ESG stands for environmental, social, and governance, and it is a set of standards that are used to screen potential investments or third parties.
ESG considers how a company safeguards the environment and its policies addressing the environment, as well as how the company manages its relationships with the community, customers, employees, and suppliers it conducts business with. It also considers the company’s leadership, internal controls, audits, and shareholder rights.
It is a concept that was first developed by the United Nations, which works with the finance industry. Officials of the United Nations argued that ESG could help protect organizations from financial risks from issues like worker disputes, human rights issues, poor governance, and climate change.
How does it Work?
The different aspects of ESG mean different things.
Environmental
The environmental aspect considers environmental issues, such as energy use, waste, animal treatment, and natural resource conservation, among others. ESG can help organizations evaluate any environmental risks that they or their third parties may encounter.
Social
The social part looks at the organization’s relationships with both the internal and external stakeholders to make sure suppliers are being held to its standards. One of the investment strategies used is socially responsible investing (SRI), and it is a big part of ESG. SRI investors look for companies that promote ethical and socially conscious themes.
Governance
Governance helps ensure that the leadership and shareholders are being held accountable. Governance standards check that companies are using accurate and transparent accounting methods and that leadership is being chosen using the correct processes. Governance is intended to lessen and eliminate corruption and conflicts of interest within organizations.
Importance of ESG
ESG is important for a variety of factors.
For the environment, ESG has multiple benefits. It brings awareness to the different climate issues that are occurring and encourages businesses to adopt practices and policies that are better for the environment.
For the social part of ESG, employees and shareholders are created equally, and their health and safety are considered. It helps avoid bad business practices.
It also forces companies to innovate, which not only uncovers different opportunities but can open up more jobs. ESG is growing, and it is showing companies that they could either be a part of the solution or a part of the problem.
ESG and Compliance
ESG and compliance are closely interconnected within an organization, and they both contribute to the trust and reputation of a business. There are some who have voiced concerns that ESG adds more to the workload of compliance teams, who are already overburdened, and that there are more pressing issues to worry about, like cybersecurity and data privacy.
Still, ESG compliance is becoming one of the top priorities for many organizations. ESG performance has become part of the evaluation of public companies, which is why businesses need to incorporate ESG into their decision-making.
Compliance teams already handle different facets of ESG, like human resource matters, legal affairs, and internal audits, which is why ESG and compliance pair so well together. They can even manage ESG with ESG software.
ESG and Investing
The ESG framework has become very important to the investment community. The number of different ESG rating agencies and reporting frameworks is growing, and they are evolving to improve the consistency and transparency of ESG information.
Within the investment industry, the markets can help improve companies’ compliance with ESG and encourage these companies to improve their ESG guidelines by either restricting access to capital or stating specific terms to capital; this can help incentivize companies to improve their ESG performance. The industry can also help reward companies that are performing well with ESG to encourage them to continue their good work. This puts more awareness on both investors and businesses that ESG is important so that they adopt sustainable strategies.
