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The following article answers the question of what ESG is and why it is becoming increasingly essential for companies. Learn more about the topic and the opportunity for ESG to lead to innovative sustainable business models and significant competitive advantage.
ESG is a business and investment term that refers to the environmental, social, and governance dimensions of the way business is conducted. It considers the impact of operations on the environment, people (employees and communities), and the standards of corporate governance.
The ‘E’ and ’S’ look at a company's positive and negative impact and how it is managed, while the ‘G’ aspect focuses on the management and leadership practices within a company.
Here a short overview of what each letter means individually:
Together, they help companies achieve their sustainability goals and have a positive impact on society and the environment.
While a lot of talk surrounding ESG is abstract, in its most practical form it is a list of specific aspects of a business’ operations that can be measured and reported. These aspects differ by company and industry, depending on the most material risks and opportunities faced by the business in question.
Companies often take a risk-based approach to these aspects, controlling for the most risky aspects that could jeopardise the business. But the opportunity for ESG to lead to innovative and sustainable business models and significant competitive advantage is the big win that investors seek.
Traditionally, ESG is beyond the concern of companies and business. But as the approach has caught on among investing and business circles, it is apparent that the time is now for a holistic view of value creation. One that prioritises a range of stakeholder concerns and that holds companies accountable to their operational footprint.
There are two main reasons why ESG is important for business:
Firstly, purely as a matter of compliance, companies in many places are bound by law to implement ESG best practices. In the last few years, the rise of ESG has resulted in an explosion of new mandates on corporate governance, Supply Chain Due Diligence, and sustainability reporting.
In the European Union, a clear shift in expectations on business responsibility has driven the focus from the financial bottom line to the Triple Bottom Line of People, Planet, and Profit. Companies are now expected to turn a profit while doing it responsibly and sustainably. They have to show that they are a part of the community, giving back and minimising any harmful footprint.
The EU is working towards integrating this framework into the core of its financial policy framework. The European Green Deal, a transformative package of strategies intended to forge a clear path to a sustainable future economy, is big on responsible business. In a coordinated effort, related movements and industry standards such as the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy have been launched as part of the ecosystem.
Sustainability is a key priority in the European Commission’s Action Plan to develop a sustainable financial system. In such a climate, businesses that ignore ESG will lose out on opportunities and possibly face legal consequences.
Policymakers are leveraging ESG-related legislation to support the implementation of initiatives like the Green Deal. For example, legislative instruments like the Corporate Sustainability Reporting Directive (CSRD) will establish the most comprehensive mandatory ESG disclosure requirements globally.
This will force companies to disclose on a broad range of ESG criteria and show how they are taking action to establish and improve their ESG practices. Reporting-related requirements are effective leverage as other pieces of the puzzle fall into place, such as hard requirements on emissions reductions and farm-to-fork policies.
New ESG reporting requirements present a new set of challenges from traditional financial reporting. Existing reporting processes do not require the collection of all relevant non-financial information, let alone data measurement and monitoring of such multifaceted aspects.
Failure to demonstrate ESG compliance could jeopardise a company’s licence to operate, directly threatening a business’ ability to operate in a transitioning economy. ESG practices including the reporting stage is important for business continuity.
The other source promoting the development of ESG is a growing crop of investors conscious of capital flow and their role in shaping a sustainable future. Investors now want to mobilise the capital under their care to put towards causes that they care about. Like consumers, they want to support businesses that can deliver on financial objectives while meeting ESG standards.
In the fast-growing market of ESG investing, investors make decisions based on how a company meets their ESG criteria. For companies that wish to qualify for financing, ESG criteria has significant bearing on their access to capital.
Besides investor altruism, there is also a strong business case for investing in ESG-compliant businesses. ESG funds have been proven to outperform traditional funds and have demonstrated more resilience during times of market volatility.
The returns on ESG investment are competitive and long-term market trends are pointing in the direction of sustainable investing, underscored by the decline of sunset industries that happen to be carbon intensive. Farsighted investors are betting on the market for ESG-oriented investments. In the EU, 40% of total assets under management take an ESG approach, totalling 12.7 trillion Euro. These factors are pushing investors to pay greater attention to ESG dimensions, and businesses are forced to meet this demand.
ESG will be the norm for all operating companies, but the transition period means that those that are able to adapt earlier stand to gain from early-bird advantage.
Companies that set themselves apart by demonstrating sound ESG practices and strategies not only attract investor interest. They also allure consumer support, tapping into the latent ESG investing market and matching a generation of consumers who are much more aware of the impact and the sustainability of their individual choices. Being able to measure and report progress is critical in this journey.