professionalethics

BY SARAH J . ADAMS & GLENN FREED

Greater Transparency , Better Prices and Better Decision Making

When the term ESG was coined in 2004 it was defined as a set of business risks and opportunities companies face that weren ’ t covered in traditional financial reports . Unfortunately , it is now commonly used as a much broader moniker . It has come to describe strategies wherein investors apply their personal preferences , like avoiding guns or abortion or nuclear power .

Investing with personal preferences was historically called SRI — socially responsible investing . When this term fell out of favor , ESG became a substitute . Unfortunately , such a broad definition , where ESG combines both business risks and personal preferences , serves no one well .

Investment approaches that integrate consideration of business risks like pollution , product safety or workers ’ rights are not going away . Metrics that relate to risk will always be relevant for investors . This is especially the case for large institutional investors with long investment horizons . In fact , 12 of the 15 largest pension funds in the world incorporate ESG metrics in their investment management .

The use of ESG as a risk screen resonates with investors who have sought accountability at large companies — think Enron and Arthur Anderson in the late 1990s . These reputable companies appeared to generate reliable returns , but unchecked accountability meant that investors ultimately lost out .

New regulations , including Sarbanes- Oxley , were introduced in the aftermath of these corporate implosions . Investors also began designing a better mousetrap to identify these risks before they lost their shirts again . Why not check in advance to see if the company ’ s audit committee is actually providing appropriate oversight ? Why not look into employee lawsuits and worker accident rates to see if the company has labor issues ? Why not ask a real estate owner if they have assessed their buildings ’ exposure to flood risk and wildfire ? Why not ask companies to disclose their energy , water and waste use in case future regulation increases costs ?

A Brief History of ESG Corporate sustainability reporting got its start in the 1990s when investors wanted to address gaps in the traditional financial reporting package . The balance sheet , income statement and statement of cashflows all provided much needed information . But after a series of corporate crises — Bhopal in India , the Exxon-Valdez oil spill in Alaska — some investors in large publicly listed companies realized the standard financial reporting boilerplate , even with management discussion and analysis , was not sufficient to reveal all relevant risks .

Non-financial reporting started as voluntary reporting with the Global Reporting Initiative ( GRI ) in 1997 . The GRI ’ s framework aimed to show linkages between the environmental , social and economic aspects of enterprise performance to all types of stakeholders . Questions ask companies to reflect on strategies for energy use , water use , investment in human capital and executive pay ratios .

Shortly after , in 2002 , the Carbon Disclosure Project ( now known as the CDP ) was founded to encourage companies to report their greenhouse gas emissions and energy use . In the early days , only a handful of companies volunteered this information . As of 2023 , more than 25,000 companies globally provide CDP reports .

Today many companies are voluntarily providing corporate sustainability reporting outside their financial reports . Since 1993 KPMG has been conducting a global survey on sustainability reporting that evaluates over 5,800 companies in 58 countries . As of 2023 , 79 percent of these firms publish sustainability reports . Of the largest 250 companies globally , 96 percent publish sustainability reports and 64 percent acknowledge climate change as a business risk .

12 CALIFORNIA CPA JULY 2024 www . calcpa . org