In today's world, running a business is not just about attaining profit; it also involves considering the impact of the business on the ecosystem and society. This has led to the emergence of ESG reporting, which stands for Environment, Social, and Governance. ESG reporting involves communicating the impact of environmental factors, society, and good governance to the business organisation, as well as the effect of the business organisation on the environment and society. ESG reporting integrates the three Ps: process, people, and policy. It focuses on the relationship between business, nature, and society, emphasising the importance of environmental issues, social responsibility, and good governance. By considering these factors, businesses can ensure their operations are sustainable and contribute positively to society and the environment.
The major elements of ESG reporting can be summarised as follows:
Environment: Businesses have an impact on the environment through their operations. Environmental factors in ESG reporting assess the consideration of the ecosystem by businesses, including issues such as waste management, animal treatment, and natural resource conservation. With increasing industrialisation, the environment has been significantly affected, leading to pollution, the extinction of species, and the development of new diseases.
Social: Social factors in ESG reporting focus on the stakeholders of the organisation, both internal and external. This includes employees, shareholders, suppliers, customers, government, and society at large. Social aspects of business involve the responsibility of the business towards society, such as ensuring employee well-being, spreading awareness, preserving cultural heritage, and increasing employment opportunities. LGBTQ+ equality, racial diversity, and inclusive programs are also considered social factors.
Governance: Governance refers to the overall mechanisms adopted by an organisation to direct and control its operations. Good governance is based on accountability, transparency, responsibility, and fairness. Corporate governance encompasses the interactions and dynamics between a company's leadership, board of directors, shareholders, and other stakeholders. The focus is on establishing procedures and practices that align with the best interests of all stakeholders and inspire trust.
Financial Reporting and ESG & Sustainability Reporting
Communication of financial information to stakeholders is known as financial reporting. The financial statements, including the statement of financial position, statement of comprehensive income, and cash flows, form the core components of financial reporting. These statements solely disclose financial transactions and events, disregarding non-financial elements. The primary focus is on the flow of financial resources and determining the amount of income generated from various activities within the entity, whether through financing or operations. Financial reporting highlights the relationship between business activities and profitability, regardless of their impact on sustainability, the environment, and society.
In contrast, ESG (Environmental, Social, and Governance) and Sustainability reporting serve a different purpose. It assesses the business's impact on society and the environment. This concept recognises that businesses cannot be sustained without addressing environmental risks, societal risks, and the risks associated with good governance. Neglecting the ecosystem and society will hinder the long-term viability of a business. As the planet's resources are finite, they must be utilised with proper care. ESG and Sustainability reporting focuses solely on disclosing non-financial information that has an impact on the sustainability of businesses.
Financial reporting has specified guidelines and standards in every country, which are directed by standards such as IFRS, NFRS, US GAAP, and others. However, there is currently no specific framework and guidelines for ESG reporting in many nations. Financial reporting is mandatory and must be prepared and communicated to stakeholders, including required disclosures as mandated by accounting and regulatory bodies. In contrast, ESG and Sustainability reporting is a voluntary responsibility undertaken by enterprises. In most nations, companies have the flexibility to employ any of the available ESG frameworks for their reporting practices.
Integrated Reporting and ESG & Sustainability Reporting
ESG and Sustainability Reports are annual documents that provide a comprehensive account of a company's efforts, initiatives, strategies, goals, and achievements regarding its environmental, social, and governance commitments. These reports typically adhere to established reporting frameworks such as GRI (Global Reporting Initiative), SASB (Sustainability Accounting Standards Board), TCFD (Task Force on Climate-related Financial Disclosures), CDP (formerly Carbon Disclosure Project), GRESB (Global Real Estate Sustainability Benchmark), SDGs (Sustainable Development Goals), and others. Integrated Reports represent a synthesis of traditional annual reports, which primarily focus on financial information, corporate structure, governance, risk analysis, and market data, along with ESG reports. These reports harmoniously combine both dimensions to provide a comprehensive overview of the company's performance, encompassing financial aspects as well as environmental, social, and governance considerations. ESG reporting involves the disclosure of non-financial factors that impact the sustainability of businesses, while integrated reporting covers both financial and non-financial factors related to the business.
Investment and ESG
Investing in specific sectors or companies has always been a significant concern for investors. They aim to achieve high returns on their investments while minimising risks. There are numerous factors that can impact a business, and investors take those into account when making investment decisions. Nowadays, investors are increasingly interested in sustainable businesses. The focus is shifting from seeking short-term returns to long-term investments.
