What is environmental social and governance (ESG)?
Written by Tim Greenhalgh
Environmental social and governance (ESG) is a broad term for criteria increasingly demanded by investors seeking to assess future financial performance of companies.
The three key areas have been identified as crucial in an accurate assessment of the environmental and ethical impact of an investment in a publicly listed company.
ESG is rapidly replacing Corporate Social Responsibility (CSR) as the main focus when companies communicate with investors on a range of issues from use of resources to health and safety, human rights and business transparency.
In essence, ESG is about providing detailed metrics on a range of activities in contrast to CSR where a company reports in general terms annually on its efforts to have a positive impact on the environment, community, employees and consumers.
The right data provided through ESG criteria will give investors clear insights into the quality of management, exposure to risk and the opportunities created through ESG activity.
What are investors looking for?
Clearly, measurement of ESG criteria will differ widely from business to business and standards are continuously evolving.
For the environmental strand, investors will seek detailed data on energy and water use, waste processes, pollution control and natural resource conservation. They will also need to know the detail of any environmental risks and regulatory compliance.
For the social element, investors will need to gauge how responsibly a company acts in its community, and how it manages relationships with suppliers and employees, as well as other stakeholders.
The final piece in the ESG jigsaw, governance, is an opportunity for companies to demonstrate to investors that all the financial data is accurate, business processes are transparent and honest, and there are no conflicts of interest at the executive level.
Why ESG is important
Research by Harvard Business School amplifies growing evidence that high-quality ESG data improves a company’s ability to attract and retain long-term investors. At the same time, comprehensive ESG metrics help companies to improve their chances of raising capital for sustainable projects, while lowering initial finance costs.
The London Stock Exchange (LSE) has issued detailed guidance on ESG reporting, identifying eight priorities:
- Strategic relevance
- Investor materiality
- Investment grade data
- Global frameworks
- Reporting formats
- Regulation and investor communication
- Green Revenue reporting
- Debt finance
Given the complexity of company reporting, these eight points help to frame data needs in a given business in the most effective way. The LSE guidance complements the range of global ESG frameworks available.
The aim of these is to improve the reliability and consistency of ESG reporting, with a rapidly growing number of investors and companies embracing the frameworks.
And almost all leading institutional investors of UK and Italian listed companies have signed up to the Principles for Responsible Investment (PRI), which represent $60 trillion in assets under management, compared to $22 trillion in 2010.
And recent Government regulations requires UK pension schemes to have a policy on financially material ESG factors including climate change.
The leading global frameworks are:
- CDP (formerly the Carbon Disclosure Project)
- Climate Disclosure Standards Board (CDSB)
- Global Reporting Initiative (GRI)
- Integrated Reporting Framework
- Sustainability Accounting Standards Board (SASB)
- UN Global Compact (UNGC)
Companies that take on the task of adapting their reporting to fully embrace one of the frameworks and LSE guidance are also better placed to manage the transition to the low-carbon economy. The process requires more than finely-tuned rhetoric and demands substantive action on the range of ESG subjects.
From efficient energy, water and fuel management to employee welfare and human-rights overview throughout the supply-chain, companies focused on ESG, with detailed policies, processes and targets will be seen as far more attractive to investors than those increasingly viewed as higher risk.