What is ESG – Overview of Environmental, Social and Governance

What is ESG - Overview of Environmental, Social and Governance

In recent years, both investment institutions and consumers are paying more and more attention to enterprise ESG. A proper enterprise ESG can obtain a positive enterprise impression and a higher amount of investment, and in the process, it can also assist enterprises in attracting talents, adapting to regulations and facing risks through operational optimization.

This article will be an in-depth introduction to ESG and its importance, as well as several terms related to ESG, and finally provide the prospective opportunities, challenges and future outlook of ESG.

What is ESG?

The term ESG originated in 2004 when ex-UN Secretary General Kofi Atta Annan invited 18 investment institutions from 9 countries to develop a Global Compact of 10 principles in the areas of human rights, labor, the environment and anti-corruption.

ESG is an acronym for Environmental, Social and Governance. Socially Responsible Investment (SRI) is based on these 3 key aspects, enterprises with strong ESG performance will outperform the industry average in terms of long-term operations and profitability. Currently, there are no common global metrics for ESG. Enterprises mainly follow the framework of the GRI Standards developed by the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD) as the basis for disclosing ESG behaviors (Refer to the related disclosure info:https://renouvo.net/esg-information/esg-goals/ ).

Each organization sets individual standards and scores for different industries. Among the more well-known organizations, MSCI (Morgan Stanley Capital International), Sustainalytics (Morningstar, Inc), and CSA (S&P Global Inc.) etc. The following is a description of the ESG assessment principles for each of the 3 ESG aspects, using the standards mostly adopted by each framework and organization.

What is ESG

Environmental

The environmental aspect refers to the assessment of the consideration of natural environment protection in business operation, as well as the awareness, management and responsiveness to risks under the threat of environmental change, including the following:

  1. GHG Emissions, such as organizational carbon emissions and the carbon footprint of various products.
  2. Water Management, such as water efficiency, water recycling and reuse.
  3. Waste Management, such as domestic waste and business waste in the factory.
  4. Utilization of Land, such as the location of enterprises, the impact on land.

The above-mentioned focus will review the organization’s own governance and supply chain management strategies to ensure the environmental impact of the enterprise’s operations and overall life-cycle of products, as well as its flexibility in the face of climate change, energy resources and land issues.

ESG Environmental

Social

The social aspect refers to the assessment of the enterprise’s support for human rights, including employees, community, consumers and clients, etc., including the following:

  1. Community Relations
  2. Occupational Health and Safety
  3. Diversity and Inclusion
  4. Consumer Welfare

This assessment also includes supply chain management to ensure that organizations have strong human resource management, community and consumer connections, and that they can be more effective in dealing with issues such as the physical and mental health of their employees, local residents and consumer safety.

ESG social

Governance

The governance of a enterprise assesses the overall management and operation of the enterprise and often including:

  1. Management Strategy
  2. Future Outlook
  3. Crisis Management
  4. Tax Transparency and Business Ethics

To ensure that corruption and illegal activities are avoided within the enterprise, and that the interests of shareholders and other investors are protected.

ESG Governance

Why ESG Matters?

The most important purpose of an enterprise is to maximize the interests of shareholders. Whereas commercial activities create a lot of negative externalities, (e.g., environmental pollution, labor exploitation, tobacco arms sales, etc.), which can generate profits but may face challenges such as regulations, climate change, and demographic changes, stable and long-term operations are more attractive to investors nowadays.

Global Challenge

With the challenges ahead, including the urgent issue of climate change, nations are making many efforts to achieve net zero, including the EU Carbon Border Adjustment Mechanism (CBAM) and the US Clean Competition Act (CCA), which will increase carbon fees on GHG emissions generated by enterprises in the future; the increasing scarcity of water and mineral resources; the new coronavirus epidemic that has broken the global supply chain; and Luckin Coffee Inc., which has led to the lack of confidence in the disclosure of enterprise financial statements, etc.

