Why do certain investments perform better than others? Why do certain businesses consistently outperform and get ahead of the cohort? The secret lies in a crucial acronym: ESG. Whether you are an investor or a company, mastering the Environmental, Social, and Governance (ESG) framework is vital to maintaining pace with the market trends of 2024 and managing your bill.
ESG is a framework that financial institutions and investors must report on. Still, it is also on the radar of employees, regulators and everyone involved in the ecosystem. Why? This is because climate change has made us realise that we are not masters of our planet but stewards of nature. ESG is taking on an even greater significance in light of recent events: companies have the responsibility and resources to accomplish positive climate action, building a more sustainable, resilient future and "putting money where their mouth is".
It is essential to state that $90tn of investment is needed by 2030 to limit the global temperature increase to 1.5°C. Let's explore ESG and its importance for businesses in 2024.
What is Environmental, Social, and Governance (ESG)?
Environmental, Social, and Governance (ESG) is the umbrella term for sustainable and responsible finance components. It is a framework that considers environmental, social, and governance factors alongside financial factors in investment decision-making. It is also a process for assessing which companies perform/score on each factor E, S, and G while determining whether a company is a viable investment.
On the other hand, ESG reporting is the disclosure of data explaining a company's impact and added value in three areas: environment, social and corporate governance.
It’s not just 5 percent of your money you give away that matters. What you do with the other 95 per cent is almost more important.
Darren Walker - President of the Ford Foundation
What does environmental mean in ESG?
Environmental (E) assessment assesses how a company performs as a steward of nature. It analyses how its activities impact the environment and manages ecological risks. It includes both direct operations and across the supply chain. For example, resource scarcity and management, natural resources preservation, animal treatment, and greenhouse gas emissions are included.
What does social mean in ESG?
Social criteria (S) examine the strengths and weaknesses of a company's management of relationships with employees, suppliers, customers, and the communities where it operates. These criteria include working conditions, operations in conflict regions, health and safety, employee relations, and diversity.
What does governance mean in ESG?
Governance (G) deals with a company's leadership, executive pay, audits, internal controls, and shareholder rights. Investors want to know if they can trust the company and what decisions are made behind closed doors. G includes executive pay, gender equity / equal pay, bribery and corruption, and board diversity.
The importance of ESG for companies and investors
The practice of ESG investing began in the 1960s. It evolved from socially responsible investing (SRI), which excluded stocks or entire industries from investments in business operations such as tobacco, guns, or goods from conflicted regions. The term ESG was coined in 2004 by former UN Secretary-General Kofi Annan. It resulted in 2005 with the first study, "Who Cares Wins," developed jointly with the world's largest institutional investors and banks.
Now, ESG is rapidly growing and evolving as many investors look to incorporate ESG factors into the investment process. In fact, the ESG market is already set to double this year. Also, the "Portfolio Decarbonisation Coalition," a United Nations-sponsored group of 27 primarily European institutional investors and asset managers controlling $3.2 trillion in assets, has committed $600 billion to fund green projects and investments.
ESG will likely play a more significant role in how companies are assessed by investors, consumers, and stakeholders.
Nathan Bonnisseau - Co-founder at Plan A
On the legal side, European regulations push for robust implementation of ESG factors within the financial sector and other industries. The ESG framework is pushed within the EU as it is a mechanism that will support the Green Deal and ensure the implementation of a more sustainable economy. "ESG is likely to play a bigger role in how companies are assessed, not only by investors but by consumers and stakeholders", explains Nathan Bonnisseau, co-founder at Plan A. "The numbers reflect a growing awareness that companies must manage their environmental impact to remain successful. Sustainability is the new ideal, and the development of sophisticated methods of evaluating ESG activities and their effects is the key to attaining it," he adds.
To learn more about ESG reporting fundamentals, download our whitepaper.
What are the most essential ESG regulations?
Legislators, investors, and the business ecosystem are mounting pressure to implement ESG. Companies must perform well on ESG to remain attractive as employers or brands. For example, 49% of millennial millionaires invest based on social factors. Therefore, investors and companies alike must anticipate the law.
