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ESG criteria: what you need to know
ESG criteria have evolved into crucial benchmarks for assessing a company's long-term viability and its impact on society and the environment. By emphasising improved governance, legal compliance, and transparency in environmental stewardship, companies contribute not only to sustainable investing but also to broader social and environmental benefits. This holistic approach integrates ESG considerations into modern business strategies, emphasising their role in building resilience, innovation, and ethical leadership across all stakeholders.
Unlike straightforward transactions like making a sale, ESG value creation is a nuanced process. However, it brings lasting and even quantifiable benefits for businesses. Recognising this, many companies are actively measuring, reporting, and enhancing their actions related to ESG criteria.
👉 In this article we'll explore the different ESG criteria and the benefits they bring to businesses that adopt them.
ESG definition
ESG stands for Environmental, Social, and Governance. These criteria are used to assess an organisation's impact in these areas, going beyond traditional financial metrics. ESG represents a comprehensive approach that companies adopt to foster sustainable business practices and create lasting value.
💡 ESG criteria provide benefits beyond economic gains, enriching society and various stakeholders, including investors, customers, employees, and community members.
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The importance of ESG
In recent years, the significance of ESG has surged, reflecting a shift in how businesses operate and are perceived by stakeholders. ESG is now a critical factor for consumers, employees, and investors, influencing their decisions and behaviours.
Consumer preferences:
- According to a McKinsey consumer sentiment survey, products making ESG-related claims have demonstrated substantial market growth. On average, these products experienced 28 percent cumulative growth over the five years leading up to 2022, compared to 20 percent for products without such claims.
- Specifically, products without ESG-related claims grew at an average of 4.7 percent per year over the past five years, while products with ESG claims grew at a significantly higher rate of 6.4 percent. This indicates a clear consumer preference for sustainable and responsibly produced goods.
Employee values:
- Employees today increasingly seek to work for organisations that align with their values. Companies that prioritise ESG factors tend to attract and retain talent more effectively. Employees are motivated by a sense of purpose and are more likely to stay with companies that are committed to positive environmental and social impacts. A recent study by PWC found that 68% of those searching for a job consider environmental policies and practices to be important when considering a job offer, 66% consider governance policies to be important, and 75% are concerned by an organisation's overall societal impact.
Investor interests:
- Investors are also placing greater emphasis on ESG factors when making investment decisions. More than 90 percent of S&P 500 companies now publish ESG reports in some form, reflecting the growing demand for transparency and accountability in these areas. Additionally, approximately 70 percent of Russell 1000 companies also publish ESG reports.
- ESG performance is often seen as an indicator of a company's long-term viability and risk management. Investors recognise that companies with strong ESG practices are better positioned to navigate regulatory changes, reputational risks, and shifting market demands.
ESG criteria meaning
ESG criteria are standards used to evaluate a company's operations and impact in three key areas:
Environmental
A significant portion of ESG growth has been fuelled by the environmental aspect of ESG and responses to climate change.
ESG criteria related to the environment serve as tools to assess a company's environmental risks and potential damage to the ecosystem. They encompass critical environmental challenges that society faces, including climate change, water security, environmental health hazards, the burden of waste, and the loss of biodiversity and potential extinctions. Companies can help address these risks through proactive management and sustainability initiatives, contributing to both environmental protection and long-term business success.
