ESG: What is it and how is it used?
ESG: What is it and how is it used?
ESG (Environmental, Social, Governance) considerations have grown in importance in investment, operational, and purchasing decisions. ESG can help investors better understand the nonfinancial factors that influence corporate performance, minimize portfolio risk, and produce competitive returns.
Companies that integrate ESG into their business strategy, on the other hand, can turn global concerns into business opportunities, positively impact their communities, and create healthy, equitable work environments. ESG can also provide a strategic framework a business can use to track performance, define goals, and communicate with multiple stakeholders. But what exactly is ESG?
ESG in a nutshell
ESG focuses on three specific, foundational pillars that are crucial to today’s corporate management and investors alike. Environmental issues can include greenhouse gas emissions, energy management, water consumption, waste management, and impact on land and biodiversity. Social issues can include human rights, customer privacy, data security, conflict risk, employee safety and labor practices, diversity and inclusion, as well as community engagement. Governance issues can include factors such as business ethics, litigation risk, supply chain management, business lifecycle management, accounting standards compliance, succession planning, and anti-competitive behavior.
When making investment decisions, these criteria are supposed to assist investors in taking into account the “unmeasured” or “unrepresented” ESG concerns. They reveal information that standard financial analysis often misses and speak to a company's long-term viability in the broadest sense. To be deemed a good ESG stock, a company must have a history of aligning its operations to support programs that benefit the environment, employees, local communities, and shareholders.
Ultimately, the purpose of ESG investing is to increase profits by backing well-managed, socially responsible companies. So, now that we’ve defined ESG, how is it used? Here are five ways investors and companies use ESG to improve performance and track impact.
#1 - ESG ratings
There is proven potential for excess returns at companies with high ESG scores. As a result, ESG has become an important aspect of investors' research processes. Independent groups can utilize ESG evaluations, such as MSCI and Sustainalytics, to verify a company's activity. Institutional investors frequently utilize ESG ratings to demand high standards of corporate behavior. Investing in ESG enterprises and supporting ESG alignment can help fund broad projects to conserve energy, reduce waste, improve working conditions, and enforce ethical corporate practices, among other things.
Understanding ESG scores and increasing year-over-year performance is critical for businesses looking to raise capital. The ramifications of a bad grade might be severe for investors that use ESG scores in their investment plans. Ratings can also be an extremely useful internal benchmarking tool for guiding decision-making, improving sustainability performance, and encouraging change within a company.
#2 - Competitive benchmarking
Sustainability benchmarking has a number of advantages, including the ability to collect comparable data from other benchmarked entities, assess the sustainability performance of voluntary or mandatory standards, forecast potential business risks and opportunities, and demonstrate the positive effects of your sustainability programs.
Stakeholders, investors, customers, and industry peers can use the benchmarking process as a roadmap to make meaningful, standardized industry comparisons. Competitive benchmarking can also help companies determine whether their sustainability efforts are effective, provide recommendations for eliminating any gaps, and evaluate the business value achieved from closing those gaps.
#3 - More accurate & confident reporting
Employees, consumers, business partners, and investors are all calling for more robust ESG reporting and disclosures. According to the Governance & Accountability Institute, in 2020, 92% of S&P 500 businesses and 70% of Russell 1000 companies issued sustainability reports.
Building a strong portfolio that attracts investment requires ESG reporting. ESG reporting can help businesses better understand and manage their impact on people and the environment, as well as identify and mitigate risks, capture new opportunities, and provide the opportunity to communicate with investors and stakeholders to increase brand value and trust.
#4 - Weeding out greenwashing
Greenwashing is the practice of marketing an organization’s products, activities, or policies as serious about ESG, when in reality they aren’t. Or a company may market positive environmental outcomes that are exaggerated or even completely false.
Using reliable, factual, consistent data, engaging in industry benchmarking, and utilizing artificial intelligence can help companies capture vast amounts of structured and unstructured data. This information can be used to report on ESG performance or improvements and offer investors greater assurance by allowing them to track progress and gather important data for peer comparison and risk mitigation.
#5 - Business strategy & guidance
Incorporating ESG factors into a business strategy ensures that environmental, social, and governance information is accounted for in corporate financial statements. Business is no longer just about the financial balance sheet; shareholders and stakeholders are demanding a more complete view of a firm, including how it runs and how it affects the environment and society.
An asset manager can utilize ESG to identify strategic risks and opportunities within a business and predict how an asset will perform if properly managed. Companies, on the other hand, can use ESG factors to define corporate goals and guide operational strategy.
ESG data: The foundation for all ESG use cases
The world of ESG is built on defined, dependable, and transparent data. The phrase “ESG data” refers to all information about an entity's impact on its surroundings, such as air quality, board independence, water use, discrimination litigation, and executive salaries.
As a result, ESG data may be used to help investors make better decisions by providing a more detailed image of a company and revealing any existing or future financial hazards. It can also be used to rank a company's socio-economic impact in comparison to similar enterprises in the same industry. For those trying to make wise long-term investing decisions, this type of data is crucial.
Companies can use ESG metrics and data to analyze performance, determine where progress needs to be made, and assess how to achieve the greatest success. Ultimately, ESG data can help organizations change their business practices, find new income prospects, and pinpoint existing targets and activities they can leverage for growth.
ESG materiality assessments
With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.
An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.