If you have ever wondered why the concept of "ESG" is so popular among investors and business owners, it is because it refers to a variety of issues that might affect a company's potential to generate long-term value.
ESG refers to a set of Environmental, Social, and Governance elements used to assess investment and company impact. At its most basic level, ESG is a method for evaluating organizations against a wide range of socially acceptable outcomes. It refers to a set of criteria for assessing the non-financial effects of specific investments and businesses. Simultaneously, ESG offers a variety of business and investment prospects.
Let us examine the individual components of ESG: The 'E' in ESG stands for environmental criteria, which include the amount of energy an organisation consumes and wastes, the resources it requires, and the effects for living beings as a result. Pollution, deforestation, and garbage management are just a few examples of environmental factors.
Every business must work in a larger, more varied society and assess the social impact of its business - the 'S' criteria. Social factors to consider include employee relations, labour rules, diversity and inclusion and product safety.
The 'G' refers to a company's internal system of processes, controls, and procedures for governing itself, making effective decisions, adhering to the law, and meeting the needs of external stakeholders.
You can consider ESG an intangible asset to a company. It is therefore important that companies understand ESG, its importance and potential implications and benefits for their businesses.
Why you need to pay attention to ESG
ESG investing dates back to the 1960s when investors decided to eliminate stocks or entire industries from their portfolios due to company activities such as tobacco production.
In recent times, there has been an increased focus on ESG in various countries. In Nigeria, the Financial Reporting Council (FRC) issued the Nigerian Code of Corporate Governance (NCCG) in 2018, with Principle 26 aimed at improving sustainability. It requires organisations to pay adequate attention to sustainability issues including environmental, social, occupational and community health and safety; to ensure successful long term business performance and project the company as a responsible corporate citizen, contributing to economic development. As such, introducing an ESG program can aid companies in complying with the NCCG.
Investors are increasingly recognising the link between ESG performance, wealth generation, and risk mitigation. A successful ESG program can not only help companies and investors address sustainability issues but may also help them gain access to vast pools of capital, strengthen their company identity, and encourage long-term growth. If appropriately managed, ESG can help companies capture opportunities, manage risk by staying ahead of the vulnerability curve, and generate business and financial outperformance. It stands to reason that businesses that perform well in terms of ESG are more efficient and less wasteful; they have a higher level of staff dedication and productivity.
Proactively acting on ESG has recently become even more imperative. Consumers and other businesses no longer have faith in businesses that are apathetic about the environment or human rights. Consumers will continue to force corporations to assess their impact on the world as they become more concerned, and hence more educated, about environmental and social issues. Robust ESG practices will only grow more crucial in the future. Integrating ESG efforts into business operations is a sure method to increase internal value and customer loyalty.
Organisations have the opportunity to demonstrate their stance on ESG by issuing a sustainability report to its stakeholders. Such reports are to be prepared according to global best practices by referencing the Global Reporting Initiative (GRI) which is the globally acceptable framework for reporting on ESG matters. Other sustainability reporting standards and guidelines include the United Nations Global Compact (UNGC) (for signatory members), the Carbon Disclosure Project (CDP), UN Guiding Principles on Business and Human Rights, the FTSE/JSE Responsible Investment Index Series, and the King Code of Governance Principles (King IV).
Drivers of ESG Investment
We may deduce that there are three drivers of ESG investment based on their impact on growth: a movement in global focus, a shift to socially concerned investors, and an increase in changing data and analytics.
Concerning the shift in global focus, it is worth noting that the global regulatory landscape is rapidly evolving, with many countries enshrining ESG criteria in their rules. According to a recent survey, governments around the world have passed over 500 new policies to promote ESG issues in the last decade. Given the scope of the undertaking, a variety of stakeholders are involved, including governments, regulators, capital markets, enterprises, and consumers, all of whom are aided by green technologies and new business models. Some politicians, senior executives, and investors want to move away from focusing solely on shareholder returns and instead consider factors such as the company's impact on climate change and other global sustainability challenges, such as flood risk, rising sea levels, data privacy, information security, and demographic shifts.
Many financial professionals believe that ESG investing is particularly appealing to millennials in order to make them socially responsible investors. In a poll conducted by a major asset management firm, 88% of respondents felt that financial returns could be balanced with a focus on social and environmental effects. Almost as many (86%) thought companies that adopted ESG standards would be more profitable and have better long-term investments. Women make up a large portion of the early ESG investors. According to one study, women are less likely than males to cite low or limited returns as a justification for not investing in ESG. The growing belief that investors may achieve financial gain while also having a good social and environmental impact is driving the adoption of sustainable investment.
Finally, access to information is a major driver of the increased attention on ESG. The proliferation of 24- hour news networks, the internet, and social media means that the general public has unprecedented access to information. It is not only a world of instant news but also a world of global news, in which we can quickly learn what is happening anywhere across the globe. Public scrutiny is at an all-time high as a result of this transparency, and people power is transforming how the investment industry operates. Companies are aware of the importance of their brand and are acutely aware of public opinion, to avoid reputational damage. This increased public scrutiny has an impact on how institutional investors allocate capital, which in turn has an impact on how asset managers deploy funds and interact with businesses.
Implication for stakeholders
To succeed in the ESG era, investors must supplement their sustainable investing abilities with the capacity to quickly, dynamically, and flexibly anticipate and respond to how ESG issues will evolve by sector and industry.
For example, companies may need to undertake a massive product portfolio review to reformulate their strategy. This may involve determining where products are harming the environment and what needs to change; identifying which products to reengineer, and pinpointing where they are adding the most value and how to remain competitive in their field.
To reinforce the public's trust, businesses must be transformed; nevertheless, the reforms should not include regulating enterprises to make them less profitable. One perceived notion about ESG is that it does not put profits first. CEOs and investors must take their responsibilities to stakeholders seriously and seek profits as a by-product of helping society rather than by exploiting customers, employees, or the environment. Creating social value is not just "worthy" – it is also profitable.
Considering the far-reaching impacts of ESG changes, leaders' focus and drive are critical to their success. For instance, some organisations have a Board Social & Ethics Committee with a remit to support the Board in remaining accountable to its shareholders for the long-term sustainability of the organisation and overseeing effective management of climate-related impacts.
Consumers, activists, and employees all have a say in which ESG concerns become relevant to businesses, but organisations and investors can too. Investors can obtain a competitive advantage by improving performance in current and future important ESG concerns.
A win-win strategy
Strong ESG performance, such as carbon reduction and increased gender equality, can have a huge positive influence on investors, companies, and society. Investors want to use their money as a force for good, to have a positive impact through sustainable investments that benefit them and the people that need it the most. These include financing hospitals that are the heartbeat of local communities, funding clean energy to make electricity more accessible, and investing in innovative solutions to clean polluted marine habitats. Similarly, incorporating forward-looking ESG factors into strategy and practice can lead to enhanced capital allocation and long-term corporate resilience.
We are seeing more companies acknowledge the importance of ESG. For instance, in 2021 a foremost food manufacturing company operating in Nigeria for over 60 years issued its maiden ESG report stating "We are happy to release our first separate sustainability report to reinforce our commitment to sustainability and generating impact for stakeholders." ESG is certainly not a fad, it is the future.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.