What is ESG? Ultimate Rules to Better Your Business (2022)
April 7, 2022
Table of Contents
“What is ESG?” has always been asked in the last 20 years. It has become crucial to deepen this theme due to the growth of the ESG movement. Indeed, it now corresponds to more than US$30 trillion in terms of managing assets.
In this article, we will explain to you what ESG is and why it is important for your business.
What Are Environmental, Social, and Governance Criteria?
ESG measures Environmental, Social and Governance factors to evaluate companies and investments on their non-financial performance and sustainability progress.
It 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 an economic matter but also an Environmental, Social and Corporate Governance issue.
Investors are taking care of these three aspects. Thus, companies must deal with them, if they want to survive.
Companies must focus their operations to ensure that they reach determined bottom-line results in these terms.
The ESG approach is relatively young even though the term was first coined in 2005. In the early 2000s, most investors believed that the sustainable approach did not have a financial return. Today it gained importance 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
It became effective on March 10, 2021. It establishes disclosure obligations on financial products.
- Sustainable finance
It partially entered into force in March 2021. It is about regulations to promote sustainable investments. It is against the “non sustainable” ones (such as fossil fuels).
- EU taxonomy for sustainable activities
They 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. Some of these are:
- food safety
- greenhouse gas emissions
- climate change
- usage of renewable resources
Summing up, this criterion refers to the impact companies have on the environment. They should try to have as little impact as possible.
The second criterion concerns the social sphere. It refers to all the social business relationships that the company has with customers, clients, and 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 events and initiatives that a company carries out.
Indeed, it can organize them to improve the welfare of the inhabitants in which it is located. For instance, they can contribute to the improvement of the local community.
Among the three, this aspect is particularly important. Indeed, it is easily seen from the outside. It can give a positive image of the company.
The last criterion concerns the governance of a company. Governance means all the “good” management practices.
These are needed to face any kind of corruption and have an ethical division of the compensation.
- a company’s leadership
- executive pay
- diversity in leadership
Thanks to this indicator, an external investor is able to understand how close the company is 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 institutional 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 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 keep growing “greenly”.
Consumers, media, customers, stakeholders, and all the business actors play an important role as well. Indeed, almost 50% of millennial millionaires invest based on these factors.
It is crucial for new start-ups to foresee future regulations and trends.
If you consider the direction in which the institutions are going, it may become compulsory for any organization very soon. Hence, companies need to start moving towards it.
Every party is now an active actor against social injustice and climate change. As the pressure became unbearable, companies have been shifting their operations into “green” strategies.
Converting means that every company has to choose an area of focus. Then, they must demonstrate what they are doing. They can do it publicly as well. Yet, it is important in their annual reporting. In ESG, transparency is the key.
ESG principles can vary from CO2 reduction to the usage of sustainable natural materials. They include:
- human rights
- diversity in workplaces
- limited executive compensation
- anti corruption
ESG represents 25% of the US investments. This means that if the investment is $4, $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 a hostile 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 of the investment process with these non-financial factors. Sustainable investing includes
- impact investing
- ESG investing
- socially responsible investing (SRI)
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.
Their aim is to make their clients understand investment strategies.
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.
Responsible investors are considering the ESG data when they start an investment operation. In this way, they can have a clear overview of the companies they are investing in.
ESG metrics are not compulsory parts of financial reporting yet. However, companies are making disclosures in an autonomous report or in their annual report.
There are diverse institutions that are working to establish standards. They want to determine practically how to incorporate ESG factors in the investment process. Some of these are:
- the Global Reporting Initiative, GRI
- the Task Force on Climate related Financial Disclosures, TCFD;
- the Sustainability Accounting Standards Board, SASB.
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 investment system and the importance of sustainability has become crucial. Now more than ever.
CFA Institute provides relevant research and 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 these factors.
Data providers collect data. Once they have measured these data, you 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 understand risks and opportunities related to ESG company’s operations and products. It works with around 300 indicators.
- Sustainalytics: it is the leader provider of ESG ratings, data and research. Now it supports ESG investors. It works with more than 200 indicators.
- Bloomberg: it provides data about the company’s ESG metrics.
If you want to apply ESG criteria to your business, you can opt for funds. It is easier to look for mutual funds online.
You can find highly rated ESG funds from a variety of brokerages and fund families using screening tools.
But you don’t have to focus on ESG characteristics only. More traditional criteria, such as cost, keep their importance.
However, ESG percentages in funds are still higher on average. The result is that you might get more funds if you adapt to these criteria.
Pros and cons
Until a few years ago, sustainability was felt like a niche investment. It was perceived as 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 their advantages, a strong ESG attitude enables companies to have competitive advantages.
These regard capital access, promote long-term growth that is sustainable and give companies and investors benefits. It also allows the development of a stranger corporate brand.