Some key examples of environmental criteria include:
| ESG Criteria | Description |
|---|---|
| Climate change | Initiatives to reduce carbon emissions and mitigate climate impact, such as adopting renewable energy sources, participating in carbon offset programs, and setting science-based emission reduction targets. |
| Energy efficiency | Practices to enhance energy use and reduce consumption, including investing in energy-efficient technologies, conducting energy audits, and implementing smart energy management systems. |
| Water management | Strategies to address water scarcity and ensure sustainable use, such as recycling and reusing water, implementing water-efficient processes, and engaging in watershed management. |
| Pollution control | Efforts to combat air and water pollution, including using non-toxic materials, installing pollution control equipment, and adhering to environmental regulations. |
| Waste and resource management | Implementation of effective waste reduction and recycling programs, promoting a circular economy approach, and reducing single-use plastics. |
| Deforestation prevention | Measures to prevent deforestation and promote reforestation, supporting sustainable forestry practices, and engaging in conservation efforts. |
| Biodiversity protection | Actions to protect ecosystems and prevent species loss, such as preserving natural habitats, supporting biodiversity initiatives, and promoting sustainable land use practices. |
Social
Social ESG criteria encompass a company's engagement and interaction with the various groups it engages with. These criteria may encompass efforts to reduce inequalities, uphold human rights, and safeguard the health and safety of both workers and the surrounding communities.
Social considerations enable businesses to cultivate operations that are inclusive, fair, and positively impactful, supporting vibrant communities on both a local and global scale. Social criteria impact all levels of the company, from the executive offices to the factory floors within the supply chain. And it's not just those working for the company that are impacted by the social aspect of ESG criteria, a broad spectrum of social groups, including customers, investors, suppliers, and local communities also benefit from such policies.
Examples of social criteria include:
| ESG Criteria | Description |
|---|---|
| Human rights observance | Ensuring fair and ethical treatment of all individuals, both within and outside the organisation |
| Compliance with labour standards | Adhering to regulations and standards that promote fair wages, safe working conditions, and workers' rights |
| Customer satisfaction measures | Implementing strategies to understand and enhance customer experiences and satisfaction levels |
| Data protection and privacy safeguards | Protecting personal and sensitive information through robust data security measures and privacy policies |
| Promotion of gender equality and diversity | Fostering an inclusive workplace by supporting equal opportunities and representation for all genders and diverse groups |
| Employee engagement strategies | Encouraging a motivated and committed workforce through programmes that promote employee involvement and well-being |
| Community relations initiatives | Building and maintaining positive relationships with local communities through engagement and support activities |
Governance
Governance is the third component of ESG criteria, focusing on the business leadership and transparency mechanisms that define a corporation's ethical backbone. This encompasses the policies that help install a diverse board of directors, uphold stringent corporate accounting standards, govern executive compensation, ensure public disclosure, manage conflicts of interest, and address other legal and ethical considerations.
Corporate governance factors also actively work to create a sense of fairness through a system of internal checks and balances. This safeguards against corporate governance issues, ranging from bribery and corruption to tax evasion. Essentially it serves as a tool for responsible and ethical business conduct.
Examples of governance criteria include:
| ESG Criteria | Description |
|---|---|
| Executive pay | Establishing fair and transparent policies for compensating executives, aligning their incentives with the company’s long-term goals |
| Board composition and diversity | Ensuring a diverse and balanced board of directors with a range of skills, experiences, and perspectives to enhance decision-making |
| Anti-bribery and corruption measures | Implementing strict policies and procedures to prevent and address bribery and corruption within the organisation |
| Lobbying regulations | Adhering to ethical guidelines and legal requirements regarding lobbying activities to ensure transparency and accountability |
| Oversight of political contributions | Monitoring and regulating political donations and contributions to avoid conflicts of interest and ensure they align with the company’s values and policies |
| Implementation of whistleblower schemes | Establishing secure and effective channels for employees to report unethical or illegal activities without fear of retaliation |
| Audit committee structure and functioning | Creating a robust audit committee to oversee financial reporting, internal controls, and compliance with laws and regulations, ensuring the integrity of financial practices |
Is ESG reporting mandatory?
ESG is usually a voluntary business activity that companies can choose to pursue or not. However, many are given explicit requests from their investors or shareholders to disclose company-wide ESG information.
Companies communicate ESG issues to their stakeholders in annual reports which they usually publish publicly. The ESG data included in these reports will normally follow a set of criteria established by the specific ESG standards and frameworks the company adheres to.
