ESG At A Glance

ESG is a set of standards introduced by the world’s leading organizations and supranational structures, inter alia European Union, and United Nations to determine the commitment of every businessperson to the new civilized future.

Nowadays, business owners are required to understand these provisions, introduce them and start adapting their companies according to the new standards. This tendency is encouraged by our urge to live in a world that is friendly to entrepreneurs, societies, nations, and our planet in general.

This article presents a review of the nature of ESG and its historical background and explains why it is so important.

WHAT IS ESG?

ESG is a set of criteria in “Environmental”, “Social” and “Governance” spheres of business or commercial activities. 

It is crucial to understand three key points that reveal the comprehension of the viability and meaning of using ESG in the enterprise:

• Environmental factors assess a company’s impact on the environment and vice versa. These factors show how the company treats the environment. 
• Social factors examine how a company manages stakeholder relationships, the rights, and the well-being of people inside and outside. These factors show how the company treats employees, consumers, and the community.
• Governance factors assess how a company governs itself and is being run.

ESG requirements force businesses to set and then meet a range of criteria in most aspects of their business and operational activities. This allows them to survive successfully in the fast-changing world and be beneficial to the whole ecosystem. 

ESG helps to highlight the ethics of the business to the external world as the main drivers of ESG frames development are as follows:

• Customers’ behavior
• Sustainability
• Strategic development frameworks
• Regulatory standards
• Rankings and reputation
• Criteria for investors

ESG HISTORY

It is safe to say that the world has been evolving to introduce ESG for 70 years. We should point out several historical dates about important decisions, which can help you understand the significance of ESG.

It takes root in the 1950s when Electrical And Mine Workers' Unions started investing their pension capital in affordable housing and health facilities. 

Then in the 1990s, the Domini 400 Social Index was created, known today as MSCI KLD 400 Social Index, Kyoto Protocol was signed and Global Reporting Initiative (GRI) was founded. 

In the early 2000s, the United National Global Compact was launched and the guidelines for companies on ESG incorporation into their operations were published.

Subsequently, in 2015, the Paris Agreement, a UN Framework Convention, and the Sustainable Development Goals were created at the UN General Assembly. 

Finally, in the 2020s countries and regulators introduced ESG requirements and disclosure criteria into banking and business regulations.

And what is most important, ESG factors can be roughly translated to Sustainable Development Goals (SDGs) on the corporate level as unique parts of ESG considerations can be assigned to all 17 goals.

HOW ESG CORRELATES WITH A WELL-KNOWN CRS?

ESG starts with CSR (Corporate Social Responsibility) as a self-regulating business model that aims to improve society and the environment. ESG puts a quantifiable stamp of credibility on the broad management philosophy of CSR. A business needs both ESG and CSR to be sustainable.

There is ISO 26000, a voluntary standard for CSR, which helps companies define social responsibility and guides achieving it practically. CSR helps companies maintain a positive brand image and boosts stakeholder morale. 

Activities in a CSR strategy include:

• lowering the business’s carbon footprint, 
• corporate volunteering, 
• improving labor practices, 
• engaging in charity.

In turn, ESG strategy focuses on reaching certain performance metrics, setting measurable goals, and conducting audits. There are explicit standards and requirements for ESG (set by regulators and rating agencies for businesses). 

ESG encourages businesses to behave ethically. It also helps investors avoid losses when companies behave in a risky manner. Investors use ESG criteria to value businesses and, ultimately, inform their investment choices.

Businesses create ESG reports to appeal to investors and other compliance requirements, while CSR efforts are highlighted in annual reporting.

WHY ESG IS SO IMPORTANT?

Recent research shows that consumers and employees are demanding more ESG action from businesses: 

• 83% of consumers think companies should be actively shaping ESG best practices
• 91% of business leaders believe their company has a responsibility to act on ESG issues
• 86% of employees prefer to support or work for companies that care about the same issues they do

Consumers want companies to commit to being good corporate citizens and transparent about managing ESG issues through reporting and disclosures.

WHAT COMPANIES DO?

To start implementing ESG, companies develop corporate ESG frameworks and programs. The way a company manages ESG can directly impact share price through reputational and litigation risks. Failure to properly consider and manage ESG risks poses an additional reputational risk to companies. Activist investors are moving money away from firms with poor records, while consumer campaigns boycott products with unethical sourcing in their supply chains. ESG failures put companies and their third parties in the spotlight with negative press and social media commentary, leading to a loss of consumer confidence and revenue.

