ESG
Environmental Social &
Governance
What is ESG?
The COVID-19 pandemic is an event that no one could have foreseen, and the collateral
damage has been felt worldwide. Widespread illness and fatalities lead to
socioeconomic disruption, halting supply chains and global trade, pushing millions
into poverty, and changing the way businesses operate “normally.” Now that we’ve
entered 2022, it has become clear that businesses cannot continue or return to
operations as they were before the pandemic. To become more resilient and robust,
organizations need to adopt business practices that positively affect society and the
environment, with a particular focus on social responsibility and gaining the social
license to operate from the communities and environments they contribute to and
depend on.
Conscious and responsible stakeholders’ enthusiasm for investing in societies for a
post-pandemic recovery is an additional incentive for businesses to contribute to the
social and environmental good. Investors can reference a company’s ESG performance
as a guide when making assessments. The COVID-19 pandemic has been a turning
point for the ESG industry and has emphasized the value of environmental, social, and
corporate governance issues in capital markets. Any progress towards achieving the
Global Goals, also known as the UN Sustainable Development Goals, directly correlates
with the overall ESG performance of businesses and the strength of partnerships with
key stakeholders (community-based organizations, governments, non-profits, etc.)
ESG
What and Why?
ESG is the umbrella term for the components of sustainable and responsible finance. It
is a framework for monitoring environmental, social, and governance factors,
propagating financial data to investment decision-making processes.
Companies that understand their corporate responsibility take into consideration ESG
issues relevant to their business operations and services. Such companies embed ESG
values into business strategies for the benefits of increased financial top-line growth,
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employee productivity, reduced bottom-line cost, volatility, and regulatory and legal
interventions (fines, sanctions.) Comparatively, companies with poor ESG performance
are associated with a higher cost of capital and level of volatility owing to operational
controversies (labor strikes, fraud, noncompliance, and other governance irregularities.)
As public awareness over the societal and environmental impacts of business reaches
an all-time high, reporting on ESG performance is fast becoming compulsory. Keeping
ahead of regulations and remaining competitive in this economy means companies
must take advantage of the benefits of ESG by embedding it into their business core.
Businesses that do not measure and manage their ESG impact will fail to comply with
new guidelines, creating issues with future regulatory, legal, and/or operational
requirements. When businesses incorporate ESG principles within their core (sooner
rather than later) they will inevitably generate more success, becoming more
diversified and equal and showing more concern for the health and welfare of their
employees and all other stakeholders. The positive impact on the communities and
environment they depend on (and subsequently, the business itself) is incalculable.
Environment
Society
Business/
Economy
As shown in the diagram, businesses/economies nest within the realm of society, while
society itself is a part of the greater environment. This shows that whatever negatively
(or positively) impacts the environment, and the society it depends on, will have a
similar impact on the businesses that exist within them.
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“E” is for Environmental
The “E” in ESG is the assessment of how a company interacts with the natural or
physical environment. It is one of the three key factors in understanding ESG risks and
opportunities, detailing a company’s utilization of natural resources and the effect of
its operation on the environment, both in direct operations and across supply chains.
As businesses directly depend on natural resources to operate, ensuring that their
operations and activities are carried out ethically and responsibly is critical. Companies
that ignore the effect of their policies and operations on the environment are more
likely to face financial risk.
Historically, businesses have not always had controls placed on the use of natural
resources. However, with the steady rise in the global population, there is a significant
increase in pressure on natural resources. Businesses (as well as individuals) must
consider their responsibility to the environment and the future generations that
depend on it.
The first step towards this responsibility is understanding how business operations
impact relevant environmental issues. The following are environmental factors that
businesses should consider when assessing their ESG performance:
Climate Change
Waste and Pollution
Resource Scarcity and Depletion
Water and Energy Efficiency
Natural Resources Preservation
Animal Welfare and Biodiversity
Greenhouse Gas (GHG) Emissions
All these issues are significantly affected by business operations (no matter the size
or type of business) and will greatly contribute to the overall health of the global,
natural environment.
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“S” is for Social
The “S'' in ESG represents how a company manages stakeholder relationships (the
workforce, the society in which it operates, and the respective political environment.)
The Social factor includes all the societal aspects connected to the business, with
particular emphasis on organizational policies and practices concerning human rights,
business ethics, supply chain management, diversity and inclusion, and social impacts.
Due to the complexities inherent to this last concern, the social pillar in ESG may be
more difficult to define and quantify than the environmental, but it can just as directly
impact the financial performance of a company.
A strategic and long-term focus on social performance provides companies the unique
opportunity to continually redefine their role and purpose in society. Currently, global
businesses need to rethink how they can collectively help address societal problems
regarding poverty, inequality, and mental health. Businesses that effectively manage
their social presence financially outperform their competitors and have acquired social
permission to operate from the communities they depend on.
