Baranga Laurentiu

Download as pdf or txt
Download as pdf or txt
You are on page 1of 8

Introducing the ESG reporting

JFS – benefits and challenges -

INTRODUCING THE ESG REPORTING


– BENEFITS AND CHALLENGES -

Laurențiu Paul Barangă1*, Elena-Ioana Țanea2


1), 2)
Bucharest University of Economic Studies, Bucharest, Romania

Abstract
Sustainable finance represents an important concern of the European Union lately,
having an essential role in achieving the political objectives of the European Climate
Pact. It is interpreted that it supports the sustainable development of economy,
simultaneously reducing the pressures on environment and taking into consideration
social and governance aspects.
The scope of sustainable finance is to improve the financial sector in the context of
fighting against climate changes. Considering this purpose, the ESG factors
(Environmental, Social and Governance) must be considered in the decisional process
regarding the investments of the financial entities, promoting long-term investments in
sustainable economic activities and projects.
There are many legislative actions at the European level, transposed into national
legislation or with direct applicability in Romania for determining developing
sustainable economies that beneficially impact the environment and climate changes.
The action plan of the European Commission regarding developing a strategy for the
sustainable finance contains ten initiatives grouped into three chapters: reorienting cash
flow to a more sustainable economy, including sustainability elements in risk
management, encouraging transparency and long-term vision.

Keywords
ESG, environment, social, governance, scoring.

JEL Classification
G30, G41, M14, Q50

Introduction
ESG represents environmental, social and governance factors which can affect the
financial performance of an entity.

*
Corresponding author, Laurențiu Paul Barangă – barangalp@yahoo.com.

174 Journal of Financial Studies


Studies and Research JFS
Environmental factors refer to an entity impact on the environment (pollution,
greenhouse gas emissions). They include climate mitigation, adaptation to climate
changes, biodiversity protection, sustainable use and protection of water and maritime
resources, transition to a circular economy, waste avoidance and recycling, reduction of
environmental pollution, healthy ecosystems protection, and sustainable use of lands.
Social factors reflect the entity’s relationship with its employees, clients and other
stakeholders. They assume compliance with recognised labour standards (no child
labour, forced labour or discrimination), safety and health at work, adequate
remuneration, equitable work conditions, diversity and developing opportunities, trade
union rights, product safety guarantee, and consideration of the interests of communities
and social minorities.
Governance factors mirror how an entity is directed (internal control, transparency,
audit) and they include fiscal honesty, anticorruption measures, sustainability
management, remuneration of the Board of directors, data protection guarantee, and
information disclosure.
Considering the novelty of ESG reporting, companies are faced with more questions
about what and how they need to report, assessing the advantages and disadvantages of
new regulations.
This paper aims to define ESG considerations, viewed from three perspectives:
investment advisors, financial entities and the issuers, in the context of adapting the
main actors to the new ESG reporting frameworks. Thus, it provides an opinion about
the strengths and the struggles of implementing ESG, using the literature review study
as a working methodology.
In the following, we will discuss about ESG reporting, the benefits and the challenges
brought with it and finally, we will detail the steps Romanian companies have taken to
implement ESG, to align with the new environmental requirements.

1. Literature review
The ESG problematics are new and for that reason, the literature does not include many
researches regarding the impact of these topics on all the stakeholders identified by the
new EU regulations issued to apply the European Climate Pact.
According to Henisz, W. et al. (2019), a strong ESG proposition can create value for the
business, improving equity returns and linking to cash flow in five important ways:
facilitating top-line growth, reducing costs, minimising legal interventions and
regulations, increasing employee productivity, optimising investment and capital
expenditures.
A study made by Broadstock, D.C. et al. (2021) about the impact of the ESG during the
COVID-19 financial crisis in China, showed that ESG performance lowered financial
risk, considering CSI300 constituents.

Vol. VII • No. 13 • November 2022 175


Introducing the ESG reporting
JFS – benefits and challenges -

However, a research realized by Prol, J.L. et al. (2022) concluded that optimized ESG
equity portfolios in the NYSE for two years provided a lower return and lower volatility
that the less optimized ones.
Given its new character, there are several concerns arising about ESG disclosure:
ensuring consistency and relevance in reporting frameworks, the elements of ESG
scoring, understanding performance and materiality, transparency and public and
regulatory engagement, as mentioned by Boffo, R. et al. (2020).

