Understand What is ESG before you Regret it Forever (2021)
November 30, 2021
Table of Contents
“What is ESG” is a question that has been continuously asked in the last 20 years. Due to the growth of the ESG movement, which now corresponds to more than US$30 trillion in terms of managing assets, it has become crucial to deepen this theme.
In this article, we will explain to you “what is ESG?” and why it is important for your business.
What is ESG?
ESG measures Environmental, Social and Governance factors to evaluate companies and investments on their non-financial performance and sustainability progress.
ESG is used by investors to identify the financial performances of a company in the future. In fact, when a company decides to invest, it has to take into account the so-called ESG criteria. Nowadays, investments are no longer considered only as an economic matter but also an Environmental, Social and Governance issue.
Due to the fact that investors are taking care of these three aspects, companies, if they want to survive, must deal with them. Companies must focus their operations to ensure that they reach determined results in Environmental, Social and Governance terms.
The ESG approach is relatively young even though the term was first coined in 2005. Despite the fact that, in the early 2000s, almost all the actors operating in the investment market believed that the sustainable approach did not have a positive impact on financial returns, today it really matters for investors.
There are three main regulations by the EU to consider if you want your company to be “ESG friendly”:
- Sustainable disclosure in the financial services sector entered into force on March 10, 2021. It establishes ESG disclosure obligations on financial products.
- Sustainable finance partially entered into force in March 2021. It is about regulations to incentivize sustainable investments against the “unsustainable” ones (such as fossil fuels).
- EU taxonomy for sustainable activities entered into force on 12 July 2020. It is a set of systems that establishes if economic activities are “ESG”. It provides companies with a list of points that defines the investment as “ESG”.
One of the three aspects that companies should consider is the Environment. This criterion says how a company behaves with its surrounding environment and the environment in general.
It refers to different indicators such as food safety, greenhouse gas emissions, climate change, usage of renewable resources.
Summing up, the environmental criterion refers to all the activities and operations that make the companies have as little impact on the environment as possible.
The second criterion concerns the social sphere. It refers to all the social business relationships that the company has with customers, clients, employees. Among all, we can find:
- Gender equality
- Respect for human rights
- The rejection of all forms of discrimination
- Animal welfare
- Attention to working conditions
- Equal wages
In addition, the “social” aspect is related to the events and initiatives that the company carries out to improve the welfare of the inhabitants in which it is located.
This aspect is particularly important because, among the three, it is easily observable from the outside and gives the company a positive image.
The last criterion concerns the governance of a company, which are all the “good” management practices that are needed to face any kind of corruption and have an ethical division of the compensation.
Thanks to this indicator, an external investor is able to understand whether the company’s board of directors, management, and stakeholders are close to the ESG criteria. Examples of governance aspects are:
- Employs a CEO autonomous of the board chair
- Companies that embrace diversity on their board
- Support corporate transparency
Why is ESG essential now?
Nowadays, many more investors are taking care of the ESG factors in their investments.
On the legal hand, the European regulations are moving to the implementation of the ESG rules in any business-related area. This strategy will help the economy to be more sustainable and “green”.
Companies have started the shift to ESG activities in order to remain successful in the near future. Sustainability is the new ideal that pushes companies to “adapt” to ESG to keep growing “greenly”.
In this developed world, pushes come not only from the EU regulations and investors but also from consumers, media, customers, stakeholders, all the business actors. Indeed, almost 50% of millennial millionaires invest based on Environmental, Social, and Governance factors.
It is crucial for new start-ups to foresee future regulations and trends.
Looking at the direction in which the institutions are going, it seems that ESG may become compulsory for any organization very soon. Hence, companies need to start moving towards ESG.
Every party is now an active actor against social injustice and climate change. As the pressure became unsustainable, companies have been shifting their operations into “green” strategies. Converting to ESG means that every company has to choose an area of focus and they must demonstrate publicly (or at least in their annual reporting) what they are doing. In ESG, transparency is the key.
ESG principles can vary from CO2 reduction to usage of sustainable natural materials, from human rights to diversity in workplaces, from limited executive compensation to anti-corruption.
ESG represents 25% of the US investments. This means that out of $4 invested,$1 comes from ESG investments.
Apart from that, people are demanding pension funds and banks some alternatives to sustainably invest their savings. As a consequence, many banks offer ESG investment solutions to enable consumers not to contribute to damaging companies. The main reason behind this is that they do not want to retire in an inhabitable world.
