What is ESG?
ESG is an acronym that stands for Environment, Social and Governance and is an umbrella term for a wide range of factors against which investors can assess the performance of the entities they are considering investing. However, ESG also has a wider application. The overall concept of ESG investing is a shift in focus from maximizing short-term profits as a primary objective of companies, towards a more sustainable business model where significant weight is given to a range of ESG factors such as as the environment, employees, supply chain and the larger community in which the company operates.
The ESG covers a wide range of factors and the following table shows some examples:
Why is ESG important?
ESG is a rapidly evolving field and in recent years it has come to the forefront of the business agenda and companies are under increasing pressure – from investors and regulators – to improve their performance. ESG. A number of factors are at play, including:
- Increased attention from governments and regulators on mandatory ESG reporting standards that build on non-mandatory frameworks that have been published by industry groups, NGOs and other international organizations.
The rise of ESG investing with the creation of ESG benchmarks and indices, the growing shift from passive to active investing and the creation of ESG funds that have attracted record capital inflows. More and more investors are selecting companies based on ESG criteria when making investment decisions.
A growing body of academic evidence suggests a link between strong ESG performance and higher returns on investment. The stock price performance of sustainable companies tends to outperform their less sustainable counterparts.
A strong ESG performance is therefore increasingly becoming an important factor influencing asset valuation and investment decisions. Companies that do not take measures to implement good ESG performance face a number of risks, including reduced access to capital, reduced long-term operational and financial performance, reduced returns to shareholders, reduced damage to the reputation and dissatisfaction of employees and stakeholders.
Considering the importance of ESG, companies cannot afford to simply treat this as a sham or front exercise. Instead, companies should develop their ESG policies and procedures and integrate ESG criteria into their decision-making processes and procedures at all levels of the company.
However, companies face a number of challenges when it comes to implementing ESG, including:
The ESG landscape is constantly changing and there is a multitude of voluntary ESG frameworks and a growing number of mandatory reporting requirements that are implemented in different jurisdictions. This lack of standardization means that businesses face a daunting task of navigating through the various standards and effectively prioritizing issues that are important and relevant to the business.
Investors increasingly want companies to measure ESG data which can then be compiled into annual reports from which, in turn, ESG data providers can extrapolate the data and generate ESG ratings. However, given the current lack of standardized reporting and data collection standards, there are challenges with the quality, consistency and reliability of the ESG data that companies collect.
Small businesses face additional challenges as they will not have the same level of financial and operational resources and sophisticated data collection systems as larger businesses. Small businesses may therefore first need to rely on external ESG consultants and data collection tools.