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Companies that embed environmental, social and governance (ESG) activities into all aspects of their operations simultaneously drive business growth and long-term sustainable value for shareholders and employees.
ESG is more than a corporate buzzword.
In recent months, the coronavirus pandemic has brought environmental, social and governance (ESG) factors into the limelight for companies of all sizes and their investors. But a commitment to strong ESG initiatives has been an important component of companies’ business practices for far longer than the acronym has been trending.
ESG factors describe how a business impacts the world around it. It’s a way to measure a company’s holistic approach to sustainability concerning financial strength, economic uncertainty, and pressing environmental and social challenges.
The term ESG was first coined in 2004 in a landmark study titled “Who Cares Wins: Connecting Financial Markets to a Changing World.” Facilitated by the UN Global Compact, the report was publicly endorsed by a group of 20 financial institutions with combined assets under management of over $6 trillion.
As evidence grows that ESG has financial implications, so, too, does interest from corporations and governments around the world.
Put simply, companies who care about ESG will outlive ones that don’t.
ESG can be broken down into three components:
The “E” in ESG focuses on how a company performs as a steward of nature. Environmental considerations may include a company’s energy use, waste, pollution and natural resource conservation, as well as the impact of their operations on the environment, both directly and throughout their supply chains.
Escalating concerns about issues such as climate change, water scarcity and carbon emissions are now integral to your business’s financial performance, as the state of the environment can directly impact your bottom line.
According to research from CDP, an environmental reporting platform, businesses estimated financial impacts of $1.26 trillion from environmental risks in the next five years, due to a loss of revenue and increased operational costs caused by environmental impacts as well as addressing regulation and market changes.
Social criteria are defined by efforts around diversity and inclusion, labor practices, community impact, product safety, and employee health and safety — all very real concerns in times of COVID-19.
The most diverse companies are now more likely than ever to outperform less diverse peers on profitability. Companies that have more gender and ethnic diversity on executive teams were between 25% and 36% more likely to have above-average profitability than companies that weren’t as diverse, according to research from McKinsey & Company.
Organizations like the Human Rights Campaign (HRC) have created metrics to evaluate efforts to improve diversity. Launched in 2002, the HRC Foundation’s Corporate Equality Index has become a roadmap and benchmarking tool for US businesses in the evolving field of lesbian, gay, bisexual, transgender and queer equality in the workplace.
The “G” in ESG, or governance factors, is often less talked about than its counterparts. However, governance is extremely important as investors and stakeholders continue to press companies for accurate and transparent accounting methods.
This component of ESG ensures efforts to improve “E” and “S” factors are measured, reported and those responsible for implementation are held accountable. With transparency at its core, governance considerations include everything from business ethics to executive pay and board diversity, to delivery on strategic initiatives.
After the financial crisis in 2008-2009 sent shockwaves around the world, one positive trend emerged from the carnage: an interest in long-term approaches to sustainable investing.
Consumers and other businesses no longer trust companies that don’t care about the environment and human rights.
Over the last decade, environmental crises like the Deepwater Horizon oil spill and the Australian bushfires, along with social reckonings like the #MeToo and Black Lives Matter movements have turned a spotlight on ESG issues.
In the US, the recent racial justice movements in response to the killing of Black citizens by white police officers have driven one of the largest protest movements in recent memory, and have inspired businesses to address racial inequality or pledge support for Black-owned businesses, adding to the momentum behind ESG.
A recent Sunday Times investigation into Boohoo, one of the fastest-growing online retailers in Britain, exposed alleged unfair working conditions in its factories. The allegations provided an important reminder to UK companies of their obligations under the Modern Slavery Act of 2015 to ensure their operations and supply chains are free from modern slavery and human trafficking.
The rise of stakeholder capitalism has made social responsibility a necessity, “not just a marketing strategy,” according to Lily Zheng, author, and diversity, equity and inclusion consultant.
Over the last year, the pandemic has revealed the importance of issues like racial disparities, paid sick leave, flexible working arrangements and fair access to healthcare.
In response to the unprecedented uncertainties and disruptions that the virus either brought about or exposes, corporations have promised to become more socially responsible.