If enterprises have started ESG initiatives to reduce carbon emissions, increase energy efficiency, enhance labor rights, and financial transparency, it is natural to reduce the impact of carbon emissions and rising raw materials in the face of global challenges, as well as to reduce the risk of human resources and investor trust caused by the shift in production.

ESG Investment

As the U.S. economy took off after the war, the Marshall Plan (officially the European Recovery Program, ERP) was launched in 1950-1970 to provide economic and technological support of Europe, enabling it to quickly restore its production capacity and promote globalized trade, thus enhancing the economic and livelihood conditions of Europe and the U.S.

The public in Europe and the U.S. turned to civil rights, anti-war and environmental issues, and investors began to realize that climate change and sustainable governance of enterprises would have a huge impact on their long-term profits. As a result, SRI (Socially Responsible Investing) was released, and by the end of 1999, it accounted for approximately 13% of total investments by U.S. professional organizations, the prototype for ESG investments.

After 2004, ESG was officially released and a number of sustainable investment institutions ( i.e., Morgan Stanley, S&P Global Ratings and DJSI) adopted ESG as a rating framework to invest funds in high-scoring projects.

According to the Global Sustainable Investment Alliance’s 2020 biennial report, ESG investment has reached 36.1% of the total professional investment in 2020 and is expected to exceed half by 2024. It is clear that ESG investment will be the future trend, and to get the attention of investors, it is urgent for enterprises to carry out ESG.

Consumer Behavior

In addition to quality and price, consumers also care about what enterprises do on ESG, including the Nike Child Labor, China’s Xinjiang’s Cotton Incident, etc., so that the image of the enterprises in the incident was badly affected, which in turn changed consumer preferences and caused an impact on the revenue.

According to McKinsey & Company research in Europe and the U.S., more than 70% of consumers are willing to pay 5% more for green products with the same performance in the fields of automobiles, construction, electronics, furniture, etc.

For an example, Sunlight, Unilever’s detergent brand featuring low water consumption, increased sales by more than 20% in water-scarce markets.

Why ESG Matters?

The Difference Among ESG, CSR and SDGs

ESG, CSR, and SDGs are all standards that enterprises can adopt for sustainability governance, yet each has its own strengths and weaknesses in operation. The following is a brief introduction to ESG, CSR, and SDGs, and an explanation of their differences.

About ESG

The principles of ESG are derived from the United Nations Global Compact (UNGC) and consist of 3 main aspects: environmental, social and governance. There is still no globally common standard, and all major organizations use different ratings.

However, there are various quantitative metrics that can be used, and they are the most commonly used by organizations to disclose sustainability issues to stakeholders.

About the Difference Between CSR and ESG

CSR is the acronym for Corporate Social Responsibility. It is a concept that enterprises incorporate social and environmental issues into their business strategies, and has become common since 2000, including Clean Beaches, Veggie Days, and Volunteer Groups, etc. The biggest difference with ESG is that it lacks quantitative metrics for overall enterprise operations.

An enterprise that claims to have proper wastewater treatment may have a worse working environment, but is not fully evaluated due to insufficient information clarity, which gives the enterprise room for greenwashing. Compared to ESG, which emphasizes transparency in disclosure, the problem of greenwashing can be better avoided.

About the correlation between SDGs and ESG

SDGs is the acronym for the 2030 Sustainable Development Goals which was announced by the UN in 2015.

The SDGs include 17 goals – No Poverty, Zero Hunger, Good Health and Well-Being, Quality Education, Gender Equality, Clean Water and Sanitation, Affordable and Clean Energy, Decent Work and Economic Growth, Industry Innovation and Infrastructure, Reduce Inequalities, Sustainable Cities and Communities, Responsible Consumption and Production, Climate Action, Life Below Water, Life on Land, Peace Justice and Strong Institutions, and Partnerships for the Goal.

It is divided into 169 targets, coverage of the current global issues, in addition to enterprises, but also rely on governments, non-for-profit organizations, the public and all together to achieve, mainly as a goal to provide, and enterprises to carry out ESG can effectively help civil society to achieve the goals of the SDGs.

