A deep dive into the development of ESG

Dec 23, 2022

Share

Copy Url

ESG refers to conducting business ethically with a strong weightage on the Environmental, Social and Governance (ESG) aspects. As ESG principles increasingly gain importance for stakeholders all over the world, the need for companies to embrace them is intensifying. This blog looks at the history of ESG, ESG reporting, ESG rating, and greenwashing while exploring some industrial examples.

Responsible investing

ESG has been around since the 19th century when the concept of “no-sin investments” or no investments in stocks involving slavery, gambling, weapons, alcohol, etc. came about. Over the years, ESG has advanced into a framework that outlines the risks and opportunities encircling the reporting company and provides acute insights to its stakeholders.

Although constant evolution in technology and innovation help us progress toward an improved world, it also enhances the risks for less-agile organizations. For example, as the risk of cyber security increases, companies that take no action to prevent it could suffer technology and reputation loss, which could be potentially disadvantageous for its stakeholders. This is why companies with a strong ESG foundation are believed to be safer investments as they are better prepared for the future.

ESG reporting

Although at present, it is not legally mandated for companies to report their ESG performance, many companies, being cognisant of its importance, are taking it up on a voluntary basis. ESG reporting not only helps companies attract investments but is also essential in identifying a business’s resilience when exposed to environmental and social risks and measuring the impact of its activities on the rest of the world. In fact, several corporations ensure that their vendors and supply chain partners also conform to ESG norms. Thus, companies adopting this kind of reporting voluntarily are on a rise.

So what is ESG?

Environmental, Social, and Governance encompass:

Environment

This looks at analyzing a company’s impact on the environment from a negative and positive standpoint. It includes factors such as climate change, biodiversity, natural resources, pollution, and waste. The resources that a company consumed, and emitted and their consequences are all investigated to illustrate the company’s environmental footprint.

For instance, as per Britannica, in 2010, BP plc (a leading corporation in the UK at the time) released approximately 4.9 million barrels of oil into the Deepwater Horizon. This is considered one of the worst oil spills in history as it had a catastrophic effect on the local wildlife ecosystems. Not only did BP lose 55% of its shareholder value, but the compensation it had to pay out amounted to $18.7 billion.

Social

The social element of ESG encompasses all people-related aspects and includes company cultures, engagement activities, and points of concern of all stakeholders. It accounts for factors such as human rights, human capital development, health and safety, and child labor.

For example, as per CBS news, in 2018, it was alleged that Facebook had deliberately leaked the data of around 87 million users to Cambridge Analytica - a British political consulting firm. This firm then undertook targeted campaigns, which are said to have helped Donald Trump win. This scandal dropped Facebook’s share price by almost 19%.

Governance

The governance section looks at the internal workings of the company and includes the composition of the board structure, business ethics, compliance, corruption, and executive pay.

As per the Times of India, Yes Bank suffered a 23% fall in its share prices when its promoter Rana Kapoor was convicted in a case of money laundering. This fall in price, triggered additional sales which further reduced the bank’s share price, all of which boils down to poor governance.

Analyzing ESG metrics is crucial as it helps investors gain a holistic view of the companies they are planning to invest in. This method of investing is known as ESG investing and is believed to prevent risky and loss-making investments. ESG investments are usually done on the basis of ESG scores given by rating agencies that specialize in this, after a thorough analysis of the company.

ESG ratings

ESG ratings are similar to credit ratings and they help investors understand the different business risks a company faces. They account for three different aspects: corporate governance, material ESG issues, and other distinctive matters specific to that company.

The most popular rating agency currently is MSCI. MSCI has been rating businesses for over two decades now and they acquired different companies to develop their rating abilities. They identify industry leaders and laggards based on their pre-defined methodologies. They give ratings on a scale of ‘AAA-CCC’ (with AAA being the highest and CCC being the lowest) basis a company’s exposure to risk, its level of mitigation, and corporate management. For example, as per the ESG investor, Microsoft Corporation has a AAA ESG rating and Volkswagen has an ESG rating of B, as of 2021.

Other ESG rating agencies include the Bloomberg ESG disclosure scores, FTSE Russell’s ESG ratings, and the Institutional Shareholder Services Ratings. While investors can refer to the ratings available, it is always recommended that they also carry out their own due diligence and proceed with caution. This is because some companies have started over-emphasizing their triple bottom line and overshadowing their environmentally damaging activities.

The triple bottom line and greenwashing

The triple bottom line is an accounting framework that was coined in 1994 by the business writer Jon Elkington. The concept states that while most companies tend to make profits their central focus, accounting for the people and planet matters just as much. This means that a company’s social and environmental performance should complement its financial performance to present a holistic picture to all its stakeholders. Some large corporations are adopting the ESG framework and transparently illustrating their practices to gain stakeholder trust.

For example, Lego has committed to working towards 100% renewable energy by 2030 and pairing up with NGOs like the Worldwide Wildlife Fund to contribute to the planet. When a company shows it cares about doing the right thing, through its triple bottom line, it eventually enhances its goodwill, which adds to its sustainability.

However, some companies portray a false impression or report inaccurate information which ends up deceiving their stakeholders. This is done to capitalize on the growing demand for ESG-compliant companies. For example, as per CNN, McDonald’s launched a campaign to replace its plastic straws with recyclable paper. Although these straws were introduced in 1,361 restaurants, it was later found out that these paper straws were too thick to be recycled and McDonald’s entire purpose of protecting the environment, was defeated.

These practices have come a long way from when they began but they are yet to completely evolve. Experts believe that it is only a matter of time till the information companies report in this regard become heavily regulated and ESG reporting becomes a mandatory exercise.

Expected developments

As per industry experts, here are some developments bound to occur in this segment:

1. Greenhouse gas emissions, employee satisfaction, and board diversity are some ESG metrics that companies need to quantify. As of now, there is no standard method used to measure or report ESG factors, but going forward, it is expected these measurement methodologies and units will all be harmonized.
2. The Securities Exchange Commission (SEC) has proposed a mandated reporting requirement that requires all companies to disclose their greenhouse gas emissions and environmental impact. We can thereby soon expect companies to prepare audited climate-related financial statements.
3. ESG ratings are expected to further develop and consider only regulated information.
4. Companies developing ESG guidelines are expected to collaborate and come together to put a uniform reporting ESG framework in place.

The paradigm shift toward ESG-centric strategies seems to be inevitable for companies in all industries. Its adoption is thereby recommended sooner rather than later to prevent being left behind.

If you are planning on publishing a report that effectively captures your ESG activities, you would need a specialized team to help you do so. Report Yak is a business reporting design agency that conceptualizes, creates content, and designs sustainability reports, CSR reports, ESG reports, annual reports, integrated reports, and impact reports for corporations.

Feel free to check out our award-winning work or get in touch and we’d be happy to discuss your next report.