In 2015, at the United Nations Summit in New York, participating countries adopted the
2030 Agenda for Sustainable Development.1 This Agenda, also known as the UN
Sustainable Development Goals (SDGs), is a broad policy agenda with 17 goals and 169
associated and integrated targets. The UN SDGs aim to unite the UN Member States in
achieving inclusive, sustainable development with a people-centered approach
allowing for no one to be left behind. The SDGs are a plan of action for people, the
planet, and prosperity that have created a strong, universal focus on social issues.
Along with caring for the planet, the SDG’s determination of ending poverty and
hunger serves to ensure that all human beings can fulfill their potential in dignity and
equality, in a safe and healthy environment. The goals also focus on the prosperity and
peace of people, entreating nations to become inclusive societies that are free from
fear and violence. As the world begins to concentrate more on ESG concerns, the UN
SDGs have gained massive momentum and are increasingly being recognized as a
foundation for responsible investment.
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Some of the societal issues from the SDGs that directly affect businesses include:
Working Conditions
Equal Opportunities
Human Rights
Employee Diversity
Child Labor and Slavery
Community Relations & Human Rights
Workplace Health & Safety
Diversity & Inclusion
Political Ties
Philanthropy
A business that can label its performance in these areas as “excellent” is
successfully navigating the social pillar of ESG.
“G” is for Governance
The “G” in ESG refers to the structure of rules, practices, and processes used to direct
and manage a company. A company’s board of directors is the primary force
influencing its corporate governance (the decision-making process regarding areas of
environmental awareness, ethical behavior, corporate strategy, compensation, and risk
management.)
Accountability, transparency, fairness, and diversity are the basic principles that
responsible corporate governance employs. By following these principles, companies
show positive growth direction and business integrity. Compelling corporate
governance practices help companies build trust with the community, promoting
financial viability for the future of the business and opportunities for investors. Poorly
planned or executed governance practices can elicit distrust in a company’s operations
and doubts about its prospects, impacting profitability and financial viability.
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To realize the state of their performance on governance issues, businesses should
analyze the following metrics:
Business Ethics
Executive Pay
Board Diversity and Structure
Bribery and Corruption
Political Lobbying and Donations
Tax Strategy
Compliance
How a business operates within these categories will affect its overall standing in
the realm of ethical governance.
What is ESG investing?
ESG Investing refers to strategic investing which prioritizes optimal environmental,
social, and governance (ESG) factors or outcomes in which a company measurably
contributes to the betterment of the world.
Commonly known as “socially responsible investing” or “impact investing,” ESG
investing involves independent ratings that assess a company’s behavior and policies
regarding environmental performance, social impact, and governance issues. ESG
investing provides the opportunity for investors to influence positive change in society,
correlating to the idea that the financial performance of organizations is increasingly
affected by environmental, societal, and governance factors.
Current trends in ESG investing
Due to this increase in public awareness of the impact of ESG concerns, ESG investing
has grown rapidly in recent years. In 2021, ESG funds accounted for 10% of worldwide
fund assets. According to Definitive Lipper data,2 by the end of 2021 $649 billion
funded ESG-related efforts worldwide, whereas in 2019 it was only $285 billion.
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Both organizations and individuals are recognizing the interdependencies of social,
environmental, and economic issues and the impact business has on them. The
COVID-19 pandemic inevitably fueled this growth in the ESG investing market, due to
the need to create more resiliency in businesses and to aid recovery after the triggered
economic crises. More investors are interested in funding organizations and products
that promote sustainability and are current with emerging regulations, such as climate
change policies and supply chain due diligence. This growing demand has been met
with an increased focus on ESG by businesses and higher returns on investment for
ESG funds due to greater resilience than conventional markets.
Determining materiality
Which ESG issues matter?
Businesses are incredibly diverse in the way they operate, their sectors, and their
impact. The relevance of ESG issues varies across sectors and organizations alike. To
monitor, manage, and report their ESG performance, companies need to first
understand what specific issues are important to their business operations, the
“material issues.”
Material issues are relevant within different contexts, including legal, financial,
regulatory, and record-keeping. For most businesses, financial materiality, or how the
bottom line is affected, is the most apparent issue. However, materiality is also relevant
in the non-financial context, such as sustainability, governance issues, and corporate
social responsibility (CSR.) Non-financial material issues can also have a financial
impact, lending relevance to the ESG investing industry. When companies invest in
ESG issues, the resulting financial outperformance is a reinvestment in the company
itself.
A materiality assessment is necessary to determine which issues are relevant to a
company. Companies can begin their materiality assessment by analyzing certain
circumstances, including their industry, sectors, and business operations. Another
integral step in a materiality assessment is determining what issues are material to the
company’s stakeholders and the societal role of that business via social engagement.
