What is the full form of ESG
ESG: Environmental, Social and Governance
ESG stands for Environmental, Social and Governance. It is responsible for deeply examining how sustainable the operations of an organization are. This framework has its major focus on ensuring that sustainability is not just limited to environmental issues but instead becomes a part of each and every aspect of human existence.
What is ESG?
The best explanation for it is that it is a framework which provides assistance to the investors and stakeholders about an organization's method of managing all the opportunities as well as risks that are linked to environmental, social and governance criteria. Even though the term is usually used in reference to investing, it also includes in it the interests of people other than those belonging to the investment community, such as customers, employees, suppliers and so on. Everyone working for an organization or spending on an organization is highly interested in the sustainable functioning of an organization.
The several criteria of ESG are discussed in detail below.
These criteria focus on an organization's impact on the environment and the ways in which it performs risk management. It involves the emission of greenhouse gases in the environment, be it directly or indirectly. It includes an organization's supervision of the natural resources as well as the ability of them to recover quickly from a drastic climate change or a natural disaster such as a flood.
The social pillar talks about an organization's relations with its investors and stakeholders. A firm may be judged on the basis of several factors, such as Human Capital Management metrics which is the data of the number of employees hired and engaged in that firm and also the fair wages that are provided to the workers. It also focuses on the impact of an organization on the community around which it is being operated and on the partners of the supply chain, specifically those who are a part of developing economies where the condition of environment and labour are not that strong.
Lastly, Governance talks about the ways in which a company is being governed or managed. ESG analysts focus on understanding how the expectations of stakeholders are taken care of, how their rights are considered, and the type of control that exists in the firm to promote accountability and transparency.
The Evolution of ESG
ESG, as mentioned above, helps to assess how a firm handles the risks and opportunities that are created by fluctuations in various conditions like environmental, social and economic as well.
Out of all these conditions, some of them are identified in the old framework works that focused on sustainability; they include:
1. EHS (Environmental, Health, and Safety)
In earlier times, back in the 1980s, all the organizations in the U.S. were drawing attention to the ways in which they could regulate themselves so that pollution and other negative factors that are a result of rapid economic growth could be managed and reduced somehow. They also tried to improve the standards of labour and safety, although not enough progress has been made even today, and this aspect still requires a lot of attention.
2. Corporate Sustainability
The evolution of EHS dates back to the 1990s. It evolved into something that was known as the corporate sustainability movement back then. This movement was a result of the management team's efforts to reduce its organization's impact on the environment. The reason they were pressing on it was that a lot of firms were resulting in the exploitation of the environment more than required.
It was agreed by the masses that corporate sustainability was employed by the firm's management teams as nothing but a marketing tool which they could use to over exaggerate or misrepresent the environmental impacts and the efforts made to sustain it. This practice later came to be known as greenwashing.
3. CSR (Corporate Social Responsibility)
The movement started in late 20th century and by the early 21st century, it started focusing on the movement of corporate sustainability started focusing on the ways in which an organization should respond to the social issues which appeared due to the functioning of these firms. These issues came to be called corporate social responsibility.
After decades of efforts to prioritize sustainability and draw attention to sustainable management, the ESG movement, from the late 2010s and into the 2020s, started to appear to control the issues rather than just reacting to them. Now, this movement has evolved into a framework that includes all the aspects of impact on social and environmental factors, in addition to the ways in which governance structures can be altered or changed in order to provide maximum well-being to the stakeholders.
ESG & Investing
The reason behind the extreme popularity of ESG and its going mainstream is the importance that this framework holds in the investment community. A large number of agencies have grown in the past decades, responsible for ESG rating. ESG reporting frameworks are growing rapidly as well. All of these are evolving in order to increase the transparency of an organization to the stakeholders as well as to improve the regularity of ESG information reports that the firms are releasing publically.
A very significant tool that can be used to create change in Capital Markets. Restricting access to capital or making its availability less favourable, even the bad actors can be brought to enhance their performance across measures such as E, S and G. Another surprisingly contrasting way is to reward the companies and management groups that are performing good in facing ESG factors. This has a positive impact on enhancing the improvement of the organization.
A number of investment methods have emerged that have helped the investors align their decisions of investment according to their values and beliefs related to E, S and G measures. These investment methods include mutual funds, ETFs, green bonds and so on.
Benefits of ESG Investing
It was once believed that sustainability was a niche that was set for only those kinds of investors who took their investment decisions according to their personal beliefs and values related to nature and people. With the implementation of the ESG method for the functioning of the corporate sector, companies have shifted their interest toward the interest of the shareholders. The impacts of this on the environment and society are in layers. This helps a company in financial advocacy.
