Why is ESG (Environmental, Social and Governance) important for a business

January 11, 2024
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Uncovering the meaning of ESG

What is the definition of ESG?

ESG stands for “Environmental, Social and Governance.” ESG can be described as a set of practices (policies, procedures, metrics, etc.) that organisations implement to limit negative impact or enhance positive impact on the environment, society, and governance bodies.

In recent years, investors have become more aware of the importance of ESG criteria in their investment decisions. As a result, many businesses have begun to integrate ESG into their operations and business strategies.

ESG can be considered a subset of sustainability, which is defined by the UN World Commission on Environment and Development as ‘meeting the needs of present generations without compromising the ability of future generations to meet their own needs’.

Where does ESG come from?

The term ESG, or environmental, social and governance factors, was coined by the Global Compact in 2004.

However, the notion of incorporating all non-financial factors in business has been around for much longer; some might point to 2001 as the beginning of mainstream ESG with the launch of FTSE4Good indices.

ESG influence has grown rapidly in recent years. But sustainable investing and responsible impact in business are not new and has been gaining more widespread acceptance in the past few decades

Impact investing—the practice of making investments that generate not only financial returns, but also positive social and environmental impact—has its origins in religious groups who placed ethical parameters on their portfolios (refusing, for example, tobacco, alcohol, and gambling businesses).

It's important to note that ESG investing differs from CSR and impact investing. ESG investments focus on environmental, social, and governance factors to guide investment decisions; CSR investments focus on company's responsibility to society; and, impact investments aim to generate a measurable and positive social or environmental impact alongside financial returns.

The importance of ESG for businesses and investors

ESG functions as a valuation technique that takes into account environmental, social and governance issues. ESG in the private sector is a set of criteria used to evaluate a company’s risks and practices.

ESG frameworks are important to sustainable investing because they can help individuals or other corporations determine whether the company is in alignment with their values, as well as analyse the ultimate worth of a company for their purposes.

Why adopt an ESG approach?

Risk Management and Adaptation for Investors

ESG framework helps identify, organise, analyse, prioritise and accordingly guide decisions on various business risks. These risks, if left unaddressed can prove costly to the functioning and sustenance of businesses.

Some examples of ESG risk management include assessing climate change risks to regular operations, assessing workplace culture, company diversity, etc.

ESG risk management supports sustainable, long-term growth by proactively evaluating potential issues; early knowledge of potential risk provides more time to adapt and develop cost-mitigating strategies.

The quality of a company’s ESG-related risk management is important to investors in weighing overall risk and return.

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How to implement an ESG strategy?

Common ESG approaches for investors

There are four main ESG strategies in the field of investing that can help guide one’s understanding of ESG application:

  • ESG integration refers to the explicit and systematic inclusion of ESG issues in investment analysis and investment decisions. It focuses on the analysis of all material factors in investment analysis and investment decisions, including environmental, social, and governance (ESG) factors.
  • Exclusionary screening rejects companies whose practices do not meet a certain standard.
  • Inclusionary screening selects for companies that do meet a certain standard.
  • Impact investing focuses on a certain category of measurable positive impact, such as renewable energy companies that are geared towards energy transition and positive environmental impact, enacting positive, measurable environmental or social change, along with financial return.

Most of the time, modern corporate ESG strategy will draw on elements of the four strategies, as each company tailors their ESG strategy to their unique strengths, weaknesses, opportunities, challenges, and timeline.

Guidelines for tailoring an ESG Strategy for companies

1. Identify the parties that will be responsible for implementation and oversight of the ESG program

Board involvement and managerial support is critical to creating value through ESG strategies. Active involvement by corporate boards can help guide and shape ESG best practices and reinforce the idea of the ESG strategy as a priority. Companies may also want to create an ESG team or committee, bring in staff experts, and/or write up a charter to stay on track.

2. Identify priority ESG concerns.

Nevertheless, ESG frameworks are systems meant to standardise the reporting of ESG metrics, so they are helpful starting points for figuring out key benchmarks and metrics. Some of the most commonly used ESG frameworks and standards include:

Reporting frameworks referenced in stock exchange ESG guide

Some corporations may choose to rely directly on one of these frameworks; the benefit to that approach is that the benchmarks have already been established, and often already provide an ESG score based on fixed criteria that allows corporations to compare their performance with peers of similar scores.

If a company chooses to tailor its metrics, there are usually a few basic metrics that universally make sense for ESG performance (for example, energy and water consumption for Environmental considerations).

The selection of other metrics will depend on considerations such as: the priorities of the company’s stakeholders, the ESG goals that the company decided to focus on, the company’s ability to consistently gather good data on the topic, etc.

3. Set SMART goals

Once the contextual research has been completed, companies will need to set the goals that will become the company’s roadmap for ESG matters. Goals should be Specific, Measurable, Achievable, Relevant, and Time-Bound. These parameters will help set a clear timeline, and facilitate the tracking process.

4. Incorporate ESG practices into company culture

This step is rather long-term because it involves altering mindsets. Management and employees need to be trained and to buy into the ESG goals, and the company as a whole needs to continually work towards improving company culture and practices.

5. Produce ESG reports for stakeholders/investors/the public, and establish a consistent reporting procedure

Compiling the gathered information into an ESG report allows firms to spotlight their initiatives and successes, thereby demonstrating progress to their stakeholders.

Transparency through these reports also has the potential to boost employee morale; being able to see the impact of their day-to-day work can encourage even stronger buy-in for ESG goals.

ESG reports are often produced annually, but timeline and distribution method can vary from company to company; the key is to have a strong and consistent reporting process.

6. Ensure that public facing information is consistent with ESG disclosures

Companies must ensure that their ESG narrative aligns with the brand and the company’s vision and future direction.

Lip service and greenwashing without evidence to back up claims of adherence to ESG factors is arguably worse than doing nothing, because a lack of authenticity can erode consumer trust and do lasting damage to the company’s reputation.

The need for ESG only seems to be growing as society enters unprecedented times: climate change, protests and social upheaval, increasing technological capabilities, the ongoing COVID-19 pandemic.

ESG strategies can help meet those needs, while providing some guidelines on how to build more resiliency into the corporate universe.

To conclude...

No company can prosper nowadays if it is not involved in the community and the people around it.

Companies need to take an active role in the community, beyond just making a profit. The positive benefits of this strategy include the company’s expansion and durability of its success.

So, what are you waiting for? Start implementing ESG today!

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Why is ESG (Environmental, Social and Governance) important for a business

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