ESG: What Is It?
ESG stands for environmental, social, and governance. It is a group of factors that assess and measure how an organization impacts the environment and society. The goal of ESG is to capture all the nonfinancial risks and opportunities inherent in a company’s day-to-day activities. ESG is a set of values for how a company operates in regard to Earth and its people.
Environmental criteria examine how a company performs as a steward of the planet. They include issues focused on climate risks, carbon emissions, energy efficiency, use of natural resources, pollution and biodiversity, waste management, and water usage. Social criteria examine how a company manages relationships with employees, suppliers, customers, and the communities where it operates. They include issues focused on human capital, labor regulations, diversity, equity, and inclusion, human rights and community involvement, privacy and data protection, health and safety, supply-chain management, and social justice issues.
Governance defines a set of rules and best practices, along with a series of processes that determine how an organization is managed and controlled. It includes issues focused on diversity, corruption and bribery, business ethics, compensation policies, strategic sustainability, oversight and compliance, political contributions, lobbying, and general risk tolerance.
ESG reporting is typically done by publishing a sustainability report, although more and more companies are disclosing data through webpages that showcase the company’s ESG performance in addition to a more standard report. In the United States, there is no affirmative duty to provide disclosures on ESG matters at the federal level, although the Securities and Exchange Commission (SEC) requires all public companies to disclose information that may be material to investors, including information on ESG-related risks, and requires disclosure of whether and how diversity is considered a factor in the process for considering director candidates. As a practical matter, however, it can be anticipated that important stakeholders, such as investors, insurance companies, lenders, regulators, and others, will increasingly look to companies’ disclosures to evaluate whether those companies have embraced ESG agendas. Even in the absence of an obligation to disclose, the substance of the information that companies choose to report regarding their actions to identify and manage ESG risks and opportunities will be subject to securities laws.
Opportunities in ESG
It is anticipated that ESG programs are going to eclipse the two major corporate compliance and financial industry regulatory revamps of recent decades in terms of company cost and investment. The Sarbanes-Oxley Act, created to address massive failures in corporate auditing and compliance functions, costs the average large company about $1.4 million annually in related compliance costs and the average smaller company about $890,000, according to Protiviti Consulting.
The Dodd-Frank Act, enacted in 2010 in response to the global financial crisis, added roughly $50 billion annually to financial industry compliance costs. As there is currently no single comprehensive regulatory statute on ESG, its agenda is being driven largely by the investment community. But regulators are now considering new rulemaking. In March, the SEC proposed rules requiring public companies to disclose extensive climate-related information in their SEC filings. And in late May, the SEC proposed rules seeking to standardize disclosures related to ESG factors made by investment funds, including scrutiny of funds that include “ESG” in their names.
Talking the Talk and Walking the Walk
Corporate clients are demanding that their legal service providers act responsibly and demonstrate their own internal commitment to ESG. Beyond clients, though, law firms’ legal and nonlegal workforce and potential hires also expect it. PwC recently reported that 86 percent of employees prefer to support or work for companies that care about the same issues they do.
A 2021 Forbes article coined Gen Z the “Sustainability Generation.” This is also the next generation of lawyers. It is vital that firms engage with them, not only to secure the best talent from a generation wanting to work with value-oriented firms, but to also learn more from their perspectives. Law firms must do more to align their actions and values with the next generation. And it is not just incoming talent—a survey from legal and business services provider DWF determined that 40 percent of companies found it difficult to hire talent due to a perception that their ESG policies are weak.
Clients and prospective clients want to see law firms “walk the walk and talk the talk.” Prospective clients want to hire lawyers who have worked with ESG in their own firms to help them create their company’s ESG structures and policies. In the 2021 Landscape Survey conducted by the Law Firm Sustainability Network, 87 percent of respondents said that they received requests for proposals that included questions about firms’ environmental efforts. Large international firms are also being asked to create practice groups to guide clients’ ESG activities, financial investment risk assessments, and responses to the ever-growing crop of national and international regulations. According to a 2020 desktop survey by The Blended Capital Group, over 50 law firms worldwide offer integrated ESG services. According to Thomson Reuters data, 42 percent of its BigLaw clients have ESG practices.
“The world is moving in one direction: more sustainability, more accountability, more responsibility. You can no longer be just left alone and pretend that nothing’s happening around you,” Olga Ivannikova, United Kingdom, said in a Law360 article regarding social responsibility.
“This whole movement towards ESG is a huge opportunity for law firms to collaborate with their clients for the greater good, because every company is trying to figure out whatever the next normal is going to be. And lawyers are the hub of every industry in the world,” offers Pamela Cone, Chicago, IL, in the same Law360 article. “They can affect change.”