What is ESG?

Previously, the Ask GIA blog has discussed topics related to green marketing. We established terms like green washing, where companies may mislead their consumers into believing that their product is more environmentally sustainable than it is. Products that are proven to be truly environmentally sustainable and marketed as such are considered green marketing. As consumers become more conscious of the effect their personal consumerism has on the environment, they have established more standards to advocate for environmentally sustainable business praxis from the companies they choose to purchase from. A result of these movements for more transparency from businesses and their contribution in conserving the environment is ESG investing

ESG stands for environmental, social and governance. They represent the three areas companies are supposed to report on in the fiscal evaluations of their companies. ESG investing first gained traction with the 2006 UN publication of its Principles for Responsible Investment called Who Cares Wins. The movement was an effort to create sustainable investments, for investors to maximize returns while creating long term social or environmental advantages. These were proposed in combination with the understanding that combating climate change could not be mitigated solely by personal contributions and that businesses had a major impact on the environment – many major governing organizations understood that there needed to be a financial incentive for commercial businesses to adopt environmentally sustainable praxes.

 

The US Securities and Exchange Commission (SEC) further established a framework for ESG ratings and reports in May 2020. There are three principles that ESG falls under and uses to categorize reports. It is quite obvious in the acronym, but the categories are environmental, social, and governance principles. For the environmental category, companies need to report on the total carbon emission produced by business processes, any water or waste emissions, and the sourcing of their raw materials. It is important to note whether companies use virgin or recycled materials in their manufacturing processes. Any additional positive environmental impacts, such as protective resources or land stewardships must be noted as well.

For the social category, companies should report on their employee relationships and labor practices. Product compliance and liability falls under the social category too. Companies should file the details of how they maintain their supply chain if there is a chance of complications when sourcing raw materials. Other aspects that fall under the social category include health and safety standards of company operations. Finally, there is the governance category which surrounds shareholder rights, the diversity of board directors, and how executives are compensated in comparison to the company’s sustainability performance.

Why Should We Abide by ESG?

Simply because it is the right thing to do. Companies profit off of the environment by mining materials and generating emissions with daily business processes. There must be a long term plan for a sustainable future. Fortunately, sustainable investing is also just as profitable compared to traditional funds. The Morgan Stanley Institute for Sustainable Investing published a white paper in 2019 which compared sustainable funds with traditional funds between 2004 to 2018.

 

The total profit of sustainable mutual and exchange-traded funds were similar to those of traditional funds. During times of market volatility, companies with ESG priorities greater capabilities of bouncing back from economic downturn. Companies that prioritize sustainability often exhibit consistent growth over time. ESG investing and ESG principles can help in retaining employees too. The current demographics of the working public consist of millennials and Gen Z who place importance on the issues ESG encompasses.

The true potential of ESG depends on the adaptability of a company to meet the social and environmental needs of today’s world. It is up to us to fulfill our responsibility as credible, socially, and environmentally sustainable businesses.