Fundamentals of Environment, Social and Governance
Environmental, Social, and Governance - or short for ESG - is a framework that evaluates an organisation’s ability to manage sustainability.
Specifically, ESG is commonly used from a business perspective. In finance, ESG is integrated into the investment process and considered alongside profits to screen targets and analyse portfolios. It provides valuable insights into a company’s non-financial impacts that are traditionally overlooked but has financial consequences.
ESG is also more broadly regarded as a framework for action and international cooperation to achieve sustainable development that ‘meets the needs of the present without compromising the ability of future generations to meet their own needs. Thus, ESG has not only become a key consideration for businesses and investors in pursuit of better profits and returns, but has emerged as a buzzword for stakeholders ranging from regulators, NGOs, to the general public in the hope of creating a more liveable planet and equitable society.
Unpacking ‘E’, ‘S’, and ‘G’
Environmental (E) factors focus on minimising an organisation’s environmental impacts and footprints. This includes greenhouse gas emissions, energy and resource conservation, biodiversity, and resilience against climate change. With the global consensus of limiting global warming, emission reduction and decarbonisation strategies are of growing importance.
Social (S) criteria examine an organisation’s relationships with its stakeholders. Examples range from labour standards, customer satisfaction, human rights, diversity and inclusion, to philanthropy and stakeholder engagement. Social factors are relevant as all organisations regardless of sector and industry are run by people and embedded in society.
Governance (G) refers to principles and standards for leading and managing an organisation with integrity, accountability and transparency. Common topics involve organisational ethics (e.g., corruption, bribery), board composition, and value chain management. A well-managed governance system creates value and helps avoid litigation risks and regulatory interventions.
ESG criteria provide a multifaceted approach to evaluate how conscious and advanced an organisation is in terms of sustainability. As more research shows that a strong ESG proposition correlates with better performance and creates long-term value - in contrast to the conventional belief that sustainable programs increase costs and drag profits - it is imperative for organisations to benchmark and report against ESG criteria alongside traditional financial reporting.
Pros and Cons of ESG
The rise of the ESG concept has raised awareness and contributed to the collective action to realise sustainable development. ESG provides a common language for organisations to enhance transparency and accountability of their non-financial impacts. It enables organisations to take into account the environmental and social consequences of their actions, and empowers them to design solutions, set goals and track progress accordingly.
Moreover, ESG helps organisations create value by taking environmentally and socially responsible actions. As stakeholders demand credible ESG data, investors look for ESG winners and policymakers tighten ESG regulations, it makes perfect business sense for organisations to integrate ESG into their operation and implement sustainable programs so as to meet stakeholder expectations, attract investors and respond to regulation change.
Aside from its positive influence, ESG has also drawn intense criticism. Opponents denounce the lack of a clear definition and consistent standard of ESG. The confusion around the term gives rise to a wave of ‘greenwashing’ - or the act of making a product, activity or organisation appear to be more sustainable than it actually is by providing misleading or false information. The vast inconsistency of ESG disclosure frameworks, standards and ratings has further fueled scepticism in regards to ESG claims.
Some argue that ESG is a manipulated agenda of ‘woke capitalism’ - a derogatory reference to ESG as a strategy that companies signal progressive causes to appeal to people and distract them from organisational malfeasance. They claim that ESG principles and regulations interfere with the free market when the financial institutions no longer base their decisions on financial concerns but on ESG considerations.
The Bottom Line
In the face of unprecedented environmental and social challenges in the 21st century, ESG provides a new approach to assess and achieve sustainable development. Understanding why ESG matters, what metrics it encompasses, and what opportunities and risks it entails are the beginning of a balanced, meaningful discourse that can lead to actionable insights into making the world more sustainable.