ESG stands for Environmental, Social and Governance; it’s defined as set of standards which gives detail insight about the company’s performance regard to the economic, environmental and social impacts caused by day to day operations and business activities. Most of the socially responsible investors check the ESG criteria as a governing factors for the companies to monitor the potential investments. ESG factors are subset of non-financial performance indicators which comprises ethical, sustainable and corporate government issues. From the beginning of this decade, the number of investment funds which incorporate ESG factors has been increasing hastily and expected to grow drastically over the upcoming decade. The total ESG investments worldwide is estimated about $250 billion, in that US accounting for 20%. A recent survey by Morgan Stanley reported that 95% of millennials are fascinated in ESG investing.
ESG analysis can provide valuable understanding for various stake holders for the assessment of company’s impact to the world. The triple bottom line approach introduced by Elkington in 2002 was based on the value creation of all the stakeholders with economic, social and environmental as the basic pillars for financial results. Incorporating governance criteria as the new dimension for evaluating ESG scores is considered as the critical aspect in determining the real business performance. So, the modern approach for ESG scores based on governance criteria is considered to assert the sustainability of the company for a long term.
The ESG business review is done based on ESG criteria which are classified into three components. The three guiding components/pillars of ESG criteria are environmental criteria, social criteria, and Governance criteria.
How ESG criteria works?
The ESG performance can be understood based on its criteria’s
Environmental criteria comprise the company’s energy usage during the implementation of project or process and how they manage its impact on the environment. This includes climate change mitigation, company’s energy efficiency, water usage, pollution, waste management, natural resource conservation and GHG gas emissions and reductions, biodiversity, renewable sources of energy, environmentally greener features incorporated based on the project.
Social criteria: This key criterion focusing on the business relationship of the company and how it nurtures the people and culture. This includes labour standards, health and safety, gender & diversity, company’s mission and its social relevance, non-discrimination, community relations and customer satisfaction, public policy, economic performance, customer privacy, human rights, labour standards.
Governance criteria: Governance considers a company’s internal and external procedures transparency in compliance with policies, company’s leadership, audits, taxation, firm management and shareholder rights. This includes tax transparency, board composition, audit committee structure, anti-corruption measures, agreement with the relevant guidelines, unbiased selection of board members, and political contributions and how it is dealt with.
Added to this, ESG criteria assist the investors to circumvent the companies with potential financial risk leading to better investment decisions. Under each of the above mentioned categories, there are comprehensive disclosure standards, boundaries and hassles on the environmental, economic and social resources accessible at the international and national level. In addition to this a widespread diversity occurs across the countries, hence varying the standards, since ESG strategies are not defined comprehensively. It is crucial to repeat the standards and guidelines for accuracy before the investors decide to invest in a particular business. However, acquiring data from the companies and assessing the ESG strategies and factors that influences each of the industry still remains a challenge.
The companies pursue with a high ESG performance have numerous financial benefits. It attracts investors to invest their funds on business. The companies with high ESG score experiences lower capital cost, lower market risk and less volatile earning compared to less ESG score companies. Moreover, the companies with high ESG values have positive brand recognition amongst their employees and customers. The ESG standards are steadily becoming an important substitute in the investment world. Recent study reported that investors who prefer ESG- screened investments accomplishes lower risk and a better rate of return (www.marketbusinessnews.com). No single company can fulfil all the factors in the listed criteria and hence the investors should decide based on their requirement and significance.
To improve the ESG performance, six steps have been reported. Integrate ESG into the business strategy, Identify the material topics (Organizations can’t address every issue, instead they can focus on planning and release based the ESG topics which are most vital to the business area), Understand the ESG ratings (investors look into the ESG ratings regularly to make decision on their investment, hence it is necessary to improve ESG rating every year), in line with global regulations (Following global standards and frameworks will provide the investors a consistent, reliable and comparable information), attempt for venture level data (7 features of investment grade data as reported by London stock exchange, includes accuracy, boundaries, compatibility and reliability, data provision, timelines, external assurance and balance), Consider the communication channel (Reporting must involve trade-offs between breadth and depth) (www.simply-sustainable.co.uk).