ESG programs can lead to cost savings by reducing waste and helping to attract better talent. A modern investor treats the costs to implement ESG as lasting. Moreover, global trends dictate that in the nearest future no business may be treated as one committed to long-term development without implementing ESG standards

Companies that demonstrate a positive ESG commitment are also enjoying more sustainable profits, setting them up for long-term success. Customers, investors, and employees increasingly want to buy from, invest in, and work for firms that can demonstrate a positive ESG impact. Increasingly, businesses are recognizing the concept of a "double bottom line" – that their performance should be measured in terms of positive social impact as well as profit.

Therefore, companies who signal that they are using actionable ESG criteria show that they have a long-term vision and possess viable opportunities for investors. 

Also, the world’s leading organizations expect corporate boards to retain diverse membership and lead change on ESG issues in their businesses, countries, and whole regions, as doing so creates long-term value and success.

WHAT IS THE IMPACT OF ESG?

A strong ESG proposition links to value creation in five essential ways:

1. Top-line growth

• Attract B2B and B2C customers with more sustainable products 
• Achieve better access to resources through stronger community and government relations

2. Cost reductions

• Lower energy consumption 
• Reduce water intake

3. Regulatory and legal interventions

• Achieve greater strategic freedom through deregulation 
• Earn subsidies and government support

4. Productivity uplift

• Boost employee motivation 
• Attract talent through greater social credibility

5. Investment and asset optimization

• Enhance investment returns by better allocating capital for the long term (e.g., more sustainable plans and equipment) 
• Avoid investments that may not pay off because of longer-term environmental issues

Management that is prepared to implement ESG criteria treats its introduction and the obligation to conduct ESG audit not just as the need to follow the rules. It is widely regarded now as creating a set of values and benefits directly connected with capital, human and reputational growth that are essential for the business.

HOW EU PUTS ESG INTO REGULATIONS?

Regulators and government authorities are asking boards if their company’s disclosure on ESG issues and products accurately reflects current practice. Institutions need early and proactive actions to ensure preparedness for ESG-related challenges and regulatory developments.

The European Commission published its action plan on sustainable finance in 2018, to create a roadmap for sustainable finance across three categories:

• reorienting capital flows toward a more sustainable economy

• integrating sustainability into risk management

• fostering transparency and long-term

The European Union has now successfully implemented three major related regulations:

•    Climate Benchmarks Regulation (EU 2019/2089) aims to enhance the transparency and comparability of benchmark methodologies relating to environmental, social, and corporate governance (ESG) metrics, providing investors with clarity on the environmental sustainability of their investments.

•    Sustainable Finance Disclosure Regulation (EU 2019/2088) aims to re-orient capital flows towards sustainable investments by increasing transparency by financial market participants and advisers on sustainability risks, whilst ensuring more uniform protection of end investors.

•    Taxonomy Regulation (EU 2020/852) establishes a harmonized taxonomy to classify financial products as sustainable at the EU level, further promoting investments in sustainable activities whilst addressing “greenwashing” concerns.

European Banking Authority is also implementing ESG in EU Banking Regulations:

• Considerations on how ESG can be incorporated into the regulatory and supervisory framework of EU credit institutions issued

• Monitor market practices related to sustainability and engage with relevant stakeholders and the industry

• Discussion on the role of environmental risks in the prudential framework launched in 2022

When a country fully implements ESG requirements for the banking sector, it means the introduction of ESG for the whole national economy.

WHY DO ESG RATINGS EXIST?

A rules-based methodology of ESG ratings is used to identify industry leaders and laggards according to their exposure to ESG risks and how well they manage those risks relative to peers. 

ESG ratings stand for: 

• measure a company's exposure to long-term environmental, social, and governance risks;

• help investors understand a company's priorities and the long-term risks it could face in the future;

• are designed to provide more data with more context to support more informed decisions for the modern institutional investor; and

• aim to measure a company’s management of financially relevant ESG risks and opportunities. 

Companies that want to be rated the highest, should implement their goals while introducing new standards and can benefit from the existing practice of adopting ESG in corporations that are regularly verified by the audits.

Having analyzed ESG provisions, we can make the following outcomes:

So, Be Proactive! – Develop an ESG framework for your Organization now! 

Leaders know that business survival depends on responding to change. Using an ESG framework can help directors and executives sustain economic growth and create a foundation for positive long-term results.

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Our team of national experts can help manage your ESG risks, and assist your business in setting up an ESG framework. We provide a full range of services across our client's investment process, including ESG strategic consultancy and ESG financial consultancy, and services to companies when implementing their ESG action plans.

If you have any questions on ESG, please get in touch with the Leopolis team: contact@leopolisgroup.com.

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