The Guide to ESG Reporting and Capital Risk

ESG (which stands for Environmental, Social, and Governance) is a set of criteria that companies can use to report their performance in these areas, and that financial institutions can use to assess the ethics and sustainability of their loan or investment portfolios.

When they are solidified, ESG scores may be based on an assortment of factors such as energy use, usage and stewardship of natural resources, cybersecurity, conservation practices, the treatment of employees, the diversity of leadership, and more.

ESG initiatives are on the rise, and although metrics and scoring methods are still forming and have not fully manifested into active regulation yet, the actualization of ESG reporting requirements is accelerating.

Many companies are struggling to meet their goals and the pressure of the ensuing requirements is causing confusion and unrest for businesses, particularly in the financial realm. The impact of investment and loan portfolios will need to be valued on an extraordinarily granular level in terms of ESG metrics, as lenders, banks, and investors will be held accountable for their ESG viability.

Just as water risk translates directly to business and financial risk, success – or lack thereof – in the ESG reporting will also translate to the same end. As this becomes clearer, actions are being taken. Some prominent banks already tie executive compensation to hitting ESG targets.

A report by Bloomberg shows that “half of the respondents said their company performs ‘very effectively’ relative to environmental metrics, but less than 40% said the same about their company’s achievements on social and governance factors.”

As of 2021, companies in Europe are more likely than U.S. businesses to have “formal ESG reporting processes in place,” but this is expected to change as agencies like the SEC roll out stricter reporting requirements. Major firms like PricewaterhouseCoopers call this a “paradigm shift” that will require businesses to take charge of ESG data.

 

With better, granular data and a thorough understanding of the three types of capital, investors and financial institutions will be better able to meet reporting requirements and identify and reduce financial risk.

 

This guide will take a deep dive into ESG reporting as the new normality unfolds, and will be updated regularly as new regulations are rolled out.

 

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ESG Investing Principles

ESG investing principles revolve around understanding and mitigating risks associated with three types of capital: financial, natural, and social.

Financial capital has historically been the dominant form of capital, in part because it’s the easiest to quantify in terms of a currency value. It’s the type of capital that, in effect, influences the decisions that impact natural and social capital; the latter two have typically been considered in the capacity that they, themselves, influence and serve financial capital.

In recent years, this perspective has been changing, and ESG investing principles seek to account for all three types of capital. The well-being of nature and society is now seen as a contributor to the long-term sustainability of investments and the security of financial capital.

Businesses and operations that steward and optimize natural resources and invest time and focus in the communities they operate in will be able to depend on those resources for a long time to come. It’s the reason why sustainable agriculture has been linked to better ROI, and why impact investments are quickly becoming more profitable than traditional investments.

Not all ESG initiatives are up to par, though, and some corporate actions have fallen short of their promises and declarations, resulting in “greenwashing,” or claiming to meet ESG criteria without the data to back their claims up.

“The sheer volume of sustainability commitments coming out of the industrial sector makes it difficult to parse which efforts are significant and which are more akin to checking a box,” Bloomberg notes.

As ESG investing becomes more commonplace, and as reporting requirements become standardized, financial institutions will need to have more consistent, in-depth, granular data to work with to make decisions on loans and investments.

By focusing on three key areas – data collection, measurement, and mitigation – they can mitigate risks to all three kinds of capital.

 

Read more about ESG investing principles here.

Why Companies’ ESG Data Will Be in High Demand

At least $12 trillion dollars – a quarter of all U.S. investments – are now in companies that profess certain ESG standards, according to Forbes. But as new regulations bring about more thorough ESG reporting requirements – and as banks themselves may be required to report on the overall sustainability of their investment portfolios – it will no longer be enough to rely on ESG scores from third-party agencies.

Bloomberg notes that many investors “prefer raw ESG data to ESG scores because it allows them to customize the data sets for their needs”. ESG initiatives vary so widely that it’s important for financial institutions to be able to make their own assessments based on the relevant criteria in their industry.

For example, ag professionals and lenders can turn to water GIS data to assess the sustainability of water resources in a given region and its effect on financial capital. The immense benefit of granular datasets, particularly in the form of GIS, is that it provides a complete picture at multiple resolutions. Those that don’t stay on par with ESG requirements may find themselves behind the curve and at risk of diminishing the value of their capital.

Ultimately, being able to interpret ESG data directly will help stakeholders at all levels identify the connection between all three types of capital. This will lay the groundwork for more successful ESG risk mitigation and reporting strategies.

Read more about collecting and understanding ESG data here.

