Short for “Environmental, Social and Governance,” ESG represents a more stakeholder-centric approach to doing business. As ESG increasingly becomes top of mind for directors, it’s essential to consider the global nuances that drive focus region by region. Companies that adhere to ESG standards agree to conduct themselves ethically in those three areas.
Multiple issues fit into the umbrella categories of environmental, social and governance. Those can include:
Preservation of our natural world
- Climate change
- Carbon emission reduction
- Water pollution and water scarcity
- Air pollution
Consideration of humans and our interdependencies
- Customer success
- Data hygiene and security
- Gender and diversity inclusion
- Community relations
- Mental health
Logistics and defined process for running a business or organization
- Board of directors and its makeup
- Executive compensation guidelines
- Political contributions and lobbying
- Venture partner compensation
- Hiring and onboarding best practices
The relationship between ESG and the board of directors is still being defined. Discussions around the “G” (i.e., governance) are often spearheaded by the nominating & governance committee with involvement from the full board — particularly when assessing how these risks integrate with the enterprise risk management (ERM) program or impact long-term strategy.
More boards are incorporating the “S” (social considerations or corporate impact) into the strategy development process. According to PwC’s Annual Corporate Directors Survey, issues like health care cost, resource scarcity, human rights, and income inequality have all surged in importance.
When it comes to structuring oversight around the “E” (i.e., environmental issues), a recent global study by the Diligent Institute found that best practices are still largely undetermined. Half of the 447 survey respondents indicated some form of board-level oversight, either by the full board or a board committee, while 19% indicated that oversight lived within the organization. Another 35% percent indicated that environmental issues are “not overseen” by the company or that they “don’t know.”
Corporate issuers are finding that the types of ESG metrics that matter to one company may not matter to the next. Both boards and investors are increasingly turning to organizations like the Sustainability Accounting Standards Board (SASB), Sustainalytics or MSCI for reporting frameworks that offer some level of consistency and financial materiality among companies within a given industry.
Equipping boards with the right data: Effective oversight of ESG reporting will depend on whether today’s boards have the right information at their fingertips. In a research report by Forrester and Diligent, governance professionals indicated that “visibility into sustainability and ESG issues” was their greatest dissatisfier.
Do you have the data your investors have? How does your board composition compare to your peers? What skill sets is the board lacking?
What conflicts of interest might your investors have uncovered? Tools like Diligent Nominations provide quick access to information that helps board members identify governance red flags raised by shareholders and activists.
ESG investment began in the 1960s. While certain ethical concerns have changed, the principle of sustainable investing remains the same. More and more investors are adopting ESG criteria as a tool to evaluate potential investments alongside traditional financial analysis.
According to a report by PWC, the practice of ESG investing has grown over the last few years. The report states that the ESG asset pool will continue to grow rapidly and become essential in the investment process in the coming years.
The growth of ESG investing can be boiled down to three reasons, according to financial firm MSCI:
- The world as we know it is changing.
- The next generation of investors is changing the way investment works.
- Data and analytics have evolved to provide more information than ever.
The face of our planet is literally shifting as a result of climate change. Droughts, food insecurity, and rising temperatures have a domino effect on the environment that impacts multiple sectors.
New risk factors are cropping up for investors, and new regulations are being enacted to mitigate the effects of environmental damage. Mass migrations and displacement from climate crises are changing the demographic makeup of certain areas — and preparing for those crises is changing the way we live our lives.
As technology advances and becomes more widely available, data privacy and security have also become something companies can’t ignore. In the wake of high-profile data breaches, companies are wisely tightening their security protocols. As these companies adapt, investors might change their strategies accordingly.
Today’s generation of investors is on the receiving end of a massive wealth transfer from the Boomer generation — as much as $68 trillion according to one report by CNBC. And the people inheriting that wealth may think differently about how it should be invested than the generation they’re inheriting it from.
According to a 2016 Bank of America report on ESG investing, $15-20 trillion of that money could go into ESG assets in the next couple of decades. If that happened, it could roughly double the size of the U.S. market.