Many investors now recognise the importance of environmental, social, and governance (ESG) factors in their investment process. These investors go beyond purely profit-driven motives and consider ESG considerations as crucial aspects of their decision-making. They analyse potential risks and seek value creation opportunities by incorporating ESG factors into their investment strategies.
By incorporating ESG risk mitigation requirements, these investors demonstrate a proactive approach to managing non-financial factors that could impact their investment portfolios. They understand that considering ESG issues can help reduce risks and improve financial returns. Numerous studies have consistently shown a positive correlation between effective ESG risk management and financial performance.
ESG investing is a form of sustainable investing that takes into account environmental, social, and governance factors when evaluating the financial returns and overall impact of an investment. Sustainability reporting plays a crucial role in ESG investing as it discloses all environmental and social risks, along with actions taken to mitigate those risks. This provides investors with assurance regarding their investments. ESG reporting serves as a tool for sustainable investment, allowing investors to consider factors beyond financial performance when making investment decisions.Investors are encouraged to allocate their resources based on the ESG score to contribute to a better planet for future generations.
A growing number of investors who adopt ESG risk mitigation requirements recognise that effectively managing environmental, social, and governance factors is not only beneficial to society but also helps generate sustainable financial returns. By incorporating ESG considerations into their investment processes, these investors actively seek companies that align with their values and demonstrate a commitment to long-term success through responsible business practices.
ESG and Sustainability in Nepal
Nepal is currently in the early stages of ESG reporting. Compared to the rest of the world, Nepal has lower carbon emissions, less pollution, and a lesser impact of business activities on the environment. Due to the limited number of industries in Nepal, natural resources such as forests, soil, water, and mountains are yet to be extensively utilised. However, as the country develops and promotes industrialisation, there is a potential for negative environmental impacts. It is crucial to take steps from now onwards to keep the environment clean. Every business organisation needs to pay attention to the risks of environmental degradation and develop mitigation strategies.
By incorporating ESG reporting practices, businesses can provide investors with a comprehensive understanding of potential future events and the impact of their operations on the environment and society.
ESG reporting in Nepal is currently a voluntary responsibility for businesses. The Nepal Rastra Bank has implemented various policy provisions to encourage green investing and incorporate environmental considerations into the decision-making processes of Banks and Financial Institutions (BFIs). One such provision is the introduction of the Environment and Social Risk Management (ESRM) framework which mandates BFIs to assess environmental risks in accordance with national laws before extending credit facilities to businesses. Through the implementation of the ESRM framework, the central bank ensures that BFIs thoroughly evaluate the potential environmental impacts associated with the businesses they provide financial support to. This assessment helps identify and mitigate environmental risks, promotes sustainable practices and reduces the negative ecological footprint of funded projects.
ESRM Guideline
The core objective of the ESRM Guideline is to mandate BFIs to integrate environmental and social risk management into their overall credit risk management process. This integration ensures that the credit authority is fully informed of the environmental and social risks associated with individual transactions before making financing decisions. An Environment & Social (E&S) policy outlines a BFI's vision and mission regarding the environment, society, and contributions to sustainable development. It is a concise, written statement that is approved and supported by senior management, expressing the BFI's commitment to incorporating E&S considerations into its business activities and contributing to sustainable development. A typical E&S policy may include one or more of the following statements and commitments:
● Incorporating E&S risk considerations into all financing activities
● Setting strategic E&S objectives, such as offering new products that address E&S sustainability
● Excluding financing clients whose business activities do not meet the B/FI’s principle
● Establishing applicable E&S requirements for clients such as complying with national E&S regulations and international standards
● Communicating E&S expectations to all staff, clients and other external stakeholders
● Committing to improving the overall E&S performance of its portfolio through enhanced risk management
● Committing to continually building capacity of its staff to manage E&S risks
The ESRM is complemented by the E&S Due Diligence (ESDD) checklist, which serves as the basis for assigning a risk rating score. This rating provides an indication of the level of E&S risk and compliance associated with the specific transaction, regardless of the sector involved. The risks are classified into categories of "HIGH," "MEDIUM," and "LOW." Based on the assigned category, the necessary actions or steps to be taken are reported to the Nepal Rastra Bank (NRB).
