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In this article, we will give you a good overview about ESG criteria and answer the following questions and more: What are ESG criteria? Why is defining a criteria list a necessary step in the management and reporting of ESG factors? Where can you begin and what pitfalls should you look out for?
ESG criteria are environmental, social, and governance dimensions that are used to evaluate, benchmark, and report the sustainability of a company. These aspects should be managed strategically and monitored year-round.
They are used by investors and other stakeholders to assess a company's commitment to sustainable and responsible business practices, and to guide investment decisions that align with their values and goals.
The criteria definition begins with a systematic assessment of materiality. This is an important concept in ESG investing, as it helps investors identify the ESG issues that are most relevant and impactful for a particular company or industry. Material ESG factors are those that have the potential to significantly affect a company's financial performance or reputation, either in the short or long term.
By focusing on material ESG criteria, investors can gain a deeper understanding of a company's risks and opportunities related to sustainability and social responsibility, and make more informed investment decisions that take these factors into account.
For example: Water consumption matters to a company with water-intensive operations, as access to water is a business-critical necessity. But the company’s use of this shared resource also matters to the community surrounding the operations site, as high withdrawals may cause water stress.
The concept of double materiality is significant in assessing materiality and considers that:
It should be noted that there are many ESG ratings and frameworks developed by international or regulatory bodies, industry associations, and investor groups and the number keeps growing. These frameworks define a list of ESG criteria for companies to report.
They are a good reference point and will certainly be helpful in narrowing the list of relevant criteria and especially in determining specific metrics and indicators. However, the selection of ESG criteria to assess and report upon for any company should also always be informed by the materiality assessment. The list of ESG frameworks to consider – besides the mandatory ones – can be heavily defined by it.
The materialty assessment should be repeated periodically. The reason is that the relevant ESG criteria can change as the business evolves.
Below is a list of ESG criteria common to a wide range of industries. It is not exhaustive and should not be taken as definitive. Companies should consult industry or topic-specific guidelines if available.
These criteria relate to aspects that have an impact on the environment. For example, if a chemicals company produces a lot of wastewaters, pollution would be a top risk both from a regulatory and reputational standpoint. Therefore, waste management would be identified as environmental criteria to manage, monitor, and report.
These criteria relate to impacts of business operations on people, usually employees and local communities where operations are located. For example, employment of local members of a community and contributions to community development would be highly relevant to a company operating on indigenous land. While the treatment of internal employees should not be neglected.
These criteria relate to the management processes within an organisation that govern the business strategies and ESG plans.
There are several reasons why investor interest in ESG criteria is growing:
While defining a criteria list is a necessary step in the management and reporting of ESG factors, companies should be wary of adopting a checklist approach. If there is too much focus placed on reporting indicators and meeting compliance and not enough is placed on actual strategies, it can affect lasting improvements.
ESG is still a developing field, and existing frameworks may be inadequate to capture the full complexity of issues that are difficult to measure. Keep pushing for real impact measurement to go beyond the blind spots and surface-level indicators.
Current developments on the regulatory side, especially with the Corporate Sustainability Reporting Directive (CSRD) will make reporting on a very comprehensive set of ESG criteria mandatory for all companies impacted by the regulation.
This does not mean, however, that the materiality assessment and the definition of ESG criteria to focus on in a company’s ESG strategy will become less relevant. Ideally, companies would comply with their reporting obligations and on top put specific focus on those ESG criteria of high relevance to their business.