The Covid-19 pandemic, supply chain disruptions, the Russia-Ukraine war, climate change issues, and global warming have reinforced the significance of environmental, social, and governance-related issues for investors and companies.
Investors believe businesses with efficient ESG performance are less risky, stand out from the competition, are better prepared for uncertain situations, and achieve long-term growth
The significance of environmental, social, and governance aspects for companies in various industries has grown in the last couple of years, primarily due to the Covid-19 pandemic. It has become a critical area of focus for stakeholders and investors as they believe environmental, social, and governance (ESG) issues present various challenges.
The focus on ESG has transformed how investors perform their activities and the companies they hold in their portfolios. It has also changed the business models and mechanisms companies previously used, emphasizing value creation through sustainability.
Investors who consider ESG factors gain a more holistic view of businesses, including small-medium enterprises and large corporations they support. The purpose is to reduce risks and identify growth opportunities, improving overall efficiency and businesses’ bottom line.
In addition, investors take a keen interest in environmental, social, and governance-related issues. According to Harvard, investors and businesses manage over $330 billion in ESG funds, which will increase in the future. Today’s article will discuss the most common questions investors ask regarding ESG before investing in a company. Read on!
ESG Questions that Investors ask:
How can I have a consolidated view of my portfolio companies’ ESG performance?
Stakeholders, investors, and businesses use the ESG factors in the public market portfolios. Investors use different ways when considering and analyzing ESG factors. For instance, investors and managers use ESG factors as integrated components of their strategy for investing.
Most investors speculate that companies with efficient ESG programs and practices and reliable financial characteristics are an excellent way to perform risk management. For example, an investor with a passive portfolio considers ESG factors to align a portfolio with their values.
These investors focus on specific qualities and factors, such as companies with optimal human rights strategies. Likewise, investors may de-emphasize specific characteristics, such as businesses with reduced carbon footprint or emissions.
On the other hand, active managers focus on financial aspects when integrating ESG factors into their investment strategies. Unlike active managers or investors, passive investors consider financially immaterial methods to incorporate environmental, social, and governance-related factors.
We recommend identifying critical characteristics, qualities, factors, or metrics to have a consolidated view of companies’ ESG performance in your portfolio. Besides, you must analyze real-time data using cutting-edge tools with good ESG scores to determine whether companies in your portfolio perform better.
How Can I Reduce My ESG-Related Risk Exposure?
Investors care about environmental, social, and governance factors in their investment strategy to reduce risks. Investors have numerous reasons to focus on ESG. We can classify these reasons into several categories, including financial, competitive, strategic, and perception.
Generally, investors consider ESG-based investment more reliable, stable, and safer. For example, climate change and global warming are the most significant risks critical to ESG. Climate change has affected numerous organizations and taken a massive toll on their financial sustainability due to infrastructure and property losses.
As an investor, you must examine an organization’s preparation assessment and strategy to forecast, analyze, and respond to different climate-related threats. Remember, this becomes crucial when you assess a company’s ESG profile.
The purpose is to reduce risks and streamline the overall process. In addition, you must analyze the social factors, such as employee treatment, labor violations, or boycotts to product recalls. Remember that these are diverse and qualitative problems and usually impact your investment.
Besides, these issues can impact all company stakeholders simultaneously. For instance, these problems can affect customers, workers, suppliers, and local communities. As a result, you will have a disrupted and unstable portfolio.
Therefore, we recommend maintaining healthy, fair, positive, and ethical relationships with all stakeholders to streamline your portfolio. It would help if you also focused on the governance factors to reduce risks. Governance risks may include:
Company integrity and ethics
ESG regulation compliance
Anticompetitive activities and practices
Board structure and diversity
Corruption and fraud prevention
Bribery and corruption
Policies and standards
So, as an investor, you must analyze and understand the compliance and regulations related to the industry. At the same time, you must understand these factors relevant to the industry in which companies in your portfolio operate.
We suggest considering the role of the board of directors regarding sustainability risk management, policy formation, and checking internal controls. A critical issue in the ESG investment is scant regulations that govern ESG measures, and risks businesses must disclose. Sometimes, these measures and risks are inconsistent due to ineffective ESG communications.
You can leverage real-time, factual, reliable, and consistent data to track progress, generate valuable insights, and use critical information to perform peer comparisons and reduce exposure risks.
Moreover, you can use financial data, artificial intelligence, predictive modeling, and industry benchmarking to capture structured and unstructured data. You must communicate critical information to companies in your portfolio and encourage them to report on ESG performance improvements.
How Can I Influence ESG Performance Improvements?
Companies that focus on environmental, social, and governance factors have state-of-the-art sustainability strategies, leading to operational efficiency, lower employee turnover, cost savings, retained talent, improved risk management, and reduce compliance costs.
So, if companies in your portfolio have strong ESG-based plans of action, it will automatically increase shareholder value. Forbes Magazine reports that ESG investing is critical for companies, and investors usually invest in businesses that receive higher ratings in environmental, social, and governance-related factors.
