What are the Environmental, Social, and Governance (ESG) criteria? How do they differ from sustainability?
ESG is the acronym for Environmental, Social, and Governance and the fact that it has been gaining more attention in recent years... It is for a very good reason! ESG factors can provide valuable insights into a company's long-term prospects and sustainability and are standards many investors use to screen potential investments. But let's start at the beginning and look at each of them in turn:
- Environmental criteria consider how a company performs regarding protecting the environment, nature, biodiversity, and water.
- Social criteria focus on how a business interacts with its employees, suppliers, customers, and the communities in which it operates.
- Governance criteria examine the company’s ability to execute its long-term business strategy, leadership, audits, internal controls, policies, and shareholder rights on top of handling material ESG issues.
Why does ESG matter?
ESG can be viewed as temporal indicators of future earnings or value creation potential for any given company or industry sector to measure sustainability impacts across portfolios and activities over time. Though ESG is not just about investing, its relevancy is growing, and investors, companies, and policymakers are focusing on it.
ESG allows investors to assess the quality of investments and portfolio construction based on risk-adjusted returns rather than returns themselves. Sustainable investing should mean more than protecting the environment, and ESG is a powerful tool to show that: it also considers social issues like fair labour practices, human rights, and community engagement, as well as good governance.
However, while not being part of mandatory financial reporting, ESG measures are becoming more frequent in company reports. Indeed, a variety of organizations, such as the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD), are working to create standards and lay down criteria for assessing materiality. Those standards should end up making ESG integration easier for companies. When thinking of ESG, remember that:
- According to PwC, 83% of consumers believe ESG best practices should be actively developed within organizations.
- The percentage of corporate executives who think their company has a responsibility to address ESG proactively is 90%.
- Employees who desire to work for organizations that care about the same concerns are 86% (which is even more critical and a top priority for younger generations, according to various reports.
What is the difference between Sustainability and ESG?
There is a lot of confusion about Sustainability and ESG and, in particular, about the relation between the two. They are two different but related concepts. In a business context, Sustainability is about the company’s business model and its ability to continue functioning in the long-term while creating value for all its stakeholders (and not just the shareholders). At the same time, ESG, as said above, is a set of criteria that help assess companies’ sustainability efforts and that are organized in 3 different areas: Environmental, Social, and Governance.
It can be affirmed that ESG can be functional for Sustainability. A company aiming to improve its ESG efforts aims to enhance its sustainability focus. On the other hand, it is important to note that a company focusing on improving its efforts toward sustainability may not explicitly apply an ESG focused strategy and approach. Regardless, environmental, social, and governance factors are important to consider when assessing a company's sustainability. For example, a company might be environmentally sustainable but have poor social policies or vice versa.
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