Due Diligence in ESG – What It Is and Why It Is Important

8 Mar 2024

ESG is becoming increasingly important in the business world as investors and consumers are prioritising sustainability and ethical impact. Due diligence in ESG is crucial for making informed decisions, driving positive change, mitigating risks, and building trust and transparency. Understanding it is crucial as it can impact the company’s reputation, financial performance, and access to capital. Discover insights as to what ESG is, the process of due diligence in ESG as well as challenges that organisations face when conducting these reports.

What is ESG?

ESG stands for Environmental, Social, and Governance, and it is a holistic approach to evaluating a company’s impact on these three aspects.

Environmental: Environmental factors look at how a company’s operations and products impact the natural environment. This can include issues such as carbon emissions, waste management, and resource usage.

Social: The social aspect of ESG considers how a company impacts its employees, customers, and local communities. This can include factors such as employee treatment and diversity, customer satisfaction and safety, and community development and engagement.

Governance: The governance aspect of ESG focuses on the company’s leadership, policies, and transparency. This can include factors such as board diversity, executive compensation, and ethical business practices.

What is Due Diligence in ESG?

Due diligence in ESG is the process of conducting thorough research and evaluation of a company’s practices and policies in these areas. This involves examining how a company’s operations and products impact the environment, society, and stakeholders, as well as its leadership and ethical standards.

When conducting due diligence in ESG, investors and businesses consider a variety of factors, such as a company’s carbon footprint, waste management practices, employee treatment and diversity, customer satisfaction and safety, community engagement, board diversity, executive compensation, and ethical business practices. By thoroughly evaluating these aspects, they can determine if the company aligns with ESG standards and values.

What steps are involved in due diligence?

Conducting due diligence for ESG can be broken down into 6 steps.

Establishing objectives and criteria: Determine what factors are important to you and your organisation, whether it be environmental impacts, social responsibility, or corporate governance. This will help guide your research and evaluation process.
Gathering information on ESG practices: You should be looking at data on ESG performance, such as environmental impact, labour practices, board composition, and diversity. This can also include public disclosures, company reports, and third-party assessments. Gather information from various sources to get a well-rounded view of a company’s ESG performance.
Processing Information: This involves analysing the data and information collected, as well as considering any potential risks and impacts.
Engage with Stakeholders: Engage with the company directly to gain a deeper understanding of its operations and practices. This can also provide an opportunity to ask questions and address any concerns.
Evaluation: With the information you have gathered, evaluate the company’s ESG practices against the industry standards and regulatory requirements.
Documenting: Record your findings and communicate them to relevant stakeholders. This can include investors, shareholders, and the company itself. By sharing your findings, you can hold the company accountable and potentially drive positive change.

Why is due diligence important in ESG?

Without properly conducting due diligence in ESG, companies will carry unnecessary risks, which can mean potential losses.

Making Informed Decisions and Mitigating Risk

By thoroughly researching and evaluating a company’s environmental, social, and governance practices, they can determine if the company aligns with ESG standards and values. This allows them to make decisions that not only consider financial returns but also the company’s sustainability and ethical impact. In addition, by identifying potential environmental, social, or governance issues, investors and businesses can make more informed and responsible decisions, preventing potential financial and reputational damages.

Drive Positive Change

As mentioned before, documenting your findings allows you to hold companies accountable for their impact on the environment, society, and governance. As a result, investors and businesses can encourage them to adopt more sustainable and ethical practices. This can create a ripple effect, where companies compete to improve their ESG scores, ultimately leading to a more sustainable and ethical business landscape.

Regulatory Compliance

In Australia, there are various laws and regulations that companies must adhere to, such as the Environmental Protection and Biodiversity Conservation Act and the Corporations Act, which includes provisions for transparency and disclosure of ESG practices. Failure to comply with these regulations can result in legal and reputational consequences for companies.

Trust and Transparency

By communicating findings to relevant stakeholders, such as investors, shareholders, and the company itself, there is increased accountability and transparency in a company’s ESG practices. This can help build trust with stakeholders and enhance the company’s reputation.

Common challenges in ESG due diligence

Even though conducting due diligence for ESG is vital to businesses, there are many challenges you may face when conducting these reports.

Limited or inconsistent data: One of the main challenges in conducting due diligence for ESG is the availability and consistency of data. Many companies do not disclose their ESG practices or have inconsistent reporting methods, making it difficult to gather accurate and comprehensive information.

Lack of standardisation: With the growing importance of ESG, there is a lack of standardisation in the industry. This can make it challenging to compare and evaluate companies’ ESG practices, as there are no universal criteria or metrics.

Time-consuming and resource-intensive: Conducting thorough ESG due diligence can be a time-consuming and resource-intensive process. It requires extensive research, data collection, and analysis, which can be challenging for companies with limited resources.

Subjectivity and bias: Performing due diligence involves evaluating a company’s practices and policies, which can be subjective and prone to bias. Different stakeholders may have different priorities and values, making it challenging to reach a consensus on a company’s ESG performance.

Difficulty in predicting future performance: As ESG due diligence is primarily focused on a company’s current practices, it is challenging to predict its future performance. This can be a significant challenge for investors looking to make long-term investments based on a company’s ESG performance.

Lack of expertise: Conducting effective ESG due diligence requires expertise in various fields, such as environmental science, social impact, and corporate governance. Many companies may not have the necessary expertise in-house, making it challenging to conduct thorough due diligence.

How BoardRoom can help you with ESG due diligence

Conducting due diligence can be challenging due to the need for precise data collection, reporting, and analysis. BoardRoom’s team of experienced ESG professionals have the expertise in multiple APAC jurisdictions to help you help you develop and implement a tailor-made ESG strategy for your business, supporting ongoing sustainability and profitability as a result.

Our ESG advisory service includes helping you identify relevant ESG risks and opportunities, setting ESG targets, creating sustainability reports, conducting a materiality assessment, drafting a sustainability policy for your company and ESG due diligence.