Stakeholders, such as ESG investors can then use the data from the ESG reports to give the reporting company an ESG rating. These ratings are used to compare the relative ESG performance of different companies.
💡 ESG rating agencies and third-party providers like Morningstar, Bloomberg, and MSCI also independently measure ESG performance for different companies to share with investors.
ESG reporting in the UK
In the UK, ESG reporting has become a critical component of corporate transparency and accountability. Publicly listed companies are required to include non-financial information in their annual reports under the Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013. This includes disclosures related to environmental matters, employees, social matters, respect for human rights, and anti-corruption and anti-bribery issues.
Furthermore, large private companies are also expected to report on their ESG performance, especially regarding greenhouse gas emissions, energy usage, and social impact, under the Streamlined Energy and Carbon Reporting (SECR) regulations.
Additionally, the UK has adopted the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, making it mandatory for large companies and financial institutions to disclose climate-related risks and opportunities. These requirements aim to provide investors and stakeholders with comprehensive and comparable information on how companies are addressing ESG issues.
What is the difference between ESG and CSR?
Environmental, Social, and Governance (ESG) and Corporate Social Responsibility (CSR) are both concepts that address the ethical and sustainable practices of a company, but they differ in terms of their scope, focus, and application.
Scope and focus
- CSR - CSR encompasses a broad range of activities aimed at contributing to societal goals, including philanthropy, volunteer efforts, and ethical business practices. It is often more focused on the company’s values and the voluntary initiatives that align with those values to create a positive impact on society and the environment.
- ESG - ESG, on the other hand, refers to specific criteria used by investors and stakeholders to evaluate a company’s performance and risk management in environmental, social, and governance areas. ESG criteria are more standardised and data-driven, focusing on measurable outcomes that can influence a company’s financial performance and sustainability.
Application and measurement
- CSR - CSR initiatives are generally driven by the company’s desire to give back to the community and are often communicated through sustainability reports and marketing campaigns. These initiatives may include charitable donations, community projects, and efforts to reduce the company’s environmental footprint. CSR activities can be subjective and vary widely between companies.
- ESG - ESG metrics are increasingly integrated into the investment decision-making process. Investors use ESG data to assess the long-term viability and risk profile of companies. ESG reporting is more structured and often follows recognised standards and frameworks such as the Global Reporting Initiative (GRI) or the Sustainability Accounting Standards Board (SASB). ESG analysis is used to ensure that companies are not only profitable but also sustainable and ethical in their operations.
💡 While CSR represents a company’s ethical stance and voluntary contributions to society, ESG provides a framework for assessing and comparing the sustainability and ethical impact of companies based on specific, standardised criteria. Both concepts are crucial for modern businesses, but ESG offers a more systematic approach to evaluating and managing sustainability-related risks and opportunities.
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What is ESG investing?
ESG investing has seen a meteoric rise in popularity in recent years. According to the Global Sustainable Investment Alliance, as of 2022, 30.3 trillion USD is invested globally in sustainable investing assets. And in non-US markets, sustainable assets under management have increased by 20% since 2020.
This remarkable growth isn't just a trend, it reflects the growing awareness that businesses with superior ESG ratings benefit from reduced business risk, robust return on investment (ROI), and enduring business sustainability. Numerous studies have highlighted the positive correlation between ESG funds and ROI. For example, Morningstar's 2019 study demonstrated that 73% of its 56 ESG indexes - 41 in total - outperformed their non-ESG counterparts.
Consequently, ESG-themed ETFs (Exchange-Traded Funds) have become an attractive avenue for institutional investors looking to support companies with strong ESG performance. The emphasis on ESG investing also reflects a broader transformation from passive to active investment styles, with various approaches available. Some ESG investors might opt for negative screening based on value-driven rules (for example by avoiding investing in funds that support oil and gas companies), while others might seek out sustainable funds or actively engage in promoting robust ESG practices through their shareholder voting strategies as part of their investment strategy.