2. ESG benefits
Strong implementation of the ESG framework can create value for the business,
improving equity returns and linking to cash flow in five important ways: facilitating
top-line growth, reducing costs, minimising legal interventions and regulations,
increasing employee productivity, and optimising investment and capital expenditures.
Top-line growth - A strong ESG proposition helps entities to achieve new markets and
to expand into existing ones. When companies gain government authorities trust, they
are more likely to get approvals, licenses and access that provide growth opportunities.
Cost reductions - ESG implementation can also contribute to costs reduction, by
lowering energy consumption and reducing water waste.
Reduced legal interventions and regulations - As mentioned before, gaining
government authorities trust can be beneficial to the companies, helping them to achieve
greater strategic freedom and less regulatory pressure. This can lead to earning
government support in future actions, for example obtaining subsidies.
Employee productivity increase - A strong ESG perspective can attract and retain
quality employees, boost employee motivation and increase productivity.
Investment and capital expenditures optimization - ESG approach can improve
investment returns by using capital in more sustainable actions that are beneficial to the
entity for a long-term period.
In addition to those presented above, there are also the following benefits brought by the
implementation of ESG principles: ensuring consistency and relevance in reporting
frameworks; ESG scoring; understanding performance and materiality; transparency;
public and regulatory engagement.
Ensuring consistency and relevance in reporting frameworks - The recent years had
provided multiple ESG frameworks and given the fact that there is not a global standard
for ESG, each company has to be careful in disclosing ESG information, aligning with
the reporting frameworks and keeping updated with all the changes, ensuring
consistency and relevance in what they report.
ESG scoring - ESG scoring appeared as a necessity to ensure protection of the investors
and to allow comparability through companies to know which one promotes a better
‘green’ vision and which one is better to invest in. However, establishing ESG scores is

176 Journal of Financial Studies


Studies and Research JFS
not an easy task for companies that are already trying to familiarize themselves with the
multiple reporting frameworks.
Understanding performance and materiality - The materiality concept appeared as a
need for addressing the most significant concerns related to ESG. Materiality aligns
with performance, as it refers to the ESG risks that are relevant to a company, which
eventually will influence the profitability of the entity. A company’s materiality
assessment is important as it tells which problems are the most important, the ones that
bring a significant impact on the financial health of the firm.
Transparency - The new reporting frameworks focus on transparency and the obligation
of the companies to comply with the regulations. Sustainable Finance Disclosure
Regulation (SFDR) indicates a few directions for the companies to be considered
transparent: publication of information on policies on the integration of sustainability
risks on the internet, publication on the internet of the main negative effects of the
investment decision on sustainability factors, a statement of due diligence policies,
establishing remuneration policies in terms of sustainability, providing results of ESG
risk assessment.
Public and regulatory engagement - To illustrate the alignment with the ESG initiative,
the companies have to make sure they engage the public and regulatory in their actions,
also improving investors’ confidence. Thus, the promotion of sustainability actions is
essential. For example, this kind of information can be promoted on the companies’
websites, in press articles and during participation at national or global conferences that
addresses ESG and sustainability subjects.

3. ESG reporting
ESG reporting represents the disclosure of environmental, social and governance
information. This has the purpose to improve transparency to the investors and
determining the companies to give attention to the climate changes, by implementing
specific actions and eliminating greenwashing. The ESG reporting is defined through
the following regulatory: the EU Taxonomy, the Sustainable Finance Disclosure
Regulation (SFDR), the proposal for Corporate Sustainability Reporting Directive
(CSRD).
EU Taxonomy establishes a unified understanding of environmentally sustainable
economic efforts in the EU through a system for classifying sustainable activities and
setting performance thresholds, represented by technical screening criteria for six
environmental goals: mitigation of climate change, adaptation to climate change,
sustainable use and protection of water and marine resources, the transition to a circular
economy, prevention and control of pollution, protection and restoration of biodiversity
and ecosystems.
The purpose of the SFDR Regulation is to achieve greater transparency on sustainability
in the financial services sector by setting out obligations to suppliers and distributors of
financial products and services to inform the customers about the impact of