And as consumers become more concerned, and thus more educated, on environmental and social issues, they’ll continue to press companies to take stock of the impact they have on the world.
Strong ESG practices will only become more important. Incorporating ESG initiatives into your business operations is a powerful way to build internal value and loyalty. Nearly 70% of consumers in the US and Canada think it is important that a brand is sustainable or eco-friendly, according to a study by IBM and the National Retail Federation.
But pleasing consumers is only part of the equation. Studies show that ESG practices benefit a company’s current employees and play a significant role in attracting future talent.
A recent report from New York-based global consulting firm Marsh & McLennan found that
top employers (as measured by employee satisfaction and attractiveness to young talent) have significantly higher ESG scores than their peers.
The report also noted the importance of ESG performance in attracting and retaining talent as Millenials and Gen Z come of age in the global workforce. People between the ages of 15 and 24 make up almost 21% of the world’s working-age population, according to the International Labour Organization.
Right now, Millennials account for over a third of the US workforce, and Deloitte estimates Millenials and Gen Z could make up nearly two-thirds of the global workforce by 2025.
When it comes to investing, millennials are looking to make a social impact that reflects their personal beliefs. According to Zacks Equity Research, 90% of millennials who invest aim to customize investment bases on their set values, especially ESG.
Your ESG strategy is a window into your company’s corporate values, organizational practices and risk management.
ESG is not just a matter of ethics; it can have a profound impact on revenues, long-term value and business resiliency.
A C2FO worldwide survey of more than 6,700 small to mid-sized businesses (SMBs) found that about one-third of businesses have already incurred substantial costs to implement new sustainable processes and to comply with a variety of different requirements from clients and customers.
However, companies that embed ESG into all aspects of their operations can actually lower their costs and drive performance. In a meta-study by the University of Oxford and London-based investment research firm Arabesque Partners of more than 190 academic sources on sustainability, 90% showed that diligent ESG practices lowered the cost of capital.
A recent report from the World Economic Forum found that companies that implemented sustainable supply chain practices:
The individual elements of ESG are intertwined. A strong ESG strategy directly impacts financial success, according to an article by McKinsey & Co., in the following ways:
In late 2019 and 2020, The European Union passed two significant ESG-related regulations that require additional ESG information and metrics in filings for publicly traded companies, beyond what may be covered in the current obligation for disclosure of material risks.
The UK government has stated its intention to bring about a “green industrial revolution” to stimulate recovery from the COVID-19 pandemic.
Now, momentum is building for the US to follow the lead of its European counterparts. The Biden administration has ambitious goals for sustainability, including achieving 100% net-zero emissions by 2050, carbon-free domestic energy production by 2035 and providing tax credits for electric vehicles.
On March 4, the Securities and Exchange Commission (SEC) announced the creation of a Climate and ESG task force under the purview of the SEC’s Division of Enforcement. It said it would monitor how ESG-oriented funds vote on shareholder ballots, and opened a review of how companies are disclosing risks they face from climate change, according to the Wall Street Journal.
Although the US government has not solidified ESG reporting methods, 90% of S&P 500 companies issued ESG-related reports in 2019, up from 75% five years earlier.
Although there isn’t a global framework for measuring and reporting ESG practices, corporate disclosure has improved since the launch of the Global Reporting Initiative (GRI) guidelines in 2000. GRI was founded in Boston in 1997 following public outcry over the environmental damage of the Exxon Valdez oil spill. The GRI exists to help organizations be more transparent and take responsibility for their impact on issues such as climate change and human rights.
Today, 80% of the world’s largest corporations use GRI standards. More recently, the International Integrated Reporting Initiative (IIRC) and the US-based Sustainability Accounting Standard Board (SASB) have helped to advance industry-specific reporting.
Currently, there are many different ESG standards, frameworks and rating agencies. Each one has its own focuses and requirements. The lack of global consensus on ESG standards won’t last long, though. Now is the time to assess your business and make sure you’re prepared for regulations in the future.
ESG represents the intersection of sustainability and finance. Your company, and more specifically its financial leaders, should be evaluating ESG-related risks and opportunities to drive value and resilience for the long-term.
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