In a nutshell, environmental, social, and governance (ESG) are a set of standards for a company’s operations that focus on environmental protection, social responsibility, and good corporate governance. Companies that set and adhere to these standards are said to maintain ESG principles. These provide valuable insight into how companies are managed and how they are impacted by their external environment.
ESG standards help investors evaluate the long-term sustainability and social impact of their investments. Through ESG investing, investors can buy stock from companies that uphold certain socially responsible or ethical standards. ESG factors are increasingly being used as part of the assessment of a company by investors and other stakeholders.
Environmental standards (sometimes called E) cover a range of areas such as climate change, renewable energy, air and water quality, waste management, and resource use efficiency. This part of the standards looks at a company’s environmental footprint and encourages them to adopt more sustainable practices.
Social standards (sometimes called S) focus on how a company operates in terms of its relationships with its customers, employees, communities, and other stakeholders. This part of the standards looks at issues such as workplace safety and diversity, human rights and fair trade, consumer health and safety, and data privacy and security.
Good governance standards (sometimes called G) describe a set of principles, processes and procedures that are followed in order to improve the quality of decision -making and expand the participation of stakeholders in the decision-making process. Good governance seeks to ensure that citizens and organisations alike are able to make and implement decisions in a transparent, accountable, equitable, and effective manner.
ESG – A Timeline
- 1970s: Environmentalism starts to become popular as environmental laws are created, and the Environmental Protection Agency is established in the United States (U.S.).
- 1980s: The United Nations (UN) formally adopts its Environmental Program (UNEP) and begins including specific dimensions in its
Agenda 21 program.
- 1990s: Interest in the financial implications of investing in businesses with good environmental practices increases; the Global Reporting Initiative (GRI) is founded.
- 2000s: Developments in technologies such as blockchain and artificial intelligence leads to an increase in the availability of data that can be used to measure companies’ ESG performance; the first comprehensive ESG rating systems are established.
- 2010s: Regulatory developments, including the European Union (EU) releasing its action plan on financing sustainable growth, lead to an increase in the demand for ESG investments; socially responsible investing gains in popularity.
- 2020s: The increased urgency of tackling climate change leads to a further surge in the demand for ESG investments. March 2022: The EU publishes regulation on sustainable finance requiring all companies and financial institutions to disclose their climate risks.
ESG has its origins in the 70s when it was recognised that “social considerations” should be of paramount importance if shareholders are to achieve reasonable long-term return on their investments. This was in contrast with the more traditional ‘bottom-line” approach that had been the focus for many years prior to this. At the time, the issues addressed under the ESG umbrella were primarily focused on environmental and social issues, such as labour practices pollution, racial inequality and corporate responsibility.
By the early 2000s, the concept evolved further with the inclusion of corporate governance principles, such as executive pay, corporate structure and board composition. The UN first used the designation ESG in its Principles for Responsible Investment (PRI) published in 2006.
The term was further popularised by then-U.S. president Barack Obama in 2009. A vocal advocate for ESG, during his presidency Obama encouraged companies and investors to take into account the social en environmental impact of investments. Obama signed a presidential memorandum in 2015 that directed federal agencies to develop strategies to integrate ESG considerations into federal procurement and contracting decisions. He has also been an outspoken supporter of the Principles for Responsible Investment, a global network that encourages the integration of ESG issues into mainstream investment decisions.
ESG Today – From Voluntary to Mandatory
While many U.S. public companies are making disclosures of their environmental, social and governance practices and policies, currently ESG reporting is not mandatory in the U.S. This is rapidly changing with a great number of ESG initiatives and proposals driven by President Biden (2021) and the U.S. Securities and Exchange Commission (SEC) already required all public companies to disclose information that may be material to investors, including information on ESG-related risks, and disclosure of weather and how diversity is a consideration in the hiring process.
In Europe, many countries are implementing mandatory ESG reporting requirements, such as France and the United Kingdom (UK), with more countries to follow. Additionally, as of March 2021 the new Europe Union’s Sustainable Finance Disclosure Regulation (SFDR), which requires disclosures related to ESG topics, came into effect.