ESG and FDI
Nepal is actively trying to attract foreign investment. However, the country has yet to see a significant inflow of Foreign Direct Investment (FDI). Foreign investors often express concerns about the guarantee and security of their investments. The current financial reporting framework may not provide sufficient information to instil confidence in potential investors considering investment in Nepal. Therefore, there is a need to establish a clear path towards sustainable investment to attract FDI.
To address these challenges and enhance investor confidence, it is crucial for businesses to prioritise Environmental, Social, and Governance (ESG) reporting. By incorporating ESG reporting practices, businesses can provide investors with a comprehensive understanding of potential future events and the impact of their operations on the environment and society. ESG reporting also emphasises good governance practices within businesses, promoting transparency and accountability. This enables foreign investors to assess the strength of a company's governance structure and practices, facilitating the investment decision-making process. Furthermore, Nepal can benefit from promoting sustainable practices across various sectors. Encouraging environmentally friendly initiatives, implementing social responsibility programs, and fostering ethical governance practices can enhance the country's attractiveness for foreign investors seeking sustainable investment opportunities.
It is essential for Nepal to create an enabling environment that supports sustainable investment and addresses the concerns of foreign investors. This includes implementing appropriate regulations, providing incentives for ESG reporting, and promoting stakeholder engagement to ensure that businesses operate in a socially and environmentally responsible manner.
Roles of Regulatory Authority
The role of regulators is crucial in establishing a regulatory framework that supports ESG investments, incentivises companies to adopt ESG practices, promotes transparency and accountability, and collaborates with industry stakeholders and other organisations. Currently, ESG and Sustainability Reporting is a voluntary responsibility in Nepal. However, Nepal Rastra Bank (NRB) requires banks and financial institutions to report on Environmental and Social Risk Management (ESRM) which is similar to ESG. Additionally, the Industrial Enterprises Act, 2076 mandates businesses to conduct Environment Impact Assessments. Apart from these requirements, there is currently no specific framework for ESG reporting in Nepal. Regulators, therefore, have a key role in making ESG reporting mandatory. The Securities Board of Nepal (SEBON) plays a vital role as the regulator for listed companies. SEBON should request ESG reports from every listed company. Similarly, NRB, Insurance Authority, and other regulators should establish clear frameworks and guidelines to support ESG reporting as soon as possible.
Considering the development and publication of ESG standards by the International Sustainability Standard Board (ISSB), it is possible that Nepal Accounting Standards Board (ASB) may eventually make ESG reporting compulsory for entities with public accountability.
Challenges in Implementing ESG
ESG reporting is perceived as daunting due to its newness, complexity, and its impact on every financial process. Implementing ESG reporting in the early stages can be challenging for businesses, especially considering the lack of a specific reporting framework at present. To effectively report on ESG factors, companies need to collect and maintain data to measure their impact. However, many Nepali businesses lack access to the necessary equipment to measure CO2 emissions, gases, and other byproducts. Emission detection is also more challenging than measurement. Additionally, Nepal's diverse multicultural and multi-ethnic society presents challenges in meeting the expectations of the entire society. Implementing ESG reporting requires allocating resources solely for this purpose, which may not always be cost-effective for businesses.
For sustainable investing to become mainstream, financial professionals must possess the necessary skills and understanding to integrate ESG considerations into their investment decisions and when advising clients.
Way Forward
Sustainability has already emerged as a significant factor shaping the future of the financial industry. The assets under management with an ESG mandate are experiencing exponential growth, and most financial market participants now recognise that they can no longer ignore this sustainability transition. The focus of discussions has shifted from debating whether to engage in sustainable investing to exploring the available sustainable investment options. Sustainable investing has become a notable trend within the financial sector. However, it is important to acknowledge that progress in this field can vary significantly across different geographies and jurisdictions.
For sustainable investing to become mainstream, financial professionals must possess the necessary skills and understanding to integrate ESG considerations into their investment decisions and when advising clients. Financial institutions that wish to offer services in this area should make ESG training mandatory for relevant staff. This training would enable front-office employees, such as investment advisors, to educate their clients and raise awareness about this new approach to investing through relevant events and discussions. ESG training would also be crucial for middle and back-office staff responsible for sustainability-related disclosures, reporting, and risk management.
(Abridged version of a paper entitled ‘Detailed Report on Environment, Social and Governance Reporting’ prepared by Bidur Associates, Chartered Accountants)
