Developing a shared understanding of ESG and what it means

ESG (which stands for environmental, social, and governance) can be seen as a risk management and opportunity framework for evaluating companies and how they integrate and behave when they interact with these principles. The ESG pillars are used by companies developing and framing business strategies and reporting on performance beyond financial measures.

ESG factors are part of an assessment process applied to non-financial factors, investment decisions and company analysis in identifying material risks and growth opportunities. ESG measures the sustainability and societal impact of a company, and ESG criteria help better determine the company's sustainability financial performance in future, often aligned to identified United Nations Sustainability Development Goals (UN SDGs).

There is now a greater requirement to understand the risks or opportunities a company faces from ESG issues and being able to measure and report on these. The key aspects that drive ESG factors are set out below.

Underlying themes that produce critical ESG risks

When considering ESG approaches, it’s essential to recognise which underlying themes produce critical risk factors within ESG investing. Below are the key risk factors that are prominent.

Climate change: Investors care about climate change and are looking for greater disclosure on how it will affect companies.

Biodiversity: Long-term biodiversity loss is becoming critical to the environmental agenda. It may seriously impact both people and the economy as biodiversity loss and climate change are accelerating the scale of the planetary crisis.

Social inequalities: The pandemic intensified social and gender inequalities and there is additional pressure on companies to take greater accountability for the welfare of the workforce and the society at large in their complex supply chains.

Supply chain management: The need for greater transparency in global supply chains was exacerbated by the COVID-19 pandemic. Companies need to provide greater visibility into their supply chains in terms of labour practices, health and safety, and human rights.

Digital ethics and inclusion: Digital ethics refers to data privacy, cybersecurity, online welfare, ethical design of artificial intelligence, and related issues. Digital inclusion refers to access to digital technologies and the associated benefits.

Corporate issuers: Providers of capital and debt are observing green and sustainable bond developments as volumes and liquidity grow. ESG isn’t just a stock-based investment; fixed income will grow in importance, with ESG ratings intermingling with credit ratings.

Standardisation: There is a range of different sustainability reporting frameworks and standards. Standard-setters, such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB), are driving better alignment of sustainability reporting frameworks.

The extent to which business aligns itself to measurement standards and reports transparently on its compliance are topics of relevance to a company’s stakeholders.