By CPA Dr. Nyatete Kenyanya
Consumers Enjoy Expanded Options in Products
Environmental, Social and Governance (ESG) sustainability issues have formed part of corporate management for a considerable duration now. Nevertheless, ESG has gained significant attention in recent times due to a multitude of reasons: corporations experiencing a heightened sense of social and ethical consciousness concerning the influence they aim to create; investors’ determination to establish enduring, sustainable business frameworks; amplified expectations from clients and other vested parties demanding greater transparency; and the introduction of fresh local, regional, and worldwide regulations that impose obligatory compliance standards.
Additionally, through ESG reporting, consumers enjoy expanded options in products, enhanced product excellence, and enhanced customer experiences, all while incurring diminished expenses. For internal stakeholders, especially marginalized minorities and individuals with disabilities, there is an increased allocation of resources, improved working conditions, and heightened economic stability. Companies exhibiting robust ESG performance also play a pivotal role in aiding governments to fulfil their objectives related to carbon reduction and sustainable development commitments. Of particular concern are investment strategies, disclosure requirements and procedures, and impact measurement. Several issues have formed discussion points in ESG. These span from investment in ESG, and disclosure requirements and procedures. The impact measurement of ESG has however received very low attention.
ESG reporting is anchored on an international and local regulatory framework. The International Sustainability Standards Board (ISSB) Exposure Draft IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information, published in March 2022 proposed general requirements for an entity to disclose sustainability-related financial information about its sustainability-related risks and opportunities. This gave birth to the IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information in June 2023. IFRS S1 prescribes how an entity prepares and reports its sustainability-related financial disclosures. The standard which will be effective for annual reporting periods beginning on or after 1 January 2024, sets out general requirements for the content and presentation of those disclosures so that the information disclosed is useful to users in making decisions relating to providing resources to the entity.
In Kenya, the ESG regulatory framework is contained in fragmented laws and regulations spanning the three pillars. Article 42 of the Constitution of Kenya enshrines the right to a clean and healthy environment for every person. The Kenya Green Bond Programme (KGBP) which was launched in 2017 to enhance ‘green’ investments resulted in the Capital Markets Authority (CMA) issuing a Policy Guidance Note on Green Bonds in February 2019. Elsewhere, Central Bank of Kenya (CBK) issued the Guidance to Financial Institutions in 2021on how to integrate climate-related management into their business decisions and activities. These are some of the regulations on the Environmental pillar which pertains to the dedication a company has to reduce waste and their carbon footprint.
With increased social media-driven consumer activism in Kenya, companies have realised that consumers want to be associated with socially responsive brands. Related to the Social pillar, the CMA has issued Guidelines on Corporate Governance Practices by Publicly Traded Companies, which require Boards to implement policies that assure diversity, including female diversity, in their composition. The NSE has also set a goal for Kenya’s listed businesses to have at least a third of the board members be female. Additionally, the Data Protection Act 2019 which will impact how organisations in Kenya manage the data that they collect is in its implementation stage. All these laws and regulations will anchor the social pillar.
To cultivate and maintain economic growth, the significance of governance matters as the last pillar of ESG has been steadily increasing. In this pillar, a corporation must analyze or accept the calculated risk of a particular investment, and how it will ultimately impact them financially. A fundamental structure for addressing governance-related concerns is provided by the Companies Act of 2015, which imposes personal accountability on directors of companies to ensure adherence to regulations. Furthermore, numerous companies are electing to embrace global industry best practices by aligning themselves with standards and reporting indices such as the IFC Performance Standards, Sustainability Accounting Standards Board (SASB), and the Global Reporting Initiative (GRI). In line with this, both the CBK and NSE have introduced guidelines that necessitate active involvement from the board of directors and senior management in crafting and executing ESG strategies, policies, and reporting mandates. In conjunction with the Companies Act, this places an increased burden on company directors to provide reports concerning ESG matters.