Third-party companies and research groups assess these ratings. As an investor, you must rely on the ESG ratings to gain clarity about the companies’ performance in your portfolio. It ensures those companies manage a wide range of risks and streamline operational performance.
Besides, you must ensure those companies engage in ethical, social, and sustainable practices. So, considering ESG factors can give you a more holistic view of a business’s performance and allow you to make informed and data-driven investment decisions.
You can use various strategies to engage corporate management and communicate your views on ESG risks to companies’ policymakers. These essential strategies include:
Public policy engagement
What are Industry Best Practices on ESG?
Identifying and reducing risks do not entirely depend on risk management. ESG risk topics are essential, and companies must integrate them into their enterprise risk management. At the same time, integrating ESG risk topics into all relevant operational processes is critical to optimizing the overall policy or program.
Some industries, such as the power and utilities sector, experience challenges regarding transitioning their business model into a more environmentally-friendly and green energy-related power supplier. So, what are the outcomes or consequences for businesses that fail to meet ESG expectations?
The quick answer is that companies can experience severe and far-reaching consequences when they fail to meet their ESG commitments. For example, climate change is an essential subject that cuts across all stakeholders and company employees.
Employees focus on and engage more with ESG and want to know whether their employer contributes to the environment. Similarly, most institutional investors, including pension funds and fund managers, push for more actions from the board of directors to protect the environment.
Moreover, mitigating reputational risk holds a lot of importance. For example, if a business fails to stay committed to ESG or attempts to greenwash its credentials, it experiences a plummeted reputation.
Remember, disclosing irrelevant and misleading messages about global warming and climate change can severely affect a company and lead to liabilities. The London School of Economics reported over 1,800 climate change cases with litigation in forty countries during the Covid-19 pandemic.
The report highlights 1,387 cases in the United States, 115 in Australia, 73 in the United Kingdom, and 58 in Europe. The implications are substantial because these numbers grow steadily. Therefore, companies need a solid commitment to ESG at the board and management levels.
At the same time, companies must set SMART goals and targets from the top down. For instance, when implementing your ESG board, you can ensure all stakeholders and groups commit to sustainability and ESG-related factors.
Moreover, the board of directors must acquire experience and skills to fully understand the external requirements for a long-term and successful ESG strategy. Boardroom agendas must consider ESG-related matters as a regular fixture and embed its protocols throughout the organization.
Which Reporting Framework / Standard Should I Use to Ensure Adequate Disclosure Based on Current and Future Regulations?
Although there is no mandatory ESG disclosure in the United States, especially at the federal level, the market influences the ESG requirements. Simply put, laws and regulations do not enforce ESG requirements in the United States. The good news is that the U.S. will experience a change in this regulatory environment soon.
The Biden administration has already issued an executive order that requires the government and relevant authorities to drive the assessment, disclosure, and mitigation of global warming and climate-related risks in all sectors of the country’s economy.
On the other hand, requirements have become stricter in Europe and other countries regarding the disclosure of ESG-related information. For instance, Europe has a clear policy on funding businesses based on ESG and non-ESG criteria.
It requires companies to disclose their ESG-related policies, programs, performance data, practices, and information related to sustainability. Here are the most popular disclosure frameworks.
Carbon Disclosure Project (CDP)
The carbon disclosure project or CDP requires companies to disclose their non-financial data, including greenhouse gas emissions, carbon footprint, and environmental performance.
The framework also focuses on forest health and preservation, water security, and a company’s carbon footprint. It uses industry peers as a benchmark and scores or ranks companies publicly.
Dow Jones Sustainability Indices (DJSI)
The DJSI is another essential, effective, and widely used disclosure framework. Its building-specific framework involves subscription-based surveys of building-related ESG information, data, assets, and other publicly available portfolios.
Global Real Estate Industry Benchmark (GRESB)
The global real estate industry benchmark, also known as GRESB, is a disclosure framework used for buildings. It requires companies to voluntarily disclose building-related data based on environmental, social, and governance standards/protocols. Besides, the results of ESG disclosures are publicly available.
Why is ESG Important for Investors?
ESG has become an integral part of investors’ strategy when funding companies. Investors want to ensure companies they invest in focus on ethical, sustainable, and environmentally-conscious business practices.
Besides, ESG data gives investors a clearer picture of a company’s operational performance. The information allows investors to make informed decisions and reduce investment risks.
ESG investing requires specific environmental, social, and governance factors because they impact a business’s overall performance. Considering ESG factors allow investors to have complete and holistic information about companies they back and support. The purpose is to reduce risks and identify growth opportunities.
Investors want to know the kind of impact companies have on the environment. It includes a company’s greenhouse gas emissions, toxic chemicals, and carbon footprint involved in manufacturing. At the same time, investors want to know the impact of sustainability efforts in the supply chain.
Investors are keen to know about a company’s impact on society, including social impact within the organization and in the broader community. Examples of this are LGBTQ+ equality, racial diversity, ethnic diversity, etc., in executive and staff, recruitment programs, and inclusion policies.
