Why ESG is a must-do for businesses of all sizes, across all industries

Whether you are a startup founder or a long-standing business owner, an investor, or a banker, you’ll have certainly faced a growing interest in environmental and CSR related initiatives. You have also probably heard of the EU Green Deal, how EU funds are tight with climate change initiatives or the Malta Stock Exchange announcement of the new Green Market amongst other ESG related news.

In this article, I elaborate on what ESG is, as opposed to CSR, and how ESG considerations and information can, and should, be central to your business and investments.

What is ESG?

ESG refers to Environmental, Social and Governance, and the way in which these issues converge to impact the business and its stakeholders. Environmental criteria refer to a company’s environmental stewardship, including how they manage the impacts of their operations, products and general business activity on the environment. Social criteria refer to how a company creates value for stakeholders. It includes corporate purpose and societal impact. Governance refers to how a company is led and managed.

ESG is used as a framework to assess how a company manages risks and opportunities created by changing market and non-market conditions, and about the ability to create and sustain long term value. As a business owner or an investor, you must be able to break down the issues and assess how they may impact performance and profitability.

ESG is often used interchangeably with Corporate Social Responsibility. However, ESG is much wider than that. It has evolved into a more holistic concept which more and more investors and stakeholders are associating with competitive advantage –  such as the latest news of Aviva Investors snubbing Deliveroo IPO over fears of employee rights.

Why is it gaining more attention?

Investors and researchers are increasingly recognising the fact that ESG influences investor risks and returns. On the other hand, clients are also demanding greater transparency around how their products are produced and sold. Moreover, regulation has also increased as the private sector is seen as a major player in both contributing and addressing public issues, such as climate change and human rights violations.

Recent events such as the BP oil spill, the Volkswagen ‘dieselgate’, and the Cambridge Analytica scandal amongst others, have contributed to increased regulation and more transparency expectations.

ESG and investments

The increasing impact of ESG factors on business has caused various types of Sustainable or Socially Responsible Investing (SRI) terms and mechanisms, and these are often a cause of confusion. To simplify things:

• SRI is when investments are screened according to specific ethical guidelines. These include screens like gambling, tobacco, weapons, or fossil fuel companies.
• Impact investing is when positive social and environmental outcomes are the key objective, not necessarily shareholder returns. One must still be financially sustainable and profitable, but the focus is on what the triple bottom line is, as opposed to one – that is, Profit, People and Plant. This is often linked with Social Enterprises.
• Green bonds – A green bond is a fixed income financial instrument designed to specifically support projects related to climate change and environmental issues. Green bonds are closely associated with ESG, as ESG-centric companies are more likely to issue green bonds to support their efforts, and so there is a link between green bonds and ESG.
• ESG Fund – As mentioned before, ESG is ultimately a measure of greater risk and reward management, so an example of an ESG fund would be a social ETF or a mutual fund that focuses on companies with mature ESG strategies.

On a day-to-day basis

ESG has significant positive impact on fundamental business issues relevant to the long-term success of companies across industries. It influences the company’s approach to reducing risk, identifying, and capitalising on, market opportunities, their corporate reputation, and their values, as well as things like culture, employee engagement and their overall approach to human capital management. For example, the way a business manages and communicates about ESG issues shows investors, customers and other stakeholders their awareness of the risks and opportunities of the changing economic, social and environmental conditions.

Good ESG considerations make it easier to accomplish business objectives and respond to crisis scenarios when key stakeholder groups challenge a company’s reputation and their policies. ESG considerations also affect their supply of resources and human capital. For instance, their culture and values can attract or detract good talent from the labour market. In a nutshell, integrating ESG factors into valuation allows for greater insight into intangible factors like culture, talent, recruitment and retention.

The collective impact of ESG on various standard business issues leads to outcomes essential to the long-term viability of the business, and the risk and reward ratios of an investment.

Trends

ESG can impact many aspects of business, both internally and externally. Investors across industries are demanding greater action, greater disclosure, and more investment in managing the impending risk of climate change. Moreover, although climate has been the existential crisis of our time, social and governance issues such as employee welfare, diversity, equity inclusion and social justice all are increasingly becoming more important.

Investors and consumers want greater transparency and disclosure on product labelling, operations sourcing, employee demographics and more. Financial analysts are specifically looking for greater detail on companies’ ESG strategy oversight protocols, the quality of their data and their KPIs and metrics. Long-term ownership mindset investors are looking for management quality indicators beyond quarterly returns in stock prices.

Investors are expecting compensation structures to be tied to longer timeframes in order to allow ESG efforts to bear fruit, and reducing the likelihood of questionable corporate behaviour to achieve short-term results. The changing demographics of investors or the new generation of investors, through crowd-investing for instance, are also looking for impact investing and long-term sustainability.

From a funds perspective, ESG funds also outperformed the markets and conventional indices during the COVID-19 pandemic in 2020. They are typically better at adapting to the market conditions and respect the increased concern and considerations of the market.

Furthermore, as the media is reporting impact, both positive and negative more actively, we can clearly see the effect of this on stock prices and company valuations. News plays a major part, and we are seeing more news items related to the ESG impact companies are having. Whether it is purely cosmetic or not, news like Prince Harry being appointed Chief Impact Officer at BetterUp is a clear example of how businesses are giving more importance to impact.

Conclusion

Careful and proper ESG considerations do not compromise on returns, but are crucial and have a direct link to value creation, which is the aim of all CEOs. From better customer attraction to employee productivity uplift, from reduced costs to lower legal issues, ESG’s connection to the bottom line and to the long-term sustainability is clear. An evident must-do for all businesses of all sizes, at all stages of the lifecycle and across all industries.

What are your thoughts on this? Are ESG considerations a top priority in your organisation or a side thought?