The ESG criteria are becoming increasingly important in a company’s decision-making process. These criteria evaluate how a business handles environmental, social and corporate government issues and can have a significant impact on the company’s long-term financial health.
In this article, we delve into the ESG criteria, explain why they are relevant to companies, and see how they can be integrated into a sustainable business strategy.
What is ESG?
The ESG (Environmental, Social and Governance) criteria refer to three key factors a company should have present to guarantee long-term sustainability.
The past few years have seen an increased focus on ESG as investors and consumers alike have begun to favour companies who show concern for the social and environmental impact of their business operations.
No one could have imagined how far it would come when Sustainability first became the new paradigm for companies at the start of the 21st Century.
John Elkington, in The Triple Bottom Line (1994), alluded to how companies needed to account for not only their financial data, but also their environmental and social impact – thus creating a three-part accounting framework. The Global Reporting Initiative (GRI) became the main worldwide standard for Sustainability reports in 1997, and two years later, the UN launched Global Compact, the greatest voluntary initiative for Corporate Social Responsibility (CSR), containing the Ten Principles of the UN Global Compact regarding human rights, employment, environment and anti-corruption.
Since then, the ESG concept has become increasingly relevant combined with Sustainability due to its use in the field of Sustainable and Responsible Investment (SRI). This has led to increased demand for sustainability reports and the need to measure and improve a company’s ESG development.
What does ESG measure?
According to the MSCI definition, the ESG ratings measure the long-term resilience of an organisation against sectoral risks in environmental, social and governance matters. Below, we take a more in-depth look at what each of the criteria mean:
- E for Environmental refers to a company’s handling of its direct and indirect environmental impact, how it cares for its surroundings, biodiversity, its commitment to reducing greenhouse gases and climate change, and its contribution towards a low-carbon economy.
- S for Social is directly associated to how the company treats its personnel and suppliers, how it fosters decent labour conditions, equal opportunities policies and work/family reconciliation, training, respect for Human Rights and stance against child labour.
- G for Governance encompasses the company’s commitment to correct governance, ethical codes and good conduct, its transparency, and anti-corruption at administrative and management level.
The results of each category are compiled to create an ESG report which summarises all the company’s non-financial information. So why is this relevant?
Why is ESG important?
The focus on ESG criteria has become increasingly important over the past few years, as investors and consumers alike have begun to favour companies which show concern for the social and environmental impact of their business operations.
Furthermore, companies who better control environmental, social and governance challenges can hold a competitive advantage over others in the market which could lead to greater financial stability in the long term. This is because companies who take into account this criteria can mitigate risks involved with legal issues and protect their reputation, as well as attract investors and consumers who are increasingly conscious of the environmental and social impacts.
ESG has become more pertinent as legislation has developed in CSR matters, above all since 2015, a turning point in sustainability management with the Paris Agreement to combat climate change and the ratification of the Sustainable Development Goals (SDG) by the UN to make the world a more inhabitable and sustainable place.
We can therefore conclude that increased relevance of ESG is down to two main factors:
- Greater demand for transparency: After the financial crisis of 2008, not just stakeholders but society at large and various other interest groups started to demand greater transparency from businesses. Recently, the Edelman Trust Barometer 2021, showed that 86% of the population consider that the CEOs should be more involved with social and environmental issues.
- Legislative needs: Spanish listed companies were already obliged to abide by the 2015 Good Governance Code of the CNMV (the Spanish government agency responsible for the financial regulation of the securities markets in Spain) with a CSR Policy approved by the Management Board, on which the CSR report was based.
European legislation has also become stricter in how companies hold themselves accountable. The EU Directive (2014) for the disclosure of non-financial and diversity information gave rise to the Law 11/2018 of 28 December on non-financial and diversity information in Spain. This requires companies with more than 500 employees or those with a turnover greater than 40 million euros to report their activities. Since 2021, it is now obligatory for companies with more than 250 employees. An estimated 6,000 European companies must prove their commitment to ESG.
What’s more, companies who have a high ESG rating are considered more sustainable and less at risk, which is attractive to investors in the long term.
To a large extent, this reduced risk is related to risk analysis of factors within these criteria.
ESG risks, also known as non-financial or sustainability risks, include climate change impact, adherence to human rights and labour relations, management structure and tax compliance.
Poor ESG risk management can negatively affect businesses and could lead to serious financial and reputation problems.
Interest groups are more concerned about the corporate social responsibility of companies, and risk management in this area is fundamental to maintaining a good image.
Although not obligatory for all, Law 11/2018 establishes the need to report ESG risks in the Non-Financial Information Statements (NFIS). If not included in the report, a company must justify its absence.
What non-financial risks associated with the environment must be taken into consideration? Waste management, carbon footprint, contamination and impact on climate change are just some examples.
And what about social risks? Human capital management, equal opportunities and equality in the workplace, diversity, and health and safety are some examples of issues to take into account.
Finally, what risks related to governance should be considered? These include corruption, bribery, directors’ pay, tax and equality on the board of directors.
It is important to consider what risks are interconnected and how their efficient management is key to any company committed to sustainability.
Why is ESG important and what benefits can be gained from adopting its criteria?
Integrating ESG criteria into the company can have both short-term and long-term benefits. If some management teams were still to doubt the relevance of ESG criteria, here we outline some of their undoubted benefits:
- Competitive advantages: ESG criteria management can offer differential value compared to the rest of the competition.
- Risk mitigation: Control of ESG information can help mitigate possible risks associated with business activity regarding environmental, social and governance issues, as well as in managing people and suppliers.
- Attracting talent: Employees prefer to join companies which are more committed to society and have a defined purpose. Integrating ESG can become an incentive for new workers.
- Investment opportunities: Over the past few years and as a result of the pandemic, investors want greater commitment from companies in helping to combat climate change, leading the way towards a low-carbon economy and helping to meet social challenges and reduce inequality.
In conclusion, the ESG criteria are a key factor to guaranteeing the long-term sustainability of a company. It is crucial for businesses to understand the environmental, social and corporate government challenges they face, and draw up suitable strategies to deal with them.
How can you be an ESG company and integrate its criteria?
Integrating Sustainability and ESG criteria is not just for large companies. It can be a differential value for any business, regardless of its size, including SMEs.
If you are starting to integrate ESG, here are a few tips:
- Team and resources: It is a good idea to designate a person or team responsible for coordinating the Sustainability and ESG within the company and draw up a Sustainability Plan for implementation and monitoring, as well as creating the Non-Financial Statement. This area should be allocated a budget just like any other part of the company.
- Materiality assessment: When creating the Sustainability Plan, it is important to prioritise the key issues for your company by means of a materiality assessment. This process allows you to identify the most relevant ESG issues based on sector activity or global trends and thus establish ESG goals.
- Technology: Technological solutions such as APLANET allow you to have a system for monitoring and measuring the role of ESG. You can use it to see its progress and take informed decisions for continuous development.
If your organisation has still not started to manage ESG criteria or finds such work cumbersome, here at APLANET, we can help you.
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