The Importance Of ESG - Environmental Social and Governance

William Huston, CCO, AIF®
by in Published on June 26, 2021

The Importance Of ESG - Environmental Social and Governance

ESG Investing

ESG stands for Environmental, Social, and Governance. These three factors are key in measuring sustainability when it comes to ESG investing. Investors usually pay a lot of attention to the ESG considerations put in place. This is because they play a critical role when it comes to projecting the future financial performance of a company, long-term decision making on the investors' side, as well as risk analysis and risk management principles and practices.

The ESG concept was derived from the ‘PPP - People, Planet & profits’ concept in the 1990s to guide the area of impact investing. The argument was that companies and businesses should not only focus on profits and financial gain but also on the other P’s - People & Planet as these two factors were equally as important for any business, company, or commercial enterprise to be sustainable. The PPP is what evolved to what is today known as ESG which forms the basis of sustainable and socially responsible investing. The three main ESG criteria; environmental, social, and governance also form a basis for non-financial KPIs which in turn guide investors when it comes to sustainable investing. These factors are key when it comes to ESG investing as they give different companies a sense of responsibility towards the environment by being mindful and cognizant of how their activities can contribute positively or negatively to issues like climate change, pollution, carbon footprint, etc. The same goes for the environmental social and corporate governance aspect when it comes to issues like diversity, health and safety, employee performance, executive compensation, corruption & bribery, and board of directors diversity.

ESG - Environmental Social and Governance

ESG Investing

The below are the three main ESG criteria:

Environmental - The environmental aspect examines how a business contributes and works toward addressing environmental issues like waste management, pollution, climate change, deforestation, etc. This is a key factor that is considered when it comes to sustainable investing.

Social - The socially responsible aspect deals with how a company/enterprise treats & interacts with its employees/people. E.g. diversity, equal opportunities, health & safety, etc.

Governance - The governance aspect deals with how a company is governed. E.g. Tax strategies, executive compensation, corruption & bribery, board of directors diversity & structure, etc.

Importance of ESG - Environmental, Social and Governance

Over the recent past, there has been quite some emphasis on ESG investing. You may ask yourself why. Here are some reasons why all companies should have a proper ESG framework in place.

Environmental Companies that create environmental risks or hazards, be it on water, air, land, or human health can eventually lead to the rise in operational costs and stand a lower chance when it comes to getting investors. This is because, such companies are more likely to experience wastage when it comes to energy consumption, regulatory issues with the relevant bodies as well as reputational risk. Incorporation of a strong ESG framework would help with mitigating such costly risks by lowering operational costs through efficient use of energy and compliance when it comes to the regulations laid out to avoid reputational risks.

Social Socially responsible companies tend to have higher employee retention. and therefore, investors may lean more towards working with such a company as opposed to one that has no ESG framework in place. A company that puts into consideration their employees' health & safety first and also regards aspects like diversity and human rights, is more likely to have a higher retention rate, increased productivity and morale, and also employee loyalty as compared to a company that disregards these aspects.

Governance

Governance or corporate governance mainly deals with how a company is run and managed by its leaders and stakeholders. This aspect helps to reduce the risk of excess executive compensation, diversity within the company or organization, board accountability to its members as well as stakeholders' rights and responsibilities. With good governance comes efficient internal processes, better allocation, and management of resources as well as improved relations among the different company stakeholders.

Overall, a proper ESG framework promotes the all-round growth of a company, eases the potential investment process, and helps to mitigate future risks in line with ESG compliance.

Impact of Covid 19 on ESG Investing

ESG Investing

COVID-19 is a crisis that has hit the entire world economically, socially & healthwise. It has caused a lot of disruption globally and shifted things around. However, organizations with strong ESG investing programs and policies may help to mitigate the impact of the pandemic to help people navigate their “new normal”.

Organizations that have invested in proper and well-functioning ESG investing programs can stay afloat at this time as they have the ability to mobilize their task force/employees and or new resources. In these uncertain times, a company culture built on trust, commitment, and proper communication keeps the morale of the employees up and thus they stay motivated and productive with very minimal supervision.

When it comes to the governance aspect, the emergence of COVID-19 brought to light the importance of business aspects like flexibility in working, business continuity planning, disaster preparedness as well as sustainability in business.