3 Sustainable Finance Trends in U.S. Agriculture to Lessen Risk and Build Resilience

Rapid growth in sustainable finance is possible because financial returns and ESG considerations have shared interests that can benefit the bottom lines of professionals in agriculture.

Sustainable stewardship, be it of land or of a loan/investment portfolio, relies on responding to the latest, most accurate information and mitigating risk are principles that operate on.

 

This article will review three trends that are of growing importance to sustainable ag finance:

  • The Internet of Things
  • Improved Irrigation
  • Regenerative Farming

 

With climate change subjecting crops to more intense heat waves, acute flooding, and severe droughts, ag lenders and investors should understand how farmers can build resiliency into their harvests and preserve parcel property value.

Financial Capital and Its Role in ESG Risk Mitigation

Financial capital has long been the main consideration of agricultural investment. As financial institutions work to more holistically address the risk to their portfolios, understanding how financial capital interacts with other capital forms assists in creating a more comprehensive risk mitigation strategy.

With growing awareness of climate change, water scarcity, and food insecurity, it’s becoming clear that financial capital is just one part of the ag equation. Companies that don’t consider other forms of capital – natural capital and social capital – will be at greater risk than those that do. As ESG reporting becomes mainstream, the relationship between natural and financial capital becomes increasingly clear.

This post explores the connection between financial capital and other types of capital, the benefits of maintaining and stewarding this connection, and how it can give businesses a competitive advantage.

 

Natural Capital and Its Role in ESG Risk Mitigation

Natural capital refers to anything from water resources, to forests, minerals, fossil fuels, and entire ecosystems – anything upon which a business or organization depends. The number of items that act as natural capital to businesses may be surprising.

Putting a value on these resources can help to “inform more sustainable choices, including market-based conservation, which can be crucial for protecting nature from unrestrained consumption.”

For example, the value of water can be measured in terms of the crops it supports, as well as the electricity it generates or the municipal users it can serve. The true value of a forest could be measured in terms of lumber, as well as the headwaters it supports, which contribute to a healthier ecosystem.

 

These calculations require complex data collection and analysis, but as ESG reporting requirements increase, this data must be more readily at hand.

 

Financial institutions can use this data to identify links between natural and financial capital and uncover risks that are less obvious when each type of capital is considered separately. As water risk translates to business risk, a risk to natural capital will be a risk to financial capital.

Ultimately, decision-makers can use ESG data to direct financial capital in more efficient and productive ways, while meeting sustainability targets and reporting requirements.

 

Learn more about natural capital and ESG risk mitigation here.

Social Capital and Its Role in ESG Risk Mitigation

Social capital is the third type of capital to consider in the context of ESG reporting and risk mitigation. While it is equally important as the other two, it can also be the most nebulous.

The Harvard Law School Forum on Corporate Governance writes that “Factors which fall within the ‘S’ of ESG are as common as (and for some companies more so than) those within ‘E’ and ‘G’ in contributing to business risk and, in turn, causing lasting damage to a company’s reputation.”

Social capital typically refers to the “shared values” that connect a company with other stakeholders in the community. A company with sufficient social capital can count on support from its employees, local organizations, and citizens to achieve its goals.

A company that blunders its social capital – for example, by using more than its fair share of natural resources – is likely to encounter resistance in the form of public protest, reputational damage, or burdensome regulations.

Social capital can be one of the hardest types of capital to measure, but recent efforts to standardize the reporting of ESG data should help. Companies can take the initiative to report on resource consumption, conflicts of interest, diversity in leadership, and other concerns that can help to build social capital with the wider community.

 

Read more about social capital and ESG risk mitigation here.

The Physical Risk of Water Issues in Agricultural Finance

Climate change, water scarcity, water stress, and more all contribute to physical risks that ag lenders need to be aware of. 

Physical risks can be either acute – such as extreme weather events – or chronic, such as long-term changes to weather patterns and temperatures. Not only can physical risks impact the viability of an agricultural operation, but they can also have adverse impacts on the well-being of nearby communities who share the same limited water resources.

Read more about physical risk in agricultural finance here.

ESG Data Collection for Agricultural Finance with GIS

ESG metrics are naturally nebulous; comparing metrics against reporting standards is not linear and is not apples:apples. Unique lending portfolios will have a unique set of risks.

Utilizing GIS for ESG data collection to curb the potential for inaccurate reporting is a smart choice. It is typically cheaper than hiring a consultant and its results can be more accurate than those of a third-party ESG data provider.

Ag lenders and financial institutions can use GIS in-house to understand the ESG risks in their diverse portfolios.

Read more about ESG data collection in agricultural finance here.

