An assessment of ESG (Environment, Social and Governance) related performance of some of the best companies over more than 10 years reveals that there is a big improvement in scope, quality, and consistency of sustainability reporting by many public companies. Unfortunately, the same cannot be said about all the companies.
The latest data related to sustainability disclosure practices put out by The Conference Board, a non-profit business membership and research group organization, paints a bleak picture of how most companies in the Russell 3000 Index (and there is a whole universe of small companies beyond that) fail to report on basic ESG indicators such as emissions, water, and waste management. This ESG reporting divide clearly indicates that the sustainability or ESG reporting in corporations has failed to trickle down beyond the largest companies in each industry.
The situation of companies in Europe could be better than this, but in emerging markets and beyond the trend is likely to be similar or worse. Now before criticizing small businesses for this shortcoming, there is a need to try to identify why small businesses refrain from reporting their sustainability performance. Some of the major reasons are:
Most initiatives are aimed at large/ public companies: Two of the largest initiatives that have improved ESG reporting by companies in the last 10 years have been 1) reporting requirements put forward by the stock exchanges/ governments, and 2) ESG ratings considered by the investors for making investment decisions. Unfortunately, both these levers are applied mostly to publicly traded companies, which rules out the large universe of private companies from being impacted by these initiatives.
- Lack of uniform reporting standards: ESG disclosures – also called extra financial disclosures – are generally subjective parameters. Unlike financial parameters, these cannot be analysed objectively and compared across organizations. While some standard Key Performance Indicators (KPIs) have emerged that apply to all companies, for most other ESG parameters uniform standards are lacking that small organizations can use to report their performance or initiatives. There are multiple standards – Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB), CDP, and more – that cover and emphasize on different parameters, and small businesses fail to figure out which standard is best for them.
- Reporting is costly: The different reporting standards continue to get comprehensive as they evolve, bringing in new parameters and indicators under their reporting requirements. To comply with these increasing reporting requirements, small companies must hire or contract specialised employees or consultants to help them with their sustainability reporting. This attaches additional cost burden, which can be difficult to overcome for a small company.
- Threat of greenwashing: Greenwashing was calling out misleading environmental claims that a company makes about its products. However, over time the definition of this well-intended term has evolved so much that any sustainability initiative put out by an organization is being screened using the “greenwashing lens” by an army of sustainability activists on social networks. This threatens small companies from putting out their simple sustainability initiatives, fearing a negative reputational impact.
- The Scope 3 refuge: When it comes to reporting GHG emissions, companies are allowed to classify a portion of the emissions in their value chain as ‘Scope 3’ emissions, stating that they do not come under direct control of the company. This Scope 3 category is where most small companies operate as tier 2 or tier 3 suppliers of large companies. For most businesses, 70% of their carbon footprint falls under Scope 3 emissions. This exclusion of small companies by large companies has restricted sustainability good practices from trickling down to small companies.
How can the companies contribute towards bridging this gap? The answer is not simple for sure, and more standards and more consultants will certainly not fix it as these are a part of the problem. We believe that large corporations can play a significant role in addressing this problem in the following two possible ways:
- Technology to drive adoption and trust: Sustainability reporting needs to be simplified for small businesses by using technology. Currently, a small business must figure out complex reporting standards, and ways to capture data and report that according to the standards using specialized consultants. To address this problem, industry or geography level initiatives driven by consortia of large companies, government agencies, or regulators, need to create a simplified framework to capture information on the most important KPIs.
Blockchain technology, which provides immutable and transparent storage and sharing of information, can be utilized to create such frameworks for the benefit of entire supply chains or regional business ecosystems.
For example: A recent industry-level initiative is the battery pass project. The stakeholders from the electric vehicle industry – OEMs, battery companies, and chemical companies -- are banding together to create a blockchain-based platform where the suppliers will be able to record their environmental and ethical data that can be shared with all relevant stakeholders on a need basis. Another example of a consortia approach is where companies in the tea supply chain ecosystem came together to pilot a blockchain-based system where small suppliers are incentivized to report social and ecological data. There are several similar initiatives being taken in different industries with complex supply chains, but many more are needed.
- Supplier engagement instead of supplier assessment: Another lever that the corporations can use is their supplier relationship management. Most companies today require their suppliers to comply with a code of conduct or guidelines that have basic sustainability requirements. Some corporations also conduct third-party risk assessments of their critical suppliers, which help them manage sustainability risk exposure of these suppliers.
This process can be made more inclusive if corporations start engaging with their suppliers on sustainability issues on a regular basis. They can encourage small suppliers to share the initiatives they are taking to address sustainability issues in their organisations. This will give confidence to these suppliers and mitigate the fear of greenwashing and allow them to record the initiatives and share the positive impacts that they are creating, with their clients.
This exercise will also strengthen the bond between the supplier and the client. Finally, if the corporation can share supplier success stories from such engagements with other suppliers or all stakeholders, it can create a wide impact among other suppliers as well. For example, sharing the positive impact the supplier can have by incentivizing employees to use public transport and then sharing the progress reported by suppliers on this front will encourage all suppliers to take such initiatives in their respective companies.
These initiatives can have a much wider positive sustainability impact that responsible corporations can drive, and will ensure that the ESG reporting gap starts to narrow down, especially on sustainability parameters that are most critical for their supply chains or business ecosystems.
(Sumit Kumar is the Founder of ESG Intelligence, a research firm involved in tracking ESG performance of technology companies and exploring how emerging technologies such as blockchain are being adopted across the world to create sustainable ecosystems.)