Last but not least, as consumers want to buy sustainable products, they also want to work for a sustainable company.
What is ESG investing (and ESG analysis)?
As mentioned above, investors are implementing their analysis on the investment process with these non-financial factors.
CFA Institute is a global, no-profit organization that gives financial education to investment professionals. Its aim is to support standards in education, ethics and professional excellence in the investment world.
They are playing an important role in considering the ESG factors in financial analysis. Nowadays, the ESG analysis is extremely important in the investing process. Investors are considering the ESG data when they start in investment operation to have a clear overview of the companies they are investing in.
Although ESG metrics are not yet compulsory parts to have in financial reporting, companies are making disclosures in an autonomous sustainability report or in their annual report.
There are diverse institutions (e.g. the Global Reporting Initiative, GRI, the Task Force on Climate-related Financial Disclosures, TCFD, and the Sustainability Accounting Standards Board, SASB) that are working to establish standards and to determine practically how to incorporate ESG factors in the investment process.
Trends of ESG investing
Due to the increase in the ESG demand, we can notice several trends such as social unrest, climate change and more. Since the beginning of the Covid-19 pandemic, the connection between the modern financial and investment system of the economy and the importance of sustainability is now more than ever crucial.
CFA Institue provides relevant research, experts advice, and it establishes standards to enable ESG investors in detecting these trends.
How to measure ESG data
ESG data are used to measure how the ESG operations of companies are. In fact, they provide information on Environmental, Social and Governance factors. Data providers collect data about this information and, once they have measured these data, we can understand how companies are “responsibly investing”.
The importance of ESG data has increased a lot over the last 50 years. At the very beginning, the data that mattered was mainly tangible goods. Today, almost 85% of valuable data comes from intangible assets such as reputation and intellectual property.
ESG Data providers
ESG data providers gather and evaluate the information of companies’ ESG operations and they give a score accordingly. These rating systems are useful for managers to understand the growth of ESG investing and to easily gather information.
Since 2016, there are over 100 ESG data providers such as:
- FTSE: it helps companies to understand risk and opportunities related to ESG company’s operational and product with around 300 indicators.
- Sustainalytics: it is leader provider of ESG ratings, data and research, and now it supports ESG investors. It uses more than 200 ESG indicators.
- Bloomberg: this company provides data about company’s ESG metrics.
Pros and cons of ESG
Until a few years ago, sustainability was felt like a niche investment, a way for investors to connect their economic activities with their personal and ethical values. Today, ESG, corporate, and investment performances go hand in hand.
Apart from Environmental, Social and Governance advantages, a strong ESG attitude enables companies to have competitive advantages regarding capital access, promote long-term growth that is sustainable and gives companies and investors benefits, and it also allows the development of a stranger corporate brand.
Why is ESG classified as an advantage?
- ESG Investors are sticky. These investors are people who look at what will happen in 10 years time rather than what will happen in the next few years. They are aware that changes take time. They usually work with companies to strengthen them, thus, they are more interested in creating a long-term relationship over a long period, rather than just flipping the stock in the very beginning.
- ESG initiatives can build competitive value. Companies that are pioneers in understanding the environmental and socio-economic trends are more able to recognise strategic opportunities and face competitive challenges both now and in the future. Leaders who take care of the diversity of their teams, work to improve labour conditions, and are aware and perform by taking into account sustainable environmental policies, increase the company’s brand. With the growth of millennials as employees as well as customers, these leaders will be rewarded.
- Companies that support strong ESG values tend to attract and maintain the best talents. Millennials do take care of the values (that are in line with them) of the companies they work for/with. The more the employees believe in what the company does, the more they will strengthen companies’ brand and promote the productivity of the personnel.
- Strong ESG strategies can raise stock liquidity. Both institutional and individual investors are heavily investing in corporations that act in a sustainable and ethical way. Investments in sustainability are growing at a double-digit rate. Consulting firms and researchers on investments have created indices that classify companies based on ESG criteria relative to their competitors. In fact, investment funds are collecting huge amounts of money to be given to companies that are performing ESG strategies.
- A proactive attitude on ESG issues can keep activists at bay. Activists are now blaming boards and management teams that do not take a proactive position on social and environmental matters. Companies that effectively “do” ESG keep away activists. However, nothing is irreversible! If your company is targeted by activists, investors in ESG funds collaborate with companies in order to build ESG strategies and activities to begin the long-term sustainable and social values.