Investors focus on a company’s governance practices and understand the management and board activities that drive positive organizational change. Governance includes various factors, such as problems regarding executive pay, diversity in leadership, and the response of leaders/board members to shareholders’ concerns.
What Do Investors Look For ESG?
The ESG risk of an investment may have a substantial effect on the company’s performance and value. As an investor, you must evaluate these risks before investing your capital.
ESG risks usually arise from different sources, such as political changes, social issues, governance problems, and environmental regulations. These risks can significantly affect a company’s reputation, operations, and financial position.
Therefore, as an investor, you must understand the potential risks, complications, and opportunities associated with investments and make evidence-based decisions to streamline the process. The purpose is to allocate your capital to an ESG-responsible and eco-conscious company.
It is an excellent way to protect your investment value and ensure companies align their values with ESG goals. So, it would help to consider various factors when evaluating risks and the material impact. These include:
Likelihood of Adverse Events
It requires you to estimate the probability of an adverse event, such as regulatory change impacting a company’s performance. At the same time, it involves measuring the likelihood of environment-related events, such as natural disasters, earthquakes, hurricanes, etc.
Impact of Specific Events
It requires you to identify and analyze the impact of specific events on a business’s operational performance. For example, you must evaluate a company’s business model and check whether it aligns with the ESG requirements. You can look for a company’s strategy regarding a carbon tax and compliance with new laws and regulations related to climate change.
Shareholder Communication and Engagement
Another critical factor to look for in ESG is shareholder communication and engagement. It requires you to review how well a company interacts and engages with communities, employees, and customers.
It would be best if you also evaluated whether a company understands its perception of risk and the impact of ESG risks on its brand reputation and operational performance.
Which ESG Factor is most Important to Investors?
Whether small or large business, and irrespective of its operations and industry, it serves multiple stakeholders, including investors and shareholders, customers and the community, upper management and executives, employees and staff, financial lenders, government agencies, and suppliers and business partners.
Governance is one of the most significant factors investors consider when discussing ESG. Corporation governance that follows the standards and protocols ensures trust among investors, allowing companies to gain access to substantial funding and improve their operations.
Investors believe the governance factor is the most critical element when evaluating ESG performance. In fact, there is a solid correlation between ESG performance and risk management at a corporate level.
Governance ensures a company’s operations are transparent, ethical, reliable, and accountable. So, as an investor, you must consider the governance factor of a company to learn about the long-term value a company can produce.
What are the 3 Pillars of ESG?
Successful companies focus on people, processes, and products. These are three core essentials of a business strategy. However, things have changed now, especially after the Covid-19 pandemic, as consumers, societies, and communities are more health-conscious, eco-conscious, and focused on human rights.
Therefore, small or large companies must build their long-term strategy and implement a framework for ESG to earn trust, optimize operations, generate revenues, and achieve sustainability. Here are the three most critical pillars of ESG.
The environment is the most widely targeted pillar of ESG. Unlike social and governance issues, the environment category has cutting-edge systems available for companies to analyze their operational performance and its impact on the environment.
No matter what kind of company you run or regardless of your industry, you can measure environmental efficiencies, such as energy consumption, water usage, and greenhouse gas emissions.
At the same time, you can implement viable solutions, such as sourcing eco-friendly materials and implementing eco-conscious practices to reduce your company’s ecological footprint. The environmental pillar focuses on the following:
Greenhouse gas emissions
Renewable energy usage
Product carbon footprint
Packaging and waste
The social pillar is not easy to measure and analyze for companies. The reason is that it deals with people and their viewpoints. The social factor may also shift because people’s opinions change from time to time.
As a result, you may find it challenging to measure social issues compared to measuring renewable energy usage. However, the social pillar requires a company to acknowledge and accept stakeholders, employees, investors, and customers.
At the same time, it requires these people to accept your company’s business strategy, operational procedures, and social practices. Common examples of the ESG’s social pillar include:
Equity and inclusion
Investment in communities
Access to career development
The governance pillar focuses on a company’s administrative policies, programs, and practices. Bear in mind that the governance factor is all about trust. For example, if you run a business and want funds for operational excellence, you must ask yourself: “can an investor trust my company?” The governance pillar emphasizes the following elements:
Establishment of an independent board
Assurance of shareholder rights
Fair wage gaps and transparency in policy
Optimal and justifiable executive compensation
ESG is equally crucial for investors, shareholders, companies, customers, and communities. Whether you are an investor or business owner, having a holistic view of ESG requirements is essential to streamlining operations and achieving value. Until Next Time!
By Shantala Hickey, ESG, Sustainability Supply Chain Manager
Shantala joined GPSI’s team in 2022, following her post-graduate diploma in Environmental Management. She is responsible for the ESG Division and the corporate social responsibility strategy. Before joining GPSI, she held several management positions at Bombardier Aerospace as well as Galderma, a company operating in the pharmaceutical and cosmetics industry. She has more than 15 years of experience in procurement, logistic, and production planning. The environment and sustainable development are undoubtedly her greatest passions.
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