What is ESG?

September 22, 2022 4 minute read

Letters spelling out ESG on a plant background

The ESG acronym has recently become synonymous with corporate initiatives demonstrating commitments and adherence to criteria and standards, metrics, and practices in three overarching pillars: Environmental, Social, and business Governance.

What many don’t realize is that ESG did not originate with companies. In fact, many companies were already goal-driven in one or more of these broader areas. It was almost a requisite given the growing societal consensus that businesses should be more than mere profit-driven; they should also be good actors (or at least not bad ones).

To that end, many businesses and sectors have been participating for years in industry and responsibility-specific certification programs, building out Corporate Social Responsibility(CSR) initiatives, and internalizing metrics to reduce carbon footprints and reduce environmental impacts, among other activities. So what is ESG, then? 

What is ESG? 

ESG Is investment market driven and it has emerged within the investment sector. It is a set of standards for a company’s behavior used by socially conscious investors to screen potential investments. And the timed arrival of ESG in the investment market is not coincidence. Although ESG has been around for several years, it is being driven by a younger generation.

In fact, according to new research, 54 percent of Gen Z and millennials hold ESG investments, compared to only 42 percent of Boomers and 25 percent of Gen Xers. This differentiation is growing, and critical enough that GreenBiz dedicated an article to appealing to these younger generational investors.

“ The recent acceleration of widespread reporting on ESG principles and practices has created the shift of power, money and jobs from baby boomers to millennials and Gen Z, in which passive investing, COVID, social injustice issues, the "Great Resignation" and talent shortages have all been contributing factors.”- Greenbiz author Terry Branstad

Top of the list for investment consideration is the extent to which a company is actively engaged in fighting climate change, specifically the threat of global warming, and corporate ESG strategy should address this overarching concern to appeal to next gen investors.

What additional concerns are important in driving investment demand and behavior and are thus factored into ESG standards, criteria, and initiatives?

What Are ESG Criteria?

ESG investing is sometimes referred to as responsible or socially responsible investing (SRI), sustainable investing, or impact investing. Companies are assessed on ESG criteria, giving investors a look at a broad range of policies, behaviors, and impacts. 

Environmental Criteria

In addition to efforts to combat or mitigate climate change (corporate climate policies and actions), environmental criteria for investing consider how a company safeguards the environment.

Criteria may include energy use, direct and indirect GHG emissions, pollution, management of toxic waste, natural resource conservation, treatment of animals, compliance with environmental regulations, and impacts to water. The criteria can also help evaluate any environmental risks a company might face specifically and across the landscape, and how the company is managing those risks.

This focus on Environmental criteria is not limited to the company alone, but may include examination of sustainability upstream and downstream across a company’s supply chain as well.

Social Criteria

Social criteria examine how a company manages relationships with direct and indirect stakeholders including employees, suppliers, customers, and the communities where it operates. This can include an array of social indicators from workplace considerations – like providing for inclusiveness and diversity, fair and equitable pay, and career architecture, to exhibiting conditions that reflect regard for employee health and safety.

For younger generations especially, also important are policies and benefits that allow employees opportunities to do not only have work-life balance, but to also do social good, such as paid volunteer time off (VT), charitable contribution matching, and donations to and support of the local community.

Beyond employment, social criteria also examine company ethics. Does the organization hold suppliers to its own ESG standards? Does it take advantage of customers unethically? Does it support policies along its supply chain that reflect its own social commitments? Are there efforts to encourage women’s, indigenous and local empowerment?

Business Governance Criteria

ESG governance standards ensure a company pursues integrity and diversity in selecting its leadership and is accountable to its shareholders. ESG investors may be seeking policies and procedures that ensure accurate and transparent accounting methods, and assurances that companies avoid conflicts of interest, refrain from misusing political contributions to obtain preferential treatment, or engage in illegal conduct.

How does ESG Criteria Work?

Brokerage firms and mutual fund companies have started offering exchange-traded funds (ETFs) and other financial products that follow ESG criteria. And these firms often set their own priorities.

Market analysts now have more expanded roles in monitoring and assessing an array of relevant issues facing specific sectors, industries, and companies as part of setting final criteria for investments. They also are heavily engaged in assessing documentation and corporate compliance to commitments and metrics to determine if companies are driving real change for the common good, or merely checking boxes or publishing reports with little transparency or verification.

Criticisms of ESG

There are several criticisms and cautions surrounding the growing ESG investment market. We detail four here.

1. Precluding Investments Can Dissuade Participation

Some investment firms preclude investments in companies that operate in high-risk environments, or perhaps rely significantly on inputs from suppliers who are not engaging in sustainability practices. And that means investors may be exempted from higher-performing companies and lower returns. This might dissuade companies from entering into commitments and advancing more rigorous sustainability practices without the investment sector incentive.

2. Exempting Underperformers Can Hinder Progress

At the same time, although investors may want to invest in companies that are “good” actors; underperformance may dissuade them from heavily investing their portfolio around ESG criteria. Because ESG can include a hefty investment price tag for companies, the ROI in these instances may derail environmental, social, and governance (sustainability) efforts that companies might have pursued without the impetus coming from the investment sector.

3. ESG Criteria isn't Always SMART

The ESG investment schema should but doesn’t always rely on criteria that are realistic, measurable, and actionable. And given the investment environment is equally “short-term gain” as it is “long-term haul,” the system itself can be volatile.

To accommodate these realities, companies must engage in very strategic decisions and investments in planning, design, monitoring and tracking, and scalable change. And that can be resource-intensive and costly, especially if it the market is fickle, and companies are required to pivot.

4. ESG Ratings May Not Reflect Real Impact 

Finally, there are also concerns about ratings and links to reporting in that the former may not necessarily translate into significant, sustainable impact on the issues that count.

An article in Bloomberg last year lofts a scathing criticism on MSCI, claiming the largest ESG rating company “doesn’t even try to measure the impact of a corporation on the world. It’s all about whether the world might mess with the bottom line.”

Still, ESG is Here for the Near Future

Despite the arduous task of implementing ESG in companies and across supply and value chains, and these criticisms, ESG is still very much part of the sustainability landscape.

This market-driven trend will continue given the push from younger generations to invest in companies that also invest in principles and practices they care about in an effort to mold an environmentally-and socially conscious world.

At the same time, given much of the uncertainty and sometimes reproach of ESG implementation, reporting, and rating, innovation and sustainability design, as well as pre-competitive and cross-sector partnerships might yield equally, if not more quantifiable sustainability outcomes, and ultimately more deliverable sustainable impact and “good.”

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If you are a corporate leader and would like to be a part of a discussion about these and other issues in the presidential transition, contact Resonance Strategic Partnerships Manager, Seth Olson.