ESG Basics

ESG includes human rights, diversity and inclusion of philanthropy and in ESG reporting companies reflect their corporate social responsibility and sustainability. ESG is becoming more popular among investors who view it as barometer of long term wealth creation as it not only reduces cost but also provide opportunities for innovation. 

What is ESG? 

ESG stands for environmental, social and governance. These are called pillars in ESG frameworks and represent the three main topic areas that companies are expected to report in. The goal of ESG is to capture all the non-financial risks and opportunities inherent to a company's day to day activities. 

Why is ESG here to stay? 

Our world faces a number of global challenges: climate change, transitioning from a linear economy to a circular one, increasing inequality, COVID, balancing economic needs with societal needs. Investors, regulators, as well as consumers and employees are now increasingly demanding that companies should not only be good stewards of capital but also of natural and social capital and have the necessary governance framework in place to support this. More and more investors are incorporating ESG elements into their investment decision making process, making ESG increasingly important from the perspective of securing capital, both debt and equity. 

What falls under the Environmental Pillar? 

Emissions such as greenhouse gases and air, water and ground pollution emissions. Resources use such as whether a company uses virgin or recycled materials in its production processes and how a company ensures that from cradle to grave the maximum material in their product is cycled back into the economy rather than ending up in a landfill and its impact on climate change. Similarly, companies are expected to be good stewards of water resources. Land use concerns like deforestation and biodiversity disclosures also fall under the Environmental Pillar. Companies also report on positive sustainability impacts they might have, which may translate into long-term business advantage. From a reporting perspective this is the most complex pillar.

What falls under the Social Pillar? 

Under the Social Pillar companies report on how they manage their employee development and labor practices. They report on product liabilities regarding the safety and quality of their product. They also report on their supply chain labor and health and safety standards and controversial sourcing issues. Labor standards and privacy and data security also falls under Social tag. Where relevant companies are expected to report on how they provide access to their products and services to underprivileged social groups.

 What falls under the Governance Pillar? 

The main issues reported under the Governance Pillar are shareholders rights, board diversity, how executives are compensated and how their compensation is aligned with the company’s sustainability performance. It also includes matters of corporate behavior such as anti-competitive practices and corruption.

What is relevant from all this for your company? 

Of course, not all sectors of the economy face the same ESG issues. For example, in the case of banks, greenhouse gas emissions are not as important as they are in the case of energy. These differences in what matters to a particular sector from an ESG perspective is called materiality. Companies report on issues that are material to them. Typically, materiality is determined based on what ESG issue is considered financially material in a given industry. Financially material issues are those that can impact a company's financial performance (e.g.: unexpected surplus costs, fines, loss of brand value, loss of revenues due to consumers choosing more sustainable alternatives). Increasingly double materiality is being recognized as an important concept in choosing what is considered material by a company. Double materiality means alongside financially material issues, socially material issues are also treated as material.

Dr Sonal Desai