When we talk about governance we mean rules, principles, rights, responsibilities and expectations concerning how a body should function as a standard, applicable to any type of body, be it in the private sector, public or third sector.
To this end the ESG (Environment, Social and Governance) was created, to apply, in the private sector, non-financial elements as part of the process for the identification or risks and opportunities for growth. This helps manage investment risks, and the performance ratings and reports help investors how a company takes risks into consideration, prevents them, and generate sustainable financial returns. ESG aims at collecting and measuring metric that are relevant to the objectives and plans, as well as accountability concerning social and environmental impact, by showing the intangible assets of an enterprise and its social credit score, thus impacting the value of the company not just in financial terms.
This standard sets criteria to measure and report the sustainability of bodies, organisations and enterprises, and it is calculated on their performance, for example the behaviour towards the ESG issues identified, construction of reputation and, if any, gap between reality and perception.
The environmental indicators regard the effects on the planet and its internal proceedings and functioning, while the social ones concern relations with people, institutions, customers and stakeholders.
Let’s dig a bit deeper on the Environmental, Social and Governance Criteria. We understand now that these are standards for operation that investors who are socially and environmentally responsible and conscious use to decide whether to potentially invest or not. How is this acting responsibly and proactively towards nature and how relationships are managed when it comes to employees, stakeholders, suppliers, customers and the community where they operate, while governance concerns leadership, audits, internal control and shareholders rights.
The good news is that ESG criteria are gaining ground and popularity when it comes to investment evaluation, and started to become a branding exercises as many products placed on the market start to boast ESG criteria to the customers; while on the other hand exposes those don’t meet the criteria and are considered more at risk due to their unsustainable practices. This we mostly witness today from the new generation of entrepreneurs and startuppers, upon deciding on investments that yes make profit and also match their values.
ESG is not that complicated, it involves mostly behaviour observation, for example use of energy, generating waste, pollution, preservation of natural resources or treatment of animals are some of the criteria against which the ESG performance of a company is assessed. Part the evaluation includes the environmental and social risks the company might face, or cause, and how this is taken into account in strategic planning; for example management of contaminated waste or emissions, and how it complies the regulating laws.
When it comes to social criteria the magnifying glass is on business relationships, such as the shared values with its suppliers and stakeholders, investments on local community improvements, corporate social responsibility, volunteering schemes, quality of working conditions for the employees and health and safety standards, and relationships with the other stakeholders.
Moreover, investors would be very interested to find out, in terms of governance, how transparent the accounting methods are and how shareholders are treated and involved in decision-making, measures in place to mitigate conflicts of interest and accountability of the board members, and of course avoiding illegal practices and political lobbying to gain favours.
One minus is that it is very unlikely for any enterprise to fully pass the test, which also leaves stakeholders and investors to prioritise what really matters, however the model allows to set priorities and therefore positioning against the ESG criteria. Moreover unclear international and national regulations make ESG just a voluntary action on behalf of companies repositioning and working on a more positive/responsible reputation, it is not mandatory nor fully accepted in the world of business, whereas there are plenty of “nasty” businesses out there which are extremely profitable to invest in.
Good news is that there is an increase of investors that are starting to believe that ESG criteria are not only about ethics but concern also profitability of an investment, demonstrating the reliability, responsibility and long term planning of a company, which makes it a safer investment, therefore, it is gaining ground.