Looking at how the wind is turning around the regulatory framework in the financial sector, ESG reporting may soon be mandatory. Companies must integrate this framework to stay ahead of regulations and competition. Organisations must comply with environmental or social factors to avoid facing regulatory, legal or reputation issues.
- The European Union Sustainable Finance Disclosure Regulation (SFDR): Entered force on March 11, 2021. It imposes mandatory ESG disclosure obligations for asset managers and other financial market participants with substantive provisions.
- The EU Sustainable Finance Action Plan: The European Union's significant policy objective is to promote sustainable investment across the continent. Parts of this plan are effective from March 2021. The aim is to reorient capital flows towards sustainable investment and away from sectors contributing to climate change, such as fossil fuels.
- The European Union Taxonomy: The EU Taxonomy is arguably the most ambitious text to give a non-financial overall score covering all aspects of sustainability, from ESG to biodiversity and pollution treatment. The EU taxonomy is a classification system that establishes a list of environmentally sustainable economic activities. For investors, companies and financial institutions—the regulation defines which economic activities qualify as sustainable and evaluates their environmental performance. From January 2022, financial market participants must report how and to what extent their financial products align with the EU Taxonomy, a framework to classify environmentally sustainable economic activities.
- The Corporate Sustainability Reporting Directive (CSRD): Adopted by the European Parliament in April 2021, the CSRD expands the scope and reporting requirements of the Non-Financial Reporting Directive (NFRD). This directive mandates that large companies and listed SMEs report detailed ESG data. It introduces more rigorous reporting standards and requires independent auditing to ensure the reliability of the reported information. The CSRD aims to improve and standardise sustainability reporting across the EU, enhancing transparency and comparability for investors.
- The ISSB reporting guidelines: The International Sustainability Standards Board (ISSB) aims to establish a comprehensive global baseline of sustainability disclosures for the capital markets. The ISSB standards, which align with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, focus on providing investors with high-quality, globally comparable sustainability information. These guidelines are designed to enhance the consistency and comparability of ESG reporting on an international scale, supporting informed investment decisions.
- The UK's streamlined energy and carbon reporting (SECR): Introduced in 2019, SECR requires large UK companies to report on their energy use and carbon emissions. The goal is to increase awareness of energy costs and encourage the implementation of energy efficiency measures. This regulation complements other UK initiatives to achieve net-zero carbon emissions by 2050.
- Japan's corporate governance code: Revised in 2021, the code now includes guidance on ESG factors. It urges companies to address sustainability issues, particularly climate change, in their corporate governance and disclosure practices. This reflects Japan's commitment to promoting sustainable growth and long-term value creation.
By understanding and adhering to these regulations, companies can ensure compliance and build trust with stakeholders, improve their sustainability performance, and gain a competitive edge in the evolving global market.
How does ESG create value?
Since 2019, European investors poured €120 billion into sustainable investment options, demonstrating something interesting: VCs and investors are increasingly interested in how startups score on their ESG policies and practices. There are many scenarios from which the pressure to implement ESG in your company comes. For example, suppose you are a company founder looking actively for funding - you will have better chances to convince investors if your company has already implemented ESG policies and performs well on these factors.
On the one hand, it has been demonstrated that companies performing on ESG practices have higher financial growth and optimisation, lower volatility, higher employee productivity, reduced regulatory and legal interventions (fines and sanctions), top-line growth, and cost reductions.
On the other hand, companies that performed poorly on ESG noticed a higher cost of capital and higher volatility due to controversies and other incidences such as labour strikes, fraud accounting, and other governance irregularities. So, if you want to be included, you can jump on this train instead.
Why is ESG inevitable?
There is increasing awareness that ESG may soon become compulsory. Companies must integrate this framework at the core of their DNA to stay ahead of regulations and competition and unleash all its benefits. In another perspective, organisations that fail to comply with environmental or social factors may struggle to deal with regulatory, legal, or reputation issues later.
The best course of action for your business is to adopt a methodology that reflects sustainability and ESG. Starting sooner allows companies to become more diversified, more concerned with their employees' welfare, and positively impact communities and the environment. Plan A offers ESG reporting software, helping companies reduce carbon emissions.
Start your ESG reporting journey with Plan A. Book a demo now.
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