Your essential 3 point guide to a better ESG understanding

Estimated reading time
4 minutes
28th January 2020
Author: Natasha Keary
Posted in: Finance

If you’re on the lookout for the most important business trends of recent years, then you have found one of the biggest ones. ESG has been picking up speed. Businesses need to be more ESG aware than ever, to best prepare for the future.

In early January 2020, Larry Fink, CEO of the world’s largest asset manager, BlackRock, published a letter. The letter announced “climate change has become a defining factor in companies’ long-term prospects.”

Climate strikes in September 2019 saw demonstrators across 150 countries stress the ecological and economic consequences of climate change. At first, the markets were slow to react. However, Larry thinks, “awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance”. 

Sustainability and ESG are not only important to those in the world of finance. They are important for all businesses and sectors. So what does ESG actually mean? Why does it matter? How can all businesses – big and small – boost their ESG rating? 

Here are the 3 things you need to know about ESG. 

ESG - green plant and soil being held in two hands

1. What is ESG?

ESG refers to environmental, social and governance criteria. These criteria are a measure of how sustainable, ethical and law-abiding a business is. A company’s ESG score is a useful indicator for those who want to make socially conscious buying decisions. 

This means that ESG is particularly useful for investors. As Investopedia puts it, ESG is a set of standards that “investors use to screen potential investments”. For this reason, ESG investing is also referred to as ‘sustainable investing’ or ‘responsible investing’. 

The term was born when former UN Secretary-General, Kofi Annan, invited 50 financial institution CEOs to discuss involving ESG in the markets. The culminating report titled “Who Cares Wins”, argued that integrating ESG into the markets would lead to businesses making more ethical and profitable decisions. 

Here’s a look at each of the criteria in detail: 

Environmental 

Evaluating a company’s environmental impact means looking at its energy use, pollution, treatment of animals, waste, and nature conservation. A company can have a low environmental score if they are neglectful of government regulations, has a large carbon footprint or owns contaminated land. 

Social 

This refers to all the relationships a company has with its business partners and employees. The social category examines whether a business works with responsible partners or donates any of its profits to the local community. In addition, to score well here, businesses should look out for its employees’ health and safety, and maintain good working conditions. 

Governance 

These criteria test the company’s internal proceedings. It looks at any conflicts of interest, any political agendas, and illegal practices. It examines whether accounting methods are transparent and if stockholders are consulted on big decisions. 

Plants sprouting in soil

2. Why it’s important now 

ESG isn’t necessarily something new. However, it’s being used in a new way to evaluate the long-term sustainability of companies. 

BlackRock’s ESG criteria are being used to help traders make decisions about which stocks to invest in. They can rule out companies that don’t have a high enough ESG rating, and prioritize those who do. This means that companies who haven’t yet focused on their ESG rating could now look unfavorable on the markets. 

BlackRock isn’t the only large corporation ramping up its focus on ESG. In recent years, studies have shown that ESG isn’t only important for promoting sustainability, but is actually profitable for companies.

ESG profitability

In 2014 and 2015 the first studies began to show that companies with a high sustainability performance were more likely to have good financial results. A review of the studies found that:

  1. 90% of the cost of capital studies show that sound ESG standards lower the cost of capital
  2. 88% of the studies show that solid ESG practices result in better operational performance
  3. 80% of the studies show that stock price performance is positively influenced by good sustainability practices

Consumer-facing brands reported similar financial gains from boosting their ESG. Robert Swannell, former Chairman of Marks & Spencers, reported: 

“At M&S we’ve put our ethical and sustainability program at the heart of our business. The work we have done on sustainability provided a net financial benefit to the business of around £145 million in 2019 through efficiencies in energy consumption, packaging, less waste, etc.” 

This means that investors might start to look at ESG as an indicator of a company with a financially stable future, and CEOs might consider ESG a driver of financial benefit. 

plant and notebook on desk

3. What this means for businesses 

All in all, if companies weren’t paying attention to their ESG rating before, they should be now. The pressure on businesses to be sustainable is not only coming from consumers who want to make socially conscious decisions. It is also stakeholders who want to invest responsibly. These pressures are only going to grow.

Some financial institutions make it easier to choose based on ESG factors. For example, individual businesses such as  Barclays are transparent over their ratingsAs the Independent reported, in the US 89 percent of consumers said they would consider switching brands to one associated with a good cause if price and quality were equal.”

So what can businesses do to increase their rating? One way is to turn to technology. Small decisions, like cutting down on paper use to go digital can go a long way. Plastic Oceans found that a key way of reducing their footprint was by swapping out paper brochures for QR codes and digital guides.

Not only did this distinguish the company at events but it increased the company’s sustainability and saved them printing costs. See the results they saw when they went paper-less in the full story:

Plastic Oceans case study

A summary:

  • ESG is a set of criteria which measures a company’s ethicality, sustainability, and governance
  • Financial companies like BlackRock are making it easier for investors to make decisions based on ESG ratings 
  • Companies are moving towards going fully digital to improve their sustainability overall

 

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