Over the past several decades, consumers have started considering social responsibility and environmental sustainability when choosing the products they buy. In the wake of the COVID-19 pandemic, there has been an even greater push for corporations to invest in more ethical, sustainable business practises. ESG provides a practical framework to guide companies as they seek to develop and implement these new policies and solutions.
What is ESG?
ESG stands for environmental, social, and governance. The term first became popular in the U.N.-backed 2004 report “Who Cares Wins,” but the underlying concept of socially responsible investing dates back to the middle of the twentieth century. As early as the 1960s, activists called for academic institutions and corporations to divest from businesses that operated in South Africa to protest the Apartheid regime. By 1971, two Methodist ministers had established the first publicly available mutual fund in the United States to consider social and environmental criteria in investment decisions. The Pax Fund, which still operates as the Impax Sustainable Allocation Fund, avoided investing in weapons manufacturers, tobacco and alcohol producers, gambling companies, and corporations with a track record of heavy pollution.
The push for businesses to implement sustainable and ethical practises continued to gain momentum throughout the late twentieth century and into the twenty-first century, and today it has become a major focus. The ESG framework measures non-financial performance indicators that can determine a company’s long-term success and ensure accountability. Criteria considered pertain to environmental sustainability, social responsibility, and corporate governance.
ESG uses several environmental factors as criteria to measure a company’s sustainability, especially how the company contributes to global warming and protects natural resources. These considerations include a company’s overall efficiency and energy consumption, pollution, greenhouse gas emissions, waste management, and the depletion of natural resource, such as deforestation. It also considers how a company’s actions may impact local biodiversity.
Social considerations address how companies treat people like employees, customers, suppliers, and stakeholders. For example, does the company provide a safe and healthy environment for its workers, offer a living wage, and uphold international human rights and labour standards? Are its suppliers fairly compensated for the raw or unfinished materials they provide? It may also look at the company’s effects on the community in which it is located. Does having the company in their community create more opportunities or challenges for the people living there? In the digital age, it is also important to consider how well a company safeguards the data and privacy of its customers.
A company’s governance serves as a support structure for its environmental and social responsibility initiatives. If the company’s internal leadership is not fully behind these initiatives, they will likely be implemented poorly or not at all. Governance considerations are meant to ensure a company does what it says it is doing to comply with regulations, best practises, and even its own policies. This can include financial transparency, whistleblower programmes, rules regarding political donations, bribery, conflicts of interest, and other factors that create opportunities for corruption.
How does ESG work?
ESG criteria help businesses identify their strengths and weaknesses as they strive to implement sustainable and ethical strategies and ensure long-term success. It also helps investors evaluate companies based on non-financial performance indicators.
One way companies can evaluate their own performance and encourage investment is by tracking their internal ESG metrics. Of course, this will look different for each organisation depending on their policies, industry, and general business structure, but there are several ESG reporting frameworks designed to help guide companies through the process of documenting and publishing their results. In addition, ESG rating agencies will analyse the reports and score companies on their success in implementing sustainable and ethical business practises.
ESG investing is when an investor chooses companies based on the ESG criteria they meet. This includes both individual investors and institutional investors, like ESG funds. ESG funds or individual investors can look at the ratings provided by the ESG rating agencies and the original reports published by companies to help guide their decisions. Investors choose to evaluate companies based on ESG criteria for two main reasons: First, they are looking to use their money to support businesses that share their values. The second is because they are looking to invest in high-performing businesses.
Why is ESG important?
We only have one planet. First and foremost, ESG considerations are designed to ensure that we protect our resources—including human resources—so we continue to have a planet to live on and do business on. Consumers recognise that the world is reaching a vital tipping point and have changed their behaviours accordingly. They are personally trying to reduce waste and make greener choices, and they are willing to reward companies that follow suit. Striving to meet these criteria allows companies a new marketing opportunity. They can also reduce energy-related costs and minimise risks, improving their overall growth and performance in the stock market.