Here is a list of advantages:
- ESG Investors are sticky.
These investors are people who look at what will happen in 10 years’ time. What will happen in the next few years is not relevant to them.
They are aware that changes take time. They usually work with companies to strengthen them.
They are thus more interested in creating a long-term relationship over a long period.
- ESG initiatives can build competitive value.
Companies that are pioneers in understanding these trends have some advantages over competitors. Indeed, they are more able to recognise strategic opportunities and face competitive challenges both now and in the future.
Leaders should take care of the diversity of their teams and try to improve labour conditions. They might be taking into account sustainable environmental policies.
This helps 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. It is essential that the company’s values are in line with theirs.
It is important that the employees believe in what the company does. In this way, they will strengthen the 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 lost! Investors in ESG funds collaborate with companies in order to build ESG strategies and activities. They cooperate to begin 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 to follow, companies must be loyal to them. They should establish metrics that verify these ESG policies, check them regularly and so on.
They should also 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. These were 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 different things. Earnings or financial situation might be the case. The reputation or the assets of a bank are at risk as well.
Risks can be related to the three ESG factors:
- Environmental risks
They can be physical risks. This means that economic activities are threatened by failures to accomplish climate goals (such as droughts or sea-level rise).
They can be transaction risks. This means that the economic activities of the business model are jeopardised by continuous changes and its negative ESG impact.
An example can be the 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, they all should be considered 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 employee’s motivation will rise as their tasks have a more beneficial impact.
- Reductions in cost
Companies that convert to ESG activities have a cost reduction in operating expenses such as water and 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. The actual resources they use are cheaper and available.
However, the world and so the regulations are shifting towards fewer emissions. The choice to wait may appear the cheap one now. Yet, it 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. It can actually 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. It introduced rules on disclosure requirements concerning sustainability in terms of risks and investments.
As mentioned above, the world is going in this direction. Companies, in order to survive, have to adapt to that, no matter the law requirements.
The investor communities care about it. 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 these 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 purpose of ESG must be in the strategies themselves, in their values, and 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 global companies, SMEs can take advantage of less bureaucracy.
They are indeed local and closer to the customers. They usually have a story the customer can recognise with. Therefore, they can easily convert to green.
Smaller margins mean that even small and simple changes might make them save a lot.
For example, they can change to renewable energies. They might use recycled products, they can have paperless offices. They can eliminate plastic and use compostable products, and so forth.
Although they seem ineffective, these changes make an important financial difference for small companies. They reduce carbon emissions as well.
Another advantage of SMEs is that during financial negotiation, investors will look at them kindly.
The new generations, in particular millennials, are more aware of certain situations in order to keep the planet alive. They will certainly buy your products if they know they are plastic-free or the package is compostable.
And do not forget that they are the customers of the future.
ESG for global companies
SMEs are not the only concerned when we are talking about ESG. There are many global companies that have started to do “something” for the planet.
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.
The key focus of the company is climate, agriculture and packaging. In addition, they focus on the quality of the products and water stewardship.
With their slogan “a world without waste”, they want to collect and recycle every bottle. The aim is 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 for parental leaving.
They both support social movements, such as Black Lives Matter, Pride month and environmental matters through their social media platforms.
The toy company will invest $400 million in the next three years to speed up its efforts. Its main aim is to have single-use plastic packaging for its bricks and have sustainable packaging 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. They are investing huge sums of money in electric vehicle manufacturing to reduce CO2 emissions.
Also energy companies, such as Centerpoint Energy (CNP) and Xcel Energy (XEL). They are moving to the production of renewable energy.
According to executives, companies are allocating funds to sustainable activities. Those 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).
These 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.
Many entrepreneurs feel that ESG will be the future. It is thus worth investing in it 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 was adopted by the European Union. It is a plan to promote and stimulate public and private investments. These are required for the transition to a green, competitive and inclusive economy.
The Green Deal is based on three dimensions:
- Financing: mobilising at the minimum of €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 safety 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 platform that allows you to connect with other companies and Chambers of Commerce worldwide.
To underline the importance of ESG, CONNECTS launched a series of events around the topic of ESG. You can participate in our online webinars for free.
At the events and on the platform, you can generate key leads for your business. Building a wide business network and finding the right business partners are both fundamental steps for every business or company.
In addition, CONNECTS created the “ESG for SMEs” community. There, ideas and new business opportunities are shared. The topic revolves around Environmental, Social and Governance strategies.
To actively use the platform and join this community, you need to become a member of the CONNECTS platform. You can also join other business communities. There, you have the opportunity to improve your ESG strategy or other aspects of your business.
Join CONNECTS and discover a world of new business opportunities you can trust.
You can try our free trial for new members.
Are you a member of a participating chamber? Join our Business Development Platform for free.