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Assessing materiality also helps companies stay on top of regulatory and legal
developments. Stock exchanges (such as the Hong Kong Stock Exchange or HKEX)
have provided tools for firms to better manage their material issues. Once a company
has identified its material issues, focusing on defined targets and goals, and allocating
resources and time are the next steps to address these material issues. Companies can
create a clear roadmap using quantitative key performance indicators (KPIs) and will
then be able to drive action and accountability on non-financial targets that influence
the society and the environment, such as decreasing the gender pay gap, promoting
diversity, reducing emissions, and aligning with UN SDGs. These actions rapidly
improve a company’s ESG performance.
Measuring and reporting ESG
performance
The first step in measuring and reporting ESG performance for a company is
conducting a materiality assessment, as mentioned in the previous section. By
planning for what exactly will be measured, the process of reporting ESG target
performance becomes easier. Through sustainability reporting, companies report their
ESG performance, while communicating their sustainability goals. At present, there are
several standards for sustainability reporting. The most universal and recognized of
these are:
Global Reporting Initiative (GRI) 3 : The GRI is a globally dominant reporting standard
that focuses on corporate social responsibility and environmental, social, and
governance issues. The GRI has also mandated the inclusion of a materiality analysis in
all GRI-aligned reports.
Sustainability Accounting Standards Board (SASB)4 : The SASB Standards were
created for US companies to communicate their financially-material sustainability
information to investors.
Carbon Disclosure Project (CDP)5 : The CDP is a global disclosure system that focuses
on environmental impacts (specifically, carbon footprint, forestry, and water.)
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Depending on which issues are material to the company and which reporting
standard is most appropriate to their business, companies can utilize these standards
to publicly disclose their non-financial information and create opportunities for ESG
investing. Several agencies and groups will use companies’ publicly disclosed
nonfinancial information from their websites, sustainability reports, or other mediums
to rate and compare them.
How can companies improve their
ESG performance?
ESG Investing enables reductions in cost to businesses through innovative strategies
and improved employee engagement, providing motivation for companies to consider
investing and prioritizing environmental, social, and governance issues relevant to
them. Essential steps that businesses can take to improve their ESG performance
include:
1. Recognizing that doing good externally and internally are not mutually exclusive.
2. Conducting a materiality assessment to identify material topics and plan ESG
targets.
3. Integrating ESG targets into the existing business strategy.
4. Understanding ESG performance and rating as compared to competitors.
5. Aligning with global and regulatory frameworks to gain a competitive advantage.
6. Educating employees about sustainability and ESG through training opportunities.
7. Measuring carbon emissions, specifically Scope 1 (emissions from direct
combustion) and Scope 2 (indirect emissions.) The GHG Protocol provides
companies with guidelines on how to measure and monitor their Scope 1 and
Scope 2 emissions.
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8. Conducting Life Cycle Assessments (LCA) on products and assessing indirect and
direct impacts from the supply chain.
9. Consulting with external ESG experts.
10. Publicly disclosing ESG performance and targets to keep stakeholders, including
investors, informed on progress concerning non-financial issues.
The future of ESG
Embedded Sustainability
At present, the world faces three significant challenges in terms of sustainability:
declining resources, demand for radical transparency, and heightened expectations.
Natural resources are dwindling faster than they can be reproduced. Customers,
investors, and governments are placing new demands on businesses for
accountability, with ever-increasing expectations for corporate social responsibility.
This pressure has forced most businesses to adopt social responsibility initiatives for
marketing and branding purposes. However, businesses are recognizing that
embedding sustainability has more than a superficial purpose.
As more companies have incorporated environmental, health, and social values into
their core business activities the market information is showing little to no trade-offs in
price or quality for their products and services. Such organizations have made a
fundamental shift across every dimension within their business systems, defying
traditional approaches to CSR that historically added cost and provided no value.
Embedding sustainability will meet both investor and stakeholder requirements by
creating monetary, environmental, and social value for a business and is the future of
ESG.
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Notes
1. Commission for Social Development (CSocD). “Transforming our world: the 2030
Agenda for Sustainable Development.” Social Development for Sustainable
Development, United Nations, https://www.un.org/development/desa/dspd/
2030agenda-sdgs.html
2. Kerber, Ross and Simon Jessop. “Analysis: How 2021 became the year of ESG
investing.” Reuters, Thomson Reuters, 23 December 2021, https://www.reuters.com/
markets/us/how-2021-became-year-esg-investing-2021-12-23/.
3. “GRI Standards English Language.” Global Reporting, Global Reporting Initiative,
2022, https://www.globalreporting.org/how-to-use-the-gri-standards/gri-
standards-english-language/.
4. “Standards Overview.” SASB Standards, Sustainability Accounting Standards Board,
2022, https://www.sasb.org/standards/.
5. “What We Do.” CDP Disclosure Insight Action, CDP North America Inc., 2022,
https://www.cdp.net/en/info/about-us/what-we-do.
CONTACT US
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