What is ESG?
A new consensus is emerging: ESG issues are central to well run businesses, company value and a sustainable future for us all
ESG is a framework based on the idea that companies must calculate and report the impact they have on the environment and on society to create value and manage risks over the mid and long-term.
ESG stands for
The E is for the environmental impact that a company has on things like CO2 emissions, water usage and recycling.
The S is for the social impact the company has through salaries and wages, employee diversity and product quality for example.
The G is for governance and includes information on the management structure, the diversity of Directors and ethics.
A UN Report, titled 'Who Cares Wins' brought the three strands - ESG - together for the first time in 2004. It introduced two key ideas for investors to consider: ESG issues are material to company value; and a 5-10 year time horizon (not just annual or quarterly) is also material. Adoption of ESG by companies and investors of all sizes has skyrocketed In the past 2-3 years.
What difference does it make?
ESG represents a different view of profit and financial performance that creates space for a different view of business. A new consensus is emerging: ESG issues are central to well run businesses of all sizes. ESG is material to company value and companies' impact on the people and the planet are critical to meeting the challenges of climate and social inequality. Every company can play its part.
Why does it matter now?
ESG is being driven by investors and regulators. In the UK Pension funds like Aviva, L&G, M&G have been mandated to report on the carbon impact of their investments.
In the EU it is already mandatory for companies with 500+ employees to report on ESG issues. In France, (under Article 173) it’s mandatory for companies with 250+ employees.
The Sustainable Finance Disclosure Regulation came into force in April 2021 and introduces ESG disclosure standards for financial market participants, advisers and products. The latest regulation extends ESG reporting to nearly 50,000 companies in the EU (up from 11,000).
How is ESG measured?
The straightforward answer is, “very differently and very confusingly”. There is a confusion of standards, principles, frameworks, ratings and scores. Correlations of ESG scores and ratings between the world’s leading ESG database providers (such as Refinitiv, Sustainalytics, MSCI) vary from 30% to 71%*. So, analysts find it very difficult to come to an informed ESG investment decision.
There is so much confusion, the latest EU regulation comes with a taxonomy (that defines what things mean and how they should be calculated). The idea is to make ESG more comparable from one company to another and to end ‘greenwashing’.
And yet investors now have to report on the ESG impact of their investments and products (scope 3 disclosures)...
There are huge data gaps for large corporates...and virtually no data for SMEs and Startups.
*(Berg, F., Koelbel, J. and Rigobon, R., 2019. Aggregate Confusion: The Divergence of ESG Ratings. SSRN Electronic Journal, p. 8)
Is ESG really that different to CSR?
ESG is replacing corporate social responsibility (CSR) as the new standard in corporate responsibility. It's not just the latest buzzword for CSR which has also been called: the triple bottom line (people, planet and profit), shared value, the circular economy, corporate purpose, sustainability, stakeholder capitalism. And ESG should not be confused with Sustainable Development Goals (SDGs).
The effect of the growing consensus and new ESG regulations can clearly be seen in the increased Google searches of the term ESG since 2018.
ESG is not the same as B-Corp or other consumer marks.
ESG accounts need to be audited for three reasons: because ESG is material to the bottom-line of your business and misrepresenting it can be detrimental to future growth; because bad press that contradicts supposedly positive ESG results can cause significant reputational damage to a company and its investors; and because it's now a legal requirement for investors and lenders to know the ESG impact of the companies they’re supporting.
Still not convinced that ESG is important?
Progressive ESG companies are on average 4% more profitable than their non-ESG counterparts according to Bank of America Merrill Lynch (2019).
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