Environmental, Social and Governance (ESG) criteria are a collection of corporate standards that socially aware investors use to monitor potential investments. Environmental criteria examine how a company manages its impact; social criteria define how it manages relationships with employees, customers, suppliers and its community; and governance encompasses executive leadership, payment practices, rules, procedures and shareholder rights.
To evaluate a company based on ESG, potential investors consider a range of factors to determine if the company’s values match their own. No single company will meet every standard, of course, so investors must decide which criteria are the most important to them and set priorities.
How Can a Business Be Environmentally, Socially and Structurally Aware?
Businesses can incorporate environmentally sustainable practices by contributing to, or taking advantage of, sustainable initiatives. Encouraging employees to recycle and using LED light bulbs are a few quick changes that companies can make.
Social sustainability describes a company’s relationship with employees and engagement with shareholders. The impact of companies on employees, suppliers and the local community falls under the social sustainability lens. Companies can contribute by improving the lives of the people they affect, making social investments and promoting positive public policies, and partnering with other local businesses to form a united social front.
Impacts on sustainability arise from the way a business structures its leadership team, sets goals and assesses performance. Sustainability structures that line up with the existing business model tend to be more successful than retooling it to match a competing structure.
ESG Trends in 2021
The pandemic has heightened the importance of sustainability. More and more companies are seeking to incorporate sustainability standards and navigate potential and existing investor requirements. Three trends in 2021 will be key:
- Synchronization of sustainability reporting. Typically, companies and investors have had to navigate a variety of reporting contexts. To streamline, standard setters have been working to synchronize ESG disclosure requirements to ensure accurate and consistent reporting.
- Increased emphasis on social criteria. Usually, the E in ESG takes center stage, but in 2021 businesses will focus more on the social benefits that companies provide. With organizations emphasizing an environmentally aware recovery post-COVID-19, there is a focus on social opportunities that businesses can develop.
- Growing focus of high-yield companies on sustainable finance. Typically, high-yield companies did not prioritize ESG criteria or related issues. Now they are beginning to focus on sustainability-linked debt, launch ESG funds and embed ESG ratings into transactions.
Risks and Benefits of Following ESG Criteria
In the past, socially responsible investors limited the number of companies they engaged with. A company’s good performance in the stock market is not enough by itself; generating measurable social and environmental impact is important to these investors, too. By using ESG standards to choose, investors can avoid companies whose practices could trigger a social or environmental debacle.
Even though ESG criteria are yet to be standardized, they are becoming become more common, and investors are keeping track of performance. With the threat of climate change, water scarcity, the proliferation of electric vehicles and the development of reusable plastics, ESG investing appears to offer a viable way forward.
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Forbes: 3 Ways to Make Sustainability a Part of Your Business
NatWest: ESG Trends: What Corporates Should Look Out for in 2021