To benefit from the ESG policies, companies should:
- Tell a story and stick to it. Once they have established which ESG criteria follow, companies must be loyal to them (establish metrics that verify these ESG policies, check them periodically…) and tell the public, in order not to be accused of “greenwashing”.
- Establish which are the best ESG criteria for their industry and for them. The best way to do that, is to look for the industry rankings within the main sustainability ranking index.
- Track inclusion within relevant ESG indices. Companies should select the best indices that fit their corporate strategy, among all the indices proposed by the market.
However, it goes without saying that once the theory of sustainability was born, new risks came out, the so-called sustainability risks, or ESG risks. They refer to the possible effects that a company’s stakeholders can exert, and, consequently the impact that the company might have on its stakeholders and on the environment caused by its activities. If risks occur, they could have a negative impact on earnings or financial situation, on the reputation or on the assets of a bank.
Risks can be related to the three ESG factors:
- Environmental risks: they can be physical meaning that economic activities are threatened by failures to accomplish climate-related goals (such as droughts or sea-level rise) or they can be transaction risks meaning that the economic activities of the business model are jeopardised by continuous changes and its negative ESG impact (such as changes in the demand and supply of services, commodities, or products).
- Social risks: they can be inadequate salaries, lack of assurance of product safety and discrepancies with labour standards.
- Governance Risks: they can be unsuitable senior management compensation, corruption or bribery, and compliance with tax law.
Top 5 tips to create value with ESG
It is not certain that the following five points will come up during your ESG investments. It can happen that the location or the sector of the company makes them more or less likely to arise. However, all five tips should be considered without regard to location or business model because they could have a very high potential for your value creation.
- Employee productivity uplift. Quality employees are more willing to operate and remain in companies with robust ESG prepositions. As a consequence, shareholders’ returns are positively affected. Employees who feel part of these sustainable activities will perform better. The more their tasks have a beneficial impact, the greater the employee’s motivation will be to perform in a social way.
- Cost reductions. Companies that convert to ESG activities, it has shown that they have a cost reduction in operating expenses such as water, carbon.
- Top-line growth. This new approach to economics will enable you both to grow your existing markets and to create new business opportunities. Companies perceived as ESG by the public or the stakeholders have a higher valuation in terms of reputation over their competitors. Moreover, more than 70 per cent of customers are willing to spend more on a “green” product, all else being equal.
- Investment and asset optimization. Investments in ESG will generate safer and bigger returns. It is true that sustainability today can be expensive for a company, and the actual resources they use are cheaper and available. However, the world and so the regulations are shifting towards fewer emissions. Hence, the choice to wait, even though it may appear cheap now, will be much more expensive than the investment itself in the future.
- Reduced regulatory and legal interventions. For companies that operate with an ESG proposition, it diminishes companies’ risk of adverse government actions, and it can also lead to the support of the governments.
How can ESG help your business?
Since March 2019, the European Commission has been talking about the importance of sustainable investments, introducing rules on disclosure requirements concerning sustainability in terms of risks and investments.
As mentioned above, the world is going in the direction of sustainability, and companies, in order to survive, have to adapt to that, no matter the law requirements. The investor communities care about sustainability. Many industries have responded to this request, and many others will follow.
Since ESG criteria are part of the investment process, combining your strategies with Environment, Social and Governance criteria will positively impact your revenues.
Due to that, the ESG shift must be perceived as an investment rather than a cost. Companies that have included ESG factors in their organization have achieved different benefits in terms of value and trust for shareholders.
However, it is not enough to plant a new forest. The ESG purpose must be in the strategies themselves, in their values, in their mission and vision. Executives should develop a sustainable strategy to keep track of the opportunities and risks available to them.
ESG for SMEs
Small companies can benefit from ESG. As opposed to large multinational companies, SMEs can take advantage of less bureaucracy, of being local and of being closer to the customers. They usually have a story the customer can recognise with. Hence, converting to green is easy for them.
Smaller margins mean that even small and simple changes might make them save a lot. For example, they can change to renewable energies, they use recycled products, they can have paperless offices, they can eliminate plastic and use biodegradable products, and so forth. Although they seem ineffective, these changes make an important financial difference for small companies (as well as the reduction of carbon emissions).
Another advantage that ESG has on SMEs, is that when they will have to do a financial negotiation, investors will look at them kindly.