Millennial-aged investors, and women, in particular, are holding the companies they invest in a higher standard. 67% of them believe that investments are a way for them to express “social, political, and environmental value,” as opposed to 36% of Boomers.
A few more statistics on the newest generation of investors as cited by MSCI:
- Millennials are more than twice as likely to be interested in investments that are dedicated to solving societal or economic problems.
- 90% of millennials wealthy enough to do so want to increase allocations to responsible investments over the next five years.
- 84% of millennials surveyed in a study by Morgan Stanley said they were interested in more sustainable investing.
- The Morgan Stanley report also claims 71% of individual investors are interested in sustainable investing.
Data and Analytics
Better data-gathering technology allows investors to examine companies in a much more granular way than they could in the past. Massive amounts of information can be harvested and used to drive objective, quantitative decisions.
Companies can be gathered and ranked according to how well they adhere to ESG principles and aggregate into ESG reporting standards. Investors can even see which principles they adhere to most closely and change the criteria to have different weights depending on the industry. Having that kind of data publicly available also puts pressure on companies that aren’t adopting ESG principles to do so or risk losing out on capital.
Companies themselves can better track ESG data using big data. In September 2020, the
Today’s data tools allow companies to set benchmarks and measure how well they’re adhering to ESG standards like internal ethical governance. Diligent has several tools to help businesses in this area:
- Diligent Compliance lets businesses track and improve their progress towards ESG goals via comparison to a comprehensive library of standards. Risk management, improvement planning, and internal audit solutions are all built-in.
- Diligent’s governance analytics programs examine your company data, including executive salaries, and flag any discrepancies in areas like diversity and compensation. This service is offered through Diligent partner CGLytics.
- Diligent Governance Intel monitors news and stakeholder sentiment to gauge the mood of your governance methods with key populations. Users can automatically track news on ESG standards, trends, and regulations from thousands of sources, keeping a finger on the pulse. This can also be useful for identifying “red flags” and keeping board members informed of anything that needs to be addressed or changed.
Third-party entities can use data to rank companies independently, comparing facts from multiple sources to come up with a more holistic picture than they’d have with the information given to them by the company itself.
The short answer? No.
People used to believe that ESG investments were a sacrifice — an investment more morally than economically motivated. Today that isn’t necessarily true.
In fact, according to a report by the US SIF Foundation, ESG investing grew at a rate of more than 38% between 2016 and 2018. Assets grew from a total value of $8.7 trillion to $12 trillion.
Some studies have even suggested that companies with good ESG practices had lower cost of capital and lower volatility. They also displayed lower instances of bribery, fraud, and corruption over time. These results suggest that, in the long run, ESG investments are more stable and can even outperform other companies.
In a recent study, MSCI investigated the ties between ESG investments and the stock market, to see if there were any financially significant effects. The study used a three-channel model to look at how ESG data embedded in stocks gets transferred to the equity market.
The study found that, after examining idiosyncratic and systematic risk profiles for the companies involved in the study, ESG had an effect on many of those companies’ valuations and performance. Companies with higher ESG ratings showed:
- Higher profitability: ESG companies with high ratings showed abnormal returns and were more competitive. This often led to higher profitability and dividend payments — especially when contrasted against low ESG companies.
- Lower tail risk: High ESG rated companies experienced fewer idiosyncratic risk events like major drawdowns. Companies with low ESG ratings were more likely to experience these incidents.
- Lower systematic risk: High ESG companies had less volatile earnings and less systematic volatility. They also had lower betas and lower costs of capital than low ESG rated companies.
ESG investing can also cut risk in emerging markets. There is research to suggest that companies adhering to ESG principles have a lower chance of tail risk — the risk of unlikely events that lead to catastrophic damage.
What once was seen as a less profitable, niche area of investing is moving to the forefront. The rise of green energy, the need to combat climate change, and growing public knowledge of the supply chain are all driving consumers to brands that adopt ESG finance and operations principles. And investors are following suit.
Because of that, companies like J.P. Morgan and Goldman Sachs are tracking ESG investments closely, taking them more seriously than ever before. If you’re interested in learning more about this growing area of investing, visit our site today to see Diligent’s ESG Solutions.