While significant steps have been made in the regulatory front, reporting remains primarily optional, resulting in inconsistencies. This is mainly because a universal reporting standard is absent, giving companies the freedom to select from an array of metrics and third-party disclosure frameworks for their ESG reporting. These standards can either be utilized individually or in combination. This situation often proves perplexing and costly for many companies. Furthermore, owing to the voluntary nature of ESG reporting, regulators have frequently embraced a “comply or explain” approach. In essence, this signifies that only ESG subjects that have been codified into substantial law are subject to enforcement, while all others are regarded as recommended or reflective of best practices. Consequently, instances of greenwashing have arisen, where corporations present misleading information about the attributes of certain products, services, and levels of compliance to conform superficially to regulations. This poses a tangible risk of legal action and damage to reputation.
Even with the heightened awareness of ESG reporting and regulation, a significant gap appears to exist between the varied expectations of different stakeholders, not just concerning reporting, but also regarding the actual impact of such reporting on corporations. For instance, consumers desire businesses to take on a larger role in expediting progress on ESG issues, whereas corporate executives assert that considerable advancements have been achieved in this pursuit. As an illustration, findings from a PwC Consumer Intelligence Series survey conducted in 2021 regarding ESG demonstrate that consumers hold differing viewpoints from business leaders regarding the direction of ESG investments, and they seek ESG-related information from sources different from where businesses currently provide it. The PwC report shows that consumers and employees believe that corporates are just complying with regulations and not making any substantial investments in making sustainable improvements to the environment and society. This then begs a question; how best can organizations measure the impact of ESG investment so that there is goal congruency among stakeholders?
In management science, accurate measurement is the precursor to effective management. To effectively evaluate an organization’s performance on ESG aspects such as decarbonization, workforce diversity and use of ethical supply chains, equally effective measurement tools must be developed. Assessing the effects of ESG brings numerous advantages to organizations. Through the measurement and disclosure of ESG performance, companies can cultivate and solidify trust among stakeholders. Grasping the implications of ESG impact measurement aids in recognizing potential challenges and prospects tied to ecological and societal concerns. Furthermore, as ESG metrics correlate with resource efficiencies like energy and water, tracking them enables organizations to enhance operational effectiveness and cut expenses. Moreover, it paves the way for accessing a broader range of capital, given the heightened interest from more investors and lenders in robust ESG performance. This could also serve as an effective method to bolster brand reputation and stand out from competitors.
As it is now, the measurement of ESG impact on organizations is highly theoretical especially for corporations in the emerging economies such as Kenya. Many existing ESG measures already very effectively capture inputs, but they presume causality. For example, an organization involved in decarbonization is presumed to cause a positive impact on the environment. However, the measurement of this impact remains unclear in real terms. Today, a range of objective ESG data, metrics and criteria can be used to track and measure ESG performance across industries and businesses. Theoretically, ESG metrics encompass both numerical and descriptive gauges utilized to evaluate a company’s ESG performance. Essentially, stakeholders and investors gauge the organization’s proficiency across all three dimensions. This can encompass various aspects, such as carbon emissions, energy consumption, waste handling, workplace security, employee welfare, community engagement, philanthropic initiatives, and more. All these are at the input stage. Academic and industry practitioners therefore need to develop specific measures of ESG outputs against which companies will be evaluated.
Currently, ESG measurement is dangerously narrow. It fails to capture the complex, systemic nature of social and environmental systems, and indeed that of business organizations themselves. ESG measurement tools that evaluate the ESG performance of a company or investment portfolio with the aim of providing a comprehensive understanding to stakeholders, investors and other related parties, are at their infancy either in development or in implementation. The most common metrics that have been developed include;
(i) ESG Ratings and Scores: These ratings are provided by specialized rating agencies such as Refinitiv, Moody’s and Bloomberg that collect data from the organizations to evaluate ethical practices. One of the most common ESG rating systems is MSCI. Others are FTSE, ISS, Sustain analytics, etc. Internally, organizations can use the Global Reporting Initiative (GRI) or the Task Force on Climate-Related Financial Disclosures (TCFD), as well as self-analysis to self-rate.
(ii) ESG Indices: These are stock indexes that track the performance of companies that meet specific ESG criteria.
(iii) ESG Audits: It is a good idea to go with audits conducted by third-party agencies that can provide you with a transparent assessment, considering all the ESG factors, and help you make a better decision.
Dr. Nyatete (Ph.D) is a Lecturer of Accounting and Finance at KCA University. ([email protected]