Environment, Social, and Governance (ESG) Explained
ESG is a framework for risk evaluation based on environmental, social and governance practices. ESG metrics are quantitative, long term, and can be subject to public disclosure. ESG strategies are complex and require measurable goals, specialized data collection and analysis, and strategic planning. ESG is broken down into three parts:
- Environmental: The measurement of the environmental impact and sustainability of a particular company and industry. Reporting areas include: carbon imprint, pollution, material disposal, resource management, efficiency, sustainability practices, and future environmental goals.
- Social: How a company interacts with and impacts employees, customers, suppliers, and communities.
- Governance: How the company is governed at the top levels. Executive compensation, corruption, conflicts of interest, and transparency are some of the areas of interest.
All three parts require a risk assessment, mitigation, and strategies for future improvement. This post will concentrate on environmental impact and explain the importance of the “E” in ESG.
5 Reasons Why the “E” in ESG Matters
The “E” in ESG can be especially difficult to unpack because “environmental” encompasses nearly every aspect of the natural world. Furthermore, environmental issues are global and interconnected. ESG frameworks condense the concept into measurable units to help investors and leaders understand a company’s environmental risks. ESG consulting services can prepare your business for ESG evaluations and set sustainability practices into place.
Here are five crucial reasons to pay attention to environmental issues.
1. Customer, Investor, and Community Scrutiny
Customers, investors, and communities are exerting pressure on businesses to disclose environmental impacts and demonstrate responsible, sustainable practices.
- Customers are more knowledgeable about sustainability and more aware of their own impact on the climate than ever before. They are putting buying power behind companies that have sustainable practices and speaking out against those seen as wasteful or harmful. A study last year found that two-thirds of North Americans prefer eco-friendly brands.
- Investors recognize a positive relationship between ESG and corporate financial performance. Major industry shifts — such as moving away from coal as an energy source — and the impact of global climate change are areas of evaluation.
- Communities have been negatively impacted, sometimes severely, by poor environmental practices and are less tolerant of businesses that aren’t environmentally responsible.
2. Brand Reputation
Brand reputations can be irreparably damaged by a major environmental disaster such as an oil spill but they can also be tarnished for less dramatic reasons. Environmental problems that were once local or special interest are now publicized quickly and easily across the globe. Brands that are seen as wasteful, overly consumptive or environmentally dangerous can be penalized by the public through boycotts or negative social media campaigns. Investors evaluate the potential for reputational risk even if your business has a low potential for major disasters.
On the flip side, improvements and responsible stewardship can improve brand reputation. Companies that demonstrate significant investment in sustainability and change can gain back their good name even after negative publicity around environmental issues.
3. Rules and Regulations
Offsetting and preventing environmental harm is a key political agenda. Lawmakers are responding to constituents and pushing for environmental protection at local and national levels. Several regulatory bodies work to implement change globally.
Businesses that anticipate environmental problems and mitigate risk will have an advantage as rules and regulations change. Being proactive about environmental concerns also increases autonomy and reduces the chances for costly violations. McKinsey research highlights the financial risks around environmental regulation:
Careful management of environmental issues can ease regulatory pressure on companies and reduce their risk of adverse government action, enabling them to achieve greater strategic freedom. … One-third of corporate profits are typically at risk from state intervention, according to our analysis. For the automotive, aerospace, defense, and tech sectors, where government subsidies are prevalent, the value at stake can reach as much as 60 percent.
4. Efficiency & Investment: Sustainability is Profitable
Energy efficiency and good resource management can reduce spending. Even though there may be a significant up-front cost, major changes in how your business impacts the environment can head off expensive and destructive environmental incidents. Reduction in waste and initiatives to reuse and recycle can also decrease costs.
In addition to more cost-effective practices, asset manager DWS has found that sustainability strategies can increase investor interest:
Companies with an ambitious sustainability strategy benefit from investor interest. According to the Forum for Sustainable Investment, 219 million euros were invested in sustainable financial products in Germany in 2019. This represents growth of 30 percent on the previous year. Sustainable management now makes sense for companies from a financial perspective too.
In 2020, sustainable investing hit a record high, with one-quarter of all newly invested money being categorized as such.
5. Employee Engagement
A culture of sustainability inspires employees and lets them participate in something that matters. The workforce, especially younger generations, are aware of environmental issues and concerned about their own negative environmental impact. Research shows that millennials factor sustainability practices heavily into where they choose to work, and most would take a pay cut to work at an environmentally friendly company.
Adopting sustainability as a core business goal aligns the corporate culture with the values of many of its employees. Furthermore, empowering employees to suggest changes or report sustainability issues lets them make a meaningful difference and can be beneficial to the company as a whole.
