Environment, Social and Governance (ESG) considerations in business – the new normal – Part 2

17 October 2021

Charles Tungwarara, Head of Business Process, ESG & Sustainability |

In our previous article, we highlighted key aspects on Environment, Social and Governance (ESG) considerations as the new normal – background and evolution of ESG, ESG in the UAE, and ESG reporting requirements in the UAE. For details - please read the article on this page Environment, Social and Governance (ESG) considerations in business – the new normal – Part 1..

In this article, we will discuss how listed companies in the UAE can comply with the ESG reporting regulatory requirements and how non-listed companies can also start voluntary ESG reporting. Some non - listed entities and government departments were already publishing sustainability reports as part of their annual reporting.

ESG, like any other overarching process such as quality, should be embedded in all business processes. This is not a one-day event but a journey with focused targeted milestones which should be periodically monitored. The journey is a bit easier for some of the companies already publishing sustainability reports on a voluntary basis as they will only need to align their reporting to the requirements of the regulator i.e SCA

ESG is still a new concept for most board members, directors, and employees. The intention by the regulator is not compliance but for companies to realise value by implementing ESG. It is this value that should provide an incentive to companies to implement ESG. The first activity is to create awareness for all employees to ensure they have buy-in and that every employee carries the same vision when the ESG framework is implemented. It has been observed that once employees are aware of the importance of any process and there is something in it for them, they will follow – sustainability of operations protects the company’s long-term bottom line.

The success of ESG in any organisation goes beyond having policies and procedures or an ESG Framework – its more about the tone at the top. After the board and senior management become aware of the importance of sustainability of operations, do they set the right tone for employees and stakeholders? This calls for weaving ESG into the strategic planning process and into sub-processes such as the supply chain.

The second step after creating awareness on employees is to develop an ESG framework -that will ensure a structured way of embedding ESG in all business processes and a consistent monitoring and reporting mechanism. ESG should be implemented using an internal control framework to ensure that consistent and sustainable results are achieved. The result of ESG is factual reporting of actual results measured against key indicators which the company selects.

Developing a consistent process to identify the critical risks in ESG and the relevant controls to mitigate those risks is very important. Good guidance to use in developing this can be the Committee of Sponsoring Organisations (COSO) and World Business Council for Sustainable Development (WBCSD) – Applying Enterprise Risk Management (ERM) to ESG-related Risks issued in 2018. The guidance helps entities better understand the full spectrum of ESG risks and to manage and disclose them effectively.

The Relevant Activities are:

To identify governance and culture for ESG-related risks;
Set strategy and objectives for ESG-related risks;
Undertake risk assessment for ESG-related risks (identifies risk, assesses, and prioritises risks implements risk responses);
Review and revise ESG-related risks; and
Set up information, communication and reporting for ESG-related risks.

Using this guidance, key risk categories for ESG can be identified and categorised as strategic risks, operational risks, and compliance risks. These risks can further be mapped into Environment (E), Social (S), and Governance (G). For example, a strategic objective might be to produce green products or services (E) in the next five years and the potential risk is clients and stakeholders boycott due to “greenwashing” i.e., when the company discloses and misrepresents that its products and services are green when they are not. The control might be periodic independent audits of the sustainability reports.

This process may be combined with the overall enterprise risk management process by ensuring that the end-to-end risk management process incorporates ESG factors.

When it comes to ESG frameworks, there is no one size fits all. Companies may adopt one framework or a mix of more than one depending on the organisation's sector. Some of the most popular ESG frameworks include Global Reporting Initiative (GRI), Sustainable Accounting Standards Board (SASB) and Task Force for Climate-related Financial Disclosures (TCFD).

Developing the ESG framework and reporting is not the end – it is a journey. Organisations will need to invest in the right people with expertise in ESG who drive the ESG agenda across the organization and coordinate the periodic data gathering and annual reporting. Organisations will also need to know their current ESG maturity level, set future target maturity, and put actions to meet the target maturity.

BDO has identified a 5-stage ESG maturity roadmap as follows:

Activating – emerging and still assessing and prioritising materiality risks and opportunities.
Compliant – business has elements of a sustainability program and is still reacting to regulatory requirements.
Proactive – sustainability program is approached systematically and holistically boosting value creation opportunities.

Strategic – business has embedded sustainability across most parts of the business.

Purpose-driven – Business has embedded sustainability across all parts of the business and uses ESG criteria beyond regulatory requirements.

It takes time to move from maturity stages (a) to (b). However, with a maturity targeted approach and constant review and performance monitoring, this can be achieved progressively.

The ESG framework will need to be reviewed periodically by independent assessors/auditors to ensure that it is best for the size, scale, and nature of the business. At BDO, we work with organisations in various sectors. We have multiple tools that businesses can use to undertake quick health check. Some of the tools are as follows:

Sustainable finance – ESG portfolio due diligence tool
Smart and sustainable communities – Smart and sustainable cities tool
Enterprise Risk Management Applying enterprise risk management to environmental, social, and governance-related risks October 2018 (COSO and WBCSD)
BDO Survey: Fourth year ESG reporting performance survey shows the evolvement in overall ESG involve - BDO
Energy transition – Energy Transition Diagnostic tool

Whenever there is a report with quantitative and qualitative information, the report's credibility becomes an issue. Companies may be tempted to overstate their ESG performance to give a good impression to shareholders and stakeholders, especially at the ‘activating’ and ‘compliant’ stages. Companies may find it helpful to bring in an independent third party to validate the contents of the Sustainability/ESG report.

This year, BDO in Hong Kong' s Survey entitled "The ESG Reporting Performance of Hong Kong Listed Companies” randomly sampled 400 of the most recent ESG reports published on or before 31 July 2020. Some of the issues that came up from the survey are:

Board oversight - Boards are increasingly involved in ESG governance - 54% of the companies disclosed information about the board's oversight of ESG issues.

Reporting quality - only 48% of surveyed companies disclosed standards, methodologies, assumptions, calculation tools, and conversion factors used to report emissions or energy consumption data.

Quality of materiality assessment disclosure - 60% of the companies disclosed that they had conducted a materiality assessment. In comparison, the rest of the remaining 40% did not provide any information about materiality in their ESG reports.

Disclosure of issues related to climate change - only 12% of companies cited issues related to climate change.

Target-setting for environment KPIs is limited - Only 15% of companies set targets for environmental KPIs, and these targets were mainly set by large, listed companies

Independent assurance on ESG reporting - independent assurance was obtained for only 5% of the ESG reports published by the companies..

Johnson Kong, Managing Director with BDO in BDO Hong Kong, remarked that " green finance is increasingly becoming more important amid the increasing ESG awareness in the investment community since the outbreak of Covid – 19. Transparency and accuracy of ESG reporting are now very important as investors and capital markets institutions factor ESG performance into investment decisions. They often consider ESG-related information to determine whether a company is adequately managing risks.

The future of a business can be viewed through an ESG lens. Investors are now considering ESG when investing, and they are increasingly focusing on long term sustainability; hence there is a global reallocation of capital towards ‘green economy’., There will be increased sustainability linked lending to business, and organisations that have not embedded sustainability in their operations will find it difficult to attract capital. There is an increasing likelihood of lower borrowing rates for ‘green organisations. Financial institutions and private equity funders are including ESG risk factors as part of due diligence. It is the responsibility of every organisation to start the ESG journey and to create a sustainable bottom line for the future.

From our experience, there are three areas that it is especially important for international businesses to focus on when setting up. These are the ‘directed and managed’ test, the interpretation of the test around having sufficient resources in the UAE and the special rules for intellectual property businesses.