How-to guide: How to understand and implement the ‘S’ in environmental, social and governance (ESG) (Global)

Introduction

This How-to guide provides guidance for in-house counsel and their teams to be able to understand and effectively develop and implement the ‘social’ (‘S’) aspect of an organisation’s ESG agenda.

The guide covers the following:

What is the ‘S’ in ESG?
The importance of the ‘S’ in ESG
Challenges in measuring the ‘S’ in ESG
How to overcome challenges
Practical implementation steps

It can be read in conjunction with How-to guides: Understanding ESG, What general counsel (GC) need to know about ESG and How to consider and navigate the consequences of ESG risks.

Section 1 – What is the ‘S’ in ESG?

The scope of the social aspect of ESG (the ‘S’) has progressively widened since the beginning of the 21st century. Traditionally the ‘S’ is described as social factors that pose a risk to a company’s financial performance – ie, information that is impactful to a company’s financial performance. This makes sense from an investor’s perspective as investors typically look for quantifiable factors to measure. However, measuring ‘S’ is challenging as very few quantifiable factors fall under its scope. In a 2021 BNP Paribas report, it was found that 51% of investors find the ‘S’ to be the most difficult area in ESG to analyse and embed into investment strategies. There are several frameworks (ie, systems for standardising the reporting and disclosure of ESG metrics) put together by non-profit organisations to assist with this. The frameworks differ widely in areas of focus. The following are three notable examples:

the Sustainability Accounting Standards Board (SASB) publishes industry-based standards that are relevant to financial performance in 77 different industries and are designed to help companies disclose financially material sustainability information to investors; and
the Global Reporting Initiative (GRI) publishes a set of standards for responsible environmental, social, economic, and governance conduct covering a wide range of topics. The European Sustainability Reporting Standards (ESRS) were adopted on 31 July 2023. All companies that are eligible to report under the Corporate Sustainability Reporting Directive will be required to adhere to two cross-cutting standards. There are an additional four social standards that will apply to companies depending on whether they have been identified as material issues. The four standards cover ‘own workforce’; ‘workers in the value chain’, ‘affected communities’; ‘consumers’; and end-users’. The focus of the ESRS Framework is to provide transparent, accurate and comparable view of a company’s ESG impact, risk and opportunities. As part of its Omnibus package, the Commission intends to adopt a delegated act to revise the first set of ESRS.

The social parameters that are generally evaluated under the ‘S’ in terms of these frameworks are as follows:

human rights;
product quality issues;
the health and safety of manufacturing processes;
data security and digital rights; and
diversity and inclusion.

Modern slavery is included in both social and governance, but is an underweighted element within the ESG framework, as it remains a complex issue that often lacks transparency and consistent measurement across industries. However, this does not mean that it should be excluded from ESG strategies. Organisations should continue to align their modern slavery efforts with relevant laws and international standards, while also working to strengthen the integration of these efforts within their broader ESG and sustainability frameworks.

The difficulties in quantifying and easily measuring the factors that fall under the ‘S’ do not undermine their importance. Social factors can provide the biggest insight into a company and how it is run, since the criteria enable investors to examine how relationships are managed with employees, customers, suppliers, and the wider communities in which the company operates. In each of these situations, the social parameters will be evaluated, and ultimately provide a well-rounded view of a company’s priorities and values.

See How-to guide: What general counsel (GC) need to know about ESG for further information on ESG frameworks.

Section 2 – The importance of the ‘S’ in ESG

To fully understand the practical implications and importance of the ‘S’ in ESG from a commercial perspective, it is important to understand what the social issues are. Like environmental issues, social ones are financially material – both in the way they dictate investor decisions and because of the financial damage that a bad reputation can cause. For example, Boohoo Group Plc (now rebranded as Debenhams Group) faced a £2 billion market value loss after poor labour practices and low pay were exposed in its supply chain in August 2020. In May 2024, 49 institutional investors filed a £100 million claim under the Financial Services & Markets Act (FSMA), alleging that the company misled investors or withheld material information about those labour practices.

Further, it is important to note that even when companies score highly on environmental issues, social issues can still exist in their supply chains. For example, in 2022 Tesla was removed from the S&P 500 ESG Index (now the S&P 500 Scored & Screened Index) because of social issues such as working conditions, lack of transparency, and racial discrimination. It was reinstated in 2023.

To avoid negative financial and reputational backlash, it is important that organisations effectively disclose their engagement with social issues. To do so, organisations should review their communications and reporting processes and ensure that these include engagement with stakeholders. An effective process would ensure that issues that align with the company’s strategy those that the company can meaningfully influence are highlighted.

Another aspect of an organisation’s analysis of ‘S’ factors is consumer awareness. Consider whether products are eco-friendly or socially responsible. Consumers are becoming more conscious of the ESG aspects of products and services, and the sustainability of brands is at the forefront of customer purchasing habits.

It is therefore important that organisations show how their business behaves in a socially responsible way and meets the ‘S’ criteria of ESG. They must be transparent in their disclosure to investors and customers as technological advancements will increase the availability of this data in the public domain.