For more information about SDGs, please read: THE 17 GOALS: WHAT ARE THE SUSTAINABLE DEVELOPMENT GOALS?

ESG,CSR,SDGs Difference

ESG Criteria

The key indicators of ESG vary depending on the industry and features of each enterprise. Currently, enterprises mainly disclose ESG based on the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD) as the basis for disclosing ESG behaviors.

GRI is the standard with the highest total market value, which includes common disclosure and management practices for all enterprises, and can be used to identify key issues in economic, environmental, and social aspects according to the operating conditions of enterprises, and to make the greatest possible improvements and disclosures; SASB is commonly adopted in Europe and includes product, manufacturing, financial, packaging, renewable resources, transportation, and service standards for enterprises to adopt; TCFD focuses on the issue of climate change, with the main concern being the actions of enterprises in carbon emissions.

ESG Criteria

ESG Investing

Among the more well-known ESG rating organizations are MSCI (Morgan Stanley Capital International), Sustainalytics (Morningstar, Inc), and CSA,SAM (S&P Global Inc.) etc.

As an example, the MSCI, which covers the most complete scope, has different issues for each of the 3 major aspects: environment, society and governance, including 10 issues such as Climate Change, Natural Resources, Pollution and Waste, Environmental Opportunities, Human Resources, Product Responsibility, Veto Right of Shareholders, Social Opportunities, Corporate Governance and Corporate Behavior.

The key indicators are subdivided into 37 key metrics, which are assigned relative ratings according to the enterprise’s industry, and the final ESG rating is calculated.

ESG Investing

Strengths and Weaknesses of ESG Development

The Strength of ESG

As investors and consumers gradually support ESG, it is expected that enterprises implementing ESG will attract more capital and revenue growth. In addition, ESG can assist enterprises in facing Black Swan Events (such as climate, energy resources, wars, epidemics, and financial crises) brought about by globalization, and improve the possibility of sustainable operation and enterprise flexibility.

The Weaknesses of ESG

The lack of a common global criteria for ESG, and the different scores and weights used by each rating organization, lead enterprises to select the rating method that is more favorable to themselves, and the final rating is determined by using the 3 aspects of the ESG criteria and the sum of the scores, which can lead to a certain degree of imbalance when comparing with the same industry. The following are two examples:

Tesla, an electric car manufacturer, rated low on the social aspect due to employee salary and welfare issues, and the petrochemical industry rated low on the environmental aspect, but with improved scores in the social and governance aspects, it achieved a relatively high rating overall.

The International Financial Reporting Standard (IFRS) has now consolidated the Climate Disclosure Standards Board (CDSB) and the Value Reporting Foundation (VRF) to support the new International Sustainability Standards Board (ISSB), in which the VRF includes the aforementioned Sustainability Accounting Standards Board (SASB). It is expected that in the future, we will be able to build a common and clear international ESG criteria to solve the problem of weakness in ESG standards.

Strengths and Weaknesses of ESG Development

How Does ESG Work in Enterprise?

In implementing ESG, enterprises can first identify issues closely related to its own industry, i.e., packaging materials, carbon footprint of products, source of raw materials, product composition and security, etc., as key indicators for ESG implementation, and start improving on each of the above aspects, recording the results and disclosing them to consumers and investors as public information, then engaging third-party organizations to perform ESG audits, continuously improving through the audit results, and aiming to achieve ESG standards in the industry.

How Does ESG Work in Enterprise?

Conclusion

ESG stands for three major aspects of environmental, social and governance. As an emerging issue in the 21st century, ESG has gained a great deal of attention from consumers and investors, and can effectively enhance the resilience of enterprises in the face of crises, increase their sustainability.

Despite the lack of international standards, there are multinational organizations such as GRI, the SASB and TCFD that provide ESG criteria for enterprises to implement. ESG implementation is a long-term trend that can provide high investment amounts and opportunities for increased revenue.

What is ESG