4 Types of Transition Risk – Water and ESG Reporting

Water stress causes paradigm shifts and progression in the world – agriculture, in particular. As agriculture feels the impacts of water’s well-being, good or bad, it is important for agriculture professionals to recognize the importance of transitioning with the necessary changes. Or, rather, recognize the risks of not doing so.

The Task Force on Climate-related Financial Disclosures identifies 4 types of climate-related transition risks to be acutely aware of and for financial institutions to act upon. This article puts them in terms of water risks that are material to agricultural lenders and other ag finance institutions.

Read more about the 4 types of transition risk ask they pertain to water risk and ESG reporting in agriculture here.

When Water and Climate Issues Turn into Material Risk for Ag Lenders

Physical risks such as drought, flooding, reduced snowpack, wildfires, water quality issues, and more can cause farmland to be liabilities agriculture. Material risks are relative and describe a risk that is a concern for a specific business operation, portfolio, and parcel.

Because these risks vary so widely across agricultural regions and impact different crops in different ways, there’s no single risk profile when it comes to assessing the health of agricultural lending portfolios.

The right tools can help agriculture lenders and investors learn where certain risks are material to their diverse portfolios so that they may implement risk mitigation strategies.

Read more about water and climate-related material risks to agriculture professionals here.

Nature-Based Solutions to Physical Risks in Agriculture

Nature-based solutions are initiatives that focus on ecosystem health as a means of protecting human communities, industries, or resources. Differentiating themselves from artificial flood barriers and reservoirs, the term refers to a wide range of initiatives, from wetland and forest conservation to coral reef preservation. 

Serving as the first line of defense against extreme weather events such as droughts and floods, these structures provide important layers of protection from danging climate-risk events. They accomplish this task through three main vectors:

  • Mitigating physical risk
  • Protecting source water
  • Robustness and flexibility

Together these attributes make investments in nature-based solutions potentially more attractive than less sustainable artificial alternatives.

Nature-based solutions aren’t cost-free, but over the long term, these initiatives can lead to improved ecosystem health and better financial outcomes for farming operations and the ag finance institutions that invest in them.

Read more about nature-based solutions to climate risk here.

Ecosystem Services Have an Important Role in Risk Mitigation

Climate change, water stress, flooding, drought, and other physical risks are growing more prominent and pose a great threat to agriculture and the businesses that give it life.

Once properly understood, these risks will need to be mitigated. A dire mistake that ag professionals can make is not utilizing the power of ecosystem services in their risk mitigation strategies.

Healthy ecosystems foster successful agriculture and communities and can offer protection that can curtail the effects of water risk. Taking the steps to empower ecosystem services to play their part can be an effective way for ag professionals to protect their businesses.

Read more about ecosystem services in agriculture here.

How to Avoid Greenwashing in Agricultural Finance

A report by Business for Social Responsibility (BSR) describes greenwashing as “disinformation disseminated by an organization … to present an environmentally responsible public image.” Whether in the form of selective disclosure or merely symbolic actions, it represents a serious concern in ESG reporting. Sometimes, greenwashing can even come from a lack of accurate data and measurement capabilities.

Greenwashing can harm a company’s reputation as well as hinder the transition to a less-risky, more water and climate-resilient future.

Following these three steps can help those seeking to avoid the risks of greenwashing:

  1. Use Good Tools
  2. Produce Verifiable Results
  3. Get the Message Right

ESG commitments should be put in place for a reason. The climate, water, social, and governance issues of today create opportunities for businesses to not only elevate their positive impact but also strengthen their own operations. 

Read more about how to avoid greenwashing here.

The Bottom Line

As ESG reporting requirements increase in scope, data will be especially important for pinpointing the connections between natural, social, and financial capital that can lead to financial risk.

Financial institutions can take steps to assess their loan portfolios in light of ESG principles and work with other stakeholders to mitigate risk.

Small, granular data – including geospatial datasets that can narrow in on a specific region or parcel of land – will be the most useful when it comes to ESG reporting. Ag professionals, in particular, can use this data to approve the right loans, make the right investments, and ensure the overall health of their portfolios.

Learning how to work with this kind of data now will help lenders stay competitive and make it easier to comply with ESG reporting requirements to come.

AQUAOSO’s Water Security Platform is designed for agricultural professionals in need of accurate, real-time, geospatial water data. In addition to information on water risk and water scarcity, users can view the outlines of specific watersheds and learn about what sustainability regulations apply. Lenders can use the Portfolio Connect tool to track the risk of individual parcels and share relevant data with other stakeholders.

Contact the team today for a free demo, or download one of the free e-books from the Resources page to learn more about reporting requirements and water security.

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