What is ESG and why does it matter?
Updated: Oct 31, 2022
What is ESG? What do these three letters stand for? Why do ESG, ESG plans and ESG consulting matter for your organization? How are ESG initiatives implemented and measured?
If you have questions like any of the above, you are not alone. The purpose of this white paper is to provide some basic clarity on ESG plans in hopes of a competitive advantage for your organization. This subject is quickly evolving and is fairly complex, so this four-minute read will not make you an expert, but it will give you the basics.
ESG stands for Environmental, Social, and Governance. ESG reporting refers to the disclosure of data related to a company's operations in these three, key areas. In short, ESG provides a “moment in time” view on a businesses’ progress towards these goals.
The analysis of performance across these three factors summarizes both quantitative and qualitative data that helps screen investments. More specifically, ESG reporting helps investors avoid companies with greater financial risk due to poor environmental performance, for example, and simultaneously helps them to discover investable opportunities in companies that score well on their corporate governance initiatives.
Environmental factors include the contribution that a company makes through its use of energy and its management of environmental impact as stewards of the planet. The “E” category measures how an organization uses resources up and down its value chain - from Scope 1 to Scope 3. Factors considered are energy efficiency, relative contribution to climate change, carbon emissions, biodiversity, air and water quality, deforestation, and waste management. Companies that fail to consider their impact in these areas may face unforeseen financial risks (such as a higher cost of capital) and investor scrutiny. Key criteria within the environmental category includes the following:
contribution to climate change
a company’s utilization of "natural capital" (such as biodiversity and raw materials sourcing)
pollution and waste management
use of green technologies and renewable energy
Social metrics include inclusivity, gender and diversity, employee engagement, customer satisfaction, data protection, privacy, community relations, human rights, labor standards. Key criteria within the social category includes the following:
health, safety, and human capital development
product and consumer safety
Governance refers to a company's internal system of controls, practices, and procedures. A well-defined governance structure can be used to balance or align interests between stakeholders and can work as a tool to support a company’s long-term strategy. Factors considered are the company’s leadership, board composition, executive compensation, audit committee structure, internal controls, and shareholder rights, bribery and corruption, lobbying, political contributions, and whistleblower programs. Key criteria within the governance category includes the following:
corporate governance fairness and accountability
transparency and ethics
Many organizations, particularly those operating in highly-regulated industries, have already made significant progress towards the “S”(ocial) and “G”overnance components of their ESG plans. But in many cases, often because of its relative and inherent complexity, the “E”nvironmental pillar has been either misunderstood, overlooked or unprioritized.
Why is ESG reporting so important?
The short answer is that companies with strong ESG performance generate higher returns, operate with lower risk and demonstrate better resiliency in times of crisis.
The longer answer is that ESG transparency and reporting is gaining momentum as a key tool used to identify and sort company investment risk and return profiles. Robust, ESG-related performance and reporting proves how a company considers/mitigates risks and generates sustainable, long-term returns. The Deloitte Center for Financial Services expects ESG-mandated assets in the United States to comprise 50% of all professionally managed investments by 2025. Furthermore, in 2020 the Forum for Sustainable and Responsible Investment reported that more than $17 trillion of professionally managed assets were held in sustainable assets, representing approximately one-third of all assets under management.
On the other hand, companies (or countries) that do not provide these reports show a lack of transparency and concerned investors may overlook them as potential investments.
So, all this said, where do you think that the “smart money” will choose to invest?
Companies that have had multiple child labor violations?
A tobacco company?
An opioid manufacturer?
A country that is a heavy polluter and with a questionable human rights record?
A coal company?
Technology that helps organizations like schools reduce their energy consumption, costs, and carbon footprint, which allows them to hire more teachers with the savings?
A company with an unrivaled ability to attract and retain the best employee talent from the nation’s most competitive colleges and universities?
The choice seems quite obvious.
So how can your organization build its ESG plan?
It’s not really that tough. You most likely already know how to do this. Treat it like any other key business initiative your organization has ever focused on.
Recognize that it is a key business initiative with the goal of creating positive financial impact
Make it a priority: Assign a leader, form a team, leverage some expert help from outside your organization to advise.
Set specific goals / KPIs and measure your progress against them. Key suggestion: report quarterly with key enterprise clients and partners.
Build momentum by sharing successes. Here are some examples:
Internally - we won a key renewal with a very large client- client stated that our “culture and focus on ESG was a key differentiator.”
Won “Top Places to Work” award
Reduced carbon emissions by 12k tons a year and saved the company $64k annually which allowed us to win a Donovan Smart Energy Award.
Promote Progress Externally: This is a key component to increasing brand value and ESG scoring. Some good news- Most companies already have some wins within the ESG consulting areas, they just need to capture those successes and know what, how, and where to share that news. So, if one really thinks about it, this is really not that much different from most other corporate initiatives.
How is ESG Scored?
This is where things get complex.
Due mostly to the fact that there is no current standard, there are dozens of firms that offer a variety of ESG rating and scoring methodologies.
These rating companies can have different criteria for measuring ESG performance based on data extracted from voluntary disclosures (including company websites), securities filings, governmental databases, academic information, and media sources. A significant source of data for most scoring/ratings providers is data published by non‑governmental organizations (NGOs) that collect ESG data from participating companies such as the global reporting initiative, the Sustainability Accounting Standards Board (SASB), the Carbon Disclosure Project, and the UN Sustainable Development Goals.
The resounding sentiment around scoring is that if your organization’s main goal is to chase a specific score, then you have already lost. Instead, organizations should strive to reduce their risk by focusing on implementing or maintaining best practices related to issues that are tied to specific ESG goals. Strive to be a leader and a score will follow!
Donovan Energy is an ESG consulting and energy advisory company with expertise in helping companies devise and implement “E” - related initiatives within their ESG plans.