Sustainability and ESG: What’s the difference?
Sustainability and ESG issues are not the same, despite the trend to use them interchangeably. Unpacking these two terms can help understanding.
Reporting on sustainability and ESG issues enables companies to improve their sustainability strategy and investors to achieve better decision-making in allocating resources to sustainable activities
Sustainability and ESG (or environmental, social and governance) issues are not the same. You might think that they were given the current trend to use the terms interchangeably to describe non-financial reporting obligations. However, sustainability is a much broader concept, about meeting the needs of the present generation without compromising the ability of future generations to meet their own needs. It’s worth unpicking these two terms a little.
The legal landscape around sustainability is fast-changing, watch this space as we continue to update as new developments arise.
Sustainability is about how we meet the need to respect and live within planetary boundaries (Cf. Rockström et al 2009). Sustainability is commonly referred to as having three pillars: environment, economy, and society. While week sustainability puts equal weight on the pillars and seek to balance them, strong sustainability weights them differently, adds an ethical touch to the concept, and sees natural capital as not being substitutable (Cf. Giddings 2002; Winter 2007; Bosselmann 2008). Despite the differences, there is consensus that the concept of “sustainable development” originated in the 1970s. The report Limits to Growth was published in 1972 by the Club of Rome and the United Nations Conference on the Human Environment, known as the Stockholm Conference, took place the same year. The Club of Rome report noted that countries must recognize and respect absolute limits to growth, especially population growth, to avoid economic, social, and environmental collapse.
The Stockholm Declaration on the Human Environment includes the statements:
Principle 2 The natural resources of the earth, including the air, water, land, flora and fauna and especially representative samples of natural ecosystems, must be safeguarded for the benefit of present and future generations through careful planning or management, as appropriate.
Principle 13 In order to achieve a more rational management of resources and thus to improve the environment, States should adopt an integrated and co-ordinated approach to their development planning so as to ensure that development is compatible with the need to protect and improve environment for the benefit of their population.
Principle 14 Rational planning constitutes an essential tool for reconciling any conflict between the needs of development and the need to protect and improve the environment.
There was one key difference between the Club of Rome report and the Stockholm Declaration: the former saw economic growth as being incompatible with ecological sustainability, and the latter aimed to reconcile them (Bosselmann 2008).
The term “sustainable development” was popularized by the 1987 Brundtland Report on Our Common Future by the World Commission on Environment and Development (WCED) of the United Nations. It defined the term as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs”.
The concept has been further developed over time, especially at the United Nations Conference on Environment and Development (Rio Earth Summit or Rio-92) in 1992, and with the adoption of Agenda 21. These both recognized that both economic and environmental issues must be part of ongoing development.
More recent development of the concepts of sustainable development and sustainability include the mentioned discussions on the weight put in the pillars and other ethical or nature-based elements. Without going in depth on these concepts, the fact is that sustainability is embedded in the legal system and pursued by companies, investors, and individuals globally. For example, the European Green Deal will transform the EU based on sustainability principles to, among others, be the first climate-neutral continent while leaving no one behind and halting and reversing biodiversity loss.
Environmental, social and governance (ESG) issues
The ‘alternative’ three pillars of environmental, social and governance issues emerged from the need to evaluate enterprises across non-financial factors. It followed growing concern from investors about potential financial risks from climate change and other environmental, social, and governance matters.
Socially responsible investing practices date back to the 1960s. However, the term ESG is widely agreed to have originated in the 2004 Global Compact report Who Cares Wins: Connecting Financial Markets to a Changing World. The report includes recommendations for the financial industry to integrate ESG issues into analysis, asset management, and securities brokerage.
Over time, several disclosure systems, standards and frameworks have been created, including the CDP (former Carbon Disclosure Project) in 2000, the United Nations Principles for Responsible Investment (PRI) in 2005, the SASB Standards in 2011, the Task Force on Climate-Related Financial Disclosures (TCFD) in 2015, and the International Sustainability Standards Board (ISSB) in 2021The creation of the ISSB to develop a global baseline of sustainability disclosure standards that meet investors needs is described by Forbes as “the biggest change in corporate reporting since the 1930s”. ISSB standards will adopt the TCFD recommendations and are expected to be published in 2023 and effective as of January 2024 for disclosures in 2025.
The TCFD recommendations are a notable example of how ESG concerns (especially climate) have been increasingly adopted and framing a global disclosure approach. The TCFD recommendations are a framework for companies to disclose climate-related financial information through their existing reports. They are widely (and rising) adopted by governmental and regulatory authorities, international and regional standard setters, and stock exchanges. The U.S. Securities and Exchange Commission and the Canadian Securities Administrators (CSA) proposed rules to mandate climate-related disclosures aligned with the TCFD recommendations. Japan, Switzerland, and New Zealand already require listed companies to disclose TCFD-aligned sustainability information. The draft European Sustainability Reporting Standard (ESRS) on climate change (ESRS E1) also adopts the TCFD recommendations and will become mandatory soon. These are just to mention a few.