Vol. VII • No. 13 • November 2022 177


Introducing the ESG reporting
JFS – benefits and challenges -

sustainability risk on the profitability of investments and the impact of investments


made on sustainability and also promoting environmental or social characteristics.
The proposal for CSRD Directive is to replace Directive 2014/95/EU (Non-Financial
Reporting Directive) in its entirety and amend the provisions of the Directive on annual
financial statements, consolidated financial statements and related reports of certain
types of undertakings (2013/34/EU), the ‘Transparency Directive’ (2004/109/EC), the
‘Audit Directive’ and the ‘Audit Regulation’ (2006/43/EC and 537/2014). The proposal
for CSRD aims to extend the reporting obligations of sustainability information to all
large companies and all companies with securities listed on regulated markets in the EU,
with the exception of micro-enterprises, to require reporting on a full range of
sustainability information relevant to the company’s activity and to ensure that the
reporting is in line with the mandatory EU sustainability reporting standards that will be
developed by the European Commission. It requires also that sustainability information
to be subject to a limited assurance provided by auditors and enforces companies to
prepare their financial statements and management reports in a digital format, labelling
sustainability information.
The proposal for CSRD Directive stipulates that Regulation (EU) 2019/2089 of the
European Parliament and of the Council, complemented by Commission Delegated
Regulations (EU) 2020/1816, (EU) 2020/1817 and (EU) 2020/1818, brings the
requirement to disclose environmental, social and governance (ESG) information for the
construction of EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks.
Regulation (EU) No 575/2013 of the European Parliament and of the Council enforce
large institutions, which have issued securities that are admitted to trading on a
regulated market to disclose information on ESG risks from 28 June 2022.
Regulation (EU) 2019/2033 of the European Parliament and of the Council and
Directive (EU) 2019/2034 of the European Parliament and of the Council, which
presents a new prudential framework for investment firms, contains provisions
regarding the introduction of an ESG risk dimension in the supervisory review and
evaluation process (SREP) by responsible authorities and contains ESG risks disclosure
requirements, applicable from 26 December 2022.

4. ESG between benefits and challenges


From our point of view, ESG benefits and challenges must be visualised from three
perspectives, where the key players are: investment advisors, financial entities and the
issuers.
Investment advisors can develop now a new area of expertise in the ESG field,
attracting new clients. However, to do that, efforts must be made. Thus, a continual
documentation about ESG reporting frameworks and a new approach of adequacy tests
to determine the risk profile of the investors got to be on their agenda.
Entities that have and promote a ‘green’ strategy are more appealing in terms of
attracting capital and have a better reputation in the market. To provide access to this
facility, they must comply with the Sustainable Finance Disclosure Regulation (SFDR)

178 Journal of Financial Studies


Studies and Research JFS
to meet transparency requirements. This means that they need to dedicate time, material
and human resources to issue new internal procedures, that are well documented and to
modify their policies regarding investments, risk, due diligence and remuneration based
on the achievement of sustainability objectives.
Issuers are also favoured in attracting more buyers as they are promoting green
instruments. Therefore, it is recommended that the financial investment prospectus has
characteristics that are in line with environmental objectives, according to the EU
Taxonomy.
Moreover, ESG reporting brings a new challenge also to the financial auditors, that
must create a new approach of audit engagements to provide an additional limited
assurance report. They will need to invest time into professional development in the
ESG area, communication with the client and developing new analysing skills and
control keys in checking the entities’ information.

5. Actions taken at the national level for the implementation of ESG


To maintain the proper functioning of the internal market for the benefit of the investor,
to improve the functioning of the internal market and to ensure a high level of investor
protection, it was necessary to introduce a regulatory framework setting out minimum
requirements for the EU benchmarks for climate transition activities, the EU
benchmarks aligned with the Paris Agreement (allowing asset portfolios to be aligned to
limit global temperature growth to 1,5˚ above pre-industrial levels).
In this regard, two new categories of benchmarks for low-carbon impact activities have
been regulated. These new benchmark rules are also applicable to benchmark providers.
In Romania, the Bucharest Stock Exchange (BVB) is currently the only entity
authorized by The Financial Supervisory Authority since June 24, 2020, as
administrator of benchmarks. As of February 08, 2022, the first ESG scores of 12
companies listed on BVB are available on the BVB Research Hub platform.
The national provisions regarding transparency on sustainability in the financial services
sector have been included in Law 158/2020 for the amendment and completion of some
regulatory acts. In this law, it has been envisaged to detail the modalities of monitoring
by ASF of certain requirements set out in the Regulation (EU) 2019/2088.

Conclusions
During the research, we learned that, in the long term, the benefits brought to the
investment advisors, entities, issuers and environment are worth the efforts made in
assimilating and familiarizing with the new regulations regarding ESG. The research is
based on the current regulations issued so far, our recommendation being to extend it
when the other ESG related standards (proposal for a Directive on corporate
sustainability due diligence and annex, proposal for Corporate Sustainability Reporting
Directive – CSRD, proposal for European Green Bond Regulation – EuGBR, proposal
for other delegated acts in the form of Regulatory Technical Standards – RTS) will be
published.

Vol. VII • No. 13 • November 2022 179


Introducing the ESG reporting
JFS – benefits and challenges -

In conclusion, although ESG reporting brings new challenges to companies regarding


consistency and relevance in reporting frameworks, ESG scoring, performance and
materiality, transparency and public and regulatory engagement, it is a necessity for the
environment, that in the end facilitates top-line growth, costs reduction, minimisation of
legal interventions and regulatory, employee productivity increase, investment and
capital expenditures optimization.
Implementing ESG reporting impacts all the financial entities, making them to redefine
their activities and the techniques for promoting the financial instruments, to modify the
internal policies (due diligence, remuneration), redefining risks framework and to
ensure training for a specialized human resource, to comply with the new professional
competence requirements.
To achieve the environmental goals, companies and specialists in this field need to be
open and always keep updated with the new legislation and good practices, creating an
active network that acts for the benefit of a sustainable future.

References
[1] Boffo, R., and Patalano, R. (2020). ESG Investing: Practices, Progress and
Challenges, OECD Paris, www.oecd.org/finance/ESG-Investing-Practices-Progress-
and-Challenges.pdf
[2] Broadstock, D.C., Chan, K., Cheng, L.T.W., and Wang, X. (2021). The role of ESG
performance during times of financial crisis: Evidence from COVID-19 in China,
Finance Research Letters, Elsevier, Volume 38
[3] Henisz, W., Koller, T., and Nuttall, R. (2019). Five ways that ESG creates value,
McKinsey Quaterly, November 2019
[4] Prol, J.L., and Kim, K. (2022). Risk-return performance of optimized ESG equity
portfolios in the NYSE, Finance Research Letters, Elsevier, Volume 50
[5] * * * Communication from the Commission to the European Parliament, the
European Council, the Council, the European Economic and Social Committee and the
Committee of the Regions - The European Green Deal (COM/2019/640 final)
[6] * * * Official Journal of the European Union, L 282, 19 October 2016 – Paris
Agreement
[7] * * * Regulation (EU) 2019/2088 of the European Parliament and of the Council
on sustainability‐related disclosures in the financial services sector
[8] * * * Regulation (EU) 2020/852 of the European Parliament and of the Council on
the establishment of a framework to facilitate sustainable investment, and amending
Regulation (EU) 2019/2088 (Taxonomy Regulation)
[9] ASF – Sustainable Finance-Green Transition. Available at:
https://asfromania.ro/en/a/2243/sustainable-finance---green-transition
[10] BVB Research Hub. Available at:
https://bvbresearch.ro/ReportDashboard/ESGScores
[11] Renewed sustainable finance strategy and implementation of the action plan on
financing sustainable growth. Available at:

180 Journal of Financial Studies


Studies and Research JFS
https://finance.ec.europa.eu/publications/renewed-sustainable-finance-strategy-and-
implementation-action-plan-financing-sustainable-growth_en
[12] Strategy for financing the transition to a sustainable economy. Available at:
https://finance.ec.europa.eu/publications/strategy-financing-transition-sustainable-
economy_en

Vol. VII • No. 13 • November 2022 181

You might also like