What else? The new generations, in particular millennials, are more and more aware of the importance of these operations in order to keep the planet alive. They will certainly buy your products if they know they are plastic-free or the package is biodegradable. And do not forget that they are the customers of the future.
ESG for Multinationals
Not only SMEs are concerned when we are talking about ESG. There are many multinationals that have started to do “something” for the planet.
- Google. The tech company, with its CEO, Sundar Pichai, stands up against social concerns, such as Donald Trump’s anti-Muslim words. With its data centre, Google uses 50% less energy than other companies in the world. It also is involved in renewable energy projects through services like Gmail.
- Coca-Cola. The key focus of the company is climate, agriculture and packaging, as well as the quality of the products and water stewardship. With their slogan “a world without waste”, they want to collect and recycle every bottle, with the aim to make their packaging 100% recyclable and reduce their carbon footprint by 25%.
- Netflix & Spotify. These two streaming and media service companies offer benefits for their employees and families. The first one offers 52 paid parental leave to the birth and non-birth parents that can be taken anytime. Spotify offers 24 paid weeks. They both support social movements, such as Black Lives Matter, Pride month and environmental sustainability through their social media platforms.
- LEGO. The toy company will invest $400 million in the next three years to speed up its efforts in sustainability. Its main aim is to have single-use plastic packaging for its bricks and have sustainable packagings by 2025. They are also investing in more sustainable products with zero waste and are carbon “free”.
ESG: challenges for entrepreneurs
Entrepreneurs in all industries are massively investing in eco-conscious business processes. Among all, we can cite General Motors which is investing huge sums of money in electric vehicle manufacturing to reduce CO2 emissions or energy companies such as Centerpoint Energy (CNP) and Xcel Energy (XEL) that are moving to the production of renewable energy.
According to executives, companies are allocating funds to sustainable activities that require time to be made, and sometimes returns are difficult to quantify.
In recent times, credit rating agencies have been downgrading or cutting some companies (oil-and-gas companies) since they are considered to be risky in this new transitional economy. As a consequence, it has negatively affected stock prices in addition to the rise of the company’s borrowing costs.
However, many entrepreneurs feel that ESG will be the future, so it is worth investing in ESG to be able to be a pioneer. There are several areas in which companies can invest to become ESG. For example, they can:
- Improving labour policies
- Promote diversity, equity and inclusion in the workplace
- Reduce carbon footprints
A European green deal
The European Green Deal Investment Plan is the plan that European Union will adopt to promote and stimulate public and private investments required for the transition to a green, competitive, climate-neutral and inclusive economy.
The Green Deal is based on three dimensions:
- Financing: mobilising at the minimum €1 trillion of sustainable investments in the next 10 years.
- Enabling: giving incentives to unlock and address private and public investment. The European Union will facilitate sustainable investments, for example, by making easier the procedure to approve State Aids for transition regions.
- Practical support: the European Commission will provide help to project promoters and public authorities to plan, design and execute sustainable projects.
The European Green Deal will improve the health and the well-being of people (current citizens and future generations) with:
- Wealthy and affordable food
- Longer lasting products that can be fixed, recycled and re-used
- Cleaner energy and cutting-edge clean technological innovation
- More public transport
- Future-proof jobs and skills training for the transition
It is possible that the European Green Deal policies will affect trade within and imports to the EU, and it is likely that ESG standards will become stricter. It is important for companies to be informed about it and to start the “green” change.
It will pay off in the future.
How CONNECTS can help your business
CONNECTS is a business matchmaking platform that allows you to connect with other companies and Chambers of Commerce worldwide.
To underline the importance of ESG, CONNECTS will be launching an event around it: “ESG for SMEs: challenges and opportunities”. It is an Online Workshop on December 2nd, 2021, moderated by Richard Tuffs, strategic thinker and expert on EU affairs.
With high-level expert speakers drawn from Brussels Enterprises Commerce and Industry (BECI), EUROCHAMBERS, Groupe Bruxelles Lambert (GBL) and the business and investor community, this workshop aims to explore how collectively we can bring SMEs ‘on board’.
In addition, CONNECTS creates the “ESG for SMEs” community, which serves to facilitate the sharing of knowledge, insight, and new business opportunities amongst SMEs and other key stakeholders in the field of Environmental, Social & Governance strategy and reporting.
To actively use the platform and join this community, you need to become a member of the CONNECTS platform.
Are you an entrepreneur wanting to discover and develop new opportunities, both locally and internationally? Join our Business Matchmaking Platform and start your free trial.
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