ESG: The comprehensive guide for beginners

ESG refers to the three less-material factors that pertain to the sustainability of a business. 

Environmental, Social and Governance factors together make up the sustainability performance of a company. These factors are varied and less material than others whose monetary values are easily understood. 

Environmental factors, for example, range from energy usage to the company’s stance towards actions on climate change. Social and governance factors represent a wide range of potential issues as well.

This means the application and use of these factors are complex and demand attention and expertise. 

To put it simply, ESG factors pertain to any issue that is not among the most material issues identified in traditional analysis but has an impact on the overall sustainability of the business. 

Sustainability, in the context of ESG, is not only environmental but social and governance-related as well. Investors and venture capitalists are increasingly identifying sustainability in ESG factors, especially governance, to be an indicator of investment risk.

This is also the reason why ESG is gaining strong traction among entrepreneurs and business owners now. If the investors and the people who represent the investors demand ESG integration and communication, businesses have but one choice. 

They become sustainable or risk their funding.

As a new generation of investors and investment professionals arise, ‘values-based’ investing is positioned to change how businesses are run.

Sustainability cannot be achieved through regulation and government measures alone. In much of the world, government processes are far too static for that. As the need for sustainable action grows, it has to be the innovative companies that solve this issue. Businesses have greater freedom to innovate and solve the problems we face today.

But in order to do that, they need motivation beyond just profit.

The stakeholders have to demand action. For better or for worse, the stakeholders with the most power in most companies today are the shareholders and investors. And as indicated by the reports from organisations like the CFA Institute and investment bankers like Morgan Stanley, they have already begun causing action.

ESG considerate investing has grown to a staggering $30 Trillion as of 2018. This figure represents investors that are part of the Global Sustainable Investment Alliance. While these investments are not exclusive to sustainable ventures, the presence of such an alliance is an encouraging sign.

To whom is ESG important?

While understanding what it is and how it works are important, it is equally important to understand who it is relevant for.

Like any aspect of business, there are those who may not gain much from spending time learning ESG and its impacts. So it will serve you best to understand the professions and people for whom it carries real value.

Investors

The investor can be anyone, ranging from an average employee buying stocks to the institutional investors who deal exclusively in seven figures and above.

The investor is the one who holds the most power to drive ESG implementation in business. An investor can choose to invest only in companies that pay attention to and perform well in ESG factors. They also have the power to demand the businesses they are invested in to implement ESG.

They can influence the executives through the board and shareholders’ meetings. They can ensure the business not only pays attention to ESG factors but also take action to improve ESG performance. 

Founders / Business Owners

Whether you are the founder of a growing startup or own a long-running family business, ESG is important to you, albeit in different ways.

To the startup founder, integration of ESG principles into their business is becoming increasingly important to secure investments. As more investors become aware and wary of businesses with questionable ESG performance, not integrating ESG is a risky move.

While it would be tempting and even the norm to tout the ‘startup culture’ to justify unhealthy working environments and culture, investors may not look kindly to it.

To the business owners, implementing ESG presents an opportunity to gain positive PR value, while reducing their risks.

It is a classic win-win situation where the business’ other stakeholders and the owner both benefit. For the more ambitious business owners, there is always the increased attractiveness of their business to consider.

Consultants / Sustainability Professionals

While not something that’s growing quite as fast as that of digital marketers, which experiences nearly 33% year over year growth, the demand for sustainability professionals is certainly on the rise. 

As more companies integrate ESG, the need for professionals who hold the required expertise in ESG and sustainability is on the rise. There is also the added pressure caused by regulation, which leads to more companies needing specialised knowledge in ESG.

How is ESG reporting useful to investors?

The usefulness of ESG to investors goes beyond just moral values. In fact, ESG is accepted as a risk-hedging tool for investors.

While it used to be the case that ESG issues are difficult to measure in monetary terms, their impacts are easily pronounced in a world that has become more aware. 

Governance

Governance issues are the most discussed and researched about, and also the one that often has the most direct impact on an investor.

The governance structure and those involved in the governance of a company (board members, executives who are on the board..etc) must serve the interests of the investor as well as the other stakeholders.

Governance factors like board diversity and the structure of the board (unitary vs separate management and supervisory boards, presence of executives on the board) are important factors that have the power to influence board performance. If the board and the governance fail to protect the interests of the shareholders, the investors risk losing their capital.

Cases of companies like Enron and Toshiba with their questionable governance practices serve as warnings to investors, as those who invested in those companies endured a significant loss of capital. There is also the more recent case of Boeing, with its 737 Max aeroplanes’ safety issues. While the board structure may have seemed fine on the surface, it is clear that the company’s governance failed to control the executives’ desire to attain short term profits.

As such, it is vital that the issues in governance be identified and remediated through purposeful action. 

Social

Social factors, or rather, issues among them are less likely to cause the drastic impact that governance issues might have. However, they do range wider.

Employee pay, and whether it is fair or generous or otherwise, can have an impact. As platforms like Glassdoor make it easier than ever to access such information, companies’ pay structure has the power to have a PR impact.

Then there are other factors like diversity in the workforce and how the business uses its diversity.

Whether or not diversity is organic is also an important issue, as people are deterred by artificial attempts to create diversity. The measures taken by the business to ensure inclusion is also an important ESG factor.

The reputation of companies can change quickly as the information is easily disseminated from employees, present or otherwise. A company with human rights and workplace safety issues is opening itself to potential lawsuits or even regulatory action.

While it is easy to dismiss social factors as internal or PR concerns, the impact of these issues will affect the investors. The case of the mining company Lonmin from South Africa is an example, where even the fixed income investors incurred losses as bad relations with employees and illegal practices led to problems for the business.

Then there’s the case of Coca-Cola, which seemingly suffered a fall in stock prices after a football player told the press to ‘drink water’ at a tournament that the company is sponsoring.

Environmental

Environmental factors are the ones that come to the minds of most when talking about sustainability. 

The impact of environmental issues varies, from cost savings to risk of regulatory or legal action. Governments are putting more pressure on companies to rely on renewable sources of energy, with there being programs in as many as 35 countries to integrate private solar panels’ output into the overall electrical grid. Dubai Electricity and Water Authority (DEWA) already has a popular program that has been used by many businesses in the Emirate.

Then there is the case of ecological impact through air and water pollution. Coca-Cola suffered massive backlashes in many parts of the world when they opened their plants there, with the case of the Plachimada plant a prime example. The questionable methods for sourcing necessary raw material, i.e; water, led to a risk of significant losses for the company, impacting the investors return.

To take another example, a company that engages in cattle farming in Brazil is unlikely to gather further investment as the world learns more about deforestation in the Amazon rainforest and related environmental concerns. For an investor in such a company, this environmental issue presents a risk. A risk that gets pronounced if a regulatory body decides not to allow the products of the venture to be sold in any specific area.

Another recent example would be the oil spill caused in the Gulf of Mexico by British Petroleum which led to the company losing nearly $105 Billion in its value, leading to unprecedented losses for its investors.

There is also the risk of regulatory action against firms involved in carbon-intensive industries like Petroleum for example. An investor would do well to avoid risk by staying away from any company with significant environmental issues.

How is ESG reporting useful to founders and business owners?

Since we have already established that investors do put weight on ESG factors in their decisions, it is easy to see how founders and business owners stand to benefit from integrating ESG into their businesses.

However, the impact of ESG issues on a business goes beyond simply the ability to attract investors. The consequences are as wide-ranging as the issues when it comes to ESG.

Environmental

Issues in environmental factors may impact the overall material targets of the company. High levels of energy consumption, for example, also means high costs. There is also the risk of legal action associated with questionable practices in raw material sourcing, biodiversity and ecological impact that may go beyond the business and even impact the owners individually.

Social

Social factors are also of strong concern to founders. A company with inadequate policies on workplace behaviour and harassment issues is opening itself up to lawsuits, which may affect the owners as well.

Moreover, a company that performs well in employee engagement and managing customer relations is also likely to be more resilient. A startup with a dysfunctional workforce will struggle to meet its goals, and will not have it easy while trying to convince the socially aware investor.

Governance

Governance factors, like in the case of investors, are important to a business owner.

A strong governance structure is a key to ensuring the interests of the business owners are represented and taken care of. To the startup founder, a functioning board will be key to ensuring their business is well-led. Issues in governance structure are also deterrents to potential investors.

Unlike the investor who can simply look elsewhere for more sustainable investment opportunities, the business owners and startup founders do not have that choice. Their job, however, is to solve those issues as they arise and more importantly, set up a strong structure in place to prevent, identify, document and solve these issues.

ESG and the sustainability professional

ESG is one of the more important topics a sustainability professional will engage in. As the topic itself encompasses several business functions, the sustainability professional can choose to learn ESG as a whole, as a management consultant would do. Or they have the option to specialize and narrow down on any area they may already have an interest or prior knowledge in. 

Someone with a background in energy can choose to focus on energy-related environmental issues. Finding and using renewable sources of energy, using energy-efficient solutions and finding alternate ways to reduce energy consumption are all tasks a sustainability professional with a background in energy would be able to do.

Similarly, someone with a background in HR could choose to specialise in some social issues. Fair compensation structures, diversity and inclusion, employee engagement, workplace safety and policies on harassment are all issues that someone with an HR background would do well to solve.

A marketer can specialise in how to communicate the ESG achievements of a company and execute that to a high level. A procurement manager can choose to learn and identify sustainable sources of raw materials for industries. An auditor or finance professional can help companies get certified as sustainable by any relevant body. 

Likewise, any professional of almost any background will have avenues to focus on, in their journey to become sustainability professionals. Even if the goal is not to craft a career in sustainability, professionals of all types from all industries can learn and incorporate ESG into their workplaces and businesses. 

Sustainability cannot be achieved without collective action from investors, business owners, founders, executive managers, consultants and other professionals, all working together. 

If you want to learn more about how you can implement sustainability in your business, access our guides and content. 

What next?

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