In this beginner’s guide to ESG, we’ll take you through what ESG means, how it affects business, and why it’s so important. Let’s jump straight in.
Key Terms: Definition of ESG
What does ESG stand for?
ESG stands for Environmental, Social and Governance.
What does ESG mean?
Before we jump into the article, let’s go back to the basics for a second.
What is the meaning of ESG?
In fact, it’s difficult to pin down a single definition for ESG. Broadly speaking it refers to a framework for Environmental, Social and Governance responsibilities against which businesses are measured:
The ‘E’ in ESG looks at the environmental impact of an entity or organisation’s activities. This means looking at energy usage, waste production, resource exploitation, pollution, carbon impact, and wider contributions to the Climate Crisis.
The ‘S’ in ESG looks at the wider societal impact of an entity or organisation’s activities by examining factors such as human relations, company culture and socio-ethical obligations. This means critically assessing standards of: employee treatment, fair wages, treatment of suppliers and other social justice considerations.
The ‘G’ in ESG assesses how the ‘E’ and the ‘S’ are implemented and overseen, as well as how the business is run. This involves critically evaluating corporate governance, such as the composition of the board, its accountability and the regulatory practices the entity adopts.
In recent years, ‘ESG’ has become a buzzword ubiquitous in legal, regulatory and corporate contexts. You’ll see it used in conjunction with references to ‘sustainability’, as well as concepts of ‘corporate governance’ and ‘social responsibility’. ESG has gained prominence within entities and organisations in response to changing societal attitudes and demands. This shift has been palpable throughout the COVID-19 pandemic, during which society at large has begun to question the social contract between society and business.
What is ESG?
ESG is used to measure how a company is performing in relation to a series of social-impact minded criteria. The whole concept underpins a shift in how businesses are valued and evaluated, because business activities are now measured not only for their financial viability, but for their adherence to ESG principles.
This framework reminds corporations, businesses and leaders that they do not operate as an insular entity but as part of a wider society to which they owe a responsibility.
Although the concept of ESG might seem abstract, its most material form is apparent when company’s disclose their environmental, social and governance data. This data will showcase their commitment to ESG principles, how they have implemented ESG friendly practices, and how they are performing. This is called ‘ESG reporting’.
Where did ESG come from?
There’s been a progressive move towards investment strategies underscored by sustainability and social responsibility. These types of investment have gained popularity in recent years, meaning noncompliant businesses are on the way out.
ESG is by no means new, but is rather a consolidation of long-standing ideas and concepts relating to ‘social’ and ‘corporate’ and ‘environmental’ responsibility. It has evolved through various forms, with each of the three pillars articulated separately.
Environmental concern has resulted in numerous environmental laws, regulations and reporting requirements.
The Social element was first recognised by the Cadbury family who recognised the need to look after their employees and the wider community.
The Governance aspect has been solidified in the UK Combined Code on Corporate Governance.
Alongside, a soft law approach started to emerge in the concept of ‘Corporate Social Responsibility’. For the first time, ESG consolidates the various aspects of doing business and delivering goods and services ‘in the right way’ into a single framework.
Clearly, it’s more important than ever for businesses to get their head in the ESG game.
Why is ESG important?
It’s important because of what it symbolises. As a concept, it is a reactionary measure that answers a rising call for a truly socially and environmentally conscious society. For obvious reasons, this touches everyone, including businesses.
Consumers and investors are leveraging their purchasing power in favour of a better way of doing business. They’re putting their money where their mouth is.
This societal message has filtered upwards to global leadership. Most notably with low-carbon, climate-conscious policies and people’s wellbeing making or breaking political agendas. With politicians promising to enact a ‘green, low carbon transition’, the economy, as we know it, is heading towards extinction.
This has been a long time coming. Government and political institutions have been slowly integrating environmental, social and governance oriented practices for decades. The approach, to this point though, has been disjointed. There’s been a notable absence of any holistic legislation that actually enacts comprehensive change.
