The concepts behind environmental, social, and governance (ESG) are not new. Over the years, the business world has prioritized mutually independent concepts such as corporate sustainability, corporate social responsibility, corporate philanthropy, corporate governance, environmentally responsible investing, and socially responsible investing. It is only more recently that ESG, which encompasses all of the aforementioned nomenclature, has taken hold of capital markets. Corporate sustainability and environmentally responsible investing are more reflective of the “E.” Corporate social responsibility, philanthropy, and socially responsible investing tend to reflect the “S.” And, corporate governance is appropriately correlated to the “G.”
Since the concepts behind ESG are not new, why is it such an important focus of capital markets and businesses today? And, more importantly, why does it matter to contractors?
Why Is ESG Top of Mind?
Backed by the idea that embedding ESG factors makes good business sense and leads to more sustainable markets and better outcomes for societies, there is currently a global rise of ESG reporting standards.
In the U.S., it is most evident in the Securities Exchange Commission’s (SEC’s) proposed climate-related reporting standards for SEC filers, which will have implications on both public and private contractors. The SEC climate proposal Release No. 33-11042 (sec.gov/rules/proposed/2022/33-11042.pdf, which was still open for public comment as of publication), will require SEC filers to report on broader climate risk disclosures and metrics.
The rules require organizations to disclose the following levels of emissions among other criteria:1
- Scope 1 emissions: Direct emissions from assets owned directly by the organization including facilities and fleet emissions.
- Scope 2 emissions: Indirect emissions from the purchase of electricity and gas (for heating) for the organization’s own use in buildings and other business processes.
- Scope 3 emissions: Indirect emissions that occur upstream or downstream that allow a company to operate effectively.
While the current proposed rules are awaiting final decisions, organizations potentially affected by these rules are gearing up for the additional administrative burden of gathering necessary data to comply with these new standards.
Why Are the Regulations Important for Contractors?
While most construction-related organizations are not publicly traded, the SEC proposal has created a tidal wave engulfing various stakeholders from all types of organizations beyond those regulated by the SEC. As a result, pressures to focus on ESG from the workforce, consumers, and investors and shareholders are being applied to many organizations. Let’s look at each of these through the lens of construction.
With the labor shortages facing the construction industry, contractors will need to appeal to every employee category if they hope to backfill all the retirements of the next decade.
Younger generations typically have different priorities and expectations of their employers than the Baby Boomer and Gen X employees (who contractors are used to recruiting). Millennial and Gen Z employees want to work for organizations that prioritize environmental and social issues. Female employees and individuals from diverse backgrounds might be hesitant to enter an industry in which they don’t see a lot of leaders who look like them.
Organizations that can best communicate and promote their contributions to their communities, their actions to reduce the company’s carbon footprint, and their inclusive environment are better positioned to secure top talent.
Project owners, especially those that are SEC filers, will likely start to require contractors to measure and provide greenhouse gas (GHG) emissions generated by the projects they procure. If the Scope 3 requirements make the final rules, then the reporting requirements likely will extend to project emissions for subcontractors and suppliers as well.
Even if a project owner is not an SEC filer, emissions reporting information on its GHG footprint — including construction projects — could be required if it is downstream or upstream from an SEC filer.
Contractors that work directly with real estate developers might also begin to feel a significant amount of pressure from developers that are facing pressure from stakeholders to implement various ESG initiatives.
Rating Agencies/Financing Pressure
Various investor reporting and rating agencies such as S&P and Moody’s are developing benchmarking and scoring related to disclosed and publicly available organizational ESG metrics. This analysis could begin to affect a contractor’s ability to get financing from private investors or banks and even affect the ability to secure bonding from sureties for projects in the future.
With pressure coming from various stakeholders, the questions around the impact of ESG on the construction industry feel much less like an “if” than a “when.”
ESG Through the Lens of Construction
Due to the pending impact of ESG on the construction industry, let’s unpack more details around what each aspect of ESG represents in a broad sense.
In general, the environmental focus of ESG takes into consideration a business’s impact on and use of such natural resources as:
- Oil and fuel consumption
- How efficiently water is used
- The makeup of materials for an
- organization’s products/deliverables
- How a company handles the waste of its production processes
- The impact a company has on the biodiversity, ecosystems, or habitats in which it operates
Part of the consideration related to natural resources also includes an organization’s compliance with product standards put in place to protect the environment.
Another environmental consideration is a business’s impact on climate change or the impact of climate change on the organization. Some questions asked in this area include:
- As a result of your business processes, how much greenhouse gases are being emitted into the atmosphere?
- Do you have a strategy to become a carbon neutral or carbon negative organization in the future?
- What is your organization’s exposure to the risk related to climate disasters like heat waves or floods?
The construction industry and related ecosystem have a considerable impact on the climate when viewed through the lens of ESG. As the industry is already taking steps to move in a positive direction, here are some environmental considerations specific to construction where progress is being made:
- Many building standards today are very close to Leadership in Energy and Environmental Design (LEED®) standards (usgbc.org/leed), and many organizations support LEED certification for their designers and engineers. The globally-recognized LEED framework provides a model for healthy, highly efficient, and cost-effective green building.
- Construction companies are recycling material packaging, reusing wood pallets, and finding additional uses for excess materials on jobsites.
- Organizations are looking into various technologies to manage the decarbonization of their vehicle and equipment fleets through electric, hydrogen, and even solar power.
- The emergence of carbon sequestration technology (which is the process of capturing and storing atmospheric carbon dioxide) is becoming more popular. One example is capturing and injecting carbon dioxide directly into concrete mix, transforming it to a mineral that no longer is harmful in the process.
The social aspect of ESG tends to lean more on people-related elements and effects. This element can be broken down into an organization’s internal and external groups. Internal elements mainly center around a company’s human capital, such as:
- Company culture and employee wellbeing
- Diversity, equity, and inclusion
- Employee training and education
- Health and safety
- Working conditions
- Fair and equal compensation models
- Employee benefits
- Labor standards
- Gender equality
Beyond an organization’s four walls are considerations such as philanthropy and community investment or its involvement in human rights and social issues. The “S” also can include transparency in the supply chain and relevant business practices.
More Fortune 1000 companies are starting to include additional criteria in their bid documents to meet their supplier diversity goals,2 which could affect a company’s ability to get work if competitors can more effectively address those requirements.
Organizations throughout the construction industry have many internal and external examples of positive social impact.
Some of the items that can be considered include:
- Safety programs
- Suicide prevention programs
- Strong antibullying and discrimination policies
- Community service
- Mentorship programs to support employee learning and growth in the industry
- Scholarships for students looking to gain access to the industry
- Adequate compensation
- Minority- and woman-owned business support programs to improve the diversity of subcontractors in the industry
- Other diversity, equity, and inclusion initiatives