Environmental, Social and Governance (ESG) criteria are a set of standards for assessing the impact of sustainability and ethical practices of a company on its financial performance and operations. Initially, ESG was used by investors who were investing into companies, organizations and funds with the intention of generating a beneficial social or environmental impact as well as a financial return. This type of investing is called impact investing. Today, however, many other types of investors are using ESG to measure the suitability of investments.
In 2018, investments related to ESG strategies reached $30 trillion. This followed a 25 percent increase to $23 trillion between 2014 and 2018. Further, it is estimated that in the near future millennial investors are set to inherit an estimated $30 trillion in wealth; moreover, millennials are twice as likely to invest in companies, organizations and funds that uphold certain environmental and social values.
This focus on social and sustainability issues means many investors are exploring the extent to which ESG can affect and explain financial performance, both in terms of corporate earnings and investment returns.
ESG affects all industries, but for the commodities industry, it is at once one of the biggest investment opportunities and one of its biggest challenges.
The factors: explained
The environmental factor is primarily concerned with the company's influence on the environment and its ability to mitigate various risks that could harm the environment. In general, a company is assessed by its use of energy, waste generation, level of pollution produced, utilization of resources and treatment of animals. For example, Company A tells investors that its approach to ESG is rooted in its overall purpose to save people money so that they can live better. The company specifically highlights the environmental factor for investors and the public by showing how it has improved its sustainability, reduced its greenhouse gas emissions, reduced waste and implemented various environmental advocacy programs. This is important because a company's environmental policies and its ability to mitigate environmental risks may influence its financial performance. As governments and regulators increase compliance requirements and penalties for non-compliance, the environmental factor is purported to show how the company will fare financially in the future.
The social factor investigates a company's relationship with other businesses and communities and how it acts as a corporate citizen. The social factor looks at the company's demeanor towards diversity, human rights and consumer protection. Company A, for instance, highlights for investors and the public the average wage for full-time associates, including benefits. It shows investors and the public the percentages of its workforce that are women or people of color. Additionally, Company A shows investors and the public its commitment to food safety by highlighting the number of independent food safety audit it conducts, globally, in each fiscal year. The social factor may affect a company's operational success by attracting new and retaining customers, maintaining relationships with business partners and influencing the health of the community, all of which also have a financial impact.
The corporate governance factor examines the company's internal affairs and the relationship the company has with its main stakeholders, including its employees and shareholders. Our fictional Company A may call this "Sustaining the ESG Agenda." Through this agenda, Company A can show investors and the public that it is committed to ESG and, by being committed to ESG, it is also committed to its stakeholders and employees. An efficient and transparent corporate governance regime could help companies avoid conflicts of interests between company stakeholders and misunderstandings between the company and employees, thus possibly reducing litigation expenses.
ESG: action steps for the commodities industry
There is no denying the fact that the global community needs commodities – metals, oil, coal, gas – and this need is not going away. At the same time, the global community is increasingly concerned about the long-term health of the planet, laying the foundation for what is being called a "green revolution." Commodities companies that can emerge as ESG leaders could also see an economic and financial benefit.
One of the steps that commodities companies may take to begin to develop an ESG is to interview subject matter experts from across all sectors of the commodities industry to identify and validate relevant ESG topics. Additionally, commodities companies should consider establishing an internal, ongoing ESG committee. That committee can work with research firms to conduct anonymous surveys of investors, nongovernmental organizations and other stakeholders to learn about ESG topics important to such groups, and then analyze these findings to create and maintain an effective and beneficial ESG policy which informs the company's activities going forward.
DLA Piper's Commodities Marketing, Trading and Shipping group has practical experience in the commodities industry and works closely with DLA Piper lawyers across our broad range of global practices, including cybersecurity, investment relations, employment relations, corporate compliance and litigation, to help commodities clients understand and establish ESP, as well as continuously manage and mitigate ESG risk factors within their organizations. Learn more by contacting either of the authors.
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