Section 3 – Challenges in measuring the ‘S’ in ESG

It is a challenge to measure the ‘S’ in ESG. This challenge arises from a lack of consensus surrounding what constitutes the ‘S’ and a lack of consistency in the different methods for measuring, managing and reporting social impacts. Historically, policies and commitments have had more attention in ratings than actual impact, skewing data towards large corporations and leaving smaller ones out of the picture. The approach has been highly criticised, given its inherent bias towards larger corporations. It does, however, highlight that it is important for an organisation to ensure that it reports on social matters itself, to demonstrate the actual impact made and to ensure that a fair picture of the company is presented. According to an Equity Quotient report, evolving the ‘S’ from subjective to substantive requires an understanding of the ‘quality or health of the relationship between a company and its stakeholders, with the ultimate goal of determining how these relationships could influence a company’s financial performance and impact the world in which it operates.’

It is also a challenge to measure the ‘S’ data due to the constraints that often exist around the collection of data. An example is the General Data Protection Regulation (EU GDPR) rules in Europe that prohibit companies from collecting any personal data points, meaning that data on diversity, such as race or ethnicity, is typically scarce. While EU GDPR restrictions are no fault of organisations and are in place for a reason, they highlight the importance of disclosing all readily available social information. This will enable investors to gain insights into a company whilst protecting employee data.

Section 4 – How to overcome challenges

There are several ways in which organisations can overcome the challenges set out in the previous section and effectively develop and implement the ‘S’ aspect of an ESG agenda. While some challenges will always exist, it is crucial that companies are aware of them and are doing everything they can to address and minimise them. Transparency on social issues is key to overcoming these challenges.

The two biggest challenges when it comes to the ‘S’ in ESG are the following:

quantifying what falls under it; and
measuring it.

The UN Guiding Principles (UNGPs) and the OECD Guidelines continue to provide extensive social considerations about what falls within the remit of ESG. It is key that organisations are familiar with these frameworks and continue to consult them for updates. How to measure ‘S’ is likely to remain a challenge due to there being few quantifiable factors to track; although heightened awareness of what ‘S’ should include for disclosure purposes could contribute towards a solution. To combat the difficulty of tracking social progress, it is vital that companies increase disclosure around social issues.

As organisations become more transparent and provide a greater level of detail, more data will be available to investors, and ‘S’ will become more quantifiable.

Section 5 – Practical implementation steps

There are a number of factors to consider to effectively develop and implement the ‘S’ in ESG when advising organisations. These include the examples listed below.

Gather data to ensure effective monitoring and measurement of relevant objectives. The data gathered in relation to ‘S’ factors could include areas such as employee satisfaction, diversity and equality, gender pay gaps, working conditions, supplier codes of conduct, and measures in place for identifying forced labour, both within the organisation itself and in its supply chain.
Determine the key ‘S’ objectives of the organisation. This can be achieved through performing a gap analysis and materiality assessment with employees and other key stakeholders to understand target areas. Organisations can use the data gathered to set key performance indicators and realistic targets to aim for each year.
Increase transparency. Social issues are less tangible, so there is a greater responsibility on organisations to find a way to present the data that investors and consumers are after. Increased transparency of data eliminates confusion and fulfils the demand for social data to demonstrate that companies are aware of their responsibilities and are taking steps to address them. To achieve this, organisations should share as much information as they can across every level of seniority to close the gap in employee knowledge. At the same time, they should increase stakeholder engagement to encourage feedback.
Consider how you manage and monitor relationships with colleagues, suppliers, customers, authorities and communities. Do you have an effective communications process in place to relay these strong relationships to investors? If common standards of communication have not been implemented throughout the entire organisation, then start doing so to increase transparency.
Create long-term value. If you lead by example regarding social responsibility, you will help your organisation gain credibility and build reputation. Organisations should strive to go beyond what is required of them by law and look to voluntary frameworks, such as the UNGPs, as an opportunity to demonstrate best practice.
Report in a meaningful way (but be mindful of GDPR considerations). Ensure that you are not just increasing transparency because there is a call for it but because it is better for society as a whole.

^* This practical resource was produced in partnership with Ardea International.

Additional resources

Harvard Law School Forum on Corporate Governance, Time to rethink the S in ESG
Chartered Governance Institute UK & Ireland, ESG – does the “S” include slavery?
ClimaTalk, How do we measure the S in ESG?
ESG Working Group, Amplifying the “S” in ESG: Investor Myth Buster
The Guardian, More than £1bn wiped off Boohoo value as it investigates Leicester Factory
Climate Markets & Investment Association, The Industry’s Roadmap to Measuring The “S” In ESG
Business for Societal Impact, B4SI News, Measuring the S

How-to guide: How to understand and implement the ‘S’ in environmental, social and governance (ESG) (Global)

Introduction

Section 1 – What is the ‘S’ in ESG?

Section 2 – The importance of the ‘S’ in ESG

Section 3 – Challenges in measuring the ‘S’ in ESG

Section 4 – How to overcome challenges

Section 5 – Practical implementation steps

Additional resources

Related Lexology Pro content

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ESG

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Global

Energy & Natural Resources

Environment & Climate Change

Introduction

Section 1 – What is the ‘S’ in ESG?

Section 2 – The importance of the ‘S’ in ESG

Section 3 – Challenges in measuring the ‘S’ in ESG

Section 4 – How to overcome challenges

Section 5 – Practical implementation steps

Additional resources

Related Lexology Pro content

How-to guides:

Quickview:

Other:

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