. Competitive Advantage 

Adopting and reporting on sustainable ESG practices can provide a competitive advantage. It attracts environmentally and socially conscious consumers, enhances brand reputation, and may lead to increased market share. Prioritizing sustainability and ESG factors contributes to long-term value creation. Companies that integrate ESG considerations into their strategies are more likely to adapt to changing market dynamics and stakeholder expectations.

In conclusion, sustainable ESG reporting is essential for fostering responsible business practices, managing risks, engaging stakeholders, gaining a competitive edge, and contributing to the long-term well-being of both companies and investors. As global awareness of sustainability issues grows and climate change takes a huge part of it, the importance of ESG reporting will likely continue to increase.

Navigating ESG Reporting Landscape in Sri Lanka

In the evolving landscape of Environmental, Social, and Governance (ESG) reporting in Sri Lanka, several international standards, including those established by the Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), European Financial Reporting Standards, and International Financial Reporting Standard, have begun to shape the discourse. These standards not only set benchmarks but also define materiality, facilitating the seamless integration of ESG factors into the investment process.

At present, ESG reporting in Sri Lanka is not mandatory for financial reporting. However, there is a notable increase in the number of companies voluntarily disclosing their annual reports alongside standalone sustainability reports. This trend highlights a growing awareness of the significance of ESG considerations in the business landscape.

To further propel this momentum, key institutions in Sri Lanka, including the Securities and Exchange Commission (SEC), The Colombo Stock Exchange, and CFA Society Sri Lanka (CFASSL) have joined forces through a Memorandum of Understanding (MOU). The collaboration aims to educate investors on ESG, emphasizing the importance of effective ESG practices and sustainable reporting by listed companies. The initiative encourages the adoption of the CFA Institute’s Global ESG Disclosure Standards for Investment Products and introduces new ESG-related products, standards, and regulations, fortifying the ESG focus on the Sri Lankan capital market.

In this journey towards heightened ESG awareness, the Colombo Stock Exchange has provided a Sustainability Guide, helping listed companies approach the topic of sustainability. Despite the longstanding emphasis on sustainability and corporate responsibility, ESG investing remains a relatively new concept in Sri Lanka. Consequently, there is limited information and data available for investors to assess. 

Beyond financial considerations, investors are encouraged to evaluate how a company directly and indirectly impacts the community and its development. Assessing the financial viability of an investment through the lens of the ESG framework provides a comprehensive approach, aligning investments with values and contributing to a more sustainable and responsible capital market in Sri Lanka.

We contacted the Chamber of Commerce in Sri Lanka for the following insights, the questions we asked and the answers they gave are mentioned below.

1. How do government policies in Sri Lanka support or influence ESG practices among businesses?

 green bond framework issued by the SEC (Securities and Exchange Commission), green taxonomy by the CBSL, Net Zero Carbon Roadmap, National Climate Change Policy

2. Are there any recent regulatory developments related to ESG that businesses are adapting to?

 IFRS S11 and IFRS S2,2 Corporates will be required to do sustainability disclosures effective from Jan 2024 onwards

3. Are there any collaborative efforts between businesses and the government in addressing climate change concerns?

 consultations on the policies and strategies, policy advocacy efforts

4.  From your perspective, what are the primary challenges businesses face in implementing robust ESG frameworks? 

Lack of funding, mindset change, lack of awareness on the gravity of climate change, many tools for environment but not for social

5. Are there untapped opportunities for businesses in Sri Lanka concerning sustainable practices? 

 many including energy efficiency, renewable energy generation

With inputs from Nuwandhara Mudalige  –