Many companies are increasing their focus on environmental, social and governance (ESG) elements of their business. The logic: 57% of investors in the Asia Pacific (APAC) region expected to have “completely” or “to a large extent” incorporated ESG issues into their investment analysis and decision-making processes at the end of 2021, according to data from investor research firm Morgan Stanley Capital International (opens in a new tab) (MSCI). Furthermore, according to the Global Sustainable Investment Association, global ESG assets are on track to exceed US$53 trillion by 2025, representing more than a third of projected total assets under management. An ESG approach may help get the attention of investors — both institutional and closer to home.
What's more, several sources link ESG to better business performance. In an aggregation of over 2,000 empirical studies, the Journal of Sustainable Finance & Investment found a positive correlation between ESG efforts and corporate performance in 63% of analyses. And the S&P ESG Index has outperformed the S&P 500 over the past year.
For those that want in on the action, this article explains ESG’s components (environmental, social and governance) and dives deeper into the potential opportunities that arise from approaching business through an ESG lens.
- Across all industries, you’ll see companies using environmental, social and governance (ESG) considerations in an effort to attract customers and investors.
- These companies each apply ESG principles to their operations differently, based on their specific industry and business setup.
- This article offers an overview of ESG for 2023, along with resources for those looking to explore further.
What Is ESG?
ESG is the environmental, social and governance “criteria that assess the robustness of a company’s governance mechanisms and its ability to effectively manage its environmental and social impacts. Institutional investors, stock exchanges and boards increasingly use sustainability and social responsibility disclosure information to explore the relationship between a company’s management of ESG risk factors and its business performance,” per Gartner(opens in a new tab).
Each component in detail:
The environmental component of ESG concerns a company’s impact on the planet. Issues that companies consider in this category include energy and natural resource usage, production and treatment of waste, pollution output and any impact on the environment, plants or animals. Companies that prioritise ESG measure their energy and resource consumption and develop plans to reduce their impact on the environment.
The second component of ESG, social, examines how companies interact with employees, customers, partners and the communities in which they conduct business. Employee-related considerations include wages, workplace safety and diversity and inclusion (D&I). Socially-minded companies work to understand the social impact they have on the regions in which they manufacture, derive resources or conduct operations.
Governance looks at an organisation’s leadership team, executive pay rates, investor relations, financial data availability and more. Governance-related ESG practices aim to develop ethical and transparent governing systems. Some governance controls include anti-money laundering (AML) policies, segregation of duties (SOD) and transparency policies.
Common ESG Areas of Focus
Companies that desire to get in on the ESG game may choose to focus their efforts in different ways. Here are some of the major areas businesses tackle today:
Prioritisation of efficient supply chains continues to grow. The pandemic exposed weaknesses, like lack of transparency and poor compliance structures, in supply chains worldwide. Strategies to fortify supply chains as part of a broader ESG plan include:
- Closely tracking supply chains for ESG reporting requirements
- Reducing a supply chain’s impact on the climate and environment
- Assuring supply chain partners’ compliance with human rights and fair labour practices
- Balancing supply chain efficiency with resilience
- Establishing a clear and transparent chain of custody for production inputs
Company disclosure on ESG factors will be a key area of progression, says PwC. According to McKinsey (opens in a new tab), there is a trend toward consolidation of ESG reporting and disclosure frameworks as well as more active regulation. Companies looking to meet modern ESG standards will need to prepare disclosures that speak to a variety of stakeholders, including employees, customers, partners and regulatory agencies. These disclosures broaden the scope of material information for investors to digest and use in making their decisions.
Driven by research on climate change and governmental sanctions around carbon emissions, companies are increasingly building plans to measure, establish targets for and reduce greenhouse gas emissions and setting goals to reach net-zero carbon emissions. Even sectors that contribute heavily to carbon emissions, such as fossil fuels, transportation and agriculture, are shifting toward more energy-efficient operations, renewable energy sources and more.
