ESG considers the impacts of corporations on the environment, human well-being, but at the same time it considers how the corporate governance is managed. With growing concerns about climate change and various social factors that pose a threat to business organisations and the entire population at large, ESG is believed to mitigate the negative impacts of corporations as it promotes a “sustainable” behaviour to the issues mentioned above. The underlying thought behind ESG in context of investments is that the environmental, social and corporate governance factors directly affect the performance of business organisations.
Imagine a world where a company doesn’t get a loan to finance a project, because they are not green enough. The European Union is implementing different instruments, starting in the financial industry, to provide incentives to become a “sustainable” company and to invest in green technology. Additionally, suppliers and partners will also have an impact on the companies on ESG performance. But the main driver for a change are the consumers which can increase the pressure on the market. E. g. FairTrade products, which certifies fair payments for farmers, increased the revenue from 340 million Euro to approx. 2 billion Euro in the last decade.
Now, let’s take a closer look on how to interpret ESG.
What is ESG and what each ESG factor signifies?
Environmental, social, and corporate governance, or ESG investing in short, is the term used for the type of investment that prioritises ideal ESG outcomes. It is also known as “impact investing” or “sustainable investing”, but it is not only about to provide investors on the market a measured value to explain how sustainable a company operates. It also helps to get an inside-in view, which means, that companies trying to better understand themselves and where are the biggest issues in context of ESG. There should be an intrinsic motivation to become a better company and measuring the ESG performance should promote that. Otherwise, corporates are running always behind the next regulations instead of making a difference.
Environmental Factor
The environmental aspect looks at the corporates values regarding climate change and the environment. This criterion might involve the company’s energy consumption methods, how it treats animals, and how it manages the waste and pollution it produces. Does it share the same values as the investors as far as the environment-related issues are concerned? In short, it examines whether the company is environmentally friendly or not.
Social Factor
The social aspect evaluates the company based on its relations with its employees, suppliers, and consumers. Does the supply chain used by the company factor in the values that the company and its shareholders adopt? Is the company involved in the betterment of the community it is operating? In short, how the company works as a society is the primary concern of this criteria.
Governance Facotr
The corporate governance aspect is an ESG criterion that deals with the company’s leadership. How strong is the company’s leadership? Is it worth investing in a company whose leadership is not operating very well? Is the company involved in transparent accounting methods?
The governance aspect deals with how the company is governed by its leadership and its board members. The investors might need assurances that there is no conflict of interest between the leadership and the board members and that the company is not involved in any illegal practices.
Not every company will pass every criterion; therefore, the market have to prioritise what aspect of ESG criteria is most important to them.
Current Challenges
Although ESG has seen a boom after COP21/COP26 and after the European Commission polished their first drafts towards a more regulated economy, it is projected to grow even further in the next two decades, because of more upcoming regulations.
It might have some potential risk for all parties. One of the main risks of the ESG criteria is that there are no standards currently available how to measure a company’s ESG performance – the European Commission only provided a definition of what green activities are to avoid any greenwashing, but not how to evaluate the ESG performance overall. This might lead to different outcomes and a challenge for investors, partners and consumers to choose the right company. But also for corporates who are evaluated can be affected by a missing standard procedure to evaluate the ESG performance. If a car manufacturer was involved in the diesel gate, for how long are they punished with a low ESG rating? Even if they are ahead of all other companies to become sustainable?
Another aspect is, it might limit the number of companies you want to work with or invest in. Some companies that rank poorly in ESG criteria might be performing well, and this requires a trade-off on the investor’s site. Profit over sustainability or sustainability over profit? We will discuss this topic in a separate article in more depth.
A tremendous amount of effort and planning is required to overcome these challenges to achieve a European or global standard for measuring and reporting with ESG factors. At the same time, it’s a lot of bureaucracy for companies and uncertainty gives opportunities for consulting companies to guide through that time.
A more technical topic to overcome is how to get the data for an internal or external assessment. For large enterprises, which are listed on the stock market, you will find in best case a sustainability report for investors and in worst case only the typical investor relation information. But, you have something at least. What are we doing in case of small and medium size companies?
The last challenge which I want to highlight is to implement an ESG analysis solution. Different startups are claiming for themselves, that they are the only once who can help you to become carbon neutral. Or, that they found a magic trick. From my perspective, The new solutions are way behind the capabilities of BI platforms. Why should we compare BI tools with startups who are addressing the ESG topics? Because if we are talking about making a decision, we will need data. And if we need data, we are following the same procedures like in all other BI projects. Gathering data, storing it and finally analysing the current situation. This is a simplified explanation of the approach, but if there are tools already out there which helps to overcome your challenge to become more sustainable, why should you count on a solution developed by a startup? Currently, I don’t see any USP by those solutions.
Regulatory Changes
There has been a long effort to have the terms “environmental,” “social,” and “governance” defined in a way that is acceptable to everyone and serves as a global standard. To achieve this, the regulations and compliance requirements need to be updated frequently. A business does not become “sustainable” just by naming it so. There has to be a standard to gauge if the company in question is actually “sustainable” or “green” and not just pretending to be following environment-friendly practices. Therefore, the European Commission has come up with a strict set of requirements to ensure that companies comply with ESG requirements rather than being pretentious about it.
The different regions in the world are trying to implement the agreement from COP21 and the new one from COP26. Because of the complexity, we will discuss this topic in a separate article.
Getting Data
The importance of ESG analysis has been growing and the data is already there, the companies need to find a way to collect and aggregate them. The advantage of ESG related data over other data, it doesn’t change frequently. If you know how much carbon dioxide your machine or office produces, you have a rough idea of your carbon footprint and you can set your goals already. However, this cannot be achieved without accurate and reliable data.
There are solutions to automate the process of fetching data from an invoice to fill up your database. Or if you have an ERP (Enterprise Resource Planning) system, you can connect to it to get the amount of products which you have produced. Those are just two examples how data can be connected to achieve a ESG analytics platform. However, there are solutions to automate the process to ingest data into a ESG database, which you can use to steer your sustainability strategy.
Conclusion
With a looming potential climate change and a dismal state of human rights created by the conventional practices in the corporate world, we must look for more sustainable alternatives. One of the key steps to creating a sustainable corporate structure is complying with the ESG factors.
The main stake in accelerating a more sustainable economy is hold by the society. A shift of the consumer preferences forces the economy to change their business model, supply chain and more.
And, you don’t need to invest in new tools to overcome you very own challenges, you can use existing BI tools like Tableau to understand the status quo, to set realistic goals and a strategy to reach those goals. In the meantime until new technologies are available to operate completely carbon neutral, you are able to purchase a compensation, which is called carbon offsetting.
Sources:
Revenue growth – FairTarde: https://de.statista.com/statistik/daten/studie/226517/umfrage/fairtrade-umsatz-in-deutschland/