ESG stands for Environmental, Social, and Corporate Governance and refers to the three main components measuring a modern business’s sustainability and societal impact.
Whistleblowing, corporate leaks, and defamation have created the need for more transparency and a higher degree of moral and ethical leadership. These factors have essentially forced companies to look more closely at how they do business and ensure their compliance policies align with the regulator’s recommendations and the market’s moral and ethical expectations.
Is ESG simply an idea, or is it put into practice? How can it be measured, and more importantly, what do businesses stand to gain from it? Let’s get into it.
Just How Prominent is ESG?
Statista reports that in 2020, over 62% of surveyed banks had a firm-wide policy on responsible or ESG investments.
To help you understand just how big an impact ESG is having on global business, let’s use an example. The Norwegian Sovereign Wealth Fund, the largest sovereign wealth fund in the world reportedly worth more than $1.1 trillion to date, has recently voiced its stance on ESG. It refuses to invest in companies that fail to live up to environmental and ethical standards and “seeks more ESG-driven divestments.”
To give you even more details on how serious this effort is on the Norwegian Fund side, the fund, which owns 1.5% of globally listed stocks and portfolios of bonds and real estate, went on to sell 42 companies in 2019, following evaluations related to ESG risks.
ESG is not a trend, a fad, or something companies use to simply build an excellent corporate image. It’s a concept that can boost or tear down a business. It has become another part of a company’s DNA, something you can’t ignore or pay little attention to.
Is There A Relationship Between ESG & Financial Performance?
We know what you’re thinking: “Is the juice worth the squeeze? What do we get in return if we invest in ESG compliance?”
While caring for the environment and our planet’s carbon footprint is a worthy cause, businesses care about the thing that keeps them alive: cash, return, profit. Where does ESG sit in the profitability equation?
A recent case study of 1038 public companies in Europe used machine learning models to investigate the accuracy of Return On Equity (ROE) and Return On Assets (ROA) based on ESG and other economic indicators. Additionally, logistic regression models examined whether ESG factors affected the performance of these financial metrics. The results? ROE and ROA had a positive correlation to ESG factors.
In the same vein, a McKinsey Quarterly Report identifies five ways in which ESG
- Top-line growth – Attract B2B and B2C customers with more sustainable products.
- Cost reductions – Lower energy consumption. Reduce water intake.
- Regulatory and legal interventions – Earn subsidies and government support.
- Productivity uplift – Attract talent through greater social credibility.
- Investment and asset optimization – Avoid investments that may not pay off because of longer-term environmental issues.
In an editorial piece on the Nasdaq website, a few years back, Betsy Atkins, President and Chief Executive Officer at venture capital firm, Baja Corp went on to give her take on how ESG policies can benefit companies. She identified five main ways:
- Strong ESG programs can increase stock liquidity – According to the US SIF Foundation, total U.S.-domiciled investments using sustainable, responsible, and impact (SRI) strategies reached $8.72 trillion, an increase of 33 percent from 2014 and a 14-fold increase since 1995.
- ESG initiatives can unlock competitive value – Companies that can adapt to evolving socio-economic and environmental conditions are better equipped to identify strategic opportunities and develop a competitive advantage.
- A proactive stance on ESG issues can keep activists at bay – Managing reputation risk is complex as it is. ESG allows you to keep activists and people who want to find holes in the way you do business.
- ESG Investors are “stickier” – The concept of ESG is steeped in a long-term mindset. That implies that ESG investors are more interested in what happens during the next decade and are in for the long haul.
- Companies that espouse strong ESG values tend to attract and retain the best talent – People are no longer interested in simply working for a paycheck. They care about a company’s story, what a company stands for and are very selective in investing their time and energy.
The Problem With ESG: No Official Requirements & Data
Until recently, while there was an appetite and a place for ESG policies and compliance, there had been no official guidelines or a unanimous regulatory stance. What we have seen up until now is individual bodies publishing their take on best practices. A good example is the London Stock Exchange, recently introducing guidelines on ESG reporting best practices.
Other than that, each financial institution is essentially interpreting ESG on its own, trying its best to implement it and, most importantly, measure it.
Recently, we have seen the guidelines being introduced, frameworks developed, and ESG landscape and practices taking shape. At ESG Bay, we have made it our mission to make ESG reporting as easy and hassle-free as possible, and to guide our clients to ESG compliance and awareness of the impacts their actions have. Contact us to learn more.