Opportunities Linked to an ESG Approach
Retention and job satisfaction
ESG has been shown to help companies attract and retain quality employees, enhance employee motivation by instilling a sense of purpose, resulting in higher levels of productivity, according to research from McKinsey (opens in a new tab). The research also showed that positive social impact correlates with higher job satisfaction, and employees react with enthusiasm when companies “give back”.
Access to capital
Many now consider ESG a standard tool for financial analysis, alongside traditional financial metrics.
“We believe that sustainability should be our new standard for investing,” said BlackRock, the largest institutional investor in the world, in a 2020 letter to clients.
In addition, ESG index funds (opens in a new tab) are outperforming their classic, non-ESG-aligned counterparts. This fast-growing investment segment saw record inflows of cash this year. It accounts for US$250 billion worldwide. In Australia, there was AU$30 billion invested (opens in a new tab) in impact investments in 2021 – over five times what it was in 2017.
For those interested in taking an ESG approach, there are several expert-vetted frameworks and reporting tools with which to assess and share your ESG performance:
The World Bank: Environmental and Social Framework
The Environment and Social Framework is a methodology the World Bank and its borrowers use to identify risks and offer business recommendations on environmental and social issues. The ESF is composed of resources such as the World Bank’s Vision for Sustainable Development, Environment and Social Policy for Investment Project Financing(opens in a new tab) and Environmental and Social Standards (ESS)(opens in a new tab). The ESS cover topics including environmental and social risk mitigation, appropriate land use, community health and safety and natural resource management.
United Nations: SDGs and Guiding Principles on Business and Human Rights
These two resources offer a high-level overview of major ESG focus areas. At the heart of the United Nations’ 2030 Agenda are 17 sustainable development goals (SDGs)(opens in a new tab) that cover many of the world's most pressing developmental issues, including climate change, poverty, clean energy and responsible production. Meanwhile, the U.N.’s Guiding Principles on Business and Human Rights(opens in a new tab) lay a framework for the role businesses and corporations may choose to take in protecting human rights.
B Lab: Impact Assessment
B Lab is the creator of the B Corp status, a designation granted to companies with high ESG performance and standards. The free B Impact Assessment(opens in a new tab) tool allows companies to assess their performance on ESG metrics, compare results to similar companies and get a customised improvement plan. Becoming a certified B Corp is a signal to investors that your company is serious about its ESG efforts, which can by itself open new investment opportunities: Before ESG considerations, corporations existed to bring advancement to their shareholders, usually in the form of a monetary return on their investment. In a B Corp, consideration is given to the betterment of stakeholders — which can include customers, employees and communities in which the company operates.
GRI: GRI Standards
The Global Reporting Initiative (GRI) helps organisations assess their environmental, social and societal impact worldwide through access to resources and standardised reporting methods. Organisations can use the GRI Standards(opens in a new tab) to develop, organise and share material issues, highlight progress and display corrective actions.
SASB: Standards and Materiality Map
The Sustainability Accounting Standards Board (SASB) provides resources and tools to businesses and investors regarding ESG standards, reporting methods and major focus areas on an international scale. SASB standards(opens in a new tab) comprise a list of 77 financially material sustainability standards and common reporting metrics, while the SASB Materiality Map(opens in a new tab) offers a graphical representation of these standards broken down by sector. The Map guides organisations toward understanding the primary issues facing their industry and which ESG metrics are top-of-mind for investors.
Financial Stability Board: Recommendations for Climate-Related Financial Disclosures
The Financial Stability Board created its Task Force on Climate-Related Financial Disclosures to increase reporting on and resources related to the relationship between the climate and global financial markets. The Task Force provides a list of recommendations for climate-related disclosures(opens in a new tab) and implementation recommendations(opens in a new tab) for general and industry-specific guidance.
The Bottom Line
ESG is no longer a buzzword that only applies to a small percentage of the world's largest companies. Today, it’s a common business approach fuelled by growing popularity among consumers and investors. For those intrigued by the potential, ESG resources can help them explore further.