A study has shown that 88% of companies have had better operational performance by following ESG practices. 80% of the companies have experienced enhanced performance in stocks with the help of these sustainable practices. ESG has helped in lowering the capital cost for almost 90% of the total companies present. The organization that had better scores in sustainability has less risk in investment and high resilience to future problems.
As explained earlier, the meaning of ESG is Environmental, Social, and Governance. Investors across the globe are moving towards these factors madder, applying them to calculate risks or growth chances for materials, even though they are not financial factors.
Organizations are applying ESG frameworks in their annual performance reports or a completely separate sustainability report to list the risk and growth metrics. These measures are taken by the organizations even though it's not really necessary for financial reports that are made by the companies. There are a number of institutions that have developed over the years which has the main goal of defining materiality and forming standards for the companies in order to help in the application of ESG criteria into the investment processes.
The reasons behind the interest of a huge number of investors seeking opportunities for sustainability are listed below:
The people behind decision-making are expecting more from the companies and are looking for more solutions for sustainable investment.
Governments are focusing more and more on the application of sustainable development in the process of investment and decision-making.
It is globally recognized that research and analysis based on ESG metrics can provide a clearer picture of the investment risks and also create more and more returns. ///
Investor's increasing interest in ESG criteria
During the initial days of awareness on sustainability, it was only the rating agencies which were specialized in sustainability that focused their attention on these concepts. Some of them focused on these concepts according to the sector of the company that was being analyzed by them. Teams responsible for sustainability analysis were supposed to provide their analyzed information to the companies, which further shared the data with their potential customers.
Institutional investors used to consider only the governance factor as an important criterion for investments in banking. It is only in recent years that their areas of interest have widened, taking into account the climate and social factors as well.
Institutional investors have historically considered aspects related to corporate Governance relevant for investing in banks. In recent years, their interest in climate and social issues has progressively increased.
Some companies that are counted as the biggest asset management organizations - specifically those which have passive management funds such as State Street and BlackRock, in addition to some active management funds, are doing their work by forming specialized teams which develop internal methods so that they can assign their personal sustainable ratings. ///
Key ESG Factors
The factors of ESG aren't defined properly with particular names. The factors are linked with each other most of the time, and it is not that easy to classify them solely to a single criterion. It is difficult to identify an issue as one belonging to only environmental or social, or Governance, as the given example talks about.
An important fact to be noted about ESG factors is that even though they can be measured (e.g. what is the employee turnover of a company), they cannot be assigned a monetary value (e.g. what is the cost of that turnover).
This factor of ESG refers to the conservation and well-being of the nature surrounding us. It includes in it the climate change that takes place due to overheating of the earth and other reasons and the amount of carbon emitted by a firm. All the environmental problems that are caused by the over-exploitation of nature by organizations are included in this factor, such as deforestation, water scarcity, waste disposal and so on.
This part talks about the consideration of people related to an organization and the relationships it manages with these people. It takes care of certain things, such as the satisfaction of customers, making sure the privacy of a person is encrypted, and gender and diversity are considered. Issues such as human rights and standards of labour are also part of this pillar.
This factor of ESG majorly focuses on the standards mandatory to run a company in a good way. There are certain measures that are to be considered when the management is being discussed, such as the structure of committees such as the Board of directors, audit committee etc. Issues such as bribery and corruption are managed in order to govern a company in a good way.
The different ESG metrics that are present don't have a particular method for the calculation or presentation of them. There are a lot of analytical approach and sources of data that can be used by the investors in order to look upon ESG considerations that also includes working according to the interest of the clients. Understanding the relative metrics and all the boundaries related to different metrics can be of great help to have a clearer picture of the risks and opportunities related to ESG.
Since the rapid growing industries are one of the major causes of the degradation of planet earth, understanding and implementing environmental, social, and Governance factors in the functioning and management of a company acts as a great step towards conservation. The rapidly growing awareness about the importance of considering sustainability in investment has resulted in more and more investors inclining towards the factors of ESG for investments. It was often believed that thinking about the safeguarding of the environment and investing while considering sustainability results in less profit, and sustainable investments demand a price to be paid.
Various studies clarify that quite the opposite is true, and the results of ESG investments have been positive. It has helped the companies gain more profit by eliminating most risk factors which is why ESG is prioritized so much. Different aspect such as the capital of knowledge, being mindful of the resources provided and corporate Governance is an interest that has been increasing rapidly with the intention to safeguard the beautiful planet that we live on.