Finally, when discussing ESG, one must not forget another landmark in reporting: the EU Corporate Sustainability Reporting Directive (CSRD) or Directive 2022/2464, which amends Directive 2014/95 (the EU Non-Financial Reporting Directive – NFRD). A landmark because it consolidated sustainability reporting based on the concept of double materiality (which encompasses impact and financial materiality) and further clarified the differences between sustainability and ESG. (More on that in a future article – watch this space!).
Acronyms getting you down? Use our glossary of the most-used ESG terms to avoid confusion.
Sustainability and ESG reports: a confusion of terms
The naming of non-financial reports increases the confusion between sustainability and ESG in the reporting realm. The precise term used depends on the framework or standard used by reporters, or the regulations that apply. For example, the mentioned TCFD recommendations aim to help companies disclose climate-related risks and opportunities in their existing reporting processes.
Concerning international standard setters, the ISSB Exposure Draft IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information proposes overall requirements for organizations to disclose sustainability-related financial information about their significant sustainability-related risks and opportunities as part of their general purpose financial reporting:
According to the mentioned exposure draft, it “does not state which entities should be required to disclose interim sustainability-related financial information, how frequently, or how soon after the end of an interim period”. The exposure draft also mentions that mandating disclosures according to ISSB standards is a competence of governments, securities regulators, stock exchanges and accountancy bodies, which may require entities whose debt or equity securities are publicly traded to publish interim reports. In addition, the draft standard explains that entities may be required or choose to provide less information at interim dates than in annual disclosures to avoid repetition of information, costs, and ensure timely disclosures.
The Global Reporting Initiative (GRI) issues sustainability reporting standards covering impact on the economy, environment, and people (including effects on human rights). These standards do not, however, name the report required. The GRI considers sustainability reporting to be the process of reporting and not the report itself. The objective of sustainability reporting using GRI Standards is to provide transparency on how organizations contribute to sustainable development. More specifically, GRI Standard 1: Foundation 2021 clarifies that reporting entities can publish or make information available using several formats (such as electronic or on paper) and across locations (such as a standalone sustainability report, web pages, or an annual report).
Stock Exchanges have also got in on the act as they increasingly require ESG or sustainability disclosures as listing obligations. Stock Exchanges commonly refer to such listing obligations interchangeably as “ESG reporting” or “sustainability report.” For example, the London Stock Exchange Group has published a Guide to ESG Reporting stating that “many companies use ‘sustainability’, ‘corporate responsibility’ or ‘corporate social responsibility’ to refer to strategies or programmes related to environmental, social or governance (ESG) activities.” The guide does not directly recommend a particular term. However, it uses the terms ‘ESG’ and ‘ESG reporting’ because these are common in investing.
The GCC Exchanges Committee, chaired by the Saudi Exchange and comprised by others, such as Abu Dhabi Securities Exchange, Bahrain Bourse, Qatar Stock Exchange, and Dubai Financial Market, has also published a unified ESG metrics for GCC listed companies. The Saudi Exchange, for example, explains under its ESG Disclosure Guidelines that they use the term “ESG” because it is commonly referred among market participants but that the term “sustainability” is more popular among companies. For that, the guidance uses both terms to describe “the broad set of environmental, social and governance considerations that can affect a company’s ability to execute its business strategy and create value”. The Guidelines also refer to ESG factors as “non-financial” or “extra-financial” factors.
As for regulators, in Brazil, the Central Bank of Brazil (BCB) Resolution 139 of 15 September 2021 introduces another term. The resolution sets obligations on financial institutions and others authorized to operate by the BCB of segments 1, 2, 3, and 4. These include multiple, commercial, investment, or foreign exchange banks carrying out relevant international activities, regardless of their size. These bodies have to publish a Report on Social, Environmental, and Climate Risks and Opportunities (GRSAC Report) annually on their website and keep it available for 5 years.
Finally, the landmark CSRD defines “sustainability reporting” as reporting information related to sustainability matters, including environmental, social, and human rights, and governance factors. Such sustainability matters include environmental, social and employee matters, respect for human rights, and anti‐corruption and anti‐bribery matters, according to Regulation 2019/2088 or Sustainable Finance Disclosure Regulation (SFDR). The CSRD requires, in summary, large undertakings, listed small and medium-sized enterprises (SMEs) except micro undertakings, and third-country companies having a certain net turnover in the EU and a subsidiary or branch in the EU to include the required sustainability information in their management report according to the mandatory standards (the above-mentioned ESRS, which are still under draft).
Sustainability and ESG: The bottom line
Various governmental and non-governmental bodies have linked sustainability and ESG. For example, the International Organization of Securities Commissions (IOSCO) has made clear that sustainability includes ESG issues. A UK government report Greening Finance: A Roadmap to Sustainable Investing suggested that the two were broadly similar, because voluntary reporting on sustainability tended to focus on the three ESG elements.
The real point is that reporting on sustainability and ESG issues enables investors to better allocate resources to sustainable activities. Reporting also provides useful information for other stakeholders, including governments, clients, workers, supply chain providers, and communities. It therefore plays a significant and necessary role in ensuring accountability and transparency. Finally, reporting gives companies themselves an opportunity to move towards sustainability and identify gaps to ensure they are protecting people and the planet. This has ancillary huge benefits, including the ability to attract investors, talent and clients, and a better company reputation.