ESG investing challenges
While socially responsible investing continues to thrive, it is not without challenges. Investors are increasingly demanding high-quality ESG data in comparable, standardised formats. Significant data gaps also persist, particularly when companies fail to report essential information like carbon emissions.
However, these challenges do not detract from the fact that ESG investing has moved from a niche interest to a mainstream financial strategy. It embodies a growing recognition that responsible investment is not only ethical but also makes sound financial sense. Socially responsible investments will likely continue to shape the investment landscape, reflecting a more conscientious and holistic approach to finance.
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How can ESG create value for companies?
As ESG continues to become a vital component of business, the connection between ESG impact and financial value is becoming increasingly clear. ESG initiatives aren't just about doing good - they're smart business strategies that can drive growth and efficiency.
Here's how ESG initiatives can make a real difference:
- Core business growth - By aligning with societal values, companies can tap into new markets and attract a wider range of customers
- Cost savings - Sustainable practices often lead to greater efficiency and lower operational costs
- Better relationships with regulators and compliance - Going beyond legal requirements builds trust with regulators and can make operations smoother
- Employee productivity and talent attraction - Companies committed to social and environmental issues tend to attract and retain top talent, which boosts overall productivity
While ESG might seem like a less direct approach compared to traditional business strategies, it actually helps align a company's operations with the values and expectations of society. This not only makes the company more socially responsible but also financially stronger and more resilient. ESG isn’t just a nice addition - it’s an essential part of good business.
Let's take a closer look at the benefits of ESG strategy:
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Core business growth
Incorporating an ESG strategy into the core offerings of a business can enable companies to tap into sustainable marketing opportunities. This can help enhance their competitive edge in traditional markets while also providing a platform for expansion into new markets through the introduction of innovative, sustainability-centred practices.
Competitive edge
By aligning their core offerings with sustainability metrics, business managers can employ analytical strategies such as life cycle analysis to identify and reduce underlying design inefficiencies and flaws. This approach helps in creating products and services that resonate with contemporary values and consumer expectations, offering a competitive edge.
Benefits to both traditional and innovative businesses
Both traditional and innovative business models can reap significant benefits from an ESG-aligned strategy. Even industries typically associated with high environmental impacts, such as steel and mining, have successfully implemented sustainability strategies. Through ESG integration, these sectors can build public trust. This trust can help companies navigate through periods of public scrutiny or regulatory review.
Strengthened relationships
ESG helps to build stronger relationships with stakeholders, including customers, regulators, employees, and communities. This alignment can lead to smoother interactions and faster approvals, reflecting a company's commitment to broader societal goals and building goodwill.
Consumer demand and growth opportunities
A growing appetite for responsible consumption is driving change. In fact, a McKinsey consumer survey revealed that 70 percent of consumers would pay 5 percent more for products from businesses demonstrating green practices. This willingness to invest in sustainability presents a valuable opportunity for companies.
💡 An ESG strategy is an opportunity for innovation, market differentiation, and long-term growth. As consumer consciousness and regulatory scrutiny continue to grow, businesses that incorporate ESG considerations into their strategic planning will likely find themselves ahead of the curve.
Cost savings
Inefficiencies within business operations come with significant costs. When we analyse waste streams, encompassing elements like wastewater, solid waste, or unsold products, waste represents a value vacuum where financial resources are lost.
Sustainable practices
The sustainability principle of "reuse, reduce, and recycle" is more than just an ecological guideline. It serves as a blueprint for financial efficiency. By reducing energy and material costs, conserving valuable natural resources like water, and integrating designs that employ recycled materials, businesses can prevent the unnecessary loss of value throughout their operations.
Significant savings
Integrating ESG strategies can lead to substantial cost savings for companies by promoting efficiency and innovation. By adopting sustainable practices, businesses can reduce waste, conserve resources, and lower energy consumption. For example, reengineering processes to use less water and energy or finding ways to recycle and repurpose materials can significantly cut operational costs. These efforts not only help the environment but also improve the bottom line, demonstrating that sustainable practices are a smart financial strategy that drives long-term profitability.