ESG is a framework that works towards achieving the overall objective of a ‘sustainable planet’ in a soft, non-legislative way that is equally palatable for business actors.
What is the objective of Environmental, Social, Governance?
Depending on who you’re speaking to, you’ll probably get a different answer. However, it’s clear that a principle aim is to help external parties, such as investors, to gauge companies’’ Cultural Commitment’ to Sustainability through the implementation of the ESG ethos.
Plus, implementation of ESG criteria will facilitate the transition to a green, low-carbon economy. This will meet global commitments, such as to the Paris Agreement, as well as sustainability on a much broader plane.
Frameworks for measuring ESG
You’re probably wondering how on earth you actually measure ESG compliance, and whether you even have to.
Current methods are highly subjective, relying on companies and entities disclosing their own evidential data and supporting opinions for each of the three aspects of Environmental, Social, and Governance.
Without a standardised measurement framework, it is near impossible to compare the performance of businesses against one another. It’s even difficult to compare the performance of one business against previous years.
Numerous standardised frameworks are currently in development, but timelines are hard to pin down. At 360 Law Group, we’ve recognised the urgent need for an effective and objective measurement framework. So we’re developing a tool that will accelerate the timeline and address a crucial gap in the market. Watch this space & join our newsletter to keep up to date.
Since there’s no standardised framework, many third party organisations have come out with their own guidelines. Some of the most important include the United Nations SDGs, the EU taxonomy for sustainable activities, and the United Nations Principles for Responsible Investment. These all aim to weave ESG principles into economic activity, investment decisions, and business operations moving forward.
What does this mean for business?
Earlier this year, the Sustainable Finance Disclosure Regulation (SFDR) came into play, making it compulsory for financial market participants to disclose their ESG data.
Now that it’s mandated, ESG data forms a competitive landscape that will increasingly inform key stakeholder decisions. Lack of compliance to ESG principles runs both a reputational and financial risk, spurring many businesses to take action.
ESG is changing the way business is carried out. In direct contrast to the outdated ‘greed is good’ mentality, ESG encourages a long-term view that cultivates a society-minded company culture and ultimately ‘future proofs’ the business.
A strong environmental, social and governance proposition can add considerable value to your business and full disclosure of relevant data can be compelling for potential investors. It appears that implementing a robust strategy is worth the while.
What does Environmental, Social, Governance mean for investors?
Investors have been leveraging their financial power to influence business ‘for the better’ for some time now. However, this has always been off-set or tempered by an overriding focus on maximising short-term cash returns.
ESG has made it possible for investors, especially younger generations, to be more discerning when it comes to the social and environmental impact of their investment portfolio – without necessarily sacrificing long-term profitability. Plus, given that compliance with ESG criteria indicates lower long-term risk, it’s a win-win for investors.
ESG criteria equates to evidence of an alignment of ethical values. So it now genuinely informs investment strategy and decisions, helping investors to filter their options effectively. Institutional investors have adopted ESG in the form of ‘sustainable finance’. As a result, many investment funds now offer ‘socially responsible investments’ through ‘Exchange Traded Funds’ and ‘Impact Investment funds’.
ESG v Sustainability: What’s the difference?
‘ESG’ and ‘sustainability’ are closely linked and often intersecting concepts.
For this reason, you’ll often hear them used together or even interchangeably. Whilst that’s not necessarily incorrect, they’re not really the same thing.
ESG is a more rigorous and precise framework than Sustainability. It aims to be an accurate means of measuring a company’s commitment to specific social, environmental, and governance responsibilities. ESG provides a roadmap which organisations should follow in order to ‘future proof’ themselves. This means ensuring their activities have a positive social and environmental impact.
Sustainability is a vague term that is used and interpreted differently according to the context. For this reason, it is an ambiguous framework for assessing businesses, and is often susceptible to greenwashing.