Some companies that have demonstrated concern towards society by being solution-oriented include; Apple & Tesla who have directed their resources to increase accessibility and production to critical medical supplies. Distilleries such as Pernod Ricard and Bacardi have redirected their efforts towards producing hand sanitizer which is a much-needed commodity at this time. When companies/organizations take initiative in being part of a solution and add value to their societies by extending goodwill to the community around them, there is more trust in the leadership style. This in turn helps to create a trusting & mutually beneficial relationship between the organization and the community at large. It also makes the company be an attractive entity to investors for future partnerships.

Now that it has been established that COVID-19 has caused a lot of disruption all around, here are some steps that organizations that don’t have proper ESG investing frameworks can consider taking into account:

Engaging and Protecting The Social Aspect In Your Organization

Socially Responsible Investing

Human capital is among the most important resources in any company or organization. The company culture, trust, and transparency now matter more than ever in any organization as these are the aspects that are keeping human capital motivated and goal-oriented even as people continue to work remotely or from home. Good company culture will keep employees and other members of the company focused on the goals at hand as well as make them solution-oriented to the challenges that come up in the workplace. Also, concern for employees at the workplace is very critical with the new measures set in place for co-existence in public spaces. Organizations that put their employees' health first by implementing health and safety measures are more likely to attract investors as ESG compliance is an important factor that’s put into consideration.

Communication With Stakeholders

Stakeholders are among the key human resource in any organization. With the emergence of COVID-19, organizations must generate a communication plan with their stakeholders to inform them of how they are addressing the crisis as well as reiterate their commitment to the pre-existing values, especially during this hard time.

Opposing Views to ESG Investing

The importance of ESG investing in any company is invaluable as it caters to the three core aspects. However, some companies - especially SMEs might find themselves on the other side of the spectrum due to factors like high employee turnover, limited resources, etc. Lack of proper organizational structures might also limit the effectiveness of ESG investing implementation in an organization because, for smaller organizations, the priority would be in the setting up and running the business for sustainability.

The Importance Of ESG - Environmental Social and Governance - Summary

Incorporation of a functional ESG investing framework in an organization is not only vital, but it also helps in maintaining clarity when it comes to an organization’s goals and overall vision, as well as the well-being of the human resource. It helps to cater to the needs of all stakeholders by ensuring that all the important needs are met and all-important guidelines are adhered to.

ESG References

https://www.cfainstitute.org/en/research/esg-investing

https://www.esg.adec-innovations.com/about-us/faqs/what-is-esg/

https://www.ey.com/en_us/assurance/why-sustainability-and-esg-are-now-more-important-than-ever#:~:text=over%20the%20future.-,When%20possible%2C%20it%20is%20important%20to%20balance%20responding%20to%20the,and%20long%20term%20value%20creation.

https://learningcenter.sourceintelligence.com/esg-frameworks

https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/five-ways-that-esg-creates-value#

Bay Street Capital is a signatory for the United Nations Principles of Responsible Investing. We invest with high conviction, through the lens of history, in organizations we believe will outperform. We cover clean energy, economic empowerment, and education technology. We write about, ESG Investments, Socially Responsible Investing, Sustainable Investing, ESG Factors, ESG Ratings, ESG Issues, ESG Data, MSCI ESG Investment, Political Contributions, ethical investment decision making, ethical portfolio allocation, and market research concerns across the industry related to recent years ESG mutual funds, Impact investing, and conflicts of interest.

William Huston founded Bay Street after 13 years of supporting the United States' largest retirement plan ($650B) Thrift Savings Plan. He is recognized as Investopedia’s Top 100 Financial Advisors for 2021. In California, only two black-owned firms out of nineteen firms received this recognition. In Scottsdale Arizona, Ekenna Anya-Gafu CFP, AAMS is recognized among the Best Financial Advisors for his responsiveness, friendliness, helpfulness, and detail. Bay Street was founded to advocate for diverse and emerging fund managers and entrepreneurs. In 2021, Bay Street was selected as a finalist out of over 900 firms across the US in the category of Asset Manager for Corporate Social Responsibility (CSR).

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