The regulatory changes of recent months constitute an additional step towards the institutionalization of ESG. Most notably, the U.S. Securities and Exchange Commission (SEC) proposed a new rule in March 2022 that would require registrants to provide weather-related information in registration statements and periodic reports. The SEC also included ESG investing in its 2022 review priorities report, saying the Commission believes climate-related statements are important information needed for investors to make informed investment decisions. In addition, the SEC on May 25 announced a proposed rule that would change disclosure requirements for investment advisers and business development companies to prevent “green money laundering” and increase market transparency.
Given these developments, it is no surprise that companies are allocating more and more resources to developing effective ESG strategies to meet the expectations of regulators, stakeholders, customers, investors, employees and communities. . ESG ratings remain a critical quantitative metric for assessing companies’ performance in this regard, and one way companies can strengthen their environmental ESG ratings is to establish or improve corporate compliance policies. companies that deal with environmental issues. These would include policies related to regulatory compliance, auditing, environmental emissions and product stewardship. The most important type of such a policy—and one that the U.S. Environmental Protection Agency has long considered a useful tool for improving compliance performance—is an environmental management system. (EMS).
How an EMS can improve an ESG score
At the highest level, an EMS is a set of voluntary, self-initiated processes and practices that enable an organization to reduce its environmental impacts and increase its operational efficiency. It is used to identify specific roles and responsibilities within an organization for environmental matters, establish goals, and provide standard protocols and procedures for ensuring compliance and achieving those goals. Moreover, as a framework document, an EMS can integrate other more specifically adapted environmental plans. For example, an EMS may include individual plans dedicated to air emissions, hazardous waste management, or any other issue of environmental interest and concern to an organization.
As stated on the EPA website, an EMS consists of seven basic elements:
- Establish the organization’s environmental objectives;
- Analyze its environmental impacts and compliance obligations;
- Set environmental compliance and environmental impact reduction targets;
- Ensure the environmental awareness and competence of employees;
- Establish programs to achieve these goals;
- Track and measure progress in achieving goals; and
- Review EMS progress and make improvements.
These elements easily align with ESG principles. (For more information on ESG principles, see Five keys to building a successful ESG program, Transparency and impact: the essential principles of ESGand What ESG principles should you care about?) For example, a fundamental principle of ESG is a company-wide commitment to reduce environmental impacts, which begins with the definition of a clear mission that guides a company’s institutional practices. To document this commitment to ESG principles, a number of companies have begun preparing written policy statements and objectives and posting them on their websites. With minor adaptations, these statements can be carried forward into an EMS, a standard element of which is the company’s signed statement of commitment to environmental stewardship and compliance (Elements 1 and 3).
Furthermore, one of the ESG characteristics is compliance with regulatory obligations. An EMS can help companies ensure compliance with these requirements (recognized in Element 2). Successful ESG programs also require a comprehensive sustainability program to be in place and then integrated into the entire corporate structure. This corresponds to the requirement of an EMS to establish programs to achieve objectives and targets and to ensure the environmental awareness and competence of employees (elements 4 and 5). Finally, ESG programs require comprehensive oversight by company management, who work with an internal review and audit process to ensure continuous improvement and success. Effective ESG disclosure will demonstrate the impact of a company’s program. An EMS can also help achieve these goals, as it requires continuous monitoring and review of progress (elements 6 and 7). Generally, a well-designed and comprehensive EMS can also serve as a practical and useful compliance guide for personnel involved in the day-to-day operations of a business. In this sense, an EMS can help bridge any potential disconnect between the strategic ESG aspirations of company management and the activities of EHS personnel “with boots on the ground”.
Trust, but verify
Each EMS may vary in quality, so it should not be assumed that all of these documents will have a beneficial impact on ESG ratings, despite the general alignment between the core principles of ESG and EMS. For an EMS to have a positive effect, it must meet as many ESG environmental criteria as possible given the company’s operations and meet basic criteria regarding the preparation, distribution (within the company) and document implementation. (The specific criteria assessed vary between rating agencies and sectors, but often include categories such as carbon emissions, pollution, environmental strategy and environmental management systems.) Regarding the latter, the International Organization for Standardization (ISO) has established a standard for the EMS. (ISO 14001), and by passing an audit by an ISO accredited auditor, companies can obtain certification of an EMS that meets or exceeds this standard. When issuing these certifications, ISO accredited auditors take into account the achievement of the five main stages of an EMS which result in a “continuous improvement loop”. (See Figure 1.) Certification to ISO 14001 provides a degree of comfort that an EMS meets a minimum level of sufficiency.
As a result, ESG rating agencies, accounting firms and companies are increasingly considering ISO certification as an ESG performance indicator. For example, ECPI, which operates a reputable ESG rating index, has explicitly recognized an ISO-certified EMS as part of a comprehensive ESG strategy. Similarly, Deloitte has promoted EMS ISO certification as a way for companies to satisfy the “Audit and Assurance” component of ESG. Along the same lines, Norsif, an independent association of asset managers, service providers and industry groups dedicated to sustainable investing, recently published a report entitled “Guide to ESG Integration in Fundamental Equity Valuation”. In the report, Norsif recommends that investors interested in the metals and mining industry ask what percentage of the target’s operations are conducted under a certified environmental management system, assuming that a certified EMS ensures “regular review of mine sites and objective assessments” and “Consistency of processes between sites.
When it comes to the actual impact of ratings, methodologies vary from rating agency to rating agency, and an EMS can be one of approximately 70-80 indicators considered for rating assignment. ESG. In such a case, no indicator would be worth more than a few percentage points of the overall score. However, a thoughtfully designed and implemented EMS can have a beneficial trickle down effect on other environmental rating indicators. Thus, in addition to a discrete individual impact on the ESG rating, an EMS may have a broader, albeit less tangible, cumulative effect that may improve a rating.
Companies wishing to obtain ISO certification or submit an EMS to a rating agency should consider the legal implications of sharing potentially sensitive corporate compliance documents with a third party. At a minimum, these companies should be prepared to talk about the details of their EMS and its implementation. Since these EMS reviews may reveal or draw attention to potential compliance shortcomings, interested companies may consider the benefits of involving legal counsel during this process to maximize privilege if issues or gaps are identified.
Companies have long used EMS to improve compliance performance both up and down the management chain and across facilities, operations and business platforms. Today, due to the push towards ESG, EMS, if carefully prepared and properly implemented, should take on a new meaning.