What is ESG?
What does ESG mean? Why does it matter? How is it relevant to investing?
With the growth of interest in how companies align to environmental, sustainable, and social impact issues, we are seeing the growth in the use of the term ESG. But not everyone knows what it means.
Many of you will have seen the term lauded by sustainability and impact champions. Many of you will also have seen the term become a point of contention and controversy amongst thought leaders and political figures alike.
Here we have created a simple overview to help you understand what ESG means - and why it matters. We will be diving into the pros, cons, and limitations in future articles. For now - this article is designed to help you understand the core principles of Environmental, Social, and Governance.
In simple terms - ESG is a framework. This framework is used to produce information (or data) about a company, and how it performs against the dimensions set out by the framework.
What does ESG mean?
Definition:
ESG stands for Environmental, Social, and Governance.
It is a framework designed to measure non-financial criteria and understand an organisation’s posture on environmental, social and governance issues - manage risks, identify opportunities, and ultimately enable decision making.
What does ESG measure?
Environmental dimensions include:
Carbon footprint;
Waste management & pollution;
Land & water management;
Environmental targets & disclosures;
Net zero transition planning.
Climate change;
Biodiversity & nature loss;
Greenhouse gas emissions;
Resource use & circularity;
Energy consumption;
Social dimensions include:
Duties towards customers & consumers;
Ethical procurement;
Modern slavery;
Human rights;
Social or community projects & partnerships;
Charitable giving.
Diversity, equity & inclusion (board-level & throughout the workforce);
Fair pay policies, and ethnic & gender pay gaps;
Health & safety;
Workforce wellbeing, both physical & mental;
Workplace policies;
Culture within an organisation;
Governance dimensions include:
Internal controls;
Data privacy & cyber security;
Transparency & accuracy of reporting;
Management of bribery, corruption & money laundering risk;
Supply chain controls;
Setting & applying organisational values, culture & purpose.
Board oversight & boardroom dynamics;
Adherence to governance codes & frameworks;
Effective integration of ESG into strategy & operations;
Compliance policies;
Codes of conduct;
Due diligence;
Why does ESG matter?
Originally ESG frameworks were used to understand a company’s viability - how do outside-in factors impact a company's long term performance and resilience as external factors change.
For example -
How impact would a water shortage due to climate change have on a company’s ability to function?
How does a company’s exposure to modern slavery in their supply chain expose the company to financial risk from fines & legal action?
How well does a company’s internal policies & procedures help manage and minimise these risks?
In practice, ESG has become synonymous with a company's ethical posture & values alignment - in simple terms: is the company a ‘good-actor’ or a ‘bad actor’ when it comes to environmental or social issues.
For example -
Has this company’s operations caused displacement, health issues, or economic harm to nearby communities?
Do this company’s products contribute to war and loss of life?
Is this company responsible for pollution and habitat destruction?
Will this company use their customers' personal information in a way that undermines their privacy rights?
How is ESG used?
By Companies -
gather operational metrics on their performance against ESG criteria both internally and across their supply chain, report publicly and to regulators, and make strategy decisions to minimise their own risk and improve their business performance.
By Investors -
ESG frameworks were originally used to understand a company’s performance and non-financial risk in order to inform investment decisions. However, with the rise in demand for values-aligned financial products, funds are using ESG information to build funds and other financial offerings that are more ‘ethical’ to attract new customers themselves.
What does this mean for me?
ESG is generally considered the first broadly adopted attempt to understand if a company is a “good-actor” or a “bad-actor” and connect this to a company's global impact and their long term viability. While this is generally considered a fair first attempt - anyone who operates in this space will probably tell you there are some fundamental gaps that need addressing before ESG becomes genuinely fit for purpose.
These gaps centre around:
Inconsistency in how the frameworks are applied or interpreted;
Inaccuracy of the information provided;
Weather what is measured matches up with the insights actually required to make strategic decisions.
We will be digging into this in a lot more detail in future articles - and sharing actionable insights to help you understand what this means for you. Subscribe to make sure you don’t miss out.
