Although it is assumed that the human-induced climate change effects will happen in the far future, it is an ongoing event impacting the planet. The alarming effects of climate change can be seen in the form of rising sea levels, changing weather patterns, increasing global warming, longer droughts, melting glaciers, floods, hurricanes, wildfires and so on. Human activities such as deforestation, greenhouse gas emission, burning of fossil fuels, etc. have contributed to the staggering effects of climate change. Moreover, we are left with less than a decade to reverse the catastrophic damage caused by it.
This has driven government bodies to enforce stringent environmental regulations and signal a transition towards a decarbonised economy. For example, in the US, the Environmental Protection Agency (EPA) has set tough emission targets for vehicles to reduce carbon emissions by 3.1 billion tonnes through 2050. Further, the US government has urged 50% of all vehicles sold to be Electric Vehicles (EVs) by 20301.
This shift towards decarbonised economy has led companies to assess the materiality risks that can emerge from this transition. Companies are forced to further probe into other ESG risks that may have a material impact on their financial performance. Further, they face mounting pressure from the growing number of eco-conscious investors, especially from the Gen-Z generation, and scrutiny to conduct responsible business. In today’s world, companies are required to broaden their perspective to include their business impacts on the environment.
As businesses across the world are judged based on their contribution to the environment and society, it is increasingly important for companies to disclose their non-financial information such as water and waste management, carbon emissions, air quality, labour practices and data privacy among others.
Conducting a materiality assessment creates a win-win situation for both companies and their stakeholders. By adopting global guidelines, companies can estimate the sustainability risks affecting their business and develop a turnaround strategy, which in turn can create long-term value for their shareholders.
There are multiple reasons why disclosure of ESG-related information is beneficial for investors:
Lowers risk for investors: Disclosing ESG information can help investors make informed decisions, which could lower risks in the long term. For example, a shift toward a low-carbon economy, large-scale adoption of EVs, disruptive technologies, policy changes, etc. could lead to stranded assets. Knowledge about these assets could lower investors’ holdings in the company, thus lowering their financial losses.
Investment decisions: A 2017 EY survey of 320+ institutional investors on the role of ESG reporting by public companies indicates that investors such as hedge funds, mutual funds, pension funds and others estimate the ESG risks informally as opposed to evaluating them methodologically2. However, with growth in ESG reporting standards such as GRI, SASB, TCFD, etc., companies can adopt any of the standards to evaluate ESG risks methodically and incorporate them into their reporting process, which can lower the burden on investors and enable them to make accurate investment decisions.
Better returns: Companies that consistently disclose their sustainability-related material risks can win the trust of stakeholders and build a strong reputation, which can increase share prices over time. Hence, by investing in companies with strong ESG reporting, shareholders can yield better returns in the long run.
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