Regulation and compliance
Complying with laws and regulations may seem like the bare minimum for maintaining a sustainable business model. However, the landscape of ESG-related regulations is becoming more diverse across different regions, which can pose a significant challenge for companies. The global consulting firm, McKinsey, estimates that up to a third of corporate profits could be at risk due to state regulatory pressures.
Engaging in ESG activities early on can help minimise the risks resulting from these emerging regulations. The various benefits to businesses include a decreased risk of litigation, lower regulatory fees, and stronger relationships with regulatory bodies and organisations.
👉 The influence of consumer protection laws and government interventions can vary widely from industry to industry. They can impact around 25-30% of sectors such as pharmaceuticals and healthcare. In contrast, industries like banking, automotive, defence, and tech, which rely heavily on government subsidies, can see impacts ranging from 50-60%. Therefore, it's important for businesses to be proactive in understanding and adhering to ESG criteria in their respective industries.
Motivating and attracting employees
ESG matters a lot in terms of employee attraction, retention, and satisfaction. To access the best talent pool, it's important to provide employees with a sense of underlying purpose.
Businesses cannot overlook the importance of a high-quality, motivated talent pool, as it correlates with higher shareholder returns. Studies have shown that publicly traded companies featured on Fortune's “100 Best Companies to Work For” list consistently beat the market average when it comes to returns.
A robust ESG proposition can significantly influence employee motivation and reduce supply chain risks. Ensuring fair treatment, providing proper working environments, and aligning organisational goals with sustainable practices not only fosters a positive workplace culture but also contributes to operational stability and efficiency.
ESG is the future
Environmental, Social, and Governance (ESG) criteria have evolved from being buzzwords to fundamental aspects of modern business strategy. Emphasising sustainability, ethical conduct, and responsible governance, these principles are reshaping industries by reducing costs, boosting employee motivation, enhancing brand image, and opening new market opportunities.
As global awareness of environmental and social issues continues to grow, ESG criteria are set to become even more integral to business operations. With increasing regulatory pressures and shifting consumer preferences, companies that align themselves with ESG standards stand to gain a competitive edge, not only surviving but thriving in a future where responsible business is synonymous with success.
How can Greenly help?
Greenly offers practical solutions to help your business excel in the environmental aspect of ESG by cutting down carbon emissions and adopting sustainable practices. Here’s how Greenly can make a difference:
Measure your GHG emissions
- Measure Scope 1, 2, and 3 emissions: Understand your greenhouse gas emissions across all scopes to know exactly where you stand.
- Advanced technology: Use the latest tools to measure your carbon footprint, analyse emissions, and set realistic reduction targets.
Custom action plans
- Expert support: Work with Greenly’s climate experts to develop tailored action plans that fit your business goals and sustainability targets.
- Seamless assessment: Look at both physical and monetary flows to gain a comprehensive understanding of your emissions and identify key areas for improvement.
Decarbonise your supply chain
- Supplier engagement: Collaborate with your suppliers to cut carbon emissions throughout your supply chain.
- Sustainable sourcing: Identify and replace wasteful suppliers with low-carbon alternatives, building greener partnerships.
- Scope 3 emissions: Achieve greater transparency and manage Scope 3 emissions effectively, which often make up the largest part of a company’s carbon footprint.
- Transition plans: Work with suppliers to create and implement transition plans aimed at reducing emissions across the board.
Intuitive and seamless platform
- Streamlined interface: Use Greenly’s intuitive platform to calculate and monitor your business’s carbon footprint, making the carbon assessment process flow smoothly.
With Greenly’s help, your business can significantly reduce its environmental impact, meet ESG goals, and enhance sustainability, all while